President Bush signed the Heroes Earnings Assistance and Tax Relief Act (H.R.6081) into law on June 17, 2008. The act eases withdrawals from retirement accounts and health flexible spending accounts (FSAs), and protects survivor and disability benefits for men and women in the military and their survivors. It also addresses the treatment of differential wage payments, imposes new tax and withholding requirements on the property of some expatriating individuals and extends the Mental Health Parity Act. The effective dates vary by provision — some are retroactive or take effect immediately and will require immediate attention from plan sponsors.
Military Tax Provisions
Current law generally treats periods of qualified military service as periods of employment for purposes of retirement plan vesting and benefit accruals. Such service is credited when the soldier-employee returns to work. So if the individual dies during military service, his or her survivors do not receive the accelerated vesting, ancillary life or other benefits they might have received if the employee had died during regular employment.
Under the Heroes act, retirement plans must pay the survivors of a soldier-employee who dies during qualified military service any benefits (other than those that accrued during the military service) the plan would have paid had the participant died during active employment. Failure to do so will result in plan disqualification.
Plans may — but are not required to — treat someone who died or became disabled during qualified military service as if he or she had resumed employment the day before the death or disability occurred and then terminated employment because of the death or disability. This would enable the plan to pay out benefits that would have accrued during the soldier’s military service. Plan sponsors that provide such benefits must make them available to all employees performing qualified military service on a reasonably equivalent basis.
These provisions take effect for deaths and disabilities occurring on or after January 1, 2007, so some plan sponsors will have to provide the benefits retroactively.
Under the Pension Protection Act of 2006, workers who were called or ordered to active military duty for at least 179 days or an indefinite period between September 11, 2001, and December 31, 2007, could take penalty-free withdrawals from their retirement accounts. The Heroes act reinstates the provision and makes it permanent. It also allows these workers to cash out all or some of their health FSA. The FSA distribution must be made between the date of the call to active duty and the last date that reimbursements can be made for the plan year that includes the date of the call to active duty. These distributions can be made as soon as the new law is enacted.
Differential Wage Payments
The Heroes act requires differential wage payments to be treated as wages for retirement plan purposes (differential pay is supplemental pay employers may offer to bring a soldier’s pay up to what he or she would earn during regular employment). So a plan will not fail minimum participation and nondiscrimination tests because of contributions or benefits based on differential pay, as long as two conditions are met:
- All employees must be eligible for differential pay on reasonably equivalent terms.
- All eligible plan participants must be allowed to make contributions from differential wage payments on reasonably equivalent terms.
Reservists on active duty for more than 30 days remain eligible for penalty-free distributions from their retirement plans even though they are receiving “wages” from the employer. However, they must wait six months after taking a distribution to contribute to the plan. The provision applies for years beginning after December 31, 2007. Differential pay will be treated as wages for withholding purposes for amounts paid after December 31, 2008. The act also provides tax credits to small employers (those with fewer than 50 workers) that provide differential pay.
Other Military Provisions
In general, survivors who roll over military death gratuities into a Roth IRA or Coverdell educational savings account (ESA) are exempt from contribution and income limits. This provision is retroactive for deaths from injuries that occurred on or after October 7, 2001, as long as the contribution is made to the Roth IRA or ESA within one year after enactment.
The act permits combat pay to be treated as earned income for purposes of the earned income tax credit. The provision takes effect for taxable years ending after December 31, 2007.
The act imposes mark-to-market taxation on the property of U.S. citizens who relinquish their citizenship and long-term residents who terminate their U.S. residency — for example, foreign workers returning to their home countries after leaving U.S. employment — to the extent the property gain exceeds $600,000. The legislation requires 30 percent withholding rather than direct taxation on the following:
- Amounts in qualified retirement plans, 403(a) and 403(b) plans, 457(b) plans, SIMPLE plans and simplified employee pension plans
- Interest in a foreign pension plan or similar retirement program
- Deferred compensation
- Any property or right to which the individual is entitled in connection with performing services to the extent the property was not previously included in income under tax code section 83
Amounts held in so-called specified tax-deferred accounts — health savings accounts, Archer medical savings accounts, IRAs, section 529 accounts and Coverdell ESAs — will be treated as if they had been distributed the day before the expatriation date (although they will not be subject to early distribution penalties).
The provisions generally apply to expatriations on or after June 17 and override existing tax treaties.
Act Also Extends Current Mental Health Parity Law
The act reinstates the Mental Health Parity Act — which requires parity in annual and lifetime dollar limits for mental health treatment — for services provided between the date of enactment and December 31, 2008. Meanwhile, negotiators will continue working toward final agreement on broader mental health parity legislation.