Other Federal Changes

The tax and compliance professionals at ADP keep a close eye on the Washington scene. So whether the federal government has enacted, adjusted, amended, revised, or appended employee-related regulations, you can count on us to give you the details.

Federal Changes You Can't Afford To Overlook.

The tax and compliance professionals at ADP keep a close eye on the Washington scene. So whether the federal government has enacted, adjusted, amended, revised, or appended employee-related regulations, you can count on us to give you the details. Federal Changes You Can't Afford To Overlook.

I.R.S. Increase Mileage Rates Through Dec. 31, 2008
I.R.S. Standard Auto Mileage Rates 2008
Pension Deferral Limits For DEFINED CONTRIBUTION Plans
DOL issues 2007 annual UC certifications of states under FUTA
IRS Announces Various Federal Annual Amounts And Limits Effective 1/1/08
Non-Qualified Deferred Compensation Plans
Discrimination Testing Limits
Tax Levy Exemption Tables
Format Changes For Magnetic/Electronic Reporting of Forms W-2
Taxability of Frequent Flyer Miles
The Application of Employment Taxes to Statutory Stock Options
I.R.S. Penalties for Form W-2 Errors Involving Employee Name and/or Social Security Number

I.R.S. Increases Mileage Rates Tthrough Dec. 31, 2008

The Internal Revenue Service has announced an increase in the optional standard mileage rates for the final six months of 2008. Taxpayers may use the optional standard rates to calculate the deductible costs of operating an automobile for business, charitable, medical or moving purposes.

The rate will increase to 58.5 cents a mile for all business miles driven from July 1, 2008, through Dec. 31, 2008. This is an increase of eight (8) cents from the 50.5 cent rate in effect for the first six months of 2008.

In recognition of recent gasoline price increases, the IRS made this special adjustment for the final months of 2008. The IRS normally updates the mileage rates once a year in the fall for the next calendar year. While gasoline is a significant factor in the mileage figure, other items enter into the calculation of mileage rates, such as depreciation and insurance and other fixed and variable costs.

I.R.S. Standard Auto Mileage Rates for 2008

For 2008, the optional standard mileage rate will be $0.505 per mile for BUSINESS travel, compared to $0.485 per mile effective 1/1/2007. (Briefly, from 9/1/2005 to 12/31/2005, the IRS authorized a temporary business rate of $0.485.) The I.R.S. bases the rate on annual studies of the fixed and variable costs of operating an automobile (maintenance, insurance, repairs, gasoline, oil, etc.). The main reason behind the 2008 increase over the 1/1/2007 rate, according to the I.R.S., is higher vehicle and fuel prices during the study period, which ended on June 30.The mileage rate for charity purposes will remain 14 cents-per-mile.

Employers may use the standard mileage rate to pay for auto expenses incurred by employees under a reimbursement or expense allowance arrangement and thereby substantiate and adequately account for such expenses, provided that accountable plan requirements are satisfied.

The standard automobile cost for fixed and variable rate allowance purposes will decrease to $27,500 Any of the standard automobile mileage rates are a "short-cut" allowed by the I.R.S. for substantiating the cost of automobile usage, for example in connection with employer-reimbursed business expenses.

Pension Deferral Limits For DEFINED CONTRIBUTION Plans

For year 2008, there are increased limits for employee contributions to qualified pension plans.

Plan	2007 and 2008	2006	2005
401(k)	$15,500	$15,000	$14,000
401(k) new "catch-up" substitute limit	$20,500	$20,000	$18,000
403(b)(annuity)	$15,500	$15,000	$14,000
403(b) new "catch-up" substitute limit	$20,500	$20,000	$18,000
403(b) old "catch-up" substitute limit	$23,500 *	$23,000 *	$21,000 *
408(k)(SEP)	$15,500	$15,000	$14,000
408(k)(SEP) new "catch-up" substitute limit	$20,500	$20,000	$18,000
408(p)(SIMPLE)	$10,500	$10,000	$10,000
408(p)(SIMPLE) new "catch-up" substitute limit	$13,000	$12,500	$12,000
457	$15,500	$15,000	$14,000
457 new "catch-up" substitute limit	$20,500	$20,000	$18,000
457 old "catch-up" substitute limit	$31,000 **	$30,000 **	$28,000 **
501(c)	$15,500	$15,000	$14,000

* The 403(b) tax-sheltered annuity, OLD "catch-up" substitute limit is an additional $3,000 above the basic 2007 contribution limit of $15,500, for a total of $18,500 ($15,500 + $3,000). However, the 403(b) OLD "catch-up" substitute limit is effective only for employees with 15 or more years of service. The employee ALSO may be eligible for a second, or NEW, "catch-up" substitute 403(b) limit if the employee is age 50 or older by the end of the calendar year. The second, or NEW, "catch-up" substitute limit is an additional $5,000 above the basic 2007 contribution limit of $15,500, for a total of $20,500 ($15,500 + $5,000). For employees eligible to make BOTH the old and new 403(b) "catch-up" contributions, in addition to the basic 2007 contribution of $15,500, the total 403(b) contribution in 2007 would be $23,500 ($15,500 + $5,000 + $3,000). * * Regarding 457 plans, participants MAY choose the OLD "catch-up" substitute limit, OR the NEW "catch-up" substitute limit, if the latter is authorized by the employer's particular plan. Participants in 457 plans are NOT permitted to adopt BOTH "catch-up" limits concurrently, unlike participants in 403(b) plans. However, the NEW "catch-up" substitute limit is not available for the last three years before retirement, IF the 457 plan already authorizes the OLD "catch-up" contribution. The OLD "catch-up" limit allows a maximum annual employee contribution of $31,000 (twice the regular limit) for 2007. Alternatively, plan participants eligible for the 457 NEW "catch-up" substitute limit must be 50 years of age or older, by the end of the year. In such cases, the elective deferral limit is increased by $5,000, to $20,500, for 2007.

* * * * *On May 26, 2001, Congress approved legislation which increases the amounts which can be contributed to 401(k) and other employer-sponsored tax-deferred retirement plans. Such contributions are exempt from Federal income tax withholding, but are subject to FICA and FUTA taxes. On June 7, 2001, President Bush signed the bill into law. The new law made multi-year changes (noted above for years 2005, 2006 and 2007) to the deferral limits for employer-sponsored tax-deferred retirement plans, such as 401(k) plans. Among many provisions, several were of particular importance to employers: Employee Contributions:

The maximum amount of employee contributions to 401(k), 403(b) and salary reduction SEP plans were raised gradually from $10,500 in 2001 to $15,000 in 2006. For 2007 and beyond, the limit will be indexed for inflation in annual $500 increments.
ForSIMPLE plans, the limit on annual employee contributions increases to $10,500 in 2007, from $10,000 in 2006. For tax years 2003-2005, the limit increased $1,000 annually (to $10,000). For 2006 and beyond, the limit will be indexed for inflation to increase annually in $500 increments.
In 2007, the employee contribution limit under state and local government 457 plans increases from $15,000 to $15,500. For tax years 2003-2006, the limit increases $1,000 annually (to $15,000). For 2007 and beyond the limit will be inflation-indexed to increase annually in $500 increments. Importantly, in the three years prior to retirement, the limit will be twice the limit otherwise applicable..
For defined contribution plans, the maximum amount of combined employer and employee contributions in a year is increased from $42,000 in 2005 to $44,000 in 2006. Thereafter, the limit will be indexed for inflation in $1,000 annual increments. In addition, the limit on compensation that may be taken into consideration under a defined contribution plan was increased from $210,000 in 2005 to $220,000 in 2006. The limit will be indexed annually.
The new tax law suspended annual cost-of-living adjustments for employee contribution limits, and substituted pre-determined increases of fixed amounts. Thus, by law the employee contribution limit for 401(k), 403(b) and salary reduction SEP plans was increased $500 for year 2002, to $11,000. Thereafter, the limit increases $1,000 annually through 2006. However, for 2007 and beyond, annual inflation indexing will resume in annual $500 increments. Importantly, there was uncertainty as to exactly which states would follow this alternative way of increasing employee contribution limits, for purposes of determining taxable wages for state income tax. Some states are pre-set generally to automatically adopt any amendments to the Internal Revenue Code, including the pre-determined increases in contribution limits. Other states must specifically adopt each Code amendment, which normally takes months or even years. For states in the latter category, there can be no state-level increases in the contribution limits until the respective state legislature adopts by specific action the alternative method added to the Code by Congress in June, 2001. By the end of 2002, all states except Arkansas had conformed to the new Internal Revenue Code deferral limits. In February, 2003, the Arkansas legislature enacted legislation conforming that state's law to the Internal Revenue Code's deferral limits, retroactive to 1/1/2002.

Also related to defined contribution plans, the limit for aggregate annual additions (employee and employer combined) was increased from 25% of compensation to 100% of compensation for years beginning after December 31, 2001. Finally, the 33% of compensation limit on deferrals to a governmental 457 plan was increased to 100% of compensation.

"Catch-Up" Provisions:

Participants in 401(k),403(b), SEP or457 plans, age 50 and above, are permitted to contribute an additional pre-tax amount (a "catch-up" contribution), under Code section 414(v). The otherwise applicable contribution limit on elective deferrals is replaced with a higher limit for such individuals. However, it is an optional provision that first must be elected by the plan sponsor (employer). Starting generally at an additional $1,000 in 2002, the amount was increased to an additional contribution of $5,000 in 2006. The $5,000 "catch-up" contribution limit will be indexed for inflation in $500 annual increments, beginning in 2007. There are parallel provisions for SIMPLE plan participants. Under a SIMPLE plan (Code Section 408(p)(2)(A)), the "catch-up" contribution is an extra $2,500 for 2006. The $2,500 "catch-up" contribution limit will be indexed for inflation in $500 annual increments in 2007 and thereafter. Importantly, these "catch-up" contribution opportunities were not available to employees until calendar year 2002 and after.

For 457 plans, coordination is necessary between the previous catch-up provision ("old" catch-up, applicable in participant's last 3 years before retirement), and the "new" catch-up provision enacted in June, 2001 (EGTRRA). Not every 457 plan provides the optional "old" catch-up provision. If the "old" catch-up provision is contained in the plan document, the "new" catch-up contribution will not apply in those last three years. However, if the plan does not contain the "old" catch-up provision, the participant will be allowed to make the "new" catch-up contribution in the last 3 years before retirement (if the latter provision is formally adopted in their plan).

Importantly, at the start of 2002 there was uncertainty as to exactly which states would follow this alternative way of increasing employee contribution limits, for purposes of determining taxable wages for state income tax. Some states are pre-set generally to adopt automatically any amendments to the Internal Revenue Code, including the pre-determined increases in contribution limits. Other states must specifically adopt each Code amendment, which normally takes months or even years. For states in the latter category, there can be no state-level increases in the contribution limits until the respective state legislature adopts by specific action the alternative method added to the Code by Congress in June, 2001. By the end of 2002, all states except Arkansas had conformed to the new Internal Revenue Code deferral limits. In February, 2003, the Arkansas legislature enacted legislation conforming that state's law to the Internal Revenue Code's deferral limits, retroactive to 1/1/2002. Note also, that because Pennsylvania has never exempted any pension deferrals from state income tax, and New Jersey exempts only 401(k) deferrals, neither is expected to become fully "conforming." Finally, Puerto Rico will not become "conforming" because it does not follow the Internal Revenue Code on deferred compensation.

DOL issues 2007 annual UC certifications of states under FUTA

The Secretary of Labor has signed the annual 12-month certifications under the Federal Unemployment Tax Act that enable employers who make contributions to state unemployment funds to obtain certain credits against their liability for federal unemployment tax. All 50 states, as well as the District of Columbia, Puerto Rico and the Virgin Islands, have received certifications for the maximum additional credit allowable based on the 12-month period ending on October 31, 2007

IRS Announces Various Federal Annual Amounts And Limits Effective 1/1/08

Type	2007	2008
Federal Withholding Allowance Amount	$3,400	$3,500
Adoption Assistance Limit	$11,390	$11,650
Qualified Transportation Limit:
Transportation/Transit Passes	$110	$115
Qualified Parking	$215	$220
Health Savings Account Limits:
Self Only Coverage	$2,850	$2,900
Family Coverage	$5,650	$5,800
Catch-Up Contributions 55 or Older	$800	$900

Non-Qualified Deferred Compensation Plans

Section 409A, added by the American Jobs Creation Act of 2004, provides that all amounts deferred under a non-qualified deferred compensation plan for all tax years are currently includible in gross income unless certain requirements are met. If section 409A requires an amount to be included in gross income, the section imposes a substantial tax. The Act requires reporting of the yearly deferrals (plus earnings) under a section 409A non-qualified deferred compensation plan, using code Y in box 12 of Form W-2. Income included under section 409A from a non-qualified deferred compensation plan will be reported in Form W-2 box 1, and in box 12 using code Z. This income is also subject to an additional tax reported on Form 1040.

Discrimination Testing Limits

Two important benchmarks for discrimination testing performed on "cafeteria" and "P.O.P." plans, are the plan treatment of "Highly-Compensated" employees and "Key" employees. For 2006, the compensation threshold for "Highly-Compensated" employees as determined by the I.R.S. under Code section 414(q)(1)(B) is $100,000, increased from $95,000 in 2005 Likewise, the 2006 compensation threshold for a "Key" employee in a top-heavy plan, under Code section 416(i)(1)(A)(i), is $140,000, increased from $135,000 in 2005.

Tax Levy Exemption Tables

Effective January 1, 2008, a revised I.R.S. table is used for figuring the amount of wages, salary and other income exempt from Federal tax levy. Generally, the 2008 exemption amounts are somewhat higher than for year 2006. For example, for a person with a marital status of "single" and claiming 3 withholding exemptions, the 2008 weekly tax levy exemption is $306.73, compared to $289.42 in 2006. For more information see I.R.S Publication 1494

Format Changes For Magnetic/Electronic Reporting of Forms W-2

The last year for filing Forms W-2 on magnetic tapes and cartridges was tax year 2004 (forms timely filed with the SSA in 2005). The last year for filing Forms W-2 on diskette was tax year 2005 (forms timely filed with the SSA in 2006). When filing 250 or more Forms W-2, it is required that they be filed electronically unless the IRS has granted a waiver.

Taxability of Frequent Flyer Miles

In Announcement 2002-18, published February 20, 2002, the I.R.S. stated that it would not attempt to tax frequent flier miles received for business travel but used for personal purposes. The I.R.S. indicated that any future guidance issued on this subject would only be applied prospectively. The I.R.S. said it did not attempt to tax frequent flyer miles because of the difficulty of determining the timing and valuation of the imputed income. Also, establishing the source of the benefit, as between business or personal expenditures, was unreliable, noted the I.R.S.

The Application of Employment Taxes to Stock Options

A. STATUTORY (QUALIFIED) STOCK OPTIONS In general, upon the exercise of a statutory stock option, the amount by which the fair market value of the stock on the date of exercise exceeds the exercise price, is "income" to the employee and later is subject to Federal income tax on Form 1040 (after the stock has been sold). Because the opportunity for this "income" arises out of an employment relationship, some commentators have argued that such "income" should also be subject to employment taxes (FIT W/H, FICA and FUTA). However, the IRS originally did not take this position, stating that FICA and FUTA taxes did not apply to the exercise of a statutory stock option because the transaction had not been made subject to income tax withholding. In Notice 2001-14, issued in January, 2001, the IRS changed its position and took the opposite view, contending that the "income" should be subject to employment taxes (FICA and FUTA). However, the IRS also provided both employers and employees a transition period for implementing the new taxability rules, proposing a delay on the imposition of employment taxes until January 1, 2003. This date was later changed. On November 13, 2001, the IRS issued proposed regulations providing for FICA and FUTA taxes to apply when an individual exercises a STATUTORY stock option, and that Federal income tax withholding would NOT apply to the exercise of a statutory stock option. The IRS requested comments as to the proposed regulations. Comments from the public were received on a wide variety of issues. Recognizing the complexity of the issues raised, the IRS concluded it would need more time, and extended the moratorium on applying employment taxes to statutory stock options. Consequently, in July, 2002, the IRS issued Notice 2002-47 which states that until Treasury and the IRS issue further guidance, the IRS will not assess Federal employment taxes (FIT W/H, FICA and FUTA) upon either the exercise of statutory stock options or the disposition of the stock acquired by an employee pursuant to the exercise of the option. Notice 2002-47 further stated that the future application of employment taxes to statutory stock options will not affect any exercise of a statutory stock option that occurs before January 1 of the year that follows the second anniversary of the publication of the final IRS guidelines thus, at least two years after the regulations are issued in final form. NOTE: The IRS uses the term "statutory stock option" to cover the incentive stock option (ISO) described in Code section 422(b), and/or an option granted under an employee stock purchase plan (ESPP) described in Code section 423(b). B. NON-STATUTORY (NON-QUALIFIED) STOCK OPTIONS Importantly, the imposition of employment taxes and income tax withholding on the exercise of NON-STATUTORY (non-qualified) stock options (as opposed to statutory stock options) has been in place for some time. If the option is for stock with a readily ascertainable market value at grant, the option itself is taxable to the employee upon receipt. The taxable amount is the difference between the market value of the stock and the amount payable by the employee for the stock. The amount is treated as wages for purposes of FIT W/H, FICA and FUTA taxes. The amount treated as wages should be reported on Form W-2. However, if a readily ascertainable fair market value cannot be determined at grant, the option is taxable to the employee when the individual exercises the option. NOTE: Beginning in 2003, employers were required to use code "V" in Box 12 of Form W-2, to report income from the employee's exercise of NON-statutory stock options. The I.R.S. defines such "income" as the price spread (fair market value of stock over the exercise price of the option). The amount reported with code "V" in Box 12, must also be included in Boxes 1, 3 (up to the Social Security wage base), and Box 5.

I.R.S. Penalties for Form W-2 Errors

In August, 2004, notwithstanding the earlier intentions reported below, the I.R.S. indicated that it intends to re-direct its efforts to penalize employers for name and Social Security number mismatches on Forms W-2, to focus only on the employers with “the most egregious mismatch rates.”

* * * * *The I.R.S. has long been authorized to assess employers with penalties for failure to file correct information on Form W-2. The penalty is $50 per form, but it can be reduced to $15 if the employer corrects the form within 30 days, or to $30 if the employer corrects it by August 1. In October, 2002, the I.R.S. indicated that for 2002 Forms W-2 it would strictly enforce the $50 penalty for employee names and Social Security Numbers which do not match the records of the Social Security Administration. Unresolved, however, was the definition of conditions employers would be able to cite in defense of their actions (or inaction). As the IRS described it, there was no clear definition of the employer defense of "reasonable cause" for failure to provide the correct name and number. In the case of information returns, such as Form 1099-MISC, under present rules the employer can establish "reasonable cause" for failure to match names and tax identification numbers (TINS), by presenting a properly completed Form W-9 (Request for Taxpayer Identification Number and Certification). However, employers do not have an equivalent document to prove due diligence for Form W-2 reporting. Form W-4 (Employee's Withholding Allowance Certificate) has been suggested for this purpose, but there is no current requirement that every employee must file Form W-4 with the employer. "Reasonable Cause" Has Been Clarified As An Employer Defense Employers penalized for putting an incorrect SSN on a Form W-2 are now helped by a seemingly more lenient I.R.S. view of "reasonable cause," based on the employee's failure to provide a correct SSN. Specifically, the I.R.S. requires only three things for the "reasonable cause" defense to apply:

that the employer received an SSN from the employee
that the employer relied on that number in good faith, entering it into its payroll records and putting it on the employee's Form W-2;
that the employer later received a penalty notice from the I.R.S. notifying that the employee's SSN was incorrect.

In addition to showing that the failure to include a correct SSN was caused by the employee, the employer must also show that it exercised reasonable care to avoid or mitigate the problem, in order to warrant waiver of the penalty. In practical terms, the I.R.S. says, "reasonable care" by the employer, justifying waiver by the I.R.S. of the penalty, could work as follows. The employer would have to show that it made an initial request for the employee's SSN, normally done routinely when the employee begins working for the employer; and that the employer indeed received the SSN from the employee, usually on Form W-4 (Employee's Withholding Allowance Certificate). The employer would not be required to make a further solicitation for the employee's SSN unless the I.R.S. notifies the employer that the employee's SSN is incorrect, for example by means of a penalty notice. An employer which receives such a notice may be required to make up to two annual requests after receiving the notice. The employer's first request for the employee's SSN must be made by December 31 of the year in which the penalty notice is received. A second annual request for the employee's SSN will be required if the employer receives an I.R.S. notice of an incorrect SSN for the employee in any later year. The I.R.S. says the employer may rely on the SSN provided by the employee in response to such requests, and may report it on the employee's Form W-2.

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