MEMORANDUM TO CLIENTS AND FRIENDS
Tax 2006-10
August 14, 2006
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Retirement Plans Update - Part VI
PR Treasury Issues Regulations for Act 87 / Status of H.R. 2710 Remains Uncertain
To address some of the ambiguities of Act 87 of May 13, 2006 (“Act 87"), the Puerto Rico Treasury Department (the “PR Treasury”) has recently issued Regulations No. 7153 (the “Regs.”). In this memorandum we briefly discuss the major provisions of the Regs. and update you on the status of House of Representatives Bill 2710 (“H.R. 2710") which was intended to amend Act 87.1
A. The Regs.
As you may recall, Act 87 was enacted to, among others: (i) provide a special 5% tax rate applicable to lump-sum distributions on account of separation from service (a “Lump-Sum Distribution”) from a Puerto Rico qualified plan (“Plan”) received during a six-month period from May 16 to November 15, 2006 (the “Window Period”); and, (ii) allow an individual to elect to prepay during the Window Period the 5% tax on all or part of his/her accumulated and undistributed balances under a Plan.
1. Special 5% Tax Rate on Lump-Sum Distributions
The Regs. provide that the trustee will be responsible to withhold a 5% tax instead of the 12.5% or 20% tax withholding generally applicable under Section 1165(b)(3) of the Puerto Rico Internal Revenue Code of 1994, as amended (the “PR Code”) in the case of a Lump-Sum Distribution made during the Window Period. On or before the 15th day of the month following the month in which the Lump-Sum Distribution is made, the trustee is required to deposit the taxes withheld at the PR Treasury’s Collections’ Office. The deposit must be made using Form 480.9D, “Voucher for the Payment of the Special Tax on Distributions From Employee’s Trusts.”2
The reporting of the Lump-Sum Distribution and the tax withheld under Act 87 will follow the standard reporting rules under the PR Code (e.g., Form 480.6B, “Informative Statement - Income Subject to Withholding”).
The trustee is liable to the PR Treasury for any tax under-withholding under Act 87 unless the participant pays the full tax due on the Lump-Sum Distribution. The general penalties under the PR Code will apply in the case of late deposit of, or failure to deposit, the tax withheld.
2. Option to Prepay at the Special Tax Rate
Act 87 allows a participant to elect to pre-pay a 5% tax on all or part of the amounts accumulated in a Plan which are not currently distributable. The participants's tax basis on his/her Plan account will be increased by the amount with respect to which the participant elected to pre-pay the tax, so that upon subsequent distribution only the earnings and accretions accumulated after the pre-payment of the 5% tax would be subject to taxation at the then applicable tax rate for Plan distributions.
The Regs. expressly prohibit that the 5% tax be paid out from assets in the participant's Plan account. A Plan that allows a distribution for the prepayment of the tax would be in jeopardy of losing its tax qualified status. In addition, the Regs. expressly prohibit the prepayment for any amount in excess of the participant’s taxable balance in the Plan as of any date from May 16 to November 15, 2006.
The participant must complete Form SC 2911, "Election for Prepayment of Special Tax on Accumulated Amounts in Employee's Trusts" (copy attached) in triplicate (all signed in original) and submit the forms to the PR Treasury along with the tax prepayment.3 The PR Treasury will keep one of the original forms. The participant will retain two stamped originals evidencing the prepayment and will provide one of them to the appropriate representative of the Plan (e.g., plan administrator, employer’s H.R. Department, recordkeeper or trustee). The remaining copy should be retained by the participant.
We have been unofficially advised by PR Treasury officials that Act 87 was not intended to result in the recharacterization of the balances for which the tax is prepaid as after-tax amounts.4 Accordingly, amounts for which the tax has been prepaid will remain subject to the same provisions of the Plan as before the prepayment (e.g., distribution and vesting rules).
B. H.R. 2710
As discussed in our Memorandum to Clients and Friends (Tax 2006-06), H.R. 2710 was intended to clarify the unfortunate language of Act 87 and, among others, change the Window Period to a six month period from June 1 to November 30, 2006. In addition, H.R. 2710 would formally lower the tax withholding rate on Lump-Sum Distributions during the Window Period to 5%. On June 23, 2006, H.R. 2710 was approved by the Puerto Rico House of Representatives. However, as of today, it remains at Puerto Rico Senate’s Finance Committee. The next ordinary session of the Puerto Rico Legislative Assembly begins on August 22. During that week, we should learn more about H.R. 2710's fate. As always, we will keep you informed about any developments in the retirement plans area.
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If you have any questions or comments, or wish additional information regarding these matters, please contact any of the attorneys listed below, members of our Employee Benefits Practice Group:
The content of this memorandum has been prepared by us for information purposes only. It is not intended as, and does not constitute, either legal advice or solicitation of any prospective client. An attorney-client relationship with McConnell Valdés cannot be formed by reading or responding to this memorandum. Such a relationship may be formed only by express agreement with McConnell Valdés.
1 For prior discussions about these topics, please see our prior Memoranda to Clients and Friends (Tax 2006-04, 05 and 06).
2 Form 480.9D should be available at the PR Treasury's Collections' Offices.
3 The PR Treasury requires that the prepayment be made in cash, money order or certified check payable to the Secretary of the Treasury.
4 Such treatment may result in having the total balance in a participant’s account readily available for immediate distribution. In addition, depending on the plan’s current provisions, such treatment may require amendments to the plan to: (i) allow after-tax contributions, and/or (ii) limit the availability of distributions from after-tax accounts. Plan administrators should confirm with their plan’s trustee an/or record-keeper how the plan will keep track of the amounts for which the tax was prepaid.
