These synopses are intended only as aids to the reader in

Bulletin No. 1999–8

February 22, 1999

Internal Revenue

bulletin

HIGHLIGHTS

OF THIS ISSUE

These synopses are intended only as aids to the reader in

identifying the subject matter covered. They may not be

relied upon as authoritative interpretations.

INCOME TAX

EMPLOYEE PLANS

T.D. 8812, page 19.

REG–121865–98, page 63.

Notice 99–11, page 56.

Final and proposed regulations under section 4980B of the

Code relate to continuation coverage requirements applicable to group health plans. A public hearing will be held on

June 8, 1999.

T.D. 8816, page 4.

Weighted average interest rate update. Guidelines for

determining the weighted average interest rate for February

1999 the weighted average interest rate and the resulting

permissible range of interest rates used to calculate current

liability for purposes of the full funding limitation of section

412(c)(7) of the Code are set forth.

Final regulations under section 408A of the Code relate to

Roth IRAs.

EXEMPT ORGANIZATIONS

T.D. 8817, page 51.

Announcement 99–15, page 78.

Final regulations under section 6038B of the Code relate to

information reporting requirements for certain transfers of

property by United States persons to foreign partnerships

and relate to reporting requirements for certain transfers of

cash to foreign corporations.

REG–106902–98, page 57.

Proposed regulations under section 1502 of the Code relate

to consolidated return regulations relating to the treatment

of overall foreign losses and separate limitation losses in the

computation of the foreign tax credit limitation.

Finding Lists begin on page 82.

Department of the Treasury

Internal Revenue Service

The list is given of organizations now classified as private

foundations.

ADMINISTRATIVE

Announcement 99–16, page 80.

New Form 8866, Interest Computation Under the Look-Back

Method for Property Depreciated under the Income Forecast

Method, is now available.

Mission of the Service

and by applying the tax law with integrity and fairness to

all.

Provide America’s taxpayers top quality service by helping them understand and meet their tax responsibilities

Statement of Principles

of Internal Revenue

Tax Administration

The Service also has the responsibility of applying and

administering the law in a reasonable, practical manner.

Issues should only be raised by examining officers when

they have merit, never arbitrarily or for trading purposes.

At the same time, the examining officer should never hesitate to raise a meritorious issue. It is also important that

care be exercised not to raise an issue or to ask a court to

adopt a position inconsistent with an established Service

position.

The function of the Internal Revenue Service is to administer the Internal Revenue Code. Tax policy for raising revenue

is determined by Congress.

With this in mind, it is the duty of the Service to carry out that

policy by correctly applying the laws enacted by Congress;

to determine the reasonable meaning of various Code provisions in light of the Congressional purpose in enacting them;

and to perform this work in a fair and impartial manner, with

neither a government nor a taxpayer point of view.

Administration should be both reasonable and vigorous. It

should be conducted with as little delay as possible and

with great courtesy and considerateness. It should never

try to overreach, and should be reasonable within the

bounds of law and sound administration. It should, however, be vigorous in requiring compliance with law and it

should be relentless in its attack on unreal tax devices and

fraud.

At the heart of administration is interpretation of the Code. It

is the responsibility of each person in the Service, charged

with the duty of interpreting the law, to try to find the true

meaning of the statutory provision and not to adopt a

strained construction in the belief that he or she is “protecting the revenue.” The revenue is properly protected only

when we ascertain and apply the true meaning of the statute.

2

Introduction

The Internal Revenue Bulletin is the authoritative instrument

of the Commissioner of Internal Revenue for announcing official rulings and procedures of the Internal Revenue Service

and for publishing Treasury Decisions, Executive Orders, Tax

Conventions, legislation, court decisions, and other items of

general interest. It is published weekly and may be obtained

from the Superintendent of Documents on a subscription

basis. Bulletin contents of a permanent nature are consolidated semiannually into Cumulative Bulletins, which are sold

on a single-copy basis.

dures must be considered, and Service personnel and others concerned are cautioned against reaching the same conclusions in other cases unless the facts and circumstances

are substantially the same.

The Bulletin is divided into four parts as follows:

Part I.—1986 Code.

This part includes rulings and decisions based on provisions

of the Internal Revenue Code of 1986.

It is the policy of the Service to publish in the Bulletin all substantive rulings necessary to promote a uniform application

of the tax laws, including all rulings that supersede, revoke,

modify, or amend any of those previously published in the

Bulletin. All published rulings apply retroactively unless otherwise indicated. Procedures relating solely to matters of internal management are not published; however, statements

of internal practices and procedures that affect the rights

and duties of taxpayers are published.

Part II.—Treaties and Tax Legislation.

This part is divided into two subparts as follows: Subpart A,

Tax Conventions, and Subpart B, Legislation and Related

Committee Reports.

Part III.—Administrative, Procedural, and Miscellaneous.

To the extent practicable, pertinent cross references to

these subjects are contained in the other Parts and Subparts. Also included in this part are Bank Secrecy Act Administrative Rulings. Bank Secrecy Act Administrative Rulings

are issued by the Department of the Treasury’s Office of the

Assistant Secretary (Enforcement).

Revenue rulings represent the conclusions of the Service on

the application of the law to the pivotal facts stated in the

revenue ruling. In those based on positions taken in rulings

to taxpayers or technical advice to Service field offices,

identifying details and information of a confidential nature

are deleted to prevent unwarranted invasions of privacy and

to comply with statutory requirements.

Part IV.—Items of General Interest.

With the exception of the Notice of Proposed Rulemaking

and the disbarment and suspension list included in this part,

none of these announcements are consolidated in the Cumulative Bulletins.

Rulings and procedures reported in the Bulletin do not have

the force and effect of Treasury Department Regulations,

but they may be used as precedents. Unpublished rulings

will not be relied on, used, or cited as precedents by Service

personnel in the disposition of other cases. In applying published rulings and procedures, the effect of subsequent legislation, regulations, court decisions, rulings, and proce-

The first Bulletin for each month includes a cumulative index

for the matters published during the preceding months.

These monthly indexes are cumulated on a quarterly and

semiannual basis, and are published in the first Bulletin of the

succeeding quarterly and semiannual period, respectively.

The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.

For sale by the Superintendent of Documents, U.S. Government Printing Office, Washington, DC 20402.

3

Part I. Rulings and Decisions Under the Internal Revenue Code of 1986

Section 408A.—Roth IRAs

26 CFR 1.408A–1: Roth IRAs in general.

T.D. 8816

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 602

Roth IRAs

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Final regulations

SUMMARY: This document contains

final regulations relating to Roth IRAs

under section 408A of the Internal Revenue Code (Code). Roth IRAs were created by the Taxpayer Relief Act of 1997

as a new type of IRA that individuals can

use beginning in 1998. Section 408A was

amended by the Internal Revenue Service

Restructuring and Reform Act of 1998.

On September 3, 1998, a notice of proposed rulemaking (REG–115393–98

I.R.B. 34) was published in the Federal

Register (63 F.R. 46937) under Code section 408A. Written comments were received regarding the proposed regulations. On December 10, 1998, a public

hearing was held on the proposed regulations. The final regulations affect individuals establishing Roth IRAs, beneficiaries

under Roth IRAs, and trustees, custodians

or issuers of Roth IRAs.

DATES: Effective date: The final regulations are effective on February 3, 1999.

Applicability date: The final regulations are applicable to taxable years beginning on or after January 1, 1998, the

effective date for section 408A.

FOR FURTHER INFORMATION CONTACT: Cathy A. Vohs, (202) 622-6030

(not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information contained in §§1.408A–2, 1.408A–4,

1.408A–5, and 1.408A–7 of the final reg-

February 22, 1999

ulations have been reviewed and approved by the Office of Management and

Budget in accordance with the Paperwork

Reduction Act of 1995 (44 U.S.C.

3507(d)) under control number 15451616. Responses to this collection of information are mandatory.

An agency may not conduct or sponsor,

and a person is not required to respond to,

a collection of information unless it displays a valid control number assigned by

the Office of Management and Budget.

Estimated average annual burden per

respondent/recordkeeper: 1 minute for

designating an IRA as a Roth IRA and 30

minutes for recharacterizing an IRA contribution. The estimated burdens for the

other reporting/recordkeeping requirements in the these final regulations are reflected in the burden of Forms 8606,

1040, 5498, and 1099R.

Comments concerning the accuracy of

this burden estimate and suggestions for

reducing this burden should be sent to the

Office of Management and Budget,

Attn: Desk Officer for the Department of

the Treasury, Office of Information and

Regulatory Affairs, Washington, DC

20503, with copies to the Internal Revenue Service, Attn: IRS Reports Clearance Officer, OP:FS:FP, Washington, DC

20224.

Books or records relating to a collection of information must be retained as

long as their contents may become material in the administration of any internal

revenue law. Generally, tax returns and

tax return information are confidential, as

required by 26 U.S.C. 6103.

Background

On September 3, 1998, a notice of proposed rulemaking was published in the

Federal Register (63 F.R. 46937) under

section 408A of the Internal Revenue

Code (Code). The proposed regulations

provide guidance on section 408A of the

Code, which was added by section 302 of

the Taxpayer Relief Act of 1997, Public

Law 105-34 (111 Stat. 788), and established the Roth IRA as a new type of individual retirement plan, effective for taxable years beginning on or after January

1, 1998. The provisions of section 408A

were amended by the Internal Revenue

4

Service Restructuring and Reform Act of

1998, Public Law 105-206 (112 Stat.

685). In addition, Notice 98–50 (1998–44

I.R.B. 10) provides guidance on reconverting an amount that had previously

been converted and recharacterized. This

notice solicited public comments concerning reconversions.

Written comments were received on the

proposed regulations and Notice 98–50.

A public hearing was held on the proposed regulations and Notice 98–50 on

December 10, 1998. After consideration

of all the comments, the proposed regulations under section 408A are adopted as

revised by this Treasury decision.

Explanation of Provisions

Overview

A Roth IRA generally is treated under

the Code like a traditional IRA with several significant exceptions. Similar to traditional IRAs, income on undistributed

amounts accumulated under Roth IRAs is

exempt from Federal income tax, and

contributions to Roth IRAs are subject to

specific limitations. Unlike traditional

IRAs, contributions to Roth IRAs cannot

be deducted from gross income, but qualified distributions from Roth IRAs are excludable from gross income.

In general, comments received on the

proposed regulations did not request significant changes. Thus, the final regulations retain the general structure and substance of the proposed regulations.

General Provisions and Establishment of

Roth IRAs

Commentators asked for clarification

regarding whether a Roth IRA may be established for the benefit of a minor child

or anyone else who lacks the legal capacity to act on his or her own behalf. On

this point, the IRS and Treasury intend

that the rules for traditional IRAs also

apply to Roth IRAs. Thus, for example, a

parent or guardian of a minor child may

establish a Roth IRA on behalf of the

minor child. However, in the case of any

contribution to a Roth IRA established for

a minor child, the compensation of the

child for the taxable year for which the

contribution is made must satisfy the

1999–8 I.R.B.

compensation requirements of section

408A(c) and §1.408A–3.

Regular Contributions

Several commentators requested clarification of the treatment of excess Roth

IRA contributions under sections 4973,

408(d)(5), and 219(f)(6). Commentators

asked for clarification regarding the removal of excess Roth IRA contributions

after the contributor’s Federal tax return

due date has passed. The final regulations

clarify that, pursuant to section 4973(f),

excess contributions may be applied, on a

year-by-year basis, against the annual

limit for regular contributions to the extent that the Roth IRA owner is eligible to

make regular Roth IRA contributions for

a taxable year but does not otherwise do

so. However, in response to several requests for clarification, the IRS and Treasury note that the rules under section

408(d)(5) for the tax- free distribution of

certain excess traditional IRA contributions after the IRA owner’s Federal income tax return due date do not apply to

Roth IRAs because Roth IRA contributions are always tax-free on distribution

(except to the extent that they accelerate

income inclusion under the 4-year

spread). Similarly, section 219(f)(6),

which provides for the deductibility of excess traditional IRA contributions in subsequent taxable years, has no application

to Roth IRAs because contributions to

Roth IRAs are never deductible.

Another commentator asked for clarification whether contributions to education

IRAs are disregarded for purposes of applying the limitation on regular contributions to Roth IRAs. No change has been

made to the final regulations on this point

because the final regulations retain the definition of an IRA provided in the proposed regulations, which excludes an education IRA under section 530. Thus,

contributions to an education IRA are disregarded in applying the Roth IRA contribution limitation (and in applying the

contribution limitation for traditional

IRAs).

Conversions

In response to certain comments, the

final regulations clarify that conversions

and recharacterizations made with the

same trustee may be accomplished by re-

1999–8 I.R.B.

designating the account or annuity contract, rather than by the opening of a new

account or the issuance of a new annuity

contract for each conversion or recharacterization.

As requested by commentators, the

final regulations provide that a change in

filing status or a divorce does not affect

the application of the 4-year spread for

1998 conversions. Thus, if a married

Roth IRA owner who is using the 4-year

spread files separately or divorces before

the full taxable conversion amount has

been included in gross income, the remainder must be included in the Roth

IRA owner’s gross income over the remaining years in the 4-year period, or, if

applicable, in the year for which the remainder is accelerated due to distribution

or death.

Two commentators questioned why the

proposed regulations require that a surviving spouse be the sole beneficiary of

all a Roth IRA owner’s Roth IRAs in

order to elect to continue application of

the 4-year spread after the Roth IRA

owner’s death. The IRS and Treasury

view this result as compelled by the statutory language of section 408A(d)(3)(E)(ii)(II). That section provides that the

surviving spouse must acquire the “entire

interest” in any Roth IRA to which a conversion contribution to which the 4-year

spread applies is “properly allocable.”

Under the aggregation and ordering rules

of section 408A(d)(4), all a Roth IRA

owner’s Roth IRAs are treated as a single

Roth IRA, and a conversion contribution

is therefore allocable to all the owner’s

Roth IRAs. Thus, a surviving spouse

must be the sole beneficiary of all a Roth

IRA owner’s Roth IRAs in order to acquire the entire interest in any Roth IRA

to which a 1998 conversion contribution

is properly allocable.

Commentators also asked the IRS and

Treasury to clarify whether Roth IRA distributions that are part of a series of substantially equal periodic payments begun

under a traditional IRA prior to conversion to a Roth IRA are subject to income

acceleration during the 4-year spread period and the 10-percent additional tax on

early distributions under section 72(t).

The final regulations clarify that those

distributions are subject to income acceleration to the extent allocable to a 1998

conversion contribution with respect to

5

which the 4-year spread applies. The

final regulations further clarify, however,

that the additional 10-percent tax under

section 72(t) will not apply, even if the

distributions are not qualified distributions (as long as they are part of a

series of substantially equal periodic

payments).

Under the proposed regulations, if an

IRA owner has reached age 70 1⁄2, any

amount distributed (or treated as distributed because of a conversion) from the

IRA for a year consists of the required

minimum distribution to the extent that an

amount equal to the required minimum

distribution for that year has not yet been

distributed (or treated as distributed); as a

required minimum distribution, that

amount cannot be converted to a Roth

IRA. Although one commentator requested that this rule be retained in the

final regulations, other commentators objected to it. A number of commentators

asked the IRS and Treasury to adopt a rule

allowing an IRA owner who wishes to

convert a traditional IRA to a Roth IRA in

the year he or she turns 701⁄2 to leave the

amount of his or her required minimum

distribution with respect to such IRA in

the IRA until April 1 of the following

year, provided the conversion is accomplished by means of a trustee-to-trustee

transfer. The commentators note that this

rule applies in the case of trustee-totrustee transfers between traditional

IRAs. The final regulations retain the rule

that the required minimum distribution

amount is ineligible for rollover, including such a distribution for the year that the

individual reaches age 701⁄2, because, pursuant to section 408A(d)(3)(C), a conversion is treated as a distribution regardless

of whether the conversion is accomplished by a trustee-to-trustee transfer.

Accordingly, the required minimum distribution amount is ineligible for rollover,

and as such, is also ineligible to be converted to a Roth IRA.

Additionally, several commentators

suggested that the rule in the proposed

regulations is inconsistent with section

401(a)(9), which generally requires that

IRA distributions begin by April 1 of the

calendar year following the calendar year

in which the IRA owner reaches age 701⁄2.

These commentators argued that, under

section 401(a)(9), distributions made during the calendar year in which the IRA

February 22, 1999

owner reaches age 701⁄2 should not be considered required minimum distributions

under sections 401(a)(9) and 408(a)(6)

and (b)(3). However, the proposed regulations under sections 401(a)(9) and

408(a)(6) and (b)(3) provide that the first

year for which distributions are required

under section 401(a)(9) is the year in

which the IRA owner reaches age 701⁄2,

and that distributions made prior to April

1 of the following calendar year are

treated as made for that first year. The

regulations under section 402(c) and the

proposed regulations under sections

401(a)(9) and 408(a)(6) and (b)(3) provide that the first amount distributed during a calendar year is treated as a required

minimum distribution to the extent that

the amount required to be distributed for

that calendar year under section 401(a)(9)

has not been distributed. For these reasons, the final regulations retain the rule

of the proposed regulations.

Recharacterizations of IRA Contributions

The final regulations clarify that the

computation of net income under §1.408–

4(c)(2)(iii) in the case of a commingled

IRA may include net losses on the amount

to be recharacterized.

Commentators asked the IRS and Treasury to clarify whether an amount converted from a SEP IRA or SIMPLE IRA

to a Roth IRA may be recharacterized

back to the SEP IRA or SIMPLE IRA

from which the amount was converted.

The final regulations provide that Roth

IRA conversion contributions from a SEP

IRA or SIMPLE IRA may be recharacterized to a SEP IRA or SIMPLE IRA (including the original SEP IRA or SIMPLE

IRA). Another commentator also asked

for clarification whether it is necessary to

track the source of assets (i.e., as employer or employee contributions) converted from a SEP IRA or SIMPLE IRA

to a Roth IRA for purposes of determining

whether such assets may be recharacterized. The prohibition on recharacterizing

employer contributions to a SEP IRA or

SIMPLE IRA set forth in the final regulations only applies to those contributions at

the time they are made to the SEP IRA or

SIMPLE IRA. Once such contributions

have been made to a SEP IRA or a SIMPLE IRA, the SEP IRA or SIMPLE IRA

may be converted to a Roth IRA and subsequently recharacterized (provided, in

February 22, 1999

the case of a SIMPLE IRA, that the twoyear rule has been satisfied prior to the

conversion).

Commentators asked for clarification

regarding whether an election to recharacterize an IRA contribution may be made

on behalf of a deceased IRA owner. The

final regulations provide that the election

to recharacterize an IRA contribution may

be made by the executor, administrator, or

other person charged with the duty of filing the decedent’s final Federal income

tax return.

Commentators also asked whether an

excess contribution to an IRA made in a

prior year, and applied against the contribution limits in the current year under

section 4973, may be recharacterized.

Only actual contributions may be recharacterized; thus, excess contributions actually made for a prior year and deemed to

be current-year contributions for purposes

of section 4973, are not contributions that

are eligible to be recharacterized (unless

the recharacterization would still be

timely with respect to the taxable year for

which the contributions were actually

made). This rule applies to any excess

contribution, whether made to a traditional or a Roth IRA.

Commentators asked for clarification

regarding a conduit IRA that is converted

to a Roth IRA and subsequently recharacterized back to a traditional IRA. The

IRS and Treasury note that a conduit IRA

that is converted to a Roth IRA and subsequently recharacterized back to a traditional IRA retains its status as a conduit

IRA because the effect of the recharacterization is to treat the amount recharacterized as though it had been transferred directly from the original conduit IRA into

another conduit IRA.

Commentators also asked whether a

recharacterization is subject to withholding. A recharacterization is not a designated distribution under section 3405 and,

therefore, is not subject to withholding.

The final regulations also provide rules

regarding the “reconversion” of an

amount that has been transferred from a

Roth IRA to a traditional IRA by means of

a recharacterization after having been earlier converted from a traditional IRA to a

Roth IRA. After publication of the proposed regulations, the IRS and Treasury

issued Notice 98–50, which provides interim rules regarding Roth IRA reconver-

6

sions made during 1998 and 1999. Notice

98-50 stated that the interim rules were

intended to clarify and supplement the

proposed regulations and permitted taxpayers to rely on those rules as if incorporated in the proposed regulations. Notice

98-50 noted that the IRS and Treasury

were considering whether the final regulations should provide that a taxpayer is

not eligible to reconvert an amount before

the end of the taxable year in which the

amount was first converted (or the due

date for that taxable year), or that a taxpayer who transfers a converted amount

back to a traditional IRA in a recharacterization must wait until the passage of a

fixed number of days before reconverting.

Although Notice 98-50 invited interested

parties to submit comments on those approaches, little comment was received on

that issue. The final regulations provide

reconversion rules for 2000 and subsequent years that generally differ from the

interim rules of Notice 98–50. However,

for 1998 and 1999, the final regulations

continue the interim rules of Notice

98–50.

Effective January 1, 2000, an IRA

owner who converts an amount from a

traditional IRA to a Roth IRA during any

taxable year and then transfers that

amount back to a traditional IRA by

means of a recharacterization may not reconvert that amount from the traditional

IRA to a Roth IRA before the beginning

of the taxable year following the taxable

year in which the amount was converted

to a Roth IRA or, if later, the end of the

30-day period beginning on the day on

which the IRA owner transfers the

amount from the Roth IRA back to a traditional IRA by means of a recharacterization. As under Notice 98–50, any

amount previously converted is adjusted

for subsequent net income in determining

the amount subject to the limitation on

subsequent reconversions.

A reconversion made before the later of

the beginning of the next taxable year or

the end of the 30-day period that begins

on the day of the recharacterization is

treated as a “failed conversion” (a distribution from the traditional IRA and a regular contribution to the Roth IRA), subject

to correction through a recharacterization

back to a traditional IRA. For these purposes, only a failed conversion resulting

from a failure to satisfy the statutory re-

1999–8 I.R.B.

quirements for a conversion (e.g., the

$100,000 modified adjusted gross income

limit) is treated as a conversion in determining when an IRA owner may make a

reconversion. Thus, an IRA owner whose

taxable year is the calendar year and who

converts an amount to a Roth IRA in 2000

and then transfers that amount back to a

traditional IRA on January 18, 2001 because his or her adjusted gross income for

2000 exceeds $100,000 cannot reconvert

that amount until February 17, 2001 (the

first day after the end of the 30-day period

beginning on the day of the recharacterization transfer) because the failed conversion made in 2000 is treated as a conversion for purposes of the reconversion

rules. However, if that IRA owner inadvertently attempts to reconvert that

amount before February 17, 2001, the attempted reconversion is not treated as a

conversion for purposes of the reconversion rules (although it is otherwise treated

as a failed conversion). Therefore, the

IRA owner could transfer the amount

back to a traditional IRA in a recharacterization and reconvert it at any time on or

after February 17, 2001. If the IRA owner

does reconvert the amount on or after

February 17, 2001, he or she cannot reconvert that amount again until 2002.

As indicated above, the final regulations continue the interim rules of Notice

98-50 applicable for 1998 and 1999.

Therefore, an IRA owner who converts an

amount from a traditional IRA to a Roth

IRA during 1998 and then transfers that

amount back to a traditional IRA by

means of a recharacterization may reconvert that amount once (but no more than

once) on or after November 1, 1998 and

on or before December 31, 1998; the IRA

owner may also reconvert that amount

once (but no more than once) during

1999. Similarly, an IRA owner who converts an amount from a traditional IRA to

a Roth IRA during 1999 that has not been

converted before and then transfers that

amount back to a traditional IRA by

means of a recharacterization may reconvert that amount once (but no more than

once) on or before December 31, 1999.

In contrast to the rule for years after 1999,

a failed conversion is not treated as a conversion for these 1998 and 1999 interim

rules.

As did Notice 98–50, the final regulations provide that a reconversion made

1999–8 I.R.B.

during 1998 or 1999 for which the IRA

owner was not eligible is deemed to be an

“excess reconversion” and does not

change the IRA owner’s taxable conversion amount. Instead, the excess reconversion and the last preceding recharacterization are not taken into account for

purposes of determining the IRA owner’s

taxable conversion amount, and the IRA

owner’s taxable conversion amount is

based on the last reconversion that was

not an excess reconversion. An excess reconversion is otherwise treated as a valid

reconversion. The final regulations

grandfather conversions and reconversions made before November 1, 1998.

Distributions

In response to concerns raised in the

comments regarding potential double taxation, the final regulations clarify that a

nonqualified distribution from a Roth

IRA is taxed only to the extent that the

amount of the distribution, when added to

all previous distributions (whether or not

they were qualified distributions) and reduced by the taxable amount of such previous distributions, exceed the owner’s

contributions to all his or her Roth IRAs.

Commentators also asked for clarification regarding whether a beneficiary may

aggregate his or her inherited Roth IRAs

with other Roth IRAs maintained by such

beneficiary. The final regulations provide

that a beneficiary’s inherited Roth IRA

may not be aggregated with any other

Roth IRA maintained by such beneficiary

(except for other Roth IRAs that the beneficiary inherited from the same decedent),

unless the beneficiary, as the spouse of

the decedent and sole beneficiary of the

Roth IRA, elects to treat the Roth IRA as

his or her own.

In addition, commentators also asked

for clarification regarding whether the 5taxable year period for determining

whether a distribution is a qualified distribution starts over for subsequent Roth

IRA contributions if the entire account

balance in a Roth IRA is distributed to the

Roth IRA owner before he or she makes

any other Roth IRA contributions. In

such a case, the 5-taxable-year period

does not start over. However, if an initial

Roth IRA contribution is made to a Roth

IRA that subsequently is revoked within 7

days, or if an initial Roth IRA contribu-

7

tion is recharacterized, the initial contribution does not start the 5-year period.

The final regulations provide that an excess contribution that is distributed in accordance with section 408(d)(4) does not

start the 5-year period.

One commentator questioned the rule

in the proposed regulations providing that

a distribution allocable to a conversion

contribution is treated as made first from

the portion (if any) that was includible in

gross income as a result of the conversion. The IRS and Treasury note that this

result is plainly compelled by section

408A(d)(4)(B)(ii). Another commentator

inquired about the treatment of all conversions as designated distributions under

section 3405; the commentator suggested

that conversions effected by means of

trustee-to- trustee transfers should not be

treated as designated distributions subject

to withholding. However, section

408A(d)(3) treats all Roth IRA conversions as distributions regardless of how

they are effected.

Reporting Requirements

The final regulations retain the reporting rules set forth in the proposed regulations.

Effective Date

The final regulations are applicable to

taxable years beginning on or after January 1, 1998, the effective date for section

408A.

Special Analyses

It has been determined that the final

regulations are not a significant regulatory action as defined in Executive Order

12866. Therefore, a regulatory assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C.

chapter 5) does not apply to these regulations. Further, it is hereby certified, pursuant to sections 603(a) and 605(b) of the

Regulatory Flexibility Act, that the collection of information in these regulations

will not have a significant economic impact on a substantial number of small entities. The cost of the collection of information is insignificant because the

primary reporting burden is on the individual and not the small entity. Therefore

the collection of information will not have

February 22, 1999

a substantial economic impact. Therefore, a regulatory flexibility analysis

under the Regulatory Flexibility Act (5

U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of the Internal

Revenue Code, the notice of proposed

rulemaking preceding these regulations

was submitted to the Chief Counsel for

Advocacy of the Small Business Administration for comment on its impact on

small business.

Drafting Information

The principal author of the final regulations is Cathy A. Vohs, Office of Associate Chief Counsel (Employee Benefits

and Exempt Organizations). However,

other personnel from the IRS and Treasury Department participated in their development.

* * * * *

Adoption of Amendments to the

Regulations

Accordingly, 26 CFR parts 1 and 602

are amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for

part 1 is amended by adding entries in numerical order to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

§1.408A–1 also issued under 26 U.S.C.

408A.

§1.408A–2 also issued under 26 U.S.C.

408A.

§1.408A–3 also issued under 26 U.S.C.

408A.

§1.408A–4 also issued under 26 U.S.C.

408A.

§1.408A–5 also issued under 26 U.S.C.

408A.

§1.408A–6 also issued under 26 U.S.C.

408A.

§1.408A–7 also issued under 26 U.S.C.

408A.

§1.408A–8 also issued under 26 U.S.C.

408A.

§1.408A–9 also issued under 26 U.S.C.

408A. * * *

Par. 2. Sections 1.408A–0 through

1.408A–9 are added to read as follows:

§1.408A–0 Roth IRAs; table of contents.

This table of contents lists the regulations relating to Roth IRAs under section

February 22, 1999

408A of the Internal Revenue Code as follows:

§1.408A–1 Roth IRAs in general.

§1.408A–2 Establishing Roth IRAs.

§1.408A–3 Contributions to Roth IRAs.

§1.408A–4 Converting amounts to Roth

IRAs.

§1.408A–5 Recharacterized contributions.

§1.408A–6 Distributions.

§1.408A–7 Reporting.

§1.408A–8 Definitions.

§1.408A–9 Effective date.

§1.408A–1 Roth IRAs in general.

This section sets forth the following

questions and answers that discuss the

background and general features of Roth

IRAs:

Q-1 What is a Roth IRA?

A-1. (a) A Roth IRA is a new type of

individual retirement plan that individuals

can use, beginning in 1998. Roth IRAs

are described in section 408A, which was

added by the Taxpayer Relief Act of 1997

(TRA 97), Public Law 105-34 (111 Stat.

788).

(b) Roth IRAs are treated like traditional IRAs except where the Internal

Revenue Code specifies different treatment. For example, aggregate contributions (other than by a conversion or other

rollover) to all an individual’s Roth IRAs

are not permitted to exceed $2,000 for a

taxable year. Further, income earned on

funds held in a Roth IRA is generally not

taxable. Similarly, the rules of section

408(e), such as the loss of exemption of

the account where the owner engages in a

prohibited transaction, apply to Roth

IRAs in the same manner as to traditional

IRAs.

Q-2. What are the significant differences between traditional IRAs and Roth

IRAs?

A-2. There are several significant differences between traditional IRAs and

Roth IRAs under the Internal Revenue

Code. For example, eligibility to contribute to a Roth IRA is subject to special

modified AGI (adjusted gross income)

limits; contributions to a Roth IRA are

never deductible; qualified distributions

from a Roth IRA are not includible in

gross income; the required minimum distribution rules under section 408(a)(6)

and (b)(3) (which generally incorporate

8

the provisions of section 401(a)(9)) do not

apply to a Roth IRA during the lifetime of

the owner; and contributions to a Roth

IRA can be made after the owner has attained age 701⁄2.

§1.408A–2 Establishing Roth IRAs.

This section sets forth the following

questions and answers that provide rules

applicable to establishing Roth IRAs:

Q-1. Who can establish a Roth IRA?

A-1. Except as provided in A-3 of this

section, only an individual can establish a

Roth IRA. In addition, in order to be eligible to contribute to a Roth IRA for a

particular year, an individual must satisfy

certain compensation requirements and

adjusted gross income limits (see

§1.408A–3 A-3).

Q-2. How is a Roth IRA established?

A-2. A Roth IRA can be established

with any bank, insurance company, or

other person authorized in accordance

with §1.408-2(e) to serve as a trustee with

respect to IRAs. The document establishing the Roth IRA must clearly designate

the IRA as a Roth IRA, and this designation cannot be changed at a later date.

Thus, an IRA that is designated as a Roth

IRA cannot later be treated as a traditional

IRA. However, see §1.408A–4 A-1(b)(3)

for certain rules for converting a traditional IRA to a Roth IRA with the same

trustee by redesignating the traditional

IRA as a Roth IRA, and see §1.408A–5

for rules for recharacterizing certain IRA

contributions.

Q-3. Can an employer or an association

of employees establish a Roth IRA to hold

contributions of employees or members?

A-3. Yes. Pursuant to section 408(c),

an employer or an association of employees can establish a trust to hold contributions of employees or members made

under a Roth IRA. Each employee’s or

member’s account in the trust is treated as

a separate Roth IRA that is subject to the

generally applicable Roth IRA rules. The

employer or association of employees

may do certain acts otherwise required by

an individual, for example, establishing

and designating a trust as a Roth IRA.

Q-4. What is the effect of a surviving

spouse of a Roth IRA owner treating an

IRA as his or her own?

A-4. If the surviving spouse of a Roth

IRA owner treats a Roth IRA as his or her

1999–8 I.R.B.

own as of a date, the Roth IRA is treated

from that date forward as though it were

established for the benefit of the surviving

spouse and not the original Roth IRA

owner. Thus, for example, the surviving

spouse is treated as the Roth IRA owner

for purposes of applying the minimum

distribution requirements under section

408(a)(6) and (b)(3). Similarly, the surviving spouse is treated as the Roth IRA

owner rather than a beneficiary for purposes of determining the amount of any

distribution from the Roth IRA that is includible in gross income and whether the

distribution is subject to the 10-percent

additional tax under section 72(t).

§1.408A–3 Contributions to Roth IRAs.

This section sets forth the following

questions and answers that provide rules

regarding contributions to Roth IRAs:

Q-1. What types of contributions are

permitted to be made to a Roth IRA?

A-1. There are two types of contributions that are permitted to be made to a

Roth IRA: regular contributions and qualified rollover contributions (including

conversion contributions). The term regular contributions means contributions

other than qualified rollover contributions.

Q-2. When are contributions permitted

to be made to a Roth IRA?

A-2. (a) The provisions of section

408A are effective for taxable years beginning on or after January 1, 1998.

Thus, the first taxable year for which contributions are permitted to be made to a

Roth IRA by an individual is the individual’s taxable year beginning in 1998.

(b) Regular contributions for a particular taxable year must generally be contributed by the due date (not including extensions) for filing a Federal income tax

return for that taxable year. (See

§1.408A–5 regarding recharacterization

of certain contributions.)

Q-3. What is the maximum aggregate

amount of regular contributions an individual is eligible to contribute to a Roth

IRA for a taxable year?

A-3. (a) The maximum aggregate

amount that an individual is eligible to

contribute to all his or her Roth IRAs as a

regular contribution for a taxable year is

the same as the maximum for traditional

IRAs: $2,000 or, if less, that individual’s

compensation for the year.

1999–8 I.R.B.

(b) For Roth IRAs, the maximum

amount described in paragraph (a) of this

A-3 is phased out between certain levels

of modified AGI. For an individual who

is not married, the dollar amount is

phased out ratably between modified AGI

of $95,000 and $110,000; for a married

individual filing a joint return, between

modified AGI of $150,000 and $160,000;

and for a married individual filing separately, between modified AGI of $0 and

$10,000. For this purpose, a married individual who has lived apart from his or her

spouse for the entire taxable year and who

files separately is treated as not married.

Under section 408A(c)(3)(A), in applying

the phase-out, the maximum amount is

rounded up to the next higher multiple of

$10 and is not reduced below $200 until

completely phased out.

(c) If an individual makes regular contributions to both traditional IRAs and

Roth IRAs for a taxable year, the maximum limit for the Roth IRA is the lesser

of—

(1) The amount described in paragraph

(a) of this A-3 reduced by the amount

contributed to traditional IRAs for the

taxable year; and

(2) The amount described in paragraph

(b) of this A-3. Employer contributions,

including elective deferrals, made under a

SEP or SIMPLE IRA Plan on behalf of an

individual (including a self-employed individual) do not reduce the amount of the individual’s maximum regular contribution.

(d) The rules in this A-3 are illustrated

by the following examples:

Example 1. In 1998, unmarried, calendar-year

taxpayer B, age 60, has modified AGI of $40,000

and compensation of $5,000. For 1998, B can contribute a maximum of $2,000 to a traditional IRA, a

Roth IRA or a combination of traditional and Roth

IRAs.

Example 2. The facts are the same as in Example

1. However, assume that B violates the maximum

regular contribution limit by contributing $2,000 to

a traditional IRA and $2,000 to a Roth IRA for 1998.

The $2,000 to B’s Roth IRA would be an excess

contribution to B’s Roth IRA for 1998 because an

individual’s contributions are applied first to a traditional IRA, then to a Roth IRA.

Example 3. The facts are the same as in Example

1, except that B’s compensation is $900. The maximum amount B can contribute to either a traditional

IRA or a Roth (or a combination of the two) for

1998 is $900.

Example 4. In 1998, unmarried, calendar-year

taxpayer C, age 60, has modified AGI of $100,000

and compensation of $5,000. For 1998, C contributes $800 to a traditional IRA and $1,200 to a

9

Roth IRA. Because C’s $1,200 Roth IRA contribution does not exceed the phased-out maximum Roth

IRA contribution of $1,340 and because C’s total

IRA contributions do not exceed $2,000, C’s Roth

IRA contribution does not exceed the maximum permissible contribution.

Q-4. How is compensation defined for

purposes of the Roth IRA contribution

limit?

A-4. For purposes of the contribution

limit described in A-3 of this section, an

individual’s compensation is the same as

that used to determine the maximum contribution an individual can make to a traditional IRA. This amount is defined in

section 219(f)(1) to include wages, commissions, professional fees, tips, and

other amounts received for personal services, as well as taxable alimony and separate maintenance payments received

under a decree of divorce or separate

maintenance. Compensation also includes earned income as defined in section 401(c)(2), but does not include any

amount received as a pension or annuity

or as deferred compensation. In addition,

under section 219(c), a married individual

filing a joint return is permitted to make

an IRA contribution by treating his or her

spouse’s higher compensation as his or

her own, but only to the extent that the

spouse’s compensation is not being used

for purposes of the spouse making a contribution to a Roth IRA or a deductible

contribution to a traditional IRA.

Q-5. What is the significance of modified AGI and how is it determined?

A-5. Modified AGI is used for purposes of the phase-out rules described in

A-3 of this section and for purposes of the

$100,000 modified AGI limitation described in §1.408A–4 A-2(a) (relating to

eligibility for conversion). As defined in

section 408A(c)(3)(C)(i), modified AGI is

the same as adjusted gross income under

section 219(g)(3)(A) (used to determine

the amount of deductible contributions

that can be made to a traditional IRA by

an individual who is an active participant

in an employer-sponsored retirement

plan), except that any conversion is disregarded in determining modified AGI. For

example, the deduction for contributions

to an IRA is not taken into account for

purposes of determining adjusted gross

income under section 219 and thus does

not apply in determining modified AGI

for Roth IRA purposes.

February 22, 1999

Q-6. Is a required minimum distribution from an IRA for a year included in income for purposes of determining modified AGI?

A-6. (a) Yes. For taxable years beginning before January 1, 2005, any required

minimum distribution from an IRA under

section 408(a)(6) and (b)(3) (which generally incorporate the provisions of section 401(a)(9)) is included in income for

purposes of determining modified AGI.

(b) For taxable years beginning after

December 31, 2004, and solely for purposes of the $100,000 limitation applicable to conversions, modified AGI does

not include any required minimum distributions from an IRA under section

408(a)(6) and (b)(3).

Q-7. Does an excise tax apply if an individual exceeds the aggregate regular

contribution limits for Roth IRAs?

A-7. Yes. Section 4973 imposes an annual 6-percent excise tax on aggregate

amounts contributed to Roth IRAs that

exceed the maximum contribution limits

described in A-3 of this section. Any contribution that is distributed, together with

net income, from a Roth IRA on or before

the tax return due date (plus extensions)

for the taxable year of the contribution is

treated as not contributed. Net income

described in the previous sentence is includible in gross income for the taxable

year in which the contribution is made.

Aggregate excess contributions that are

not distributed from a Roth IRA on or before the tax return due date (with extensions) for the taxable year of the contributions are reduced as a deemed Roth IRA

contribution for each subsequent taxable

year to the extent that the Roth IRA owner

does not actually make regular IRA contributions for such years. Section 4973

applies separately to an individual’s Roth

IRAs and other types of IRAs.

§1.408A–4 Converting amounts to Roth

IRAs.

This section sets forth the following

questions and answers that provide rules

applicable to Roth IRA conversions:

Q-1. Can an individual convert an

amount in his or her traditional IRA to a

Roth IRA?

A-1. (a) Yes. An amount in a traditional IRA may be converted to an

amount in a Roth IRA if two requirements

February 22, 1999

are satisfied. First, the IRA owner must

satisfy the modified AGI limitation described in A-2(a) of this section and, if

married, the joint filing requirement described in A-2(b) of this section. Second,

the amount contributed to the Roth IRA

must satisfy the definition of a qualified

rollover contribution in section 408A(e)

(i.e., it must satisfy the requirements for a

rollover contribution as defined in section

408(d)(3), except that the one-rolloverper-year limitation in section

408(d)(3)(B) does not apply).

(b) An amount can be converted by any

of three methods—

(1) An amount distributed from a traditional IRA is contributed (rolled over) to a

Roth IRA within the 60-day period described in section 408(d)(3)(A)(i);

(2) An amount in a traditional IRA is

transferred in a trustee-to-trustee transfer

from the trustee of the traditional IRA to

the trustee of the Roth IRA; or

(3) An amount in a traditional IRA is

transferred to a Roth IRA maintained by

the same trustee. For purposes of sections

408 and 408A, redesignating a traditional

IRA as a Roth IRA is treated as a transfer

of the entire account balance from a traditional IRA to a Roth IRA.

(c) Any converted amount is treated as

a distribution from the traditional IRA and

a qualified rollover contribution to the

Roth IRA for purposes of section 408 and

section 408A, even if the conversion is

accomplished by means of a trustee-totrustee transfer or a transfer between

IRAs of the same trustee.

(d) A transaction that is treated as a

failed conversion under §1.408A–5

A–9(a)(1) is not a conversion.

Q-2. What are the modified AGI limitation and joint filing requirements for

conversions?

A-2. (a) An individual with modified

AGI in excess of $100,000 for a taxable

year is not permitted to convert an amount

to a Roth IRA during that taxable year.

This $100,000 limitation applies to the

taxable year that the funds are paid from

the traditional IRA, rather than the year

they are contributed to the Roth IRA.

(b) If the individual is married, he or

she is permitted to convert an amount to a

Roth IRA during a taxable year only if the

individual and the individual’s spouse file

a joint return for the taxable year that the

10

funds are paid from the traditional IRA.

In this case, the modified AGI subject to

the $100,000 limit is the modified AGI

derived from the joint return using the

couple’s combined income. The only exception to this joint filing requirement is

for an individual who has lived apart from

his or her spouse for the entire taxable

year. If the married individual has lived

apart from his or her spouse for the entire

taxable year, then such individual can

treat himself or herself as not married for

purposes of this paragraph, file a separate

return and be subject to the $100,000

limit on his or her separate modified AGI.

In all other cases, a married individual filing a separate return is not permitted to

convert an amount to a Roth IRA, regardless of the individual’s modified AGI.

Q-3. Is a remedy available to an individual who makes a failed conversion?

A-3. (a) Yes. See §1.408A–5 for rules

permitting a failed conversion amount to

be recharacterized as a contribution to a

traditional IRA. If the requirements in

§1.408A–5 are satisfied, the failed conversion amount will be treated as having

been contributed to the traditional IRA

and not to the Roth IRA.

(b) If the contribution is not recharacterized in accordance with §1.408A–5,

the contribution will be treated as a regular contribution to the Roth IRA and, thus,

an excess contribution subject to the excise tax under section 4973 to the extent

that it exceeds the individual’s regular

contribution limit. This is the result regardless of which of the three methods

described in A-1(b) of this section applies

to this transaction. Additionally, the distribution from the traditional IRA will not

be eligible for the 4-year spread and will

be subject to the additional tax under section 72(t) (unless an exception under that

section applies).

Q-4. Do any special rules apply to a

conversion of an amount in an individual’s SEP IRA or SIMPLE IRA to a Roth

IRA?

A-4. (a) An amount in an individual’s

SEP IRA can be converted to a Roth IRA

on the same terms as an amount in any

other traditional IRA.

(b) An amount in an individual’s SIMPLE IRA can be converted to a Roth IRA

on the same terms as a conversion from a

traditional IRA, except that an amount

1999–8 I.R.B.

distributed from a SIMPLE IRA during

the 2-year period described in section

72(t)(6), which begins on the date that the

individual first participated in any SIMPLE IRA Plan maintained by the individual’s employer, cannot be converted to a

Roth IRA. Pursuant to section 408(d)(3)(G), a distribution of an amount from

an individual’s SIMPLE IRA during this

2-year period is not eligible to be rolled

over into an IRA that is not a SIMPLE

IRA and thus cannot be a qualified

rollover contribution. This 2-year period

of section 408(d)(3)(G) applies separately

to the contributions of each of an individual’s employers maintaining a SIMPLE

IRA Plan.

(c) Once an amount in a SEP IRA or

SIMPLE IRA has been converted to a

Roth IRA, it is treated as a contribution to

a Roth IRA for all purposes. Future contributions under the SEP or under the

SIMPLE IRA Plan may not be made to

the Roth IRA.

Q-5. Can amounts in other kinds of retirement plans be converted to a Roth

IRA?

A-5. No. Only amounts in another

IRA can be converted to a Roth IRA. For

example, amounts in a qualified plan or

annuity plan described in section 401(a)

or 403(a) cannot be converted directly to

a Roth IRA. Also, amounts held in an annuity contract or account described in section 403(b) cannot be converted directly

to a Roth IRA.

Q-6. Can an individual who has attained at least age 701⁄2 by the end of a calendar year convert an amount distributed

from a traditional IRA during that year to

a Roth IRA before receiving his or her required minimum distribution with respect

to the traditional IRA for the year of the

conversion?

A-6. (a) No. In order to be eligible for

a conversion, an amount first must be eligible to be rolled over. Section 408(d)(3)

prohibits the rollover of a required minimum distribution. If a minimum distribution is required for a year with respect to

an IRA, the first dollars distributed during that year are treated as consisting of

the required minimum distribution until

an amount equal to the required minimum distribution for that year has been

distributed.

(b) As provided in A-1(c) of this section, any amount converted is treated as a

1999–8 I.R.B.

distribution from a traditional IRA and a

rollover contribution to a Roth IRA and

not as a trustee-to-trustee transfer for purposes of section 408 and section 408A.

Thus, in a year for which a minimum distribution is required (including the calendar year in which the individual attains

age 701⁄2), an individual may not convert

the assets of an IRA (or any portion of

those assets) to a Roth IRA to the extent

that the required minimum distribution

for the traditional IRA for the year has not

been distributed.

(c) If a required minimum distribution

is contributed to a Roth IRA, it is treated

as having been distributed, subject to the

normal rules under section 408(d)(1) and

(2), and then contributed as a regular contribution to a Roth IRA. The amount of

the required minimum distribution is not a

conversion contribution.

Q-7. What are the tax consequences

when an amount is converted to a Roth

IRA?

A-7. (a) Any amount that is converted

to a Roth IRA is includible in gross income as a distribution according to the

rules of section 408(d)(1) and (2) for the

taxable year in which the amount is distributed or transferred from the traditional

IRA. Thus, any portion of the distribution

or transfer that is treated as a return of

basis under section 408(d)(1) and (2) is

not includible in gross income as a result

of the conversion.

(b) The 10-percent additional tax under

section 72(t) generally does not apply to

the taxable conversion amount. But see

§1.408A–6 A-5 for circumstances under

which the taxable conversion amount

would be subject to the additional tax

under section 72(t).

(c) Pursuant to section 408A(e), a conversion is not treated as a rollover for purposes of the one-rollover-per-year rule of

section 408(d)(3)(B).

Q-8. Is there an exception to the income-inclusion rule described in A-7 of

this section for 1998 conversions?

A-8. Yes. In the case of a distribution

(including a trustee-to-trustee transfer)

from a traditional IRA on or before December 31, 1998, that is converted to a

Roth IRA, instead of having the entire

taxable conversion amount includible in

income in 1998, an individual includes in

gross income for 1998 only one quarter of

that amount and one quarter of that

11

amount for each of the next 3 years. This

4-year spread also applies if the conversion amount was distributed in 1998 and

contributed to the Roth IRA within the

60-day period described in section

408(d)(3)(A)(i), but after December 31,

1998. However, see §1.408A–6 A-6 for

special rules requiring acceleration of inclusion if an amount subject to the 4-year

spread is distributed from the Roth IRA

before 2001.

Q-9. Is the taxable conversion amount

included in income for all purposes?

A-9. Except as provided below, any

taxable conversion amount includible in

gross income for a year as a result of the

conversion (regardless of whether the individual is using a 4-year spread) is included in income for all purposes. Thus,

for example, it is counted for purposes of

determining the taxable portion of social

security payments under section 86 and

for purposes of determining the phase-out

of the $25,000 exemption under section

469(i) relating to the disallowance of passive activity losses from rental real estate

activities. However, as provided in

§1.408A–3 A-5, the taxable conversion

amount (and any resulting change in other

elements of adjusted gross income) is disregarded for purposes of determining

modified AGI for section 408A.

Q-10. Can an individual who makes a

1998 conversion elect not to have the 4year spread apply and instead have the

full taxable conversion amount includible

in gross income for 1998?

A-10. Yes. Instead of having the taxable conversion amount for a 1998 conversion included over 4 years as provided

under

A-8 of this section, an individual can

elect to include the full taxable conversion amount in income for 1998. The

election is made on Form 8606 and cannot be made or changed after the due date

(including extensions) for filing the 1998

Federal income tax return.

Q-11. What happens when an individual who is using the 4-year spread dies,

files separately, or divorces before the full

taxable conversion amount has been included in gross income?

A-11. (a) If an individual who is using

the 4-year spread described in A-8 of this

section dies before the full taxable conversion amount has been included in

gross income, then the remainder must be

February 22, 1999

included in the individual’s gross income

for the taxable year that includes the date

of death.

(b) However, if the sole beneficiary of

all the decedent’s Roth IRAs is the decedent’s spouse, then the spouse can elect to

continue the 4-year spread. Thus, the

spouse can elect to include in gross income

the same amount that the decedent would

have included in each of the remaining

years of the 4-year period. Where the

spouse makes such an election, the amount

includible under the 4-year spread for the

taxable year that includes the date of the

decedent’s death remains includible in the

decedent’s gross income and is reported on

the decedent’s final Federal income tax return. The election is made on either Form

8606 or Form 1040, in accordance with the

instructions to the applicable form, for the

taxable year that includes the decedent’s

date of death and cannot be changed after

the due date (including extensions) for filing the Federal income tax return for the

spouse’s taxable year that includes the

decedent’s date of death.

(c) If a Roth IRA owner who is using

the 4-year spread and who was married in

1998 subsequently files separately or divorces before the full taxable conversion

amount has been included in gross income, the remainder of the taxable conversion amount must be included in the

Roth IRA owner’s gross income over the

remaining years in the 4-year period (unless accelerated because of distribution or

death).

Q-12. Can an individual convert a traditional IRA to a Roth IRA if he or she is

receiving substantially equal periodic

payments within the meaning of section

72(t)(2)(A)(iv) from that traditional IRA?

A-12. Yes. Not only is the conversion

amount itself not subject to the early distribution tax under section 72(t), but the

conversion amount is also not treated as a

distribution for purposes of determining

whether a modification within the meaning of section 72(t)(4)(A) has occurred.

Distributions from the Roth IRA that are

part of the original series of substantially

equal periodic payments will be nonqualified distributions from the Roth IRA until

they meet the requirements for being a

qualified distribution, described in

§1.408A–6 A-1(b). The additional 10percent tax under section 72(t) will not

February 22, 1999

apply to the extent that these nonqualified

distributions are part of a series of substantially equal periodic payments. Nevertheless, to the extent that such distributions are allocable to a 1998 conversion

contribution with respect to which the 4year spread for the resultant income inclusion applies (see A-8 of this section) and

are received during 1998, 1999, or 2000,

the special acceleration rules of

§1.408A–6 A-6 apply. However, if the

original series of substantially equal periodic payments does not continue to be

distributed in substantially equal periodic

payments from the Roth IRA after the

conversion, the series of payments will

have been modified and, if this modification occurs within 5 years of the first payment or prior to the individual becoming

disabled or attaining age 591⁄2, the taxpayer will be subject to the recapture tax

of section 72(t)(4)(A).

Q-13. Can a 1997 distribution from a

traditional IRA be converted to a Roth

IRA in 1998?

A-13. No. An amount distributed from

a traditional IRA in 1997 that is contributed to a Roth IRA in 1998 would not

be a conversion contribution. See A-3 of

this section regarding the remedy for a

failed conversion.

§1.408A–5 Recharacterized

contributions.

This section sets forth the following

questions and answers that provide rules

regarding recharacterizing IRA contributions:

Q-1. Can an IRA owner recharacterize

certain contributions (i.e., treat a contribution made to one type of IRA as made

to a different type of IRA) for a taxable

year?

A-1. (a) Yes. In accordance with section 408A(d)(6), except as otherwise provided in this section, if an individual

makes a contribution to an IRA (the

FIRST IRA) for a taxable year and then

transfers the contribution (or a portion of

the contribution) in a trustee-to-trustee

transfer from the trustee of the FIRST

IRA to the trustee of another IRA (the

SECOND IRA), the individual can elect

to treat the contribution as having been

made to the SECOND IRA, instead of to

the FIRST IRA, for Federal tax purposes.

A transfer between the FIRST IRA and

12

the SECOND IRA will not fail to be a

trustee-to-trustee transfer merely because

both IRAs are maintained by the same

trustee. For purposes of section

408A(d)(6), redesignating the FIRST IRA

as the SECOND IRA will be treated as a

transfer of the entire account balance

from the FIRST IRA to the SECOND

IRA.

(b) This recharacterization election can

be made only if the trustee-to-trustee

transfer from the FIRST IRA to the SECOND IRA is made on or before the due

date (including extensions) for filing the

individual’s Federal income tax return for

the taxable year for which the contribution was made to the FIRST IRA. For

purposes of this section, a conversion that

is accomplished through a rollover of a

distribution from a traditional IRA in a

taxable year that, 60 days after the distribution (as described in section 408(d)(3)(A)(i)), is contributed to a Roth IRA in the

next taxable year is treated as a contribution for the earlier taxable year.

Q-2. What is the proper treatment of the

net income attributable to the amount of a

contribution that is being recharacterized?

A-2. (a) The net income attributable to

the amount of a contribution that is being

recharacterized must be transferred to the

SECOND IRA along with the contribution.

(b) If the amount of the contribution

being recharacterized was contributed to a

separate IRA and no distributions or additional contributions have been made from

or to that IRA at any time, then the contribution is recharacterized by the trustee of

the FIRST IRA transferring the entire account balance of the FIRST IRA to the

trustee of the SECOND IRA. In this case,

the net income (or loss) attributable to the

contribution being recharacterized is the

difference between the amount of the

original contribution and the amount

transferred.

(c) If paragraph (b) of this A-2 does not

apply, then the net income attributable to

the amount of a contribution is calculated

in the manner prescribed by §1.408–

4(c)(2)(ii) (disregarding the parenthetical

clause in §1.408–4(c)(2)(iii)).

Q-3. What is the effect of recharacterizing a contribution made to the FIRST

IRA as a contribution made to the SECOND IRA?

A-3. The contribution that is being

recharacterized as a contribution to the

1999–8 I.R.B.

SECOND IRA is treated as having been

originally contributed to the SECOND

IRA on the same date and (in the case of a

regular contribution) for the same taxable

year that the contribution was made to the

FIRST IRA. Thus, for example, no deduction would be allowed for a contribution to the FIRST IRA, and any net income transferred with the recharacterized

contribution is treated as earned in the

SECOND IRA, and not the FIRST IRA.

Q-4. Can an amount contributed to an

IRA in a tax-free transfer be recharacterized under A-1 of this section?

A-4. No. If an amount is contributed

to the FIRST IRA in a tax-free transfer,

the amount cannot be recharacterized as a

contribution to the SECOND IRA under

A-1 of this section. However, if an

amount is erroneously rolled over or

transferred from a traditional IRA to a

SIMPLE IRA, the contribution can subsequently be recharacterized as a contribution to another traditional IRA.

Q-5. Can an amount contributed by an

employer under a SIMPLE IRA Plan or a

SEP be recharacterized under A-1 of this

section?

A-5. No. Employer contributions (including elective deferrals) under a SIMPLE IRA Plan or a SEP cannot be recharacterized as contributions to another IRA

under A-1 of this section. However, an

amount converted from a SEP IRA or

SIMPLE IRA to a Roth IRA may be

recharacterized under A-1 of this section

as a contribution to a SEP IRA or SIMPLE IRA, including the original SEP IRA

or SIMPLE IRA.

Q-6. How does a taxpayer make the

election to recharacterize a contribution to

an IRA for a taxable year?

A-6. (a) An individual makes the election described in this section by notifying,

on or before the date of the transfer, both

the trustee of the FIRST IRA and the

trustee of the SECOND IRA, that the individual has elected to treat the contribution as having been made to the SECOND

IRA, instead of the FIRST IRA, for Federal tax purposes. The notification of the

election must include the following information: the type and amount of the contribution to the FIRST IRA that is to be

recharacterized; the date on which the

contribution was made to the FIRST IRA

and the year for which it was made; a direction to the trustee of the FIRST IRA to

1999–8 I.R.B.

transfer, in a trustee-to-trustee transfer,

the amount of the contribution and net income allocable to the contribution to the

trustee of the SECOND IRA; and the

name of the trustee of the FIRST IRA and

the trustee of the SECOND IRA and any

additional information needed to make

the transfer.

(b) The election and the trustee-totrustee transfer must occur on or before

the due date (including extensions) for filing the individual’s Federal income tax

return for the taxable year for which the

recharacterized contribution was made to

the FIRST IRA, and the election cannot

be revoked after the transfer. An individual who makes this election must report

the recharacterization, and must treat the

contribution as having been made to the

SECOND IRA, instead of the FIRST

IRA, on the individual’s Federal income

tax return for the taxable year described in

the preceding sentence in accordance with

the applicable Federal tax forms and instructions.

(c) The election to recharacterize a contribution described in this A-6 may be

made on behalf of a deceased IRA owner

by his or her executor, administrator, or

other person responsible for filing the

final Federal income tax return of the

decedent under section 6012(b)(1).

Q-7. If an amount is initially contributed to an IRA for a taxable year, then

is moved (with net income attributable to

the contribution) in a tax-free transfer to

another IRA (the FIRST IRA for purposes

of A-1 of this section), can the tax-free

transfer be disregarded, so that the initial

contribution that is transferred from the

FIRST IRA to the SECOND IRA is

treated as a recharacterization of that initial contribution?

A-7. Yes. In applying section

408A(d)(6), tax-free transfers between

IRAs are disregarded. Thus, if a contribution to an IRA for a year is followed by

one or more tax-free transfers between

IRAs prior to the recharacterization, then

for purposes of section 408A(d)(6), the

contribution is treated as if it remained in

the initial IRA. Consequently, an individual may elect to recharacterize an initial

contribution made to the initial IRA that

was involved in a series of tax-free transfers by making a trustee-to-trustee transfer from the last IRA in the series to the

SECOND IRA. In this case the contribu-

13

tion to the SECOND IRA is treated as

made on the same date (and for the same

taxable year) as the date the contribution

being recharacterized was made to the initial IRA.

Q-8. If a contribution is recharacterized, is the recharacterization treated as a

rollover for purposes of the one-rolloverper-year limitation of section 408(d)(3)(B)?

A-8. No, recharacterizing a contribution under A-1 of this section is never

treated as a rollover for purposes of the

one-rollover-per-year limitation of section

408(d)(3)(B), even if the contribution

would have been treated as a rollover contribution by the SECOND IRA if it had

been made directly to the SECOND IRA,

rather than as a result of a recharacterization of a contribution to the FIRST IRA.

Q-9. If an IRA owner converts an

amount from a traditional IRA to a Roth

IRA and then transfers that amount back

to a traditional IRA in a recharacterization, may the IRA owner subsequently reconvert that amount from the traditional

IRA to a Roth IRA?

A-9. (a) (1) Except as otherwise provided in paragraph (b) of this A-9, an IRA

owner who converts an amount from a traditional IRA to a Roth IRA during any taxable year and then transfers that amount

back to a traditional IRA by means of a

recharacterization may not reconvert that

amount from the traditional IRA to a Roth

IRA before the beginning of the taxable

year following the taxable year in which

the amount was converted to a Roth IRA

or, if later, the end of the 30-day period beginning on the day on which the IRA

owner transfers the amount from the Roth

IRA back to a traditional IRA by means of

a recharacterization (regardless of whether

the recharacterization occurs during the

taxable year in which the amount was converted to a Roth IRA or the following taxable year). Thus, any attempted reconversion of an amount prior to the time

permitted under this paragraph (a)(1) is a

failed conversion of that amount. However, see §1.408A–4 A-3 for a remedy

available to an individual who makes a

failed conversion.

(2) For purposes of paragraph (a)(1) of

this A-9, a failed conversion of an amount

resulting from a failure to satisfy the requirements of §1.408A–4 A-1(a) is

treated as a conversion in determining

February 22, 1999

whether an IRA owner has previously

converted that amount.

(b) (1) An IRA owner who converts an

amount from a traditional IRA to a Roth

IRA during taxable year 1998 and then

transfers that amount back to a traditional

IRA by means of a recharacterization may

reconvert that amount once (but no more

than once) on or after November 1, 1998

and on or before December 31, 1998; the

IRA owner may also reconvert that

amount once (but no more than once) during 1999. The rule set forth in the preceding sentence applies without regard to

whether the IRA owner’s initial conversion or recharacterization of the amount

occurred before, on, or after November 1,

1998. An IRA owner who converts an

amount from a traditional IRA to a Roth

IRA during taxable year 1999 that has not

been converted previously and then transfers that amount back to a traditional IRA

by means of a recharacterization may reconvert that amount once (but no more

than once) on or before December 31,

1999. For purposes of this paragraph

(b)(1), a failed conversion of an amount

resulting from a failure to satisfy the requirements of §1.408A–4 A-1(a) is not

treated as a conversion in determining

whether an IRA owner has previously

converted that amount.

(2) A reconversion by an IRA owner

during 1998 or 1999 for which the IRA

owner is not eligible under paragraph

(b)(1) of this A-9 will be deemed an excess reconversion (rather than a failed

conversion) and will not change the IRA

owner’s taxable conversion amount. Instead, the excess reconversion and the last

preceding recharacterization will not be

taken into account for purposes of determining the IRA owner’s taxable conversion amount, and the IRA owner’s taxable

conversion amount will be based on the

last reconversion that was not an excess

reconversion (unless, after the excess reconversion, the amount is transferred

back to a traditional IRA by means of a

recharacterization). An excess reconversion will otherwise be treated as a valid

reconversion.

(3) For purposes of this paragraph (b),

any reconversion that an IRA owner made

before November 1, 1998 will not be

treated as an excess reconversion and will

not be taken into account in determining

February 22, 1999

whether any later reconversion is an excess reconversion.

(c) In determining the portion of any

amount held in a Roth IRA or a traditional

IRA that an IRA owner may not reconvert

under this A-9, any amount previously

converted (or reconverted) is adjusted for

subsequent net income thereon.

Q-10. Are there examples to illustrate

the rules in this section?

A-10. The rules in this section are illustrated by the following examples:

Example 1. In 1998, Individual C converts the

entire amount in his traditional IRA to a Roth IRA.

Individual C thereafter determines that his modified

AGI for 1998 exceeded $100,000 so that he was ineligible to have made a conversion in that year. Accordingly, prior to the due date (plus extensions)

for filing the individual’s Federal income tax return

for 1998, he decides to recharacterize the conversion contribution. He instructs the trustee of the

Roth IRA (FIRST IRA) to transfer in a trustee-totrustee transfer the amount of the contribution, plus

net income, to the trustee of a new traditional IRA

(SECOND IRA). The individual notifies the trustee

of the FIRST IRA and the trustee of the SECOND

IRA that he is recharacterizing his IRA contribution

(and provides the other information described in A6 of this section). On the individual’s Federal income tax return for 1998, he treats the original

amount of the conversion as having been contributed to the SECOND IRA and not the Roth IRA.

As a result, for Federal tax purposes, the contribution is treated as having been made to the SECOND

IRA and not to the Roth IRA. The result would be

the same if the conversion amount had been transferred in a tax-free transfer to another Roth IRA

prior to the recharacterization.

Example 2. In 1998, an individual makes a

$2,000 regular contribution for 1998 to his traditional

IRA (FIRST IRA). Prior to the due date (plus extensions) for filing the individual’s Federal income tax

return for 1998, he decides that he would prefer to

contribute to a Roth IRA instead. The individual instructs the trustee of the FIRST IRA to transfer in a

trustee-to-trustee transfer the amount of the contribution, plus attributable net income, to the trustee of a

Roth IRA (SECOND IRA). The individual notifies

the trustee of the FIRST IRA and the trustee of the

SECOND IRA that he is recharacterizing his $2,000

contribution for 1998 (and provides the other information described in A-6 of this section). On the individual’s Federal income tax return for 1998, he treats

the $2,000 as having been contributed to the Roth

IRA for 1998 and not to the traditional IRA. As a result, for Federal tax purposes, the contribution is

treated as having been made to the Roth IRA for

1998 and not to the traditional IRA. The result

would be the same if the conversion amount had

been transferred in a tax-free transfer to another traditional IRA prior to the recharacterization.

Example 3. The facts are the same as in Example

2, except that the $2,000 regular contribution is initially made to a Roth IRA and the recharacterizing

transfer is made to a traditional IRA. On the indi-

14

vidual’s Federal income tax return for 1998, he

treats the $2,000 as having been contributed to the

traditional IRA for 1998 and not the Roth IRA. As a

result, for Federal tax purposes, the contribution is

treated as having been made to the traditional IRA

for 1998 and not the Roth IRA. The result would be

the same if the contribution had been transferred in a

tax-free transfer to another Roth IRA prior to the

recharacterization, except that the only Roth IRA

trustee the individual must notify is the one actually

making the recharacterization transfer.

Example 4. In 1998, an individual receives a distribution from traditional IRA 1 and contributes the

entire amount to traditional IRA 2 in a rollover contribution described in section 408(d)(3). In this

case, the individual cannot elect to recharacterize the

contribution by transferring the contribution

amount, plus net income, to a Roth IRA, because an

amount contributed to an IRA in a tax-free transfer

cannot be recharacterized. However, the individual

may convert (other than by recharacterization) the

amount in traditional IRA 2 to a Roth IRA at any

time, provided the requirements of §1.408A–4 A-1

are satisfied.

§1.408A-6 Distributions.

This section sets forth the following

questions and answers that provide rules

regarding distributions from Roth IRAs:

Q-1. How are distributions from Roth

IRAs taxed?

A-1. (a) The taxability of a distribution

from a Roth IRA generally depends on

whether or not the distribution is a qualified distribution. This A-1 provides rules

for qualified distributions and certain

other nontaxable distributions. A-4 of

this section provides rules for the taxability of distributions that are not qualified

distributions.

(b) A distribution from a Roth IRA is

not includible in the owner’s gross income if it is a qualified distribution or to

the extent that it is a return of the owner’s

contributions to the Roth IRA (determined in accordance with A-8 of this section). A qualified distribution is one that

is both—

(1) Made after a 5-taxable-year period

(defined in A-2 of this section); and

(2) Made on or after the date on which

the owner attains age 591⁄2, made to a beneficiary or the estate of the owner on or

after the date of the owner’s death, attributable to the owner’s being disabled

within the meaning of section 72(m)(7),

or to which section 72(t)(2)(F) applies

(exception for first-time home purchase).

(c) An amount distributed from a Roth

IRA will not be included in gross income

to the extent it is rolled over to another

1999–8 I.R.B.

Roth IRA on a tax-free basis under the

rules of sections 408(d)(3) and 408A(e).

(d) Contributions that are returned to

the Roth IRA owner in accordance with

section 408(d)(4) (corrective distributions) are not includible in gross income,

but any net income required to be distributed under section 408(d)(4) together

with the contributions is includible in

gross income for the taxable year in

which the contributions were made.

Q-2. When does the 5-taxable-year period described in A-1 of this section (relating to qualified distributions) begin and

end?

A-2. The 5-taxable-year period described in A-1 of this section begins on the

first day of the individual’s taxable year

for which the first regular contribution is

made to any Roth IRA of the individual or,

if earlier, the first day of the individual’s

taxable year in which the first conversion

contribution is made to any Roth IRA of

the individual. The 5-taxable-year period

ends on the last day of the individual’s

fifth consecutive taxable year beginning

with the taxable year described in the preceding sentence. For example, if an individual whose taxable year is the calendar

year makes a first-time regular Roth IRA

contribution any time between January 1,

1998, and April 15, 1999, for 1998, the 5taxable-year period begins on January 1,

1998. Thus, each Roth IRA owner has

only one 5-taxable-year period described

in A-1 of this section for all the Roth IRAs

of which he or she is the owner. Further,

because of the requirement of the 5-taxable-year period, no qualified distributions

can occur before taxable years beginning

in 2003. For purposes of this A-2, the

amount of any contribution distributed as

a corrective distribution under A-1(d) of

this section is treated as if it was never

contributed.

Q-3. If a distribution is made to an individual who is the sole beneficiary of his

or her deceased spouse’s Roth IRA and

the individual is treating the Roth IRA as

his or her own, can the distribution be a

qualified distribution based on being

made to a beneficiary on or after the

owner’s death?

A-3. No. If a distribution is made to

an individual who is the sole beneficiary

of his or her deceased spouse’s Roth IRA

and the individual is treating the Roth

IRA as his or her own, then, in accordance

1999–8 I.R.B.

with §1.408A-2 A-4, the distribution is

treated as coming from the individual’s

own Roth IRA and not the deceased

spouse’s Roth IRA. Therefore, for purposes of determining whether the distribution is a qualified distribution, it is not

treated as made to a beneficiary on or

after the owner’s death.

Q-4. How is a distribution from a Roth

IRA taxed if it is not a qualified distribution?

A-4. A distribution that is not a qualified distribution, and is neither contributed to another Roth IRA in a qualified rollover contribution nor constitutes a

corrective distribution, is includible in the

owner’s gross income to the extent that

the amount of the distribution, when

added to the amount of all prior distributions from the owner ’s Roth IRAs

(whether or not they were qualified distributions) and reduced by the amount of

those prior distributions previously includible in gross income, exceeds the

owner’s contributions to all his or her

Roth IRAs. For purposes of this A-4, any

amount distributed as a corrective distribution is treated as if it was never contributed.

Q-5. Will the additional tax under 72(t)

apply to the amount of a distribution that

is not a qualified distribution?

A-5. (a) The 10-percent additional tax

under section 72(t) will apply (unless the

distribution is excepted under section

72(t)) to any distribution from a Roth IRA

includible in gross income.

(b) The 10-percent additional tax under

section 72(t) also applies to a nonqualified distribution, even if it is not then includible in gross income, to the extent it is

allocable to a conversion contribution, if

the distribution is made within the 5-taxable-year period beginning with the first

day of the individual’s taxable year in

which the conversion contribution was

made. The 5-taxable-year period ends on

the last day of the individual’s fifth consecutive taxable year beginning with the

taxable year described in the preceding

sentence. For purposes of applying the

tax, only the amount of the conversion

contribution includible in gross income as

a result of the conversion is taken into account. The exceptions under section 72(t)

also apply to such a distribution.

(c) The 5-taxable-year period described

in this A-5 for purposes of determining

15

whether section 72(t) applies to a distribution allocable to a conversion contribution

is separately determined for each conversion contribution, and need not be the

same as the 5-taxable-year period used for

purposes of determining whether a distribution is a qualified distribution under A1(b) of this section. For example, if a calendar-year taxpayer who received a

distribution from a traditional IRA on December 31, 1998, makes a conversion

contribution by contributing the distributed amount to a Roth IRA on February

25, 1999 in a qualifying rollover contribution and makes a regular contribution for

1998 on the same date, the 5-taxable-year

period for purposes of this A-5 begins on

January 1, 1999, while the 5-taxable-year

period for purposes of A-1(b) of this section begins on January 1, 1998.

Q-6. Is there a special rule for taxing

distributions allocable to a 1998 conversion?

A-6. Yes. In the case of a distribution

from a Roth IRA in 1998, 1999 or 2000 of

amounts allocable to a 1998 conversion

with respect to which the 4-year spread

for the resultant income inclusion applies

(see §1.408A–4 A-8), any income deferred as a result of the election to years

after the year of the distribution is accelerated so that it is includible in gross income in the year of the distribution up to

the amount of the distribution allocable to

the 1998 conversion (determined under

A-8 of this section). This amount is in addition to the amount otherwise includible

in the owner’s gross income for that taxable year as a result of the conversion.

However, this rule will not require the inclusion of any amount to the extent it exceeds the total amount of income required

to be included over the 4-year period.

The acceleration of income inclusion described in this A-6 applies in the case of a

surviving spouse who elects to continue

the 4-year spread in accordance with

§1.408A–4 A-11(b).

Q-7. Is the 5-taxable-year period described in A-1 of this section redetermined when a Roth IRA owner dies?

A-7. (a) No. The beginning of the 5taxable-year period described in A-1 of

this section is not redetermined when the

Roth IRA owner dies. Thus, in determining the 5-taxable-year period, the period

the Roth IRA is held in the name of a beneficiary, or in the name of a surviving

February 22, 1999

spouse who treats the decedent’s Roth

IRA as his or her own, includes the period

it was held by the decedent.

(b) The 5-taxable-year period for a

Roth IRA held by an individual as a beneficiary of a deceased Roth IRA owner is

determined independently of the 5-taxable-year period for the beneficiary’s own

Roth IRA. However, if a surviving

spouse treats the Roth IRA as his or her

own, the 5-taxable-year period with respect to any of the surviving spouse’s

Roth IRAs (including the one that the surviving spouse treats as his or her own)

ends at the earlier of the end of either the

5-taxable-year period for the decedent or

the 5-taxable-year period applicable to the

spouse’s own Roth IRAs.

Q-8. How is it determined whether an

amount distributed from a Roth IRA is allocated to regular contributions, conversion contributions, or earnings?

A-8. (a) Any amount distributed from

an individual’s Roth IRA is treated as

made in the following order (determined

as of the end of a taxable year and exhausting each category before moving to

the following category)—

(1) From regular contributions;

(2) From conversion contributions, on

a first-in-first-out basis; and

(3) From earnings.

(b) To the extent a distribution is

treated as made from a particular conversion contribution, it is treated as made

first from the portion, if any, that was includible in gross income as a result of the

conversion.

Q-9. Are there special rules for determining the source of distributions under

A-8 of this section?

A-9. Yes. For purposes of determining

the source of distributions, the following

rules apply:

(a) All distributions from all an individual’s Roth IRAs made during a taxable

year are aggregated.

(b) All regular contributions made for

the same taxable year to all the individual’s Roth IRAs are aggregated and added

to the undistributed total regular contributions for prior taxable years. Regular

contributions for a taxable year include

contributions made in the following taxable year that are identified as made for

the taxable year in accordance with

§1.408A–3 A-2. For example, a regular

contribution made in 1999 for 1998 is ag-

February 22, 1999

gregated with the contributions made in

1998 for 1998.

(c) All conversion contributions received during the same taxable year by all

the individual’s Roth IRAs are aggregated. Notwithstanding the preceding

sentence, all conversion contributions

made by an individual during 1999 that

were distributed from a traditional IRA in

1998 and with respect to which the 4-year

spread applies are treated for purposes of

A-8(b) of this section as contributed to the

individual’s Roth IRAs prior to any other

conversion contributions made by the individual during 1999.

(d) A distribution from an individual’s

Roth IRA that is rolled over to another

Roth IRA of the individual in accordance

with section 408A(e) is disregarded for

purposes of determining the amount of

both contributions and distributions.

(e) Any amount distributed as a corrective distribution (including net income),

as described in A-1(d) of this section, is

disregarded in determining the amount of

contributions, earnings, and distributions.

(f) If an individual recharacterizes a

contribution made to a traditional IRA

(FIRST IRA) by transferring the contribution to a Roth IRA (SECOND IRA) in accordance with §1.408A–5, then, pursuant

to §1.408A–5 A-3, the contribution to the

Roth IRA is taken into account for the

same taxable year for which it would have

been taken into account if the contribution

had originally been made to the Roth IRA

and had never been contributed to the traditional IRA. Thus, the contribution to

the Roth IRA is treated as contributed to

the Roth IRA on the same date and for the

same taxable year that the contribution

was made to the traditional IRA.

(g) If an individual recharacterizes a

regular or conversion contribution made

to a Roth IRA (FIRST IRA) by transferring the contribution to a traditional IRA

(SECOND IRA) in accordance with

§1.408A–5, then pursuant to §1.408A–5

A-3, the contribution to the Roth IRA and

the recharacterizing transfer are disregarded in determining the amount of both

contributions and distributions for the taxable year with respect to which the original contribution was made to the Roth

IRA.

(h) Pursuant to §1.408A–5 A-3, the effect of income or loss (determined in accordance with §1.408A–5 A-2) occurring

16

after the contribution to the FIRST IRA is

disregarded in determining the amounts

described in paragraphs (f) and (g) of this

A-9. Thus, for purposes of paragraphs (f)

and (g), the amount of the contribution is

determined based on the original contribution.

Q-10. Are there examples to illustrate

the ordering rules described in A-8 and A9 of this section?

A-10. Yes. The following examples illustrate these ordering rules:

Example 1. In 1998, individual B converts

$80,000 in his traditional IRA to a Roth IRA. B has

a basis of $20,000 in the conversion amount and so

must include the remaining $60,000 in gross income. He decides to spread the $60,000 income by

including $15,000 in each of the 4 years 1998-2001,

under the rules of §1.408A–4 A-8. B also makes a

regular contribution of $2,000 in 1998. If a distribution of $2,000 is made to B anytime in 1998, it will

be treated as made entirely from the regular contributions, so there will be no Federal income tax consequences as a result of the distribution.

Example 2. The facts are the same as in Example

1, except that the distribution made in 1998 is

$5,000. The distribution is treated as made from

$2,000 of regular contributions and $3,000 of conversion contributions that were includible in gross

income. As a result, B must include $18,000 in

gross income for 1998: $3,000 as a result of the acceleration of amounts that otherwise would have

been included in later years under the 4-year-spread

rule and $15,000 includible under the regular 4year-spread rule. In addition, because the $3,000 is

allocable to a conversion made within the previous 5

taxable years, the 10-percent additional tax under

section 72(t) would apply to this $3,000 distribution

for 1998, unless an exception applies. Under the 4year-spread rule, B would now include in gross income $15,000 for 1999 and 2000, but only $12,000

for 2001, because of the accelerated inclusion of the

$3,000 distribution.

Example 3. The facts are the same as in Example

1, except that B makes an additional $2,000 regular

contribution in 1999 and he does not take a distribution in 1998. In 1999, the entire balance in the account, $90,000 ($84,000 of contributions and $6,000

of earnings), is distributed to B. The distribution is

treated as made from $4,000 of regular contributions, $60,000 of conversion contributions that were

includible in gross income, $20,000 of conversion

contributions that were not includible in gross income, and $6,000 of earnings. Because a distribution has been made within the 4-year-spread period,

B must accelerate the income inclusion under the 4year-spread rule and must include in gross income

the $45,000 remaining under the 4-year-spread rule

in addition to the $6,000 of earnings. Because

$60,000 of the distribution is allocable to a conversion made within the previous 5 taxable years, it is

subject to the 10-percent additional tax under section 72(t) as if it were includible in gross income for

1999, unless an exception applies. The $6,000 allocable to earnings would be subject to the tax under

section 72(t), unless an exception applies. Under the

1999–8 I.R.B.

4-year-spread rule, no amount would be includible

in gross income for 2000 or 2001 because the entire

amount of the conversion that was includible in

gross income has already been included.

Example 4. The facts are the same as in Example

1, except that B also makes a $2,000 regular contribution in each year 1999 through 2002 and he does

not take a distribution in 1998. A distribution of

$85,000 is made to B in 2002. The distribution is

treated as made from the $10,000 of regular contributions (the total regular contributions made in the

years 1998-2002), $60,000 of conversion contributions that were includible in gross income, and

$15,000 of conversion contributions that were not

includible in gross income. As a result, no amount

of the distribution is includible in gross income;

however, because the distribution is allocable to a

conversion made within the previous 5 years, the

$60,000 is subject to the 10-percent additional tax

under section 72(t) as if it were includible in gross

income for 2002, unless an exception applies.

Example 5. The facts are the same as in Example

4, except no distribution occurs in 2002. In 2003,

the entire balance in the account, $170,000 ($90,000

of contributions and $80,000 of earnings), is distributed to B. The distribution is treated as made from

$10,000 of regular contributions, $60,000 of conversion contributions that were includible in gross income, $20,000 of conversion contributions that were

not includible in gross income, and $80,000 of earnings. As a result, for 2003, B must include in gross

income the $80,000 allocable to earnings, unless the

distribution is a qualified distribution; and if it is not

a qualified distribution, the $80,000 would be subject to the 10-percent additional tax under section

72(t), unless an exception applies.

Example 6. Individual C converts $20,000 to a

Roth IRA in 1998 and $15,000 (in which amount C

had a basis of $2,000) to another Roth IRA in 1999.

No other contributions are made. In 2003, a $30,000

distribution, that is not a qualified distribution, is

made to C. The distribution is treated as made from

$20,000 of the 1998 conversion contribution and

$10,000 of the 1999 conversion contribution that

was includible in gross income. As a result, for

2003, no amount is includible in gross income; however, because $10,000 is allocable to a conversion

contribution made within the previous 5 taxable

years, that amount is subject to the 10-percent additional tax under section 72(t) as if the amount were

includible in gross income for 2003, unless an exception applies. The result would be the same

whichever of C’s Roth IRAs made the distribution.

Example 7. The facts are the same as in Example

6, except that the distribution is a qualified distribution. The result is the same as in Example 6, except

that no amount would be subject to the 10-percent

additional tax under section 72(t), because, to be a

qualified distribution, the distribution must be made

on or after the date on which the owner attains age

591⁄2, made to a beneficiary or the estate of the owner

on or after the date of the owner’s death, attributable

to the owner’s being disabled within the meaning of

section 72(m)(7), or to which section 72(t)(2)(F) applies (exception for a first-time home purchase).

Under section 72(t)(2), each of these conditions is

also an exception to the tax under section 72(t).

Example 8. Individual D makes a $2,000 regular

contribution to a traditional IRA on January 1, 1999,

for 1998. On April 15, 1999, when the $2,000 has

1999–8 I.R.B.

increased to $2,500, D recharacterizes the contribution by transferring the $2,500 to a Roth IRA (pursuant to §1.408A–5 A-1). In this case, D’s regular

contribution to the Roth IRA for 1998 is $2,000.

The $500 of earnings is not treated as a contribution

to the Roth IRA. The results would be the same if

the $2,000 had decreased to $1,500 prior to the

recharacterization.

Example 9. In December 1998, individual E receives a distribution from his traditional IRA of

$300,000 and in January 1999 he contributes the

$300,000 to a Roth IRA as a conversion contribution. In April 1999, when the $300,000 has increased to $350,000, E recharacterizes the conversion contribution by transferring the $350,000 to a

traditional IRA. In this case, E’s conversion contribution for 1998 is $0, because the $300,000 conversion contribution and the earnings of $50,000 are

disregarded. The results would be the same if the

$300,000 had decreased to $250,000 prior to the

recharacterization. Further, since the conversion is

disregarded, the $300,000 is not includible in gross

income in 1998.

Q-11. If the owner of a Roth IRA dies

prior to the end of the 5-taxable-year period described in A-1 of this section (relating to qualified distributions) or prior

to the end of the 5-taxable-year period described in A-5 of this section (relating to

conversions), how are different types of

contributions in the Roth IRA allocated to

multiple beneficiaries?

A-11. Each type of contribution is allocated to each beneficiary on a pro-rata

basis. Thus, for example, if a Roth IRA

owner dies in 1999, when the Roth IRA

contains a regular contribution of $2,000,

a conversion contribution of $6,000 and

earnings of $1,000, and the owner leaves

his Roth IRA equally to four children,

each child will receive one quarter of each

type of contribution. Pursuant to the ordering rules in A-8 of this section, an immediate distribution of $2,000 to one of

the children will be deemed to consist of

$500 of regular contributions and $1,500

of conversion contributions. A beneficiary’s inherited Roth IRA may not be aggregated with any other Roth IRA maintained by such beneficiary (except for

other Roth IRAs the beneficiary inherited

from the same decedent), unless the beneficiary, as the spouse of the decedent and

sole beneficiary of the Roth IRA, elects to

treat the Roth IRA as his or her own (see

A-7 and A-14 of this section).

Q-12. How do the withholding rules

under section 3405 apply to Roth IRAs?

A-12. Distributions from a Roth IRA

are distributions from an individual retirement plan for purposes of section 3405

17

and thus are designated distributions unless one of the exceptions in section

3405(e)(1) applies. Pursuant to section

3405(a) and (b), nonperiodic distributions

from a Roth IRA are subject to 10-percent

withholding by the payor and periodic

payments are subject to withholding as if

the payments were wages. However, an

individual can elect to have no amount

withheld in accordance with section

3405(a)(2) and (b)(2).

Q-13. Do the withholding rules under

section 3405 apply to conversions?

A-13. Yes. A conversion by any

method described in §1.408A–4 A-1 is

considered a designated distribution subject to section 3405. However, a conversion occurring in 1998 by means of a

trustee-to-trustee transfer of an amount

from a traditional IRA to a Roth IRA established with the same or a different

trustee is not required to be treated as a

designated distribution for purposes of

section 3405. Consequently, no withholding is required with respect to such a conversion (without regard to whether or not

the individual elected to have no withholding).

Q-14. What minimum distribution

rules apply to a Roth IRA?

A-14. (a) No minimum distributions

are required to be made from a Roth IRA

under section 408(a)(6) and (b)(3) (which

generally incorporate the provisions of

section 401(a)(9)) while the owner is

alive. The post-death minimum distribution rules under section 401(a)(9)(B) that

apply to traditional IRAs, with the exception of the at-least-as-rapidly rule described in section 401(a)(9)(B)(i), also

apply to Roth IRAs.

(b) The minimum distribution rules

apply to the Roth IRA as though the Roth

IRA owner died before his or her required

beginning date. Thus, generally, the entire interest in the Roth IRA must be distributed by the end of the fifth calendar

year after the year of the owner’s death

unless the interest is payable to a designated beneficiary over a period not

greater than that beneficiary’s life expectancy and distribution commences before the end of the calendar year following the year of death. If the sole

beneficiary is the decedent’s spouse, such

spouse may delay distributions until the

decedent would have attained age 701⁄2 or

may treat the Roth IRA as his or her own.

February 22, 1999

(c) Distributions to a beneficiary that

are not qualified distributions will be includible in the beneficiary’s gross income

according to the rules in A-4 of this section.

Q-15. Does section 401(a)(9) apply

separately to Roth IRAs and individual

retirement plans that are not Roth IRAs?

A-15. Yes. An individual required to

receive minimum distributions from his

or her own traditional or SIMPLE IRA

cannot choose to take the amount of the

minimum distributions from any Roth

IRA. Similarly, an individual required to

receive minimum distributions from a

Roth IRA cannot choose to take the

amount of the minimum distributions

from a traditional or SIMPLE IRA. In addition, an individual required to receive

minimum distributions as a beneficiary

under a Roth IRA can only satisfy the

minimum distributions for one Roth IRA

by distributing from another Roth IRA if

the Roth IRAs were inherited from the

same decedent.

Q-16. How is the basis of property distributed from a Roth IRA determined for

purposes of a subsequent disposition?

A-16. The basis of property distributed

from a Roth IRA is its fair market value

(FMV) on the date of distribution,

whether or not the distribution is a qualified distribution. Thus, for example, if a

distribution consists of a share of stock in

XYZ Corp. with an FMV of $40.00 on the

date of distribution, for purposes of determining gain or loss on the subsequent sale

of the share of XYZ Corp. stock, it has a

basis of $40.00.

Q-17. What is the effect of distributing

an amount from a Roth IRA and contributing it to another type of retirement

plan other than a Roth IRA?

A-17. Any amount distributed from a

Roth IRA and contributed to another type

of retirement plan (other than a Roth IRA)

is treated as a distribution from the Roth

IRA that is neither a rollover contribution

for purposes of section 408(d)(3) nor a

qualified rollover contribution within the

meaning of section 408A(e) to the other

type of retirement plan. This treatment

also applies to any amount transferred

from a Roth IRA to any other type of retirement plan unless the transfer is a

recharacterization described in §1.408A-5.

Q-18. Can an amount be transferred

directly from an education IRA to a Roth

February 22, 1999

IRA (or distributed from an education

IRA and rolled over to a Roth IRA)?

A-18. No amount may be transferred

directly from an education IRA to a Roth

IRA. A transfer of funds (or distribution

and rollover) from an education IRA to a

Roth IRA constitutes a distribution from

the education IRA and a regular contribution to the Roth IRA (rather than a qualified rollover contribution to the Roth

IRA).

Q-19. What are the Federal income tax

consequences of a Roth IRA owner transferring his or her Roth IRA to another individual by gift?

A-19. A Roth IRA owner’s transfer of

his or her Roth IRA to another individual

by gift constitutes an assignment of the

owner’s rights under the Roth IRA. At

the time of the gift, the assets of the Roth

IRA are deemed to be distributed to the

owner and, accordingly, are treated as no

longer held in a Roth IRA. In the case of

any such gift of a Roth IRA made prior to

October 1, 1998, if the entire interest in

the Roth IRA is reconveyed to the Roth

IRA owner prior to January 1, 1999, the

Internal Revenue Service will treat the

gift and reconveyance as never having occurred for estate tax, gift tax, and generation-skipping tax purposes and for purposes of this A-19.

§1.408A–7 Reporting.

This section sets forth the following

questions and answers that relate to the

reporting requirements applicable to Roth

IRAs:

Q-1. What reporting requirements

apply to Roth IRAs?

A-1. Generally, the reporting requirements applicable to IRAs other than Roth

IRAs also apply to Roth IRAs, except

that, pursuant to section 408A(d)(3)(D),

the trustee of a Roth IRA must include on

Forms 1099-R and 5498 additional information as described in the instructions

thereto. Any conversion of amounts from

an IRA other than a Roth IRA to a Roth

IRA is treated as a distribution for which a

Form 1099-R must be filed by the trustee

maintaining the non-Roth IRA. In addition, the owner of such IRAs must report

the conversion by completing Form 8606.

In the case of a recharacterization described in §1.408A–5 A-1, IRA owners

must report such transactions in the man-

18

ner prescribed in the instructions to the

applicable Federal tax forms.

Q-2. Can a trustee rely on reasonable

representations of a Roth IRA contributor

or distributee for purposes of fulfilling reporting obligations?

A-2. A trustee maintaining a Roth IRA

is permitted to rely on reasonable representations of a Roth IRA contributor or

distributee for purposes of fulfilling reporting obligations.

§1.408A–8 Definitions.

This section sets forth the following

question and answer that provides definitions of terms used in the provisions of

§§1.408A–1 through 1.408A–7 and this

section:

Q-1. Are there any special definitions

that govern in applying the provisions of

§§1.408A–1 through 1.408A–7 and this

section?

A-1. Yes, the following definitions

govern in applying the provisions of

§§1.408A–1 through 1.408A–7 and this

section. Unless the context indicates otherwise, the use of a particular term excludes the use of the other terms.

(a) Different types of IRAs—(1) IRA.

Sections 408(a) and (b), respectively, describe an individual retirement account

and an individual retirement annuity. The

term IRA means an IRA described in either section 408(a) or (b), including each

IRA described in paragraphs (a)(2)

through (5) of this A-1. However, the

term IRA does not include an education

IRA described in section 530.

(2) Traditional IRA. The term traditional IRA means an individual retirement

account or individual retirement annuity

described in section 408(a) or (b), respectively. This term includes a SEP IRA but

does not include a SIMPLE IRA or a Roth

IRA.

(3) SEP IRA. Section 408(k) describes

a simplified employee pension (SEP) as

an employer-sponsored plan under which

an employer can make contributions to

IRAs established for its employees. The

term SEP IRA means an IRA that receives

contributions made under a SEP. The

term SEP includes a salary reduction SEP

(SARSEP) described in section 408(k)(6).

(4) SIMPLE IRA. Section 408(p) describes a SIMPLE IRA Plan as an employer-sponsored plan under which an

1999–8 I.R.B.

employer can make contributions to SIMPLE IRAs established for its employees.

The term SIMPLE IRA means an IRA to

which the only contributions that can be

made are contributions under a SIMPLE

IRA Plan or rollovers or transfers from

another SIMPLE IRA.

(5) Roth IRA. The term Roth IRA

means an IRA that meets the requirements

of section 408A.

(b) Other defined terms or phrases—

(1) 4-year spread. The term 4-year

spread is described in §1.408A–4 A-8.

(2) Conversion. The term conversion

means a transaction satisfying the requirements of §1.408A–4 A-1.

(3) Conversion amount or conversion

contribution. The term conversion

amount or conversion contribution is the

amount of a distribution and contribution

with respect to which a conversion described in §1.408A–4 A-1 is made.

(4) Failed conversion. The term failed

conversion means a transaction in which

an individual contributes to a Roth IRA an

amount transferred or distributed from a

traditional IRA or SIMPLE IRA (including a transfer by redesignation) in a transaction that does not constitute a conversion under §1.408A-4 A-1.

(5) Modified AGI. The term modified

AGI is defined in §1.408A–3 A-5.

(6) Recharacterization. The term

recharacterization means a transaction described in §1.408A–5 A-1.

(7) Recharacterized amount or recharacterized contribution. The term recharacterized amount or recharacterized contribution means an amount or contribution

treated as contributed to an IRA other

than the one to which it was originally

contributed pursuant to a recharacterization described in §1.408A–5 A-1.

(8) Taxable conversion amount. The

term taxable conversion amount means

the portion of a conversion amount includible in income on account of a conversion, determined under the rules of

section 408(d)(1) and (2).

(9) Tax-free transfer. The term tax-free

transfer means a tax-free rollover described in section 402(c), 402(e)(6),

403(a)(4), 403(a)(5), 403(b)(8), 403(b)(10)

or 408(d)(3), or a tax-free trustee-to-trustee

transfer.

(10) Treat an IRA as his or her own.

The phrase treat an IRA as his or her own

1999–8 I.R.B.

means to treat an IRA for which a surviving spouse is the sole beneficiary as his or

her own IRA after the death of the IRA

owner in accordance with the terms of the

IRA instrument or in the manner provided

in the regulations under section 408(a)(6)

or (b)(3).

(11) Trustee. The term trustee includes

a custodian or issuer (in the case of an annuity) of an IRA (except where the context clearly indicates otherwise).

§1.408A–9 Effective date.

This section contains the following

question and answer providing the effective date of §§1.408A–1 through

1.408A–8:

Q-1. To what taxable years do

§§1.408A–1 through 1.408A–8 apply?

A-1 Sections 1.408A–1 through

1.408A-8 apply to taxable years beginning on or after January 1, 1998.

PART 602—OMB CONTROL

NUMBERS UNDER THE

PAPERWORK REDUCTION ACT

Paragraph 9. The authority citation for

part 602 continues to read as follows:

Authority: 26 U.S.C. 7805 * * *

Par.10. In §602.101, paragraph (c) is

amended by adding an entry in numerical

order to the table to read as follows:

§602.101 OMB control numbers.

* * * * *

(c) * * *

CFR part or section

where identified and

described

Current OMB

control no.

* * * * *

1.408A–2 . . . . . . . . . . . . . . . . 1545–1616

1.408A–4 . . . . . . . . . . . . . . . . 1545–1616

1.408A–5 . . . . . . . . . . . . . . . . 1545–1616

1.408A–7 . . . . . . . . . . . . . . . . 1545–1616

* * * * *

Robert E. Wenzel,

Deputy Commissioner of

Internal Revenue.

Approved January 25, 1999.

19

Donald C. Lubick,

Assistant Secretary of

the Treasury.

(Filed by the Office of the Federal Register on February 3, 1999, 8:45 a.m., and published in the issue

of the Federal Register for February 4, 1999, 64 F.R.

5597)

Section 4980B.—Failure to

Satisfy Continuous Coverage

Requirements of Group Health

Plans

26 CFR 54.4980B–1: COBRA in general.

T.D. 8812

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 54 and 602

Continuation Coverage

Requirements Applicable to

Group Health Plans

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Final rule.

SUMMARY: The Consolidated Omnibus

Budget Reconciliation Act of 1985

(COBRA) added health care continuation

requirements that apply to group health

plans. Coverage required to be provided

under those requirements is referred to as

COBRA continuation coverage. Proposed regulations interpreting the

COBRA continuation coverage requirements were published in the Federal

Register of June 15, 1987 and of January

7, 1998. This document contains final

regulations based on these two sets of

proposed regulations. The final regulations also reflect statutory amendments to

the COBRA continuation coverage requirements since COBRA was enacted. A

new set of proposed regulations

REG–121865–98 addressing additional

issues under the COBRA continuation

coverage provisions is on page 63 of this

Bulletin. The regulations will generally

affect sponsors of and participants in

group health plans, and they provide plan

sponsors and plan administrators with

guidance necessary to comply with the

law.

February 22, 1999

DATES: Effective Date: These regulations are effective February 3, 1999.

Applicability Dates:

Sections

54.4980B–1 through 54.4980B–8 apply

to group health plans with respect to qualifying events occurring in plan years beginning on or after January 1, 2000. See

the Effective Date portion of this preamble and Q&A-2 of §54.4980B–1.

FOR FURTHER INFORMATION CONTACT: Yurlinda Mathis, 202-622-4695.

This is not a toll-free number.

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information contained in these final regulations have

been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act

of 1995 (44 U.S.C. 3507) under control

number 1545-1581. Responses to these

collections of information are mandatory

in some cases and required in order to obtain a benefit in other cases. Group

health plans are required to provide certain individuals a notice of their COBRA

continuation coverage rights when certain qualifying events occur and are required to inform health care providers

who contact the plan to confirm the coverage of certain individuals of the individuals’ complete rights to coverage. To

obtain COBRA continuation coverage or

extended coverage, certain individuals

are required to notify the plan administrator of certain events or that they are electing COBRA continuation coverage, and

plans are required to notify certain individuals of insignificant underpayments if

the plan wishes to require the individuals

to pay the deficiency. This information

will be used to advise employers and plan

administrators of their obligation to offer

COBRA continuation coverage, or an extended period of such coverage; to advise

qualified beneficiaries of their right to

elect COBRA continuation coverage and

of insignificant errors in payment; and to

inform health care providers of individuals’ rights to COBRA continuation

coverage.

An agency may not conduct or sponsor,

and a person is not required to respond to,

a collection of information unless the col-

February 22, 1999

lection of information displays a valid

control number.

The estimated average annual burden

per respondent varies from 30 seconds to

330 hours, depending on individual circumstances, with an estimated average of

14 minutes.

Comments concerning the accuracy of

this burden estimate and suggestions for

reducing this burden should be sent to the

Internal Revenue Service, Attn: IRS

Reports Clearance Officer, OP:FS:FP,

Washington, DC 20224, and to the Office

of Management and Budget, Attn: Desk

Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503.

Books or records relating to these collections of information must be retained

as long as their contents may become material in the administration of any internal

revenue law. Generally, tax returns and

tax return information are confidential, as

required by 26 U.S.C. 6103.

Background

On June 15, 1987, proposed regulations

(EE–143–86, 1987–2 C.B. 929) relating

to continuation coverage requirements applicable to group health plans were published in the Federal Register (52 F.R.

22716). A public hearing was held on

November 4, 1987. Written comments

were also received. A supplemental set of

proposed regulations (REG–209485–86,

1998–11 I.R.B. 21) was published in the

Federal Register of January 7, 1998 (63

F.R. 708). No public hearing was requested or held after the publication of the

supplemental proposed regulations; written comments were received. After consideration of these comments, after review of the reported court decisions under

the parallel COBRA continuation coverage provisions of the Employee Retirement Income Security Act of 1974

(ERISA) and the Public Health Service

Act, and based on the experience of the

IRS in administering the COBRA continuation coverage requirements, a portion

of the regulations proposed by EE–143–

86 and REG–209485–86 is adopted as revised by this Treasury decision. The revisions are summarized in the explanation

below. Also being published elsewhere in

this issue of the Federal Register is a

20

new set of proposed regulations, which

addresses additional issues.

Explanation of Provisions

Overview

The regulations are intended to provide

clear, administrable rules regarding

COBRA continuation coverage. The regulations give comprehensive guidance on

many questions under COBRA, with a

view to enhancing the certainty and reliance available to all parties – including

employees, qualified beneficiaries, employers, employee organizations, and

group health plans – in determining their

COBRA rights and obligations. The

guidance is designed to further the protective purposes of COBRA without undue

administrative burdens or costs on employers, employee organizations, or group

health plans.

For example, the regulations:

• Prevent group health plans from terminating COBRA continuation coverage on the basis of other coverage

that a qualified beneficiary had prior

to electing COBRA continuation

coverage, in accordance with the

Supreme Court’s decision in Geissal

v. Moore Medical Corp.

• Give employers and employee organizations significant flexibility in determining, for purposes of COBRA,

the number of group health plans

they maintain. This will reduce burdens on employers and employee organizations by permitting them to

structure their group health plans in

an efficient and cost-effective manner and to satisfy their COBRA

obligations based upon that structure.

• Provide baseline rules for determining the COBRA liabilities of buyers

and sellers of corporate stock and corporate assets and permit buyers and

sellers to reallocate and carry out

those liabilities by agreement. This

will significantly enhance employers’

ability to negotiate and to plan appropriately for the treatment of qualified

beneficiaries in connection with

mergers and acquisitions, while protecting the rights of qualified beneficiaries affected by the transactions.

• Limit the application of COBRA for

most health flexible spending

1999–8 I.R.B.

arrangements. This will ensure that

COBRA continuation coverage under

health flexible spending arrangements is available in appropriate

cases without requiring continuation

coverage where that would not serve

the statutory purposes.

• Eliminate the requirement that group

health plans offer qualified beneficiaries the option to elect only core

(health) coverage under a group

health plan that otherwise provides

both core and noncore (vision and

dental) coverage.

• Give employers, in determining

whether the small-employer plan exception applies, the option of counting by pay period rather than by

every business day, and provide, for

that exception, for the consistent

treatment of part-time employees

through the use of full-time equivalents.

The COBRA continuation coverage requirements enacted on April 7, 1986 have

been amended by the Omnibus Budget

Reconciliation Act of 1986 (OBRA

1986), the Tax Reform Act of 1986 (TRA

1986), the Technical and Miscellaneous

Revenue Act of 1988 (TAMRA), the Omnibus Budget Reconciliation Act of 1989

(OBRA 1989), the Omnibus Budget Reconciliation Act of 1990 (OBRA 1990), the

Small Business Job Protection Act of

1996 (SBJPA), and the Health Insurance

Portability and Accountability Act of

1996 (HIPAA). 1 These amendments

made numerous clarifications and modifications to the COBRA continuation coverage requirements, moved the requirements from section 162(k) to section

4980B, added various other features, such

as the disability extension to the required

period of coverage, and significantly altered the sanctions imposed on employers

and plans for failing to comply with the

requirements. The specific changes made

by these amendments are discussed below

in connection with the provisions of the

regulations that relate to them.

The legislative history of COBRA provides that the Department of the Treasury

has the authority to interpret the coverage

and tax sanction provisions of COBRA

and that the Department of Labor has the

authority to interpret the reporting and

disclosure provisions. Accordingly, these

regulations apply in interpreting the coverage provisions of COBRA in Title I of

ERISA, as well as those in the Internal

Revenue Code. With minor exceptions,

the final regulations and the new proposed regulations being published today

do not address the notice provisions of the

COBRA continuation coverage requirements.

1 The COBRA continuation coverage requirements have also been affected by an amendment

made to the definition of group health plan by the

Omnibus Budget Reconciliation Act of 1993

(OBRA 1993). OBRA 1993 amended the definition

of group health plan in section 5000(b)(1), which the

COBRA continuation coverage provisions of the Internal Revenue Code incorporate by reference.

Effective Date

1999–8 I.R.B.

Organization

The final regulations being published

today follow the structure of the 1987

proposed regulations, with related questions-and-answers grouped into topics.

Each topic is now in a separate section,

and sections have been added to the new

proposed regulations being published

today for (1) business reorganizations and

employer withdrawals from multiemployer plans and (2) the interaction of the

Family and Medical Leave Act of 1993

(FMLA) and COBRA. The substance of

the 1998 proposed regulations has been

integrated into the questions-and-answers

of the 1987 proposed regulations. The ordering of some of the questions-and-answers has changed, and all of the questions-and-answers relating to the original

statutory effective date have been deleted.

In addition, in a few cases, the content of

two separate questions-and-answers in the

1987 proposed regulations has been combined into a single question-and-answer;

in other cases the content of a single question-and-answer has been expanded to

two or more questions-and-answers.

These changes have resulted in the

renumbering of the questions-and-answers. The new proposed regulations

being published today are designed to fill

gaps designated in the final regulations as

reserved.

The 1987 proposed regulations provide

that they will be effective upon publication as final regulations. Some commenters suggested that the final regulations should have a delayed effective date.

21

The final regulations follow this suggestion; they apply with respect to qualifying

events occurring in plan years beginning

on or after January 1, 2000. For any period before the effective date of the final

regulations, the plan and the employer

must operate in good faith compliance

with a reasonable interpretation of the requirements in section 4980B. For the period before the effective date of the final

regulations, the IRS will consider compliance with the proposed regulations in

§1.162–26 (the 1987 proposed regulations) and §54.4980B–1 (the 1998 proposed regulations) to constitute good faith

compliance with a reasonable interpretation of the statutory requirements for the

topics that those proposed regulations address, except to the extent inconsistent

with a statutory amendment adopted after

the dates the proposed regulations were

issued, during the period the amendment

is effective, or with a decision of the

United States Supreme Court released

after the proposed regulations were issued, during the period after the decision

is released. For any period beginning on

or after the effective date of the final regulations with respect to topics not addressed in the final regulations, such as

how to calculate the applicable premium,

the plan and the employer must operate in

good faith compliance with a reasonable

interpretation of the requirements in section 4980B.

Compliance with the new proposed

regulations will constitute good faith

compliance with a reasonable interpretation of the statutory requirements addressed in the new proposed regulations

until the new proposed regulations are finalized. In addition, actions inconsistent

with the terms of the new proposed regulations will not necessarily constitute a

lack of good faith compliance with a reasonable interpretation of the statutory requirements addressed in the new proposed regulations; whether there has been

good faith compliance with a reasonable

interpretation of the statutory requirements will depend on all the facts and circumstances of each case.

The IRS will not assess the excise tax

with respect to a plan that operates in

good faith compliance with a reasonable

interpretation of the statutory requirements, as described in the preceding two

paragraphs. Note, however, that in the

February 22, 1999

case of lawsuits brought by qualified beneficiaries to enforce their COBRA continuation coverage rights under ERISA or

the Public Health Service Act, the courts

generally have not applied any good faith

compliance standard.

Plans That Must Comply

The final regulations provide rules regarding which group health plans are subject to COBRA. These rules are generally

similar to those set forth in the 1987 proposed regulations. However, the rules for

determining, for purposes of the COBRA

continuation coverage requirements, the

number of group health plans maintained

by an employer have been deleted, and

the new proposed regulations set forth

substantially different rules, which provide that employers and employee organizations generally have broad discretion to

determine the number of group health

plans that they maintain. Other significant changes to the 1987 proposed regulations on this point (some of which are set

forth in the 1998 proposed regulations)

include exceptions for long-term care services and medical savings accounts and

new rules regarding the small-employer

plan exception.

As in the 1987 proposed regulations,

the final regulations provide that, in general, all group health plans are subject to

the COBRA continuation coverage requirements. However, small-employer

plans (discussed below), church plans

(within the meaning of section 414(e)),

and governmental plans (within the meaning of section 414(d)) are not subject to

COBRA. (The final regulations refer to

these as plans excepted from COBRA.)

Plans excepted from COBRA are generally not subject to the COBRA continuation coverage requirements or the

COBRA excise tax, although group health

plans maintained by state or local governments are subject to parallel continuation

coverage requirements in the Public

Health Service Act (which is administered

by the Department of Health and Human

Services). Also, the Federal Employees

Health Benefit Program is subject to generally similar, although not parallel, temporary continuation of coverage provisions under the Federal Employees Health

Benefits Amendments Act of 1988.

The final regulations define group

health plan in a manner generally similar

February 22, 1999

to that in the 1987 proposed regulations.

However, certain changes in terminology

have been made to reflect the statutory

cross-reference to section 5000(b)(1) set

forth in section 4980B(g)(2) (such as the

use of the term health care and the definition of employee). Additionally, the final

regulations, in accordance with section

4980B(g)(2), provide that a plan is not a

group health plan if substantially all the

coverage provided under the plan is for

qualified long-term care services (as defined in section 7702B(c)). The final regulations allow plans to use any reasonable

method in determining whether a plan satisfies this exception. The final regulations also provide, in accordance with

section 106(b)(5), that amounts contributed by an employer to a medical savings account (as defined in section

220(d)) are not considered part of a group

health plan for purposes of COBRA (although a high-deductible health plan will

not fail to be a group health plan simply

because it covers a holder of a medical

savings account).

Under the final regulations, a group

health plan is a plan maintained by an employer or employee organization to provide health care to individuals who have

an employment-related connection to the

employer or employee organization or to

the families of such individuals. In accordance with section 5000(b)(1), these individuals include employees, former employees, the employer, and others

associated or formerly associated with the

employer or employee organization in a

business relationship. The final regulations generally refer to all individuals covered under a plan by virtue of the performance of services or by virtue of

membership in an employee organization

as employees. (As discussed below, the

term employee has a narrower meaning for

purposes of the small-employer plan exception.) The final regulations use the

term employer to refer to a person for

whom an individual performs services.

Pursuant to section 414(t), the term employer also includes, with respect to such a

person, any member of a group described

in section 414(b), (c), (m), or (o) that includes the person (a controlled group) as

well as any successor of the person or of a

member of the controlled group.

Under the final regulations, as under

the 1987 proposed regulations, a plan

22

generally is considered to provide health

care whether it does so directly or through

insurance, reimbursement, or other means

and whether it does so through an on-site

facility or a cafeteria or other flexible

benefit arrangement. Insurance includes

group insurance policies and one or more

individual policies under an arrangement

maintained by the employer or employee

organization to provide health care to two

or more employees. Under the final regulations, as under the 1987 proposed regulations, in the case of a cafeteria plan or

other flexible benefit arrangement, the

COBRA continuation coverage requirements apply only to the health care benefits under the cafeteria plan or other flexible benefit arrangement that an employee

has actually chosen to receive.

Many commenters on the 1987 proposed regulations requested clarification

of the application of COBRA to health

care benefits provided under flexible

spending arrangements (health FSAs).

Some commentators argued that health

FSAs should not be subject to COBRA.

Health FSAs satisfy the definition of

group health plan in section 5000(b)(1)

and, accordingly, are generally subject to

the COBRA continuation coverage requirements. However, COBRA is intended to ensure that a qualified beneficiary has guaranteed access to coverage

under a group health plan and that the cost

of that coverage is no greater than 102

percent of the applicable premium.

The IRS and Treasury believe that the

purposes of COBRA are not furthered by

requiring an employer to offer COBRA

for a plan year if the amount that the employer could require to be paid for the

COBRA coverage for the plan year would

exceed the maximum benefit that the

qualified beneficiary could receive under

the FSA for that plan year and if the qualified beneficiary could not avoid a break

in coverage, for purposes of the HIPAA

portability provisions 2 , by electing

COBRA coverage under the FSA. Accordingly, the new proposed regulations

contain a rule limiting the application of

2 Under HIPAA, a qualified beneficiary who

maintains coverage after termination of employment

under a group health plan that is subject to HIPAA

can avoid a break in coverage and thereby avoid becoming subject to a preexisting condition exclusion

upon later becoming covered by another another

group health plan.

1999–8 I.R.B.

the COBRA continuation coverage requirements in the case of health FSAs.

Under this rule, if the health FSA satisfies two conditions, the health FSA need

not make COBRA continuation coverage

available to a qualified beneficiary for

any plan year after the plan year in which

the qualifying event occurs. The first

condition that the health FSA must satisfy

for this exception to apply is that the

health FSA is not subject to the HIPAA

portability provisions in sections 9801

though 9833 because the benefits provided under the health FSA are excepted

benefits. (See sections 9831 and 9832.)3

The second condition is that, in the plan

year in which the qualifying event of a

qualified beneficiary occurs, the maximum amount that the health FSA could

require to be paid for a full plan year of

COBRA continuation coverage equals or

exceeds the maximum benefit available

under the health FSA for the year. It is

contemplated that this second condition

will be satisfied in most cases.

Moreover, if a third condition is satisfied, the health FSA need not make

COBRA continuation coverage available

with respect to a qualified beneficiary at

all. This third condition is satisfied if, as

of the date of the qualifying event, the

maximum benefit available to the qualified beneficiary under the health FSA for

the remainder of the plan year is not more

than the maximum amount that the plan

could require as payment for the remainder of that year to maintain coverage

under the health FSA.

A plan is maintained by an employer or

employee organization even if the employer or employee organization does not

directly or indirectly contribute to it if

coverage under the plan would not be

available to an individual at the same cost

if the individual did not have an employment-related connection to the employer

3 The IRS and Treasury, together with the U.S.

Department of Labor and the U.S. Department of

Health and Human Services, have issued a notice

(62 F.R. 67688) holding that a health FSA is exempt

from HIPAA because the benefits provided under it

are excepted benefits under sections 9831 and 9833

if the employer also provides another group health

plan, the benefits under the other plan are not limited

to excepted benefits, and the maximum reimbursement under the health FSA is not greater than two

times the employee’s salary reduction election (or if

greater, the employee’s salary reduction election

plus five hundred dollars.

1999–8 I.R.B.

or employee organization. The final regulations, for purposes of the definition of a

group health plan, use the term health

care instead of the term medical care

(which was used in the 1987 proposed

regulations). This change reflects the

change in the definition of group health

plan made by OBRA 1989. However, the

final regulations provide that health care

has the same meaning as the term medical

care under section 213(d). Like the 1987

proposed regulations, the final regulations

set forth a summary of items that do and

do not constitute health care.

The final regulations, generally following the 1987 proposed regulations, set

forth rules for determining whether a

group health plan is a small-employer

plan. In general, a group health plan other

than a multiemployer plan is a small-employer plan if it is maintained for a calendar year by an employer that normally employed fewer than 20 employees during

the preceding calendar year, and a group

health plan that is a multiemployer plan is

a small-employer plan if each of the employers contributing to the plan for a calendar year normally employed fewer than

20 employees during the preceding calendar year. Whether the plan is a multiemployer plan or not, the term employer includes all members of a controlled group.

An example in the final regulations clarifies that the controlled group includes foreign members, and thus a U.S. subsidiary

with fewer than 20 employees is subject to

COBRA if the controlled group has 20 or

more employees world-wide. The final

regulations set forth additional rules for

the application of the small-employer plan

exception to multiemployer plans, and the

new proposed regulations contain the

same definition of multiemployer plan

that is in section 414(f).

Under the final regulations, an employer is considered to have normally employed fewer than 20 employees during a

particular calendar year if it had fewer

than 20 employees on at least 50 percent

of its typical business days during that

year. This rule differs from the rule in the

1987 proposed regulations in two ways.

First, the 1987 proposed regulations use

the term working days, whereas the final

regulations use the statutory term typical

business days.

The second difference relates to the

term employee. Under the 1987 proposed

23

regulations, self-employed individuals

and independent contractors are counted

as employees for purposes of the smallemployer plan exception if they are covered under a plan of the employer. Commenters argued that only common law

employees should be counted for this purpose. Unlike the definition of covered

employee (amended by OBRA 1989 to

make clear that individuals who are not

common law employees but who are covered under the group health plan of an

employer or employee organization by

virtue of the performance of services are

still considered covered employees) and

the definition of group health plan

(amended by OBRA 1993 to make clear

that a health plan covering individuals

who are not common law employees of

the employer or employee organization,

and who are not family members of common law employees, is still a group health

plan) the reference to employees for purposes of the small-employer plan exception have not been amended to include individuals who are not common law

employees. Consequently, under the final

regulations, only common law employees

are taken into account for purposes of the

small-employer plan exception; self-employed individuals, independent contractors, and directors are not counted.

Although a small-employer plan is generally excepted from COBRA, a plan that

is not a small-employer plan for a period

remains subject to COBRA for qualifying

events that occurred during that period,

even if it subsequently becomes a smallemployer plan.

In determining whether a plan is eligible for the small-employer plan exception, part-time employees, as well as fulltime employees, must be taken into

account. Several commenters on the

1987 proposed regulations requested clarification of how to count part-time employees for the small-employer plan exception, and the new proposed regulations

provide guidance on this issue. Under the

new proposed regulations, instead of each

part-time employee counting as a full employee, each part-time employee counts

as a fraction of an employee, with the

fraction equal to the number of hours that

the part-time employee works for the employer divided by the number of hours

that an employee must work in order to be

considered a full-time employee. The

February 22, 1999

number of hours that must be worked to

be considered a full-time employee is determined in a manner consistent with the

employer’s general employment practices, although for this purpose not more

than eight hours a day or 40 hours a week

may be used. An employer may count

employees for each typical business day

or may count employees for a pay period

and attribute the total number of employees for that pay period to each typical

business day that falls within the pay period. The employer must use the same

method for all employees and for the entire year for which the small-employer

plan determination is made.

In determining whether a multiemployer plan satisfies the requirements for

the small-employer plan exception, the

1987 proposed regulations provide a special rule permitting the multiemployer

plan to be considered a small-employer

plan for a year if any contributing employer that grew to be too large to qualify

for the exception during the preceding

year ceases to contribute to the plan by

February 1 of the current year. Questions

have been raised about the need for and

the authority for this special rule, and one

commenter pointed out the uncertainty of

how to deal with a qualified beneficiary

experiencing a qualifying event under

such a plan in January of the current year

if the qualified beneficiary needed confirmation of coverage for urgent services before it was clear that the too-large employer would cease contributing to the

multiemployer plan by February 1. Based

on these concerns, the final regulations

eliminate this special rule for multiemployer plans.

The new proposed regulations provide

guidance, for purposes of the COBRA

continuation coverage requirements, on

how to determine the number of group

health plans that an employer or employee

organization maintains. Under these rules,

the employer or employee organization is

generally permitted to establish the separate identity and number of group health

plans under which it provides health care

benefits to employees. Thus, if an employer or employee organization provides

a variety of health care benefits to employees, it generally may aggregate the benefits into a single group health plan or disaggregate benefits into separate group

health plans. The status of health care

February 22, 1999

benefits as part of a single group health

plan or as separate plans is determined by

reference to the instruments governing

those arrangements. If it is not clear from

the instruments governing an arrangement

or arrangements to provide health care

benefits whether the benefits are provided

under one plan or more than one plan, or if

there are no instruments governing the

arrangement or arrangements, all such

health care benefits (other than those for

qualified long-term care services) provided by a single entity (determined without regard to the controlled group) constitute a single group health plan.

Under the new proposed regulations, a

multiemployer plan and a plan other than

a multiemployer plan are always separate

plans. In addition, any treatment of health

care benefits as constituting separate

group health plans will be disregarded if a

principal purpose of the treatment is to

evade any requirement of law. Of course,

an employer’s flexibility to treat benefits

as part of separate plans may be limited by

the operation of other laws, such as the

prohibition in section 9802 on conditioning eligibility to enroll in a group health

plan on the basis of any health factor of an

individual.

The final regulations modify the rules

set forth in the 1987 proposed regulations

for determining the plan year of a group

health plan under COBRA. These modifications are made to be consistent with

the rules in the temporary regulations

under HIPAA. The definition of plan year

is important in applying, for example, the

effective date provisions under the final

regulations and the rules for health FSAs

under the new proposed regulations.

Under the final regulations, the plan year

is the year designated as such in the plan

documents. If the plan documents do not

designate a plan year (or if there are no

plan documents), the plan year is the deductible/limit year used by the plan. If

the plan does not impose deductibles or

limits on an annual basis, the plan year is

the policy year. If the plan does not impose deductibles or limits on an annual

basis and the plan is not insured (or the insurance policy is not renewed annually),

the plan year is the taxable year of the employer. In any other case, the plan year is

the calendar year.

The final regulations reflect the statutory provisions that provide for the impo-

24

sition of an excise tax in the event of a

failure by a group health plan to comply

with the COBRA continuation coverage

requirements of section 4980B(f). In the

case of a multiemployer plan, the excise

tax is imposed on the plan4; in the case of

any other plan, the excise tax is imposed

on the employer maintaining the plan. In

certain circumstances, the excise tax can

be imposed on other persons involved

with the provision of benefits under the

plan, such as an insurer providing benefits

under the plan or a third party administrator administering claims under the plan.

Separate, non-tax remedies may be available in the case of a plan that fails to comply with the COBRA continuation coverage requirements in ERISA.

Qualified Beneficiaries

The rules in the final regulations for determining who is a qualified beneficiary

generally follow those set forth in the

1987 proposed regulations, as well as

those set forth in the 1998 proposed regulations regarding the status of newborn

and adopted children as qualified beneficiaries. However, certain provisions have

been added to the final regulations to reflect the special statutory rules that apply

in the case of bankruptcy of the employer

as a qualifying event. Modifications have

also been made to reflect the decision of

the Supreme Court in Geissal v. Moore

Medical Corp., 118 S. Ct. 1869 (1998),

which held that an individual covered

under another group health plan at the

time she or he elects COBRA continuation coverage cannot be denied COBRA

continuation coverage on the basis of that

other coverage.

Under the final regulations, a qualified

beneficiary is, in general: (1) any individual who, on the day before a qualifying

event, is covered under a group health

plan either as a covered employee, the

spouse of a covered employee, or the dependent child of a covered employee; or

(2) any child born to or placed for adoption with a covered employee during a pe4 In this regard, the U.S. Department of Labor

has advised the IRS and Teasury that to the extent a

plan fiduciary subjects a plan to liability for the

COBRA excise tax on account of her or his imprudent actions, the plan fiduciary may be held personally liable under Title I of ERISA for the amount of

the tax.

1999–8 I.R.B.

riod of COBRA continuation coverage.

(The final regulations retain the definitions of the terms placement for adoption

and being placed for adoption that were

in the 1998 proposed regulations.) For a

qualifying event that is the bankruptcy of

the employer, any covered employee who

retired on or before the date of any substantial elimination of group health plan

coverage is a qualified beneficiary; the

spouse, surviving spouse, or dependent

child of the retired covered employee is

also a qualified beneficiary if the spouse,

surviving spouse, or dependent child was

a beneficiary under the plan on the day

before the bankruptcy qualifying event.

The final regulations add a provision clarifying that if an individual is denied coverage under a group health plan in violation of applicable law (including HIPAA)

and experiences an event that would be a

qualifying event if the coverage had not

been wrongfully denied, the individual is

considered a qualified beneficiary.

A covered employee can be a qualified

beneficiary only in connection with a

qualifying event that is the termination (or

reduction of hours) of the covered employee’s employment or the employer’s

bankruptcy. As under the 1987 proposed

regulations, the final regulations provide

that a covered employee is not a qualified

beneficiary if her or his status as a covered employee is attributable to certain

periods in which she or he was a nonresident alien (in which case the covered employee’s spouse and dependent children

are also not qualified beneficiaries). Although a child born to or placed for adoption with a covered employee during a period of COBRA continuation coverage is

a qualified beneficiary, a child born to or

placed for adoption with a qualified beneficiary other than the covered employee

after a qualifying event, or a person who

becomes the spouse of a qualified beneficiary (regardless of whether the qualified

beneficiary is the covered employee) after

a qualifying event is not a qualified beneficiary. The final regulations retain the

rule of the 1987 proposed regulations

under which an individual is not a qualified beneficiary if, on the day before the

qualifying event, the individual is covered

under the group health plan solely because of another individual’s election of

COBRA continuation coverage. How-

1999–8 I.R.B.

ever, consistent with Geissal, the final

regulations eliminate the rule in the 1987

proposed regulations that an individual is

not a qualified beneficiary if, on the day

before the qualifying event, the individual

was entitled to Medicare benefits.

An individual ceases to be a qualified

beneficiary if she or he does not elect

COBRA continuation coverage by the end

of the election period (discussed below).

The final regulations clarify that an individual who elects COBRA continuation

coverage ceases to be a qualified beneficiary once the plan’s obligation to provide

COBRA continuation coverage has

ended.

The term covered employee is defined

in the final regulations in a manner substantially the same as in the 1987 proposed regulations. Although some commenters on the 1987 proposed regulations

objected to the inclusion in this definition

of individuals other than common law

employees, the statutory definition was

amended by OBRA 1989 to include such

individuals. Under the final regulations,

a covered employee generally includes

any individual who is or has been provided coverage under a group health plan

(other than one excepted from COBRA as

of the date of what would otherwise be a

qualifying event) because of her or his

present or past performance of services

for the employer maintaining the group

health plan (or by reason of membership

in the employee organization maintaining

the plan). Thus, retirees and former employees covered by a group health plan

are covered employees if the coverage is

provided in whole or in part because of

the previous employment. Any individual

who performs services for the employer

maintaining the plan or who is a member

of the employee organization maintaining

the plan may be a covered employee.

Thus, common law employees, selfemployed individuals, independent contractors, and corporate directors can be

covered employees. Generally, mere eligibility for coverage – as opposed to actual coverage – does not make an individual a covered employee. However, if an

individual who otherwise would be a covered employee is denied coverage under a

group health plan in violation of applicable law (including HIPAA), the individual

is considered a covered employee.

25

Qualifying Events

The rules regarding qualifying events

under the final regulations generally are

the same as those in the 1987 proposed

regulations. Under the final regulations, a

qualifying event is any of a set of specified events that occurs while a group

health plan is subject to COBRA and that

causes a covered employee (or the spouse

or dependent child of the covered employee) to lose coverage under the plan.

These specified events are: the death of a

covered employee; the termination (other

than by reason of gross misconduct), or

reduction of hours, of a covered employee’s employment; the divorce or legal

separation of a covered employee from

the covered employee’s spouse; a covered

employee’s becoming entitled to

Medicare benefits under Title XVIII of

the Social Security Act; a dependent

child’s ceasing to be a dependent child of

the covered employee under the plan; and

a proceeding in bankruptcy under Title 11

of the United States Code with respect to

an employer from whose employment a

covered employee retired at any time.

The addition of employer bankruptcy as a

qualifying event reflects the amendments

made to COBRA by OBRA 1986.

The reasons for which an employee has

a termination of employment or a reduction of hours of employment generally are

not relevant in determining whether the

termination or reduction of hours is a

qualifying event. Thus, a voluntary termination, a strike, a lockout, a layoff, or

an involuntary discharge each may constitute a qualifying event. However, if an

employee is discharged for gross misconduct, the termination of employment does

not constitute a qualifying event. The

final regulations clarify that a reduction of

hours of a covered employee’s employment includes any decrease in the number

of hours that a covered employee works

or is required to work that does not constitute a termination of employment. Thus,

if a covered employee takes a leave of absence, is laid off, or otherwise performs

no hours of work during a period, the covered employee has experienced a reduction in hours that, if the other applicable

requirements are satisfied, constitutes a

qualifying event. (But see Notice 94–

103 (1994–2 C.B. 569) and the new pro-

February 22, 1999

posed regulations, described below, for

special rules regarding FMLA leave.) A

covered employee’s loss of coverage by

reason of a failure to work the minimum

number of hours required for coverage

constitutes a reduction of hours of employment.

Under the final regulations, to lose coverage means to cease to be covered under

the same terms and conditions as in effect

immediately before the event. The final

regulations clarify that a loss of coverage

includes an increase in an employee premium or contribution resulting from one

of the events described above. The loss

of coverage need not be concurrent with

the event; it is enough that the loss of coverage occur at any time before the end of

the maximum coverage period (described

below). For employer bankruptcies, the

term to lose coverage also includes a substantial elimination of coverage that occurs within 12 months before or after the

date on which the bankruptcy proceeding

begins.

Under the final regulations, as under

the 1987 proposed regulations, reductions

or eliminations in coverage in anticipation

of an event are disregarded in determining

whether the event results in a loss of coverage. Although several commenters objected to this rule, the final regulations retain the provision in order to protect

qualified beneficiaries from being deprived of their COBRA rights because an

employer or employee organization transposes a loss or reduction of coverage to a

time before the qualifying event. This

rule also applies in cases where a covered

employee discontinues the coverage of a

spouse in anticipation of a divorce or

legal separation. In such a case, upon receiving notice of the divorce or legal separation, a plan is required to make

COBRA continuation coverage available,

effective on the date of the divorce or

legal separation (but not for any period

before the date of the divorce or legal separation).

Under the final regulations, as under

the 1987 proposed regulations, an event

must occur while the group health plan is

subject to COBRA in order to constitute a

qualifying event. A plan that is excepted

from COBRA (for example, by reason of

the small-employer plan exception) and

that later becomes subject to COBRA is

not required to provide COBRA continua-

February 22, 1999

tion coverage to individuals who experienced what would otherwise be a qualifying event during the period when the plan

was not subject to COBRA.

Finally, in the case of a child born to or

placed for adoption with a covered employee during a period of COBRA continuation coverage, the qualifying event that

gives rise to that period of COBRA continuation coverage is the qualifying event

applicable to that child. Thus, if a second

qualifying event has occurred before such

a child is born (for example, if the covered employee dies), the second qualifying event also applies to the newborn

child.

COBRA Continuation Coverage

The 1987 proposed regulations generally refer to the coverage that a qualified

beneficiary is entitled to as the coverage

that was in effect on the day before the

qualifying event. While that is generally

true, the final regulations have been revised to incorporate the statutory standard

that a qualified beneficiary is entitled to

the coverage made available to similarly

situated beneficiaries with respect to

whom a qualifying event has not occurred. The final regulations generally

use as a shorthand for this statutory language the phrase “similarly situated nonCOBRA beneficiaries” instead of the

phrase “similarly situated active employees” used in the 1987 proposed regulations. In certain contexts in the final regulations, though, the phrase “similarly

situated active employees” is still used

because in those contexts – such as the

right to make an independent election for

COBRA continuation coverage – qualified beneficiaries who are spouses and dependent children of covered employees

are entitled to the rights that employees

have (and in those contexts, spouses and

dependent children who are not qualified

beneficiaries typically do not have the

rights that employees have).

The 1987 proposed regulations address

in a separate question-and-answer the

type of coverage that must be made available to qualified beneficiaries if a change

is made in the coverage provided to similarly situated nonCOBRA beneficiaries.

The final regulations include this rule in

the question-and-answer that defines

COBRA continuation coverage. In doing

26

so, the final regulations delete several

specific requirements in the 1987 proposed regulations. For example, if coverage for the similarly situated nonCOBRA

beneficiaries is changed or eliminated, the

1987 proposed regulations require that

qualified beneficiaries be permitted to

elect coverage under any remaining plan

made available to the similarly situated

active employees. Many commenters objected that in the case of a mere change in

benefits, the requirement to give qualified

beneficiaries an election among other

plans would give them greater rights than

those active employees might have. The

final regulations follow the suggestion of

the commenters in providing that the general principle – that qualified beneficiaries have the same rights as similarly situated nonCOBRA beneficiaries – applies

in this situation. The same principle also

applies in determining whether credit for

deductibles must be carried over from a

discontinued plan to a new plan. Nevertheless, if an employer or employee organization providing more than one plan to

a group of similarly situated nonCOBRA

beneficiaries eliminates benefits under

one plan without giving the similarly situated nonCOBRA beneficiaries the right to

enroll in another plan, that option w

This text is long and has been trimmed here. Open the source document for the complete record.