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News Notes

AICPA Comments on Automatic Contribution Arrangement Proposed Regs. • Tax Court Holds—Repeatedly—That Antarctica Is Not a Foreign Country • IRS Changes Its Position on Performance-Based Compensation for $1 Million Compensation Limit (box) • President Signs Stimulus Tax Legislation

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Alistair M. Nevius, J.D.

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AICPA Activities

AICPA Comments on Automatic Contribution Arrangement Proposed Regs.

The Pension Protection Act of 2006, P.L. 109-280 (PPA ’06), made it easier for plan sponsors to automatically enroll participants in 401(k), 403(b), and 457(b) plans. Last November, the Service released proposed regulations on the tax aspects of automatic enrollment of participants in cash or deferred arrangements (REG-133300-07).

The AICPA has several concerns about the regulations as proposed and sent a letter to the IRS on February 1, 2008, outlining those concerns.

First, the AICPA has asked the Service to clarify what amount should be distributed under Sec. 414(w) when an employee has elected to contribute an amount in excess of the default amount. If the employee later decides to no longer make 401(k) contributions and elects to withdraw any contributions (assuming the plan allows for this under Sec. 414(w)), it is unclear how much should be distributed to the employee. Prop. Regs. Sec. 1.414(w)-1(c)(3)(i) specifies that the distribution must be equal to the default elective contributions. This appears to require that the distribution be based on the 3% default contribution rate of Prop. Regs. Sec. 1.401(k)-3(j)(2)(ii)(A) and not include any additional amount contributed by the employee. It also seems under the proposed regulations that only the employer match on the 3% default rate would be forfeited, but the match on any excess contributions would not be subject to forfeiture (Prop. Regs. Sec. 1.414(w)-1(d)(2)). The AICPA suggests that the final regulations clarify these points.

Second, the AICPA has asked that the final regulations include a grace period for the employee notice requirements for new hires who are immediately eligible to participate in a plan. The preamble to the proposed regulations states that the notice requirement can be met by providing notice to the employee on his or her first day of employment. The AICPA is concerned that this gives employers no leeway (some, for example, may not perform new-employee orientation on the first day of employment). It also does not give employees a reasonable period before the first contribution is made. The AICPA has asked for a grace period, such as two weeks from the date of hire, for employers to meet the notice requirements.

Third, the AICPA has asked for clarification of how employees who have not made an affirmative election in a preexisting plan should be treated when a qualified automatic contribution arrangement (QACA) is instituted. Sec. 401(k)(13)(C)(iv) provides that automatic contributions are not required for employees who were eligible to participate in the plan immediately before the QACA was put in place and who had an election in effect on that date either to participate or not to participate. With respect to these employees, Prop. Regs. Sec. 1.401(k)-3(j)(1)(iii) states that automatic contributions are not required if these employees had affirmative elections in effect to have elective contributions made or not to have elective contributions made.

This rule appears to treat employees who simply made no election at all (and thus no elective contributions were made to the plan on their behalf) as not having made an affirmative election to have no contributions made; therefore, automatic contributions are required for these employees. The AICPA has requested that the final regulations state that, for purposes of Sec. 401(k)(13)(C)(iv), in an ongoing plan adopting QACAs, an employer could treat employees who made no election in the past as having elected not to participate (thereby treating the failure to make an affirmative election to participate as, in effect, an election not to participate). Thus, automatic contributions would not be required for employees already eligible under the plan but not participating.

Fourth, the AICPA has asked that the final regulations explicitly address whether the actual deferral percentage test of Sec. 401(k)(3)(A)(ii) and actual contribution percentage test of Sec. 401(m)(2) are satisfied for the entire plan as a result of the QACA, even though not all plan participants must be covered under the automatic contribution feature. The AICPA also requested that the final regulations explicitly address whether em-ployer contributions required for a QACA under Sec. 401(k)(13)(D)(i) (i.e., matching or nonelective contributions) are required for all employees, including those for whom automatic contributions are not required.

Finally, the AICPA has requested that the notice content requirement for the eligible automatic contribution arrangement (EACA) and QACA notices should be similar to the relief given in Notice 98-52 to the required safe-harbor notices for plan years beginning before January 1, 2000. This relief stated that a notice will not fail to satisfy the content requirement for that plan year, merely because the notice does not include all of the required items, if the notice satisfies a reasonable good-faith interpretation of the statutory requirements. Due to the complexity of EACAs and QACAs and the short time period to implement them, the AICPA believes it is appropriate to provide transitional relief for plan years beginning in 2008.

Court Decisions

Tax Court Holds—Repeatedly—That Antarctica Is Not a Foreign Country

Those who pay attention to Tax Court decisions may have noticed a trend in 2007: case after case decided on the issue of whether a taxpayer can exclude income earned while in Antarctica under the foreign earned income exclusion provisions of Sec. 911.

By mid-February 2008, 74 decisions had been issued on this subject. Most of these cases were litigated in the Tax Court, but one made it up to the Seventh Circuit on appeal. In every case, the courts have held that Antarctica is not a foreign country and therefore income earned there does not qualify for the exclusion.

The taxpayers in most of these cases worked for Raytheon Support Services under contract with the National Science Foundation at McMurdo Station in Antarctica. (According to Larry Harvey, the lawyer who represented the petitioners in most of these cases, about 160 such cases have been filed.)

The first case was decided by the Tax Court in 2006. It was appealed to the Seventh Circuit, which affirmed the Tax Court’s decision that Antarctica is not a foreign country and income earned there by U.S. citizens is not excludible under Sec. 911 (Arnett, 126 TC 89 (2006), aff’d, 473 F3d 790 (7th Cir. 2007)).

Sec. 911(b)(1)(A) defines “foreign earned income” to generally mean amounts earned “from sources within a foreign country.” Regs. Sec. 1.911-2(h) defines “foreign country” as “any territory under the sovereignty of a government other than the United States.” In holding that Antarctica is not a foreign country under these definitions, the Tax Court in Arnett looked to its prior decision in Martin, 50 TC 59 (1968), which held that under the Antarctic Treaty, December 1, 1959, 12 U.S.T. 794, which currently has 45 signers, Antarctica is a “sovereignless region.”

The Seventh Circuit also noted that, under Sec. 863, activity in Antarctica is deemed to be “space or ocean activity,” and the United States is considered to be the source country of income from such activity (Arnett, 473 F3d at 797).

While Antarctica has been consistently held not to be a foreign country for tax purposes, it has been held by federal courts to be a foreign country for other purposes. In Smith v. Raytheon, 297 FSupp2d 399 (D. Mass. 2004), a district court held that, for purposes of the Fair Labor Standards Act, Antarctica was a foreign country and therefore workers there were not entitled to overtime compensation.

The Supreme Court has held that the “ordinary meaning of ‘foreign country’ includes Antarctica, even though it has no recognized government” (Smith, 507 US 197 (1993)), thereby barring a claim under the Federal Tort Claims Act, which precludes “any claim arising in a foreign jurisdiction” (28 USC §2680(k)).

The taxpayer in Arnett argued that the more recent Smith v. Raytheon and Smith decisions overruled the older Martin case, but the Tax Court distinguished the newer cases because they did not deal with tax issues. According to Mr. Harvey, the taxpayer also argued on the grounds of consistency and fairness that Antarctica should be treated as a foreign country for all purposes: “Why do you get a different result in a tax context?” he asks.

Mr. Harvey also points out that taxpayers who work in a no-income-tax country, such as the Bahamas, still get the Sec. 911 exclusion, even though the ostensible purpose of the exclusion is to account for the added foreign tax burden U.S. taxpayers will bear when living and working in a foreign country.

However, the Tax Court was unpersuaded by these arguments and spent 2007 routinely ruling against the taxpayers in these cases.

Legislation

President Signs Stimulus Tax Legislation

On February 13, 2008, President Bush signed into law the Economic Stimulus Act of 2008, P.L. 110-185, which included several tax items among its provisions.

The most publicized item was the provision to send “recovery rebates” to taxpayers. This provision gives individuals a credit of between $300 and $600 (between $600 and $1,200 for joint returns). The Act makes individuals eligible for this credit for tax year 2007, and the amount of the credit will initially be computed using the taxpayer’s 2007 tax liability. Treasury is directed to refund this credit to taxpayers “as rapidly as possible” (Sec. 6428(g)). As this issue of The Tax Adviser went to press, Treasury was estimating that rebate checks would be sent to taxpayers starting in May and would be “largely completed this summer” (Scott Stanzel, White House Deputy Press Secretary (2/8/08)).

Because the checks will be calculated based on the 2007 income tax return filed, it is advisable for taxpayers with no true filing requirement to consider e-filing a 2007 tax return via the IRS website to qualify for a rebate check.

Taxpayers will figure the credit on their 2008 returns. To the extent that the amount of the credit shown on the 2008 return exceeds the amount a taxpayer received in his or her rebate check, the taxpayer may claim that amount as a refundable credit against his or her 2008 tax liability. If the amount of the check exceeds the amount of the credit shown on the taxpayer’s 2008 return, the taxpayer will not be required to pay back that amount (Joint Committee on Taxation, Technical Explanation of the Economic Stimulus Act of 2008, JCX-16-08 (2/8/08)).

The Act also further increased the limitation under Sec. 179 for expensing certain otherwise depreciable business assets. The Sec. 179 limitation is increased, for tax years beginning in 2008, to $250,000 and the phaseout amount is increased to $800,000 (Sec. 179(b)). The prior limits for 2008 were $128,000 and $510,000 (as adjusted for inflation) (Rev. Proc. 2007-66). These changes are effective for tax years beginning after 2007. The Act did not change the temporary nature of the increased Sec. 179 limitation; the increased amount will not apply to tax years beginning after 2011 (Sec. 179(b)(1)).

Finally, the Act increases the bonus first-year depreciation provision under Sec. 168(k) for certain property acquired after December 31, 2007, to 50% (from 30%), and the allowance is extended to include property placed in service before January 1, 2009 (before Jan. 1, 2010, if the property has a recovery period of at least 10 years, is transportation property, or is a qualifying aircraft). The amount of the limitation under Sec. 280F(a)(1)(A)(i) for qualified passenger automobiles is increased by $8,000 (from $4,600) (Sec. 168(k)(2)(f)).

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© 2008 AICPA