Part III. — Internal Revenue Bulletin 2004-9

Weighted Average Interest Rate Update

Notice 2004–14

Sections 412(b)(5)(B) and 412(l)(7) (C)(i) of the Internal Revenue Code provide that the interest rates used to calculate current liability and to determine the required contribution under § 412(l) must be within a permissible range around the weighted average of the rates of interest on 30-year Treasury securities during the four-year period ending on the last day before the beginning of the plan year.

Month Year

Weighted

Average

Notice 88–73, 1988–2 C.B. 383, provides guidelines for determining the weighted average interest rate and the resulting permissible range of interest rates used to calculate current liability.

Section 417(e)(3)(A)(ii)(II) of the Code defines the applicable interest rate, which must be used for purposes of determining the minimum present value of a participant’s benefit under § 417(e)(1) and (2), as the annual rate of interest on 30-year Treasury securities for the month before the date of distribution or such other time as the Secretary may by regulations prescribe. Section 1.417(e)–1(d)(3) of the Income Tax Regulations provides that the ap

plicable interest rate for a month is the annual interest rate on 30-year Treasury securities as specified by the Commissioner for that month in revenue rulings, notices or other guidance published in the Internal Revenue Bulletin.

The rate of interest on 30-year Treasury Securities for January 2004 is 4.98 percent. Pursuant to Notice 2002–26, 2002–1 C.B. 743, the Service has determined this rate as the monthly average of the daily determination of yield on the 30-year Treasury bond maturing in February 2031.

The following rates were determined for the plan years beginning in the month shown below.

90% to 110% Permissible

Range

90% to 105% Permissible

Range

February 2004 5.23 4.70 to 5.49 4.70 to 5.75

§ 72(q)(2)(D) had not applied to the prior distributions.

Section 72(t)(1) imposes an additional tax on premature distributions from “qualified” annuity contracts ( e.g., a § 403(b) annuity contract or a § 408 individual retirement annuity) that is similar to the penalty tax imposed by § 72(q). Section 72(t)(2)(A)(iv) also provides that the additional tax does not apply to a series of substantially equal periodic payments and § 72(t)(4) sets forth a recapture rule similar to the rule of § 72(q)(3).

Notice 89–25 provides guidance regarding the imposition of the additional tax on distributions from qualified employee plans, § 403(b) annuity contracts, and individual retirement annuities (IRAs). Notice 89–25 sets forth three methods for determining whether payments to individuals from their IRAs or from their qualified retirement plans constitute a series of substantially equal periodic payments for purposes of § 72(t)(2)(A)(iv). The three methods are: (i) the required minimum distribution method; (ii) the fixed amortization method; and (iii) the fixed annuitization method.

Under the required minimum distribution method, the annual payment for each year is determined by dividing the account balance for that year by the number from

Drafting Information

The principal authors of this notice are Paul Stern and Tony Montanaro of the Employee Plans, Tax Exempt and Government Entities Division. For further information regarding this notice, please contact the Employee Plans’ taxpayer assistance telephone service at 1–877–829–5500 (a toll-free number), between the hours of 8:00 a.m. and 6:30 p.m. Eastern time, Monday through Friday. Mr. Stern may be reached at 1–202–283–9703. Mr. Montanaro may be reached at 1–202–283–9714. The telephone numbers in the preceding sentences are not toll-free.

Section 72.—Annuities; Certain Proceeds of Endowment and Life Insurance Contracts

Notice 2004–15

This notice provides guidance regarding when a distribution from a non-qualified annuity will satisfy § 72(q)(2)(D) and, therefore, be exempt from the penalty tax imposed by § 72(q)(1). Specifically, the

Internal Revenue Service (IRS) and Treasury will treat a distribution as satisfying § 72(q)(2)(D) if the taxpayer uses one of the methods described in Notice 89–25, 1989–1 C.B. 662, as modified by Rev. Rul. 2002–62, 2002–2 C.B. 710, to determine whether the payment is part of a series of substantially equal periodic payments.

LAW

Section 72 sets forth rules for the taxation of amounts received under an annuity contract. Section 72(q)(1) imposes a penalty tax on certain premature or early distributions under annuity contracts equal to ten percent of the amount that is includible in gross income. The penalty tax under § 72(q)(1) will not be imposed, however, if the distribution satisfies one of the exceptions set forth in § 72(q)(2). Section 72(q)(2)(D) provides that a distribution will not be subject to the penalty tax if it is “part of a series of substantially equal periodic payments (not less frequent than annually) made for the life (or life expectancy) of the taxpayer or the joint lives (or joint life expectancies) of such taxpayer and his designated beneficiary.” If the payments are subsequently modified, § 72(q)(3) generally requires a taxpayer to take into account the penalty tax, plus interest, that would have been imposed if

March 1, 2004 526 2004-9 I.R.B.

fied by Rev. Rul. 2002–62, to determine whether a distribution from a non-qualified annuity contract is part of a series of substantially equal periodic payments under § 72(q)(2)(D).

DRAFTING INFORMATION

The principal author of this notice is Linda K. Boyd of the Office of Associate Chief Counsel (Financial Institutions and Products). For further information regarding this notice, please contact Ms. Boyd at (202) 622–3970 (not a toll-free number).

Relief From Retroactive Application of Information Reporting Requirements for Health Flexible Spending Arrangements and Health Reimbursement Arrangements

Notice 2004–16

This notice provides that certain information reporting requirements of Rev. Rul. 2003–43, 2003–1 C.B. 935, will not apply to payments made pursuant to flexible spending arrangements (FSAs) or health reimbursement arrangements (HRAs) prior to January 1, 2003.

Rev. Rul. 2003–43 generally addresses the issue of whether employer-provided expense reimbursements made through debit cards, credit cards, and other electronic media are excludable from gross income under section 105 of the Internal Revenue Code. Rev. Rul. 2003–43 states that payments made to medical care providers through the use of debit, credit, and stored-value cards are reportable to the Internal Revenue Service by the employer on Form 1099–MISC under section 6041 except to the extent that the exceptions provided in section 1.6041–3 apply.

On December 8, 2003, the Medicare Prescription Drug, Improvement, and Modernization Act of 2003, Pub. L. No. 108–173, 117 Stat. 2066, (the Medicare Act) was enacted. Section 1203 of the Medicare Act amends the Code by adding a new section 6041(f), which provides that section 6041 will not apply to any payment for medical care (as defined in section 213(d)) made under FSAs (as de

the chosen life expectancy table for that year. See Rev. Rul. 2002–62 § 2.02(a) (life expectancy tables). With this method, the account balance, the number from the chosen life expectancy table and the resulting annual payments are redetermined for each year. If this method is chosen, no modification in the series of substantially equal periodic payments will be deemed to occur, even if the amount of payments changes from year to year, provided there is not a change to another method of determining the payments.

Under the fixed amortization method, the annual payment for each year is determined by amortizing in level amounts the account balance over a specified number of years determined by using the chosen life expectancy table and the chosen interest rate. See Rev. Rul. 2002–62 § 2.02(a) (interest rates). With this method, the account balance, the number from the chosen life expectancy table and the resulting annual payment are determined once for the first distribution year and the annual payment is the same amount in each succeeding year.

Under the fixed annuitization method, the annual payment for each year is determined by dividing the account balance by an annuity factor that is the present value of an annuity of $1 per year beginning at the taxpayer’s age and continuing for the life of the taxpayer (or the joint lives of the taxpayer and beneficiary). The annuity factor is derived using the mortality table in Appendix B to Rev. Rul. 2002–62 and using the chosen interest rate. With this method, the account balance, the annuity factor, the chosen interest rate and the resulting annual payment are determined once for the first distribution year and the annual payment is the same amount in each succeeding year.

Prior to 2002, Notice 89–25 provided that the additional § 72(t)(1) tax would be imposed if (i) at any time before attaining age 59 ¹ /2 a taxpayer changed the distribution method to a method that does not qualify for the exception, or (ii) the taxpayer changed the distribution method within 5 years after the receipt of the first payment. Rev. Rul. 2002–62 modified Notice 89–25 by providing two exceptions to this rule. First, an individual is not subject to the § 72(t)(1) additional tax if (i) the payments are not substantially equal because the assets in the individuals account

plan or IRA are exhausted, and (ii) the individual followed one of the prescribed methods of determining whether payments are substantially equal periodic payments. See Rev. Rul. 2002–62 § 2.03(a). Second, an individual who begins receiving distributions in a year using either the fixed amortization or fixed annuitization method may switch to the minimum distribution method for the year of the switch, and all subsequent years, and the change will not be treated as a modification within the meaning of § 72(t)(4). Any subsequent change, however, will be a modification for purposes of § 72(t)(4). See Rev. Rul. 2002–62 § 2.03(b).

APPLICATION OF NOTICE 89–25, AS MODIFIED BY REV. RUL. 2002–62, TO SECTION 72(q)(2)(D).

The IRS and Treasury believe that, when the provisions of § 72 are intended to address different concerns with respect to the treatment of qualified and non-qualified annuities, it is appropriate to apply those provisions in a different manner. However, if the provisions of § 72 are designed to achieve the same purpose whether or not the annuity is qualified or non-qualified, it is appropriate to apply that provision in the same manner to both qualified and non-qualified annuities.

The current language of § 72(q)(2) derives from § 1123(b)(2) of the Tax Reform Act of 1986, Pub. L. No. 99–514, (the “1986 Act”). The legislative history relating to the 1986 Act’s amendments to § 72 indicates that Congress intended that the additional income tax on early withdrawals should be the same for all taxfavored retirement savings arrangements and should be increased so that the additional tax serves, in most cases, to recapture a significant portion of the benefits of deferral of tax on income. See H. Rept. No. 99–426, 99 ^th Cong. 1st Sess. 703–04 (1985), 1986–3 C.B. (vol. 2) 703–04; S. Rept. No. 99–313, 99th Cong. 2d Sess. 567 (1986), 1986–3 C.B. (vol. 3) 567. The IRS and Treasury believe that because these provisions were enacted for the same purpose it is appropriate to apply the same methods to determine whether a distribution is part of a series of substantially equal periodic payments. Therefore, taxpayers may use one of the methods set forth in Notice 89–25, as modi

2004-9 I.R.B. 527 March 1, 2004

of the Public Health Service Act, 42 U.S.C. §§ 300bb–1-300bb–8 (2003));

(2) State-based continuation coverage: Coverage under a state law that requires continuation coverage;

(3) High risk pool: Coverage offered through a qualified state high risk pool (as defined in section 2744(c)(2) of the Public Health Service Act, 42 U.S.C. § 300gg–44(c)(2) (2003));

(4) State employees’ health plan: Coverage under a health insurance program offered for state employees;

(5) Comparable state employees’ health plan: Coverage under a state-based health insurance program that is comparable to the health insurance program offered for state employees;

(6) State arrangement: An arrangement to offer coverage to HCTC eligible individuals entered into by a state with —

(a) an issuer of health insurance coverage;

(b) an administrator;

(d) a group health plan (including a multiemployer plan);

(7) Private purchasing pool: Coverage offered through a state arrangement with a private sector health care coverage purchasing pool;

(8) Other state plans: Coverage under a state-operated health plan that does not receive any federal financial assistance;

(9) Spousal coverage: Coverage under a group health plan that is available through the employment of the HCTC eligible individual’s spouse (but only if the spouse’s employer contributes less than 50 percent of the total cost of coverage for the spouse, the eligible individual, and any dependents); and

(10) Individual health insurance: Coverage under individual health insurance if the HCTC eligible individual was covered under the insurance during the entire 30-day period that ended on the date that the individual became separated from the employment that qualifies the individual as a TAA or PBGC recipient.

.06 Coverage described in paragraphs (1), (9), and (10) of section 2.05 of this revenue procedure - COBRA coverage, spousal coverage, and individual health in

fined in section 106(c)(2)), or under HRAs that are treated as employer-provided coverage under accident or health plans for purposes of section 106. This amendment is effective for payments made after December 31, 2002.

Pursuant to section 7805(b)(8), the Form 1099 requirement described in Rev. Rul. 2003–43 will be applied without retroactive effect for payments made under FSAs and HRAs prior to January 1, 2003. This action is taken to assure employers and third party administrators that FSA and HRA payments for medical care will not be subject to information reporting prior to the effective date of the amendment to section 6041 in the Medicare Act.

The principal author of this notice is Nancy Rose of the Office of Associate Chief Counsel (Procedure and Administration), Administrative Provisions and Judicial Practice Division. For further information regarding this notice, contact Ms. Rose at (202) 622–4910 (not a tollfree call).

Section 35.—Health Insurance Costs of Eligible Individuals

Rev. Proc. 2004–12