Puerto Rico 401(k) Plans: Do You Know the Rules that Apply?

1 Puerto Rico 401(k) Plans: Do You Know the Rules that Apply? Ren J. Avil s Garcia, MemberFerraiuoli, of Contents Background on Puerto Rico Retirement Plans in Puerto Rico PR-only and Dual Qualified Plans Income Source Rules ERISA 1022(i) Code versus PR Code Comparisons for Retirement Plans Special PR Taxation, Reporting, and Withholding Rules Tax Qualification with Hacienda Recent Amendments to PR Code3 Background on Puerto Rico s Interactions with the USA USTerritorysince1898(Spanish-AmericanWar ) (since1917) PuertoRicohasitsowntaxcode(currentlytheP RInternalRevenueCodeof2011,asamended,ort he PRCode ) Bona-fideindividualresidentsofPRareexemp tfromFederalincometaxationonPR-sourceinc ome( ) However, ( (e)) ERISA generallyappliestoPRbenefitplans,subject tocertainlimitedexceptions( , )4 Who Maintains Retirement Plans in Puerto Rico? Existingemployers:PRaffiliatesofUS/multi nationalsthatofferretirementplanbenefits totheiremployeesandwishtomaintainsimilar retirementplanofferingstoitsworkforceacr ossgeographies Existingemployers:localPRemployerswhowis htoofferretirementbenefitstotheirworkfor ce Newemployers:US/multinationalsexpandingo perationsinPuertoRico M&Aemployers:corporateacquisitionswithop erationsinPuertoRico5 Alternatives for Providing Retirement Plan Benefits to PR Workforce ( ,DualQualifiedPlan) EstablishseparatePRstand-aloneplan(PR-On lyQualifiedPlan)6 Dual Qualified Plans: How Do You Do That?

2 ( , ) AmendmentsshouldonlyapplytoPRresidentsan d/orpersonswhoprovideservices primarilywithinPuertoRico ( , ) ( , ,recordkeeping,andinvestments),butshould determineifseparatePRtaxreportingandwith holdingisrequired InmanyinstancesaPR-payingagentishiredtoa ssistinsuchtaxreportingandwithholdings7P R-Only Qualified Plans: Steps Step1:Establishstand-alonePRplancovering onlyPRresidentindividualsand/orpersonspr ovidingservicesprimarilywithinPuertoRico Step2:EstablishPRtrustforPRplan Step3:Coordinatewithcustodian(canbesameU Splancustodian)toreceiveassetsandexecute investments Step4:Establishtaxwithholdingandreportin g(maybesametrustee,custodian,orthird-par ty)8 Types of PR-Only Qualified designed MasterPlanAdoption:AdoptswithMasterPlana ndMasterTrust PrototypePlanAdoption:AdoptsaPrototypePl anbuthasitsownstand-alonetrustdocument9 Pros and Cons of Dual Qualified PlansAdvantagesDisadvantagesOne PlanDual TaxationIRS/PR Treasury (source)One 5500 Additional PR withholding/reportingOne TrustSome Plan providers will not want to handle PR accountsOne SPDC orrection of errorsrequires and PR ComplianceEasyto handle expats to PRIssues with rolloversSame 401k limits ($18k for 2017)Coverage/ADP testing complexities10 Pros and Cons of Puerto Rico-Only Qualified PlansAdvantagesDisadvantagesNo impact on Plan by PR Plan operation2 Plans ( Plan andPR Plan)Easier to administer corrections (PR only)2 TrustSimpler taxation to participants (PR only)2 SPDsNO ACP testing (for 401kplans)Difficult to handle expats to PRLower 401k limits ($15k vs $18k in 2017)No rollovers to Source Rules to Consider RevenueRuling79-388(SourceRules) RevenueRuling2008-40(TransferRules)

3 RevenueProcedure2004-37(sourceallocation ofD/Bpensionpaymentstoparticipants)12 Income Source Rules to Consider (Continued)IfPlan has a TrustIf Plan has a PR TrustContributionsPR SourcePR Source* **PRresidentsareworldwidetaxableinPRandt akecreditfortaxespaidinotherjurisdiction s13 ERISA Section 1022(i) CertainPuertoRicanPension,etc.,PlanstoBe ExemptFromTaxunderSection501(A) ,1973,forpurposesofsection501(a)oftheInt ernalRevenueCodeof1954(relatingtoexempti onfromtax),anytrustformingpartofapension ,profitsharing,orstockbonusplanallofthep articipantsofwhichareresidentsoftheCommo nwealthofPuertoRicoshallbetreatedasanorg anizationdescribedinsection401(a) ,profitsharing,orstockbonusplan, Section 1022(i) (Continued) ,andamendmentsmadeby, ,profitsharing,orstockbonusplanwhichiscr eatedororganizedinPuertoRicoelects,atsuc htimeandinsuchmannerastheSecretaryoftheT reasurymayrequire,tohavetheprovisionsoft hisparagraphapply,forplanyearsbeginninga fterthedateofelection,anytrustformingapa rtofsuchplanshallbetreatedasatrustcreate dororganizedintheUnitedStatesforpurposes ofsection401(a) (a),oncemade, Section 1022(i)(1)

4 Allowsforexemptionfromfederalincometaxat ionofearningsandaccretionsofPRtrustsrela tedtoPuertoRicoonlytaxqualifiedretiremen tplansduringtheparticipants accumulationperiodbytreatingsuchplansasa planqualifiedunderUSCodeSection401(a)(fo rpurposesofUSCodeSection501(a))16 ERISA Section 1022(i)(1) (Continued) Requirements: PRqualifiedplan CoveringONLYPR residentsorpersonsprovidingservicesprima rilywithinPR17 ERISA Section 1022(i)(2) Allowsforspecialkindofdual-qualifiedplan withaPRtrust Suchplananditsenablingtrustwillbetreated asaUStax-qualifiedretirementplanunderSec tion401(a)oftheUSCode Generallyusedfor(i)PRemployersexpandingo perationsintheUSA;(ii)USemployersthatwan taseparatePRplanbutthatcanallowfortransf ersofemployeesandtheirbenefitsbetweenthe PRandUSplans;and/or(iii)forUSemployersth athavePRparticipantswhoseaccountbalancea reintendedtobesegregatedfromtheUSplan stax-qualifiedtrust18 Comparison of Statutory Provisions (US Code Versus PR Code): CodePR CodeMinimumCoverage410(b) (c)(3)Non-Discrimination401(a)(4) (a)(4)Cash or Deferred Arrangement401(k) (d)Catch-UpContributions414(v) (d)(7)(c)ADP Testing401(k)(3) (d)(3)Benefit/Contribution Limits415(b)/415(c) (a)(11)(A)and (B)CompensationLimits401(a)(17) (a)(12)19 Comparison of Statutory Provisions (US Code Versus PR Code).

5 CodePR CodeMinimum Participation410(a)(2)N/ATop-Heavy Provisions416N/AMRDs401(a)(9)N/ACODA Limits$18k(adjusted)$15k (staticfor PR-Q only)*Catch-Up Contributions$5k (adjusted)$1,500 (static)ACPT esting401(m)N/AHCEs414(q)(Notop-paid group Rule)*Dual qualified plan are allowed the same Code CODA limits (with IRA interaction)20 Special Taxation and Withholding Rules in Puerto RicoType of DistributionTaxationWithholdingLump SumGeneralRule: 20% (*)10% of taxable amount (**)Exception: 10% if plan meetscertain PR investment rule (or ordinary income at the taxpayer s election)) (*)10% of taxable amountInstallment/AnnuityOrdinaryincome with $11k (under age 60) or $15k (age 60+) annual exemption10% in excess of $31k (under age 60) or $35k (age 60+) annuallyOther PaymentsOrdinary income10% of taxable amount(*) Subject to PR AMT Rules .(**) For distributions made on/after 1/1 Tax Reporting Rules for PR Qualified Plan Distributions (Dual or PR-only) (localequivalenttoIRSForm1099-R) Reporting Rules for PR Qualified Plans and Trusts (Both Dual and PR-only) Planqualification(filingwithPRTreasurya/ k/aHacienda):a)Uponplanestablishment(ono rbeforetheduedatefortheemployertofileinc ometaxreturn)b)Uponadoptionofa qualificationamendment c)Uponmergerorconsolidationoftwoormorequ alifiedplansd)Uponplantermination RulesforPlanqualificationsubmissiontoHac iendacurrentlysetforthinPRTreasuryCircul arLetter16-0823 Tax Qualification Rules for Puerto Rico Tax-Qualified Plans: What Constitutes a Qualification Amendment?

6 Changesineligibilityrules( ,participationfreezes,etc.) Changesinformulastodetermineparticipantb enefits( ,allocationformulas) Changesintheformormethodforpaymentofbene fits(installments,partialpayments,etc.) Add,remove,orsubstituteparticipatingempl oyers(excludingrenamingwithsameEIN) Changesinrulestocorrectcoverage,discrimi nation,orADPtesting24 Tax Qualification Rules for Puerto Rico Tax-Qualified Plans: What Constitutes a Qualification Amendment? (Continued) Changesinrulestograntservicecreditwithpr edecessoremployerortocalculatebenefitsor contributions Benefitfreezesorcessationoffuturebenefit s Planconsolidations,mergers,ortermination s Substitutionofplansponsor,administrator, orpayingagentforPRparticipants ChangesinplannameorplantrustEIN Substitutionofmaster/prototypeplansponso r Others,asthePRTreasurymaydeterminepursua nttoregulationsorguidance25 Annual PR Qualified Plan Reporting Requirements AnnualForm5500reportingrequirements,same asforUS-basedretirementplans AnnualFormSC6042(foryearsbeginningin2015 andthereafter) (OE)(forprioryears) SeePRTreasuryCircularLetters16-05(establ ishingtheFormSC6042requirement)and12-02( (OE)throughuseofcopyofForm5500foryearsbe ginningin2011until2015)26 Recent PR Code Amendments to Be Considered Act 9-2017 (February 2017) Act 106-2017 (August 2017)27 Most Important Changes Brought byActs 9 and 106 (q)(1)(B)

7 Tostatic$150K PRSafe-HarborRuleforADPT esting:IF(i)employerhasunder$10millionin annualgrossincome;(ii)plancoverslessthan 100participants;and(iii)employerprovides abenefittoalleligibleemployeesofatleastt hreepercentofcompensation,THEN,ADPT estingwillbedeemedpassedforsuchyear28 Most Important Changes Brought byActs 9 and 106 (Continued) :FordualqualifiedplanswithUStrusts( ,non-ERISA1022(i)(2)dualqualifiedplans) ( (b))thentheplanwillbedeemedtocomplywithP RCoveragetesting( (a)(3)) Changeintaxwithholdingforlumpsumdistribu tions(effective1/1/18) ,taxratesremainthesame(20percentordinary taxrates,attheelectionoftaxpayer).29 Questions?Miss the 2018 Spring Virtual Conference?Go to: the On-Demand Recording!Member price: $299 Nonmember price: $349 Worth CE Credits!