Minimum Cost Requirement Permitting the
Transfer of Excess Assets of a Defined Benefit
Pension Plan to a Retiree Health Account

DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Part 1 [REG-116468-00] RIN 1545-AY43

TITLE: Minimum Cost Requirement permitting the transfer of excess
assets of a defined benefit pension plan to a retiree health account

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

SUMMARY: This document contains proposed Income Tax Regulations
relating to the minimum cost requirement under section 420, which
permits the transfer of excess assets of a defined benefit pension
plan to a retiree health account. Pursuant to section 420(c)(3)(E),
these proposed regulations provide that an employer who
significantly reduces retiree health coverage during the cost
maintenance period does not satisfy the minimum cost requirement of
section 420(c)(3). In addition, these proposed regulations clarify
the circumstances under which an employer is considered to have
significantly reduced retiree health coverage during the cost
maintenance period. This document also provides a notice of public
hearing on these regulations.

DATES: Written or electronic comments must be received by March 6,
2001. Requests to speak (with outlines of oral comments to be
discussed) at the public hearing scheduled for March 15, 2001, must
be received by February 21, 2001.

ADDRESSES: Send submissions to: CC:M&SP:RU (REG-116468-00), room
5226, Internal Revenue Service, POB 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand delivered Monday
through Friday between the hours of 8 a.m. and 5 p.m. to: CC:M&SP:RU
(REG-116468-00), Courier's Desk, Internal Revenue Service, 1111
Constitution Avenue, NW., Washington, DC. Alternatively, taxpayers
may submit comments electronically via the Internet by selecting the
"Tax Regs" option on the IRS Home Page, or by submitting comments
directly to the IRS Internet site at
http://www.irs.gov/tax_regs/regslist.html.

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Vernon
S. Carter or Janet A. Laufer, (202) 622-6060; concerning
submissions, Treena Garrett, (202) 622-7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

The Revenue Reconciliation Act of 1990 (Public Law 101-508)(104
Stat. 1388), section 12011, added section 420 of the Internal
Revenue Code (Code), a temporary provision permitting certain
qualified transfers of excess pension assets from a non-
multiemployer defined benefit pension plan to a health benefits
account (defined as an account established and maintained under
section 401(h) of the Code (401(h) account)) that is part of the
plan1. One of the conditions of a qualified section 420
transfer was that the employer satisfy a maintenance of effort
requirement in the form of a "minimum cost requirement" under which
the employer was required to maintain employer-provided retiree
health expenditures for covered retirees, their spouses, and
dependents at a minimum dollar level for a 5-year cost maintenance
period, beginning with the taxable year in which the qualified
transfer occurs.

The Uruguay Round Agreements Act (Public Law 103-465)(108 Stat.
4809) (December 8, 1994), extended the availability of section 420
through December 31, 2000. In conjunction with the extension,
Congress modified the maintenance of effort rules for plans
transferring assets for retiree health benefits so that employers
could take into account cost savings realized in their health
benefit plans. As a result, the focus of the maintenance of effort
requirement was shifted from health costs to health benefits. Under
this "benefit maintenance requirement," which applied to qualified
transfers made after December 8, 1994, an employer had to maintain
substantially the same level of employer-provided retiree health
coverage for the taxable year of the transfer and the following 4
years. The level of coverage required to be maintained was based on
the coverage provided in the taxable year immediately preceding the
taxable year of the transfer.

The Tax Relief Extension Act of 1999 (title V of H.R. 1180, the
Ticket to Work and Work Incentives Improvement Act of 1999)(Public
Law 106-170,113 Stat 1860) (TREA-99) extended section 420 through
December 31, 2005. In conjunction with this extension, the minimum
cost requirement was reinstated as the applicable "maintenance of
effort" provision (in lieu of requiring the maintenance of the level
of coverage) for qualified transfers made after December 17, 1999.
Because the minimum cost requirement relates to per capita cost, an
employer could satisfy minimum cost requirement by maintaining the
average cost even though the employer defeats the purpose of the
maintenance of effort requirement by reducing the number of people
covered by the health plan. In response to concerns regarding this
possibility, TREA-99 also added section 420(c)(3)(E), which requires
the Secretary of the Treasury to prescribe such regulations as may
be necessary to prevent an employer who significantly reduces
retiree health coverage during the cost maintenance period from
being treated as satisfying the minimum cost requirement of section
420(c)(3). If the minimum cost requirement of section 420(c)(3) is
not satisfied, the transfer of assets from the pension plan to the
401(h) account is not a "qualified transfer" to which the provisions
of section 420(a) apply.

Explanation of Provisions

These proposed regulations would provide that the minimum cost
requirement of section 420(c)(3) is not met if the employer
significantly reduces retiree health coverage during the cost
maintenance period. The proposed regulations would measure whether
this occurs by looking at the number of individuals (retirees, their
spouses, and dependents) who lose coverage during the cost
maintenance period as a result of employer actions, measured on both
an annual basis and a cumulative basis.

In determining whether an employer has significantly reduced retiree
health coverage, the regulations would provide that the employer
does not satisfy the minimum cost requirement if the percentage
decrease in the number of individuals provided with applicable
health benefits that is attributable to employer action exceeds 10%
in any year, or if the sum of the annual percentage decreases during
the cost maintenance period exceeds 20%. The 10% annual limit would
not apply to a taxable year that begins before February 5, 2001.

The regulations would provide a broad definition of employer action,
including not only plan amendments but also situations in which
other employer actions, such as the sale of all or part of the
employer's business, operate in conjunction with the existing plan
terms to have the indirect effect of ending an individual's
coverage. The definition of employer action would include plan
amendments that are executed before the cost maintenance period but
take effect during the cost maintenance period, unless the amendment
occurred before the later of December 18, 1999, and 5 years before
the start of the cost maintenance period.

The regulations contain a special rule that addresses situations in
which an employer adopts plan terms that establish eligibility for
health coverage for some individuals, but provide that those same
individuals lose health coverage upon the occurrence of a particular
event or after a stated period of time. In those cases, an
individual is not counted as having lost health coverage by reason
of employer action merely because that individual's coverage ends
upon the occurrence of the event or after the stated period of time.

Under the proposed regulation, when an individual's coverage ends by
reason of a sale of all or part of the employer's business, the
individual is counted as an individual losing coverage by reason of
employer action. The proposed regulation contains no exceptions from
this rule even if the buyer provides coverage for such individuals
(on the implicit assumption that the buyer rarely undertakes to
provide such coverage to retirees in these transactions). Comments
are specifically requested as to (1) the circumstances, if any, in
which buyers commonly provide the seller's retirees, and their
spouses and dependents, with health coverage following a corporate
transaction, and (2) in such cases, criteria that should apply to
the replacement coverage in determining whether to treat those
individuals as not having lost coverage.

Proposed Effective Date

The regulations are proposed to be applicable to transfers of excess
pension assets on or after December 18, 1999.

Special Analyses

It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in Executive Order
12866. Therefore, a regulatory assessment is not required. It has
also been determined that section 553(b) of the Administrative
Procedure Act (5 U.S.C. chapter 5) does not apply to these
regulations, and, because the regulations do not impose a collection
of information on small entities, the Regulatory Flexibility Act (5
U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the
Code, this notice of proposed rulemaking will be submitted to the
Chief Counsel for Advocacy of the Small Business Administration for
comment on its impact on small business.

Comments and Public Hearing

Before these proposed regulations are adopted as final regulations,
consideration will be given to any written comments (a signed
original and (8) copies) or electronic comments that are submitted
timely to the IRS. The IRS and Treasury Department specifically
request comments on the clarity of the proposed rule and how it may
be made easier to understand. All comments will be available for
public inspection and copying.

A public hearing has been scheduled for March 15, 2001, beginning at
10 a.m. in the IRS Auditorium, Seventh Floor, Internal Revenue
Service, 1111 Constitution Avenue, NW., Washington, DC. Due to
building security procedures, visitors must enter at the 10th Street
entrance, located between Constitution and Pennsylvania Avenues, NW.
In addition, all visitors must present photo identification to enter
the building. Because of access restrictions, visitors will not be
admitted beyond the immediate entrance area more than 15 minutes
before the hearing starts. For information about having your name
placed on the building access list to attend the hearing, see the
"For Further Information Contact" portion of this preamble. The
rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who wish
to present oral comments must submit written comments and an outline
of the topics to be discussed and time to be devoted to each topic
(a signed original and eight (8) copies) by February 21, 2001. A
period of 10 minutes will be allotted to each person for making
comments. An agenda showing the scheduling of the speakers will be
prepared after the deadline for receiving outlines has passed.
Copies of the agenda will be available free of charge at the
hearing.

Drafting Information

The principal authors of these regulations are Vernon S. Carter and
Janet A. Laufer, Office of Division Counsel/Associate Chief Counsel
(Tax Exempt and Government Entities). However, other personnel from
the IRS and Treasury Department participated in their development.

Proposed Amendments to the Regulations Accordingly, 26 CFR part 1 is
proposed to be amended as follows:

PART 1--INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by adding
a new entry in numerical order to read in part as follows:

Authority: 26 U.S.C. 7805, 26 U.S.C. 420(c)(3)(E) * * *

Par. 2. Section 1.420-1 is added to read as follows: §1.420-1
Significant reduction in retiree health coverage during the cost
maintenance period.

(a) In general. Notwithstanding section 420(c)(3)(A), the minimum
cost requirements of section 420(c)(3) are not met if the employer
significantly reduces retiree health coverage during the cost
maintenance period.

(b) Significant reduction--

(1) In general. An employer significantly reduces retiree health
coverage during the cost maintenance period if, for any taxable year
during the cost maintenance period, either --

(i) The employer-initiated reduction percentage for that taxable
year exceeds 10%; or

(ii) The sum of the employer-initiated reduction percentages for
that taxable year and all prior taxable years during the cost
maintenance period exceeds 20%.

(2) Special rule for certain taxable years. Notwithstanding
paragraph (b)(1)(i) of this section, an employer will not be treated
as significantly reducing retiree health coverage for a taxable year
that begins before February 5, 2001, merely because the employer-
initiated reduction percentage for that taxable year exceeds 10%.

(3) Employer-initiated reduction percentage. The employer-initiated
reduction percentage for any taxable year is the fraction B/A,
expressed as a percentage, where

A = The total number of individuals (retired employees plus their
spouses plus their dependents) receiving coverage for applicable
health benefits as of the day before the first day of the taxable
year.

B = The total number of individuals included in A whose coverage for
applicable health benefits ended during the taxable year by reason
of employer action.

(4) Employer action--

(i) General rule. For purposes of paragraph (b)(3) of this section,
an individual's coverage for applicable health benefits ends during
a taxable year by reason of employer action, if on any day within
the taxable year, the individual's eligibility for applicable health
benefits ends as a result of a plan amendment or any other action of
the employer (e.g., the sale of all or part of the employer's
business) that, in conjunction with the plan terms, has the effect
of ending the individual's eligibility. An employer action is taken
into account for this purpose regardless of when the employer action
actually occurs (e.g., the date the plan amendment is executed),
except that employer actions occurring before the later of December
18, 1999, and the date that is 5 years before the start of the cost
maintenance period are disregarded.

(ii) Special rule. Notwithstanding paragraph (b)(4)(i) of this
section, coverage for an individual will not be treated as having
ended by reason of employer action merely because such coverage ends
under the terms of the plan if those terms were adopted
contemporaneously with the provision under which the individual
became eligible for retiree health coverage.

(c) Definitions. The following definitions apply for purposes of
this section:

(1) Applicable health benefits. Applicable health benefits means
applicable health benefits as defined in section 420(e)(1)(C)

(2) Cost maintenance period. Cost maintenance period means the cost
maintenance period as defined in section 420(c)(3)(D).

(d) Examples. The following examples illustrate the application of
this section:

Example 1.

(i) Employer W maintains a defined benefit pension plan that
includes a 401(h) account and permits qualified transfers that
satisfy section 420. The number of individuals receiving coverage
for applicable health benefits as of the day before the first day of
Year 1 is 100. In Year 1, Employer W makes a qualified transfer
under section 420. There is no change in the number of individuals
receiving health benefits during Year 1. As of the last day of Year
2, applicable health benefits are provided to 99 individuals,
because 2 individuals became eligible for coverage due to retirement
and 3 individuals died in Year 2. During Year 3, Employer W amends
its health plan to eliminate coverage for 5 individuals, 1 new
retiree becomes eligible for coverage and an additional 3
individuals are no longer covered due to their own decision to drop
coverage. Thus, as of the last day of Year 3, applicable health
benefits are provided to 92 individuals. During Year 4, Employer W
amends its health plan to eliminate coverage under its health plan
for 8 more individuals, so that as of the last day of Year 4,
applicable health benefits are provided to 84 individuals. During
Year 5, Employer W amends its health plan to eliminate coverage for
8 more individuals.

(ii) There is no significant reduction in retiree health coverage in
either Year 1 or Year 2, because there is no reduction in health
coverage as a result of employer action in those years.

(iii) There is no significant reduction in Year 3. The number of
individuals whose health coverage ended during Year 3 by reason of
employer action (amendment of the plan) is 5. Since the number of
individuals receiving coverage for applicable health benefits as of
the last day of Year 2 is 99, the employer-initiated reduction
percentage for Year 3 is 5.05% (5/99), which is less than the 10%
annual limit.

(iv) There is no significant reduction in Year 4. The number of
individuals whose health coverage ended during Year 4 by reason of
employer action is 8. Since the number of individuals receiving
coverage for applicable health benefits as of the last day of Year 3
is 92, the employer-initiated reduction percentage for Year 4 is
8.70% (8/92), which is less than the 10% annual limit. The sum of
the employer-initiated reduction percentages for Year 3 and Year 4
is 13.75%, which is less than the 20% cumulative limit.

(v) In Year 5, there is a significant reduction under paragraph (b)
(1)(ii) of this section. The number of individuals whose health
coverage ended during Year 5 by reason of employer action (amendment
of the plan) is 8. Since the number of individuals receiving
coverage for applicable health benefits as of the last day of Year 4
is 84, the employer-initiated reduction percentage for Year 5 is
9.52% (8/84), which is less than the 10% annual limit. However, the
sum of the employer-initiated reduction percentages for Year 3, Year
4, and Year 5 is 5.05% + 8.70% + 9.52% = 23.27%, which exceeds the
20% cumulative limit.

Example 2.

(i) Employer X maintains a defined benefit pension plan that
includes a 401(h) account and permits qualified transfers that
satisfy section 420. X also provides lifetime health benefits to
employees who retire from Division A as a result of a plant
shutdown, no health benefits to employees who retire from Division
B, and lifetime health benefits to all employees who retire from
Division C. In 2000, X amends its health plan to provide coverage
for employees who retire from Division B as a result of a plant
shutdown, but only for the 2-year period coinciding with their
severance pay. Also in 2000, X amends the health plan to provide
that employees who retire from Division A as a result of a plant
shutdown receive health coverage only for the 2-year period
coinciding with their severance pay. A plant shutdown that affects
Division A and Division B employees occurs in 2000. The number of
individuals receiving coverage for applicable health benefits as of
the last day of 2001 is 200. In 2002, Employer X makes a qualified
transfer under section 420. As of the last day of 2002, applicable
health benefits are provided to 170 individuals, because the 2-year
period of benefits ends for 10 employees who retired from Division A
and 20 employees who retired from Division B as a result of the
plant shutdown that occurred in 2000.

(ii) There is no significant reduction in retiree health coverage in
2002. Coverage for the 10 retirees from Division A who lose coverage
as a result of the end of the 2-year period is treated as having
ended by reason of employer action, because coverage for those
Division A retirees ended by reason of a plan amendment made after
December 17, 1999. However, the terms of the health plan that limit
coverage for employees who retired from Division B as a result of
the 2000 plant shutdown (to the 2- year period) were adopted
contemporaneously with the provision under which those employees
became eligible for retiree coverage under the health plan.
Accordingly, under the rule provided in paragraph (b)(4)(ii) of this
section, coverage for those 20 retirees from Division B is not
treated as having ended by reason of employer action. Thus, the
number of individuals whose health benefits ended by reason of
employer action in 2002 is 10. Since the number of individuals
receiving coverage for applicable health benefits as of the last day
of 2001 is 200, the employer-initiated reduction percentage for 2002
is 5% (10/200), which is less than the 10% annual limit.

(e) Effective date. This section is applicable December 18, 1999,
for qualified transfers occurring on or after that date.

Robert E. Wenzel
Deputy Commissioner of Internal Revenue

Section 420(a)(1) and (2) provide that the trust that
is part of the plan is not 1 treated as failing to satisfy the
qualification requirements of section 401(a) or (h) of the Code, and
no amount is includible in the gross income of the employer
maintaining the plan, solely by reason of such transfer. Also,
section 420(a)(3) provides that a qualified transfer is not treated
as either an employer reversion for purposes of section 4980 or a
prohibited transaction for purposes of section 4975.

In addition, Title I of the Employee Retirement Income Security
Act of 1974 (88 Stat. 829), as amended (ERISA), provides that a
qualified transfer pursuant to section 420 is not a prohibited
transaction under ERISA (ERISA section 408(b)(13)) or a prohibited
reversion of assets to the employer (ERISA section 403(c)(1)). ERISA
also provides certain notification requirements with respect to such
qualified transfers.

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