Taxes: Changes in Law Affect the Workplace

President Bush has signed the Working Families Tax Relief Act of 2004 and the American Jobs Creation Act of 2004, both of which make important tax changes employers need to keep in mind.

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Working Families Tax Relief Act

The Working Families Tax Relief Act of 2004 contains these key HR-related provisions:

• Benefits laws extended. The current mental health parity law, which would have expired Dec. 31, 2004, was extended through Dec. 31, 2005. The law prohibits a group health plan that offers mental health coverage from applying a lower annual or lifetime aggregate dollar limit to mental health benefits than the plan sets for other types of medical benefits. In addition, the Archer Medical Savings Accounts (MSAs) program, which expired on Dec. 31, 2003 (the last date new accounts could be created), was extended through Dec. 31, 2005. MSAs, which are similar to the new Health Savings Accounts (HSAs), are available to individuals covered by a small employer’s high deductible health plan and to the self-employed.

   

• Uniform definition of dependent. A new, uniform definition was created for who qualifies as a dependent for purposes of federal income tax law. For employers, the new definition could affect employee benefits and cafeteria plans that rely on the Internal Revenue Code definition of a dependent. The new definition requires dependents to meet these three tests:

   

  1. The child has the same principal residence in the United States as the taxpayer for more than half the taxable year.

      

  2. The child is the taxpayer’s child or stepchild, sibling or stepsibling, or a descendent of these individuals.

      

  3. The child is either under age 19, under age 24 if he or she is a full-time student, or totally and permanently disabled. Note that as under the current law, a child who is not disabled must be younger than 13 to qualify for the child and dependent care tax credit.

   

• Tax credits extended. The Welfare-to-Work and Work Opportunity tax credits for employers who hire disadvantaged individuals were extended for two years—for the the 2004 and 2005 tax years.

American Jobs Creation Act

Among the many provisions in the American Jobs Creation Act of 2004, a sweeping corporate tax bill, the following are of special interest for employers:

• Double tax on contingent fees ended. The bill permits a plaintiff in a discrimination or whistleblower lawsuit to take a tax deduction for the full amount of attorney’s fees and costs the individual paid (or that were paid on the individual’s behalf). This provision took effect immediately. Previously, IRS policy resulted in double taxation of such fees and costs because the plaintiff paid taxes on the entire damages award or settlement, including attorney’s fees, and the lawyer receiving the payment was also taxed. Note that there are cases pending before the U.S. Supreme Court that challenge this IRS double-taxation rule. Despite the new legislation, the cases may not be moot, as the new law may only apply prospectively and not affect past victims of the double tax.

   

• New rules for deferred compensation. Changes were made to nonqualified deferred compensation arrangements, including stricter new rules regarding how these arrangements are designed and administered and new penalties for noncompliance. The new rules would apply to amounts deferred after Dec. 31, 2004. The new rules apply to all compensation-deferral plans, arrangements, and agreements. The only exceptions are qualified employer plans (for example, 401(k), 403(b), and 457(b) plans), and bona fide vacation leave, sick leave, compensatory time, disability pay, or death benefit plans. Thus, the new law will probably cover some deferral arrangements that previously weren’t subject to deferred compensation rules, such as restricted stock units and stock appreciation rights.

  The new rules include strict limits on permissible distributions, prohibitions on acceleration of distributions, and requirements for initial and subsequent deferral elections. If a plan doesn’t comply in a particular year, all compensation deferred under the plan or arrangement—including amounts deferred that year and in previous years—will be included in the participant’s gross income for that taxable year and interest will be imposed. Plus, there will be a 20 percent penalty on the amount required to be included in income.

   

• Retiree health benefit costs. Large employers were given more flexibility with respect to retiree health benefit costs. Under current law, large companies can withdraw surplus pension assets to cover medical costs for retirees, but can’t significantly reduce retiree health benefits for five years after such a transfer and must maintain the same per-retiree cost for five years, although the company can cut the overall number of retirees covered. Under the new law, beginning Jan. 1, 2005, employers won’t have to maintain the per capita cost, but can cut overall benefit costs for all retirees—but only by the amount the company would have saved by cutting coverage for some retirees.