United States: HEART Act Provides Benefits For Employees On Active Military Duty

The Heroes Earnings Assistance and Relief Tax Act of 2008 primarily amends the Internal Revenue Code of 1986 to provide certain benefits for military personnel and their beneficiaries, including enhanced retirement and welfare benefits.

On June 17, 2008, U.S. President George Bush signed into law the recently passed Heroes Earnings Assistance and Relief Tax Act of 2008 (the HEART Act). The HEART Act amends primarily the Internal Revenue Code of 1986 (the Code) to provide certain benefits for military personnel and their beneficiaries, including enhanced retirement and welfare benefits.

Retirement Benefits

The following summarizes the provisions of the HEART Act that affect the administration of tax-qualified retirement plans. Unless otherwise provided, employers are required (or may in the case of optional provisions) to administer their plans to implement these changes effective January 1, 2007. However, plans do not need to be formally amended until the last day of the 2010 plan year.

Survivor Benefits

If a tax-qualified retirement plan offers certain benefits to survivors of participants who die while actively employed, such as an incidental death benefit or accelerated vesting, the plan must offer these same benefits to survivors of participants who die while performing qualified military service.

Additional Benefit Accruals

Under the HEART Act, employers may amend their plans to credit a participant who dies or becomes disabled during qualified military service with his/her period of qualified military service for purposes of determining benefit accruals under the plan. Under this optional provision, the participant is treated as returning to work on the date preceding his/her death or disability and terminating employment on the actual date of his/her death or disability. By treating the deceased or disabled participant as returning to active employment prior to his/her date of death or disability, the participant may be credited with additional benefit accrual credit in much the same manner as a returning veteran under the Uniformed Services Employment and Reemployment Rights Act (USERRA).

Additionally, under this optional provision, employers may contribute make-up contributions under defined contribution plans and make-up accruals under contributory defined benefit plans for contributions missed while deceased or disabled participants are engaged in qualified military service. For this purpose, employers may treat these individuals as having contributed or deferred under the plan at the average of their participant contributions or deferrals for the 12-month period before their qualified military service or their actual period of service if less than 12 months.

The additional benefit accruals provided under these optional rules must be credited on a reasonably equivalent basis to all employees performing qualified military service who otherwise meet the conditions for receiving the additional accruals.

Extension of Exemption from Early Withdrawal Penalty

Individuals called to active duty after September 11, 2001 and prior to December 31, 2007 for a period of at least 180 days were exempt from the 10 percent penalty tax on early withdrawals from qualified retirement plans. Individuals who took an early withdrawal also had the option to repay the distribution within the two-year period after the end of active duty. The HEART Act indefinitely extends both the penalty exemption and the repayment option to individuals called to active duty after December 31, 2007.

Differential Wage Payments

Any payments made by an employer after December 31, 2008 to an employee on active duty for a period of more than 30 days will be treated as "differential wage payments" to the extent the payments represent all or a portion of the wages the individual would have received from the employer absent being called to active military service. Any such payments will be subject to federal withholding rules and will be reportable as W-2 wages (currently differential wage payments are treated as benefits reportable on IRS Form 1099). Moreover, in the retirement plan context, participants receiving differential wage payments must be treated as active employees and the payments treated as compensation for purposes of determining plan benefits.

A participant on active duty who is treated as an employee due to receipt of differential wage payments is still entitled to take advantage of the rule allowing for distributions from a qualified plan, 403(b) plan or 457 plan upon commencement of military leave lasting at least 30 days (because, in this unique context, leave with differential wage payments is still treated as a separation from service). If a participant receiving differential wage payments takes a distribution, he/she may not make elective deferrals or contributions to the plan for six months following the date of distribution.

Rollovers to Roth IRAs

Recipients of a military death gratuity are eligible to roll this amount over to a Roth IRA or a Coverdell education savings account so long as the rollover is completed within the year following receipt of the gratuity payment. The traditional limitations on rollovers to Roth IRAs do not apply. This change applies to any gratuity payments made with respect to a death that occurs after June 17, 2008. If the gratuity payment was made with respect to a death that occurred after October 7, 2001 and before June 17, 2008, recipients can still take advantage of this rule so long as the rollover is completed by June 17, 2009. This change should not affect an employer's administration of its plans, but employers should be aware of this option.

Welfare Benefits

Flexible Spending Accounts

An employer may amend its health flexible spending arrangement (FSA) to allow reservists called to active duty to withdraw all or a portion of the balance in their account. This distribution will be taxable to the employee. In order to take advantage of this option, the individual must be called to active duty for at least 180 days (or indefinitely) and the distribution must be made on or after the day the individual is called to active duty and on or before the last date on which employees can submit claims for reimbursement under the FSA for the year in which the individual is called to active duty. This optional change allows employers to prevent the active duty employee from forfeiting his/her unused account balance and may be implemented immediately following the enactment of the HEART Act. Employers will have to amend their FSA plans accordingly.

Extension of Mental Health Parity Requirements

The HEART Act amends the Code, the Employee Retirement Income Security Act of 1974 (ERISA), and the Public Health Service Act to extend the mental health party requirements applicable to group health plans through the end of 2008.

To help employers track which of the provisions will apply to their plans, we have created a HEART Act compliance chart. If you would like a copy of that chart or you need further information regarding the issues raised in this On the Subject, please contact your regular McDermott lawyer or either of the contacts to the right.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.