The Empire’s Death Star is Destroyed

The Force (of Industry Leaders) saves small-business retirement plans as IRS withdraws controversial portion of proposed nondiscrimination testing regulations.

A New Hope (For Small Business Owners)

In a twist of irony, reasonableness has prevailed. The IRS has withdrawn the portion of its proposed regulations that would have applied the reasonable classification standard currently used only in coverage testing, to nondiscrimination testing for qualified plans. This portion of the regulations would have brought a facts and circumstances variable, with little regulatory guidance, into what had been a purely objective and numerical test for 25 years.

The rebels have prevailed as Luke Skywalker has destroyed the Death Star, keeping small company retirement plans safe from the Empire for at least the foreseeable future. Remember, however, that the Empire built a second Death Star – so the IRS could certainly revisit this issue in the future. Whether or not that happens, or to what extent, likely depends very much on what transpires in November.

The Force (of Industry Leaders) Awakens

The IRS delivered this good news via Announcement 2016-16 (PDF), rewarding the efforts of various organizations that had lobbied Congress and the Treasury Department on behalf of small-business America. These lobbyists demonstrated that these rules would be extremely damaging to the goal of expanding retirement-plan coverage among small businesses and would result in many scaling back or abandoning their plans. I have said in this space a number of times that the ability of small-business owners to reap reasonable tax-deferred benefits is a huge driver toward their willingness to provide meaningful levels of annual contributions for their employees, often 7.5% to 10% or more of pay.

The current Administration has unsuccessfully tried for nearly eight years to attack and limit tax- deferred contributions to retirement plans, and expand retirement coverage instead with meager mandates. I keep emphasizing that these are tax deferrals because taxes will eventually be paid on these benefits in the future, a very important point when you consider the expected ratio of workers to retirees 20 years from now. It’s a case of governmental shortsightedness at its best, or perhaps its worst.

The Phantom Menace (Of Abusive Designs)

I should note that the regulations that were proposed in January still stand for the most part, including permanent relief provisions concerning coverage and nondiscrimination testing for frozen defined benefit plans. There were also some provisions that provided more flexibility in meeting certain requirements for nondiscrimination testing, and those remain as well.

I understand there are abusive designs out there, where overly aggressive practitioners and their clients take advantage of the rules to their benefit without the corresponding intended consequences of providing meaningful contributions to their employees. I applaud the IRS efforts to educate the industry on these abusive designs and cracking down on them. Reason says to target enforcement against abuses, not take away a small-business owner’s $100,000 tax deferral, and as a result take away the 7.5%+ in contributions for most or all of its employees. Thankfully, reason prevailed over reasonable classification.

May the force be with you.