Puerto Rico and U.S. laws affecting retirement plans have changed extensively in the last few years.  Puerto Rico adopted a new tax code in 2011, and both the U.S. and Puerto Rico Treasury Departments issued a number of rulings that have a significant impact on employers that sponsor retirement plans benefiting Puerto Rico employees.  Action is required on many of these changes by the end of 2012 or early 2013.

Following is a list of the primary compliance issues that U.S. employers should consider in 2012 if they maintain tax-qualified retirement plans with Puerto Rico employees—both dual-qualified (i.e., plans qualified under both the U.S. and Puerto Rico Internal Revenue Codes) and Puerto Rico-only qualified retirement plans.

Amendments for Compliance with the New 2011 Puerto Rico Tax Code

In 2011 Puerto Rico adopted a new tax code, which contains a number of significant changes to the requirements for both dual-qualified and Puerto Rico-only qualified retirement plans.  Plan sponsors must either amend or restate their plans to comply with the 2011 Puerto Rico tax code on or before the end of the plan year beginning on or after January 1, 2012 (i.e., on or before December 31, 2012, for calendar year plans).

Puerto Rico Circular Letter No. 11-10 contains a list of the new qualification provisions that must be included in the plan document to comply with the 2011 Puerto Rico tax code.  All tax-qualified retirement plans benefiting Puerto Rico employees must be amended to provide for compliance with the following:

• The new definition of “highly compensated employees” used to apply nondiscrimination tests
• Maximum limits on benefits and annual contributions
• The maximum limit on annual compensation used to calculate benefits or contributions
• The definition of the term “employer” used to apply nondiscrimination tests (i.e., application of controlled group rules)
• Rules with respect to the types of distributions or payments that may be rolled over to an individual retirement account established in Puerto Rico or another Puerto Rico-qualified retirement plan

In addition, employers should be aware of the following requirements:

• Plans that include a cash or deferred contribution arrangement must adopt new plan year limits for elective deferrals and catch-up contributions.
• Plans that allow voluntary after-tax contributions must adopt rules on the maximum limit of such contributions.
• Plans that allow Puerto Rico participants to take loans must adopt new loan procedures.
• Plans that allow Puerto Rico participants to take advantage of special distributions rules applicable when at least 10 percent of the benefits are invested in Puerto Rico property must adopt new rules.
• Money purchase plans converted into profit sharing plans must adopt special provisions.

Plan sponsors should also review their plans for the applicability of other changes not described above that may be specified in the plan document (e.g., new rules on the correction of excess contributions).  More information on the changes made by the 2011 Puerto Rico tax code is available in McDermott’s On the Subject  “New Puerto Rico Tax Code Means Significant Changes to Retirement Plans for Puerto Rico Employees.”

Application for a Determination Letter on the Qualified Status of the Plan in Puerto Rico Under the 2011 Puerto Rico Internal Revenue Code

All Puerto Rico tax-qualified plans, both dual-qualified and Puerto Rico-only, including plans with recent determination letters issued under the Puerto Rico Internal Revenue Code of 1994, must be filed for an updated determination letter on the plan’s tax-qualified status on or before the due date, including an extension, of the participating employer’s 2012 Puerto Rico income tax return.  The income tax return is due on the 15th day of the fourth month after the close of the tax year, or the 15th day of the seventh month if an automatic extension is timely obtained.  In other words, for an employer that is a calendar year taxpayer, the determination letter filing is due by either April 15, 2013, or July 15, 2013.

Plans previously amended to comply with the new qualification requirements of the 2011 Puerto Rico tax code that were submitted prior to the issue of Circular Letter No. 11-10 in December 2011 may not need to be filed again, but plans that are subsequently amended to comply with technical corrections adopted for the 2011 tax code or other material changes may need to file again (albeit with reduced filing fees.)

Application for a Retroactive Determination Letter on the Qualified Status of a Plan Under the Puerto Rico Internal Revenue Code of 1994

Circular Letter No. 11-10 contains procedures providing relief for plan sponsors that have never filed a plan benefiting Puerto Rico employees, or have failed to file a plan that was materially changed after receiving a determination letter, to be filed for retroactive qualification under the Puerto Rico Internal Revenue Code of 1994.  Plan sponsors may obtain retroactive qualification by (1) retroactively amending the plan for compliance with the Puerto Rico Internal Revenue Code of 1994, as applicable, and amending the plan for compliance with the 2011 Puerto Rico tax code, as applicable, on or before the end of the plan year beginning on or after January 1, 2012 (i.e., by December 31, 2012, for calendar year plans), and (2) filing the plan for qualification on or before the due date, including an extension, of the participating employer’s 2012 Puerto Rico income tax return (i.e., either by April 15, 2013, or July 15, 2013, for calendar year taxpayers).

Tax and Withholding Rules – Compliance with 2011 Puerto Rico Tax Code Changes

Plan sponsors should ensure they are complying with changes in the 2011 Puerto Rico tax code affecting taxation and withholding of participant distributions.  For example, the 2011 Puerto Rico tax code changed the withholding rules for non-lump-sum distributions and the ability of participants to roll over partial distributions.  Plan sponsors should ensure they have updated election forms, rollover forms and tax notices for Puerto Rico participants, as well as updated summary plan descriptions reflecting the changes made by the 2011 Puerto Rico tax code.

Participation by Puerto Rico Plans in U.S. Group and Master Trusts

The Internal Revenue Service (IRS) has been reviewing the ability of Puerto Rico-only qualified plans to pool assets with U.S.-qualified plans in group and master trusts described in Revenue Ruling 81-100.  In December 2011, the IRS issued Notice 2012-4, which provides continued transition relief allowing employers to continue to pool Puerto Rico plan assets with U.S.-qualified plans in group and master trusts until further notice, provided the plan was participating in the trust as of January 10, 2011, or holds assets that had been held by a qualified plan immediately prior to the transfer of those assets to an Employee Retirement Income Security Act (ERISA) Section 1022(i)(1) plan in connection with a spin-off from a U.S.-qualified plan under Revenue Ruling 2008-40.

The IRS’s ultimate position on this issue is critical for employers that sponsor qualified plans for Puerto Rico employees.  Puerto Rico retirement plan assets are often too small to meet minimum investment requirements and may not be able to obtain the same investments at the same costs as U.S.-qualified plans.  Notice 2012-4 allows Puerto Rico plans to continue to participate in U.S. group and master trusts until further notice without facing potential disqualification of the participating U.S. plans and trusts.  However, the ruling only provides transition relief.  Permanent relief is needed to allow Puerto Rico-only plans to continue to pool assets with U.S. plans in group and master trusts.

Transferring Puerto Rico Participants in a U.S.-Qualified Retirement Plan to a Puerto Rico-Qualified Retirement Plan

The IRS continues to provide a transition period for sponsors of dual-qualified plans to spin off and transfer assets attributable to Puerto Rico employees to Puerto Rico-only qualified plans in accordance with Revenue Ruling 2008-40.  Notice 2012-4 provides that the general deadline to transfer assets to a Puerto Rico-only plan is now December 31, 2012.  The extension was granted to give plan sponsors time to consider the impact of the changes to Puerto Rico plans made by the 2011 Puerto Rico tax code.  In addition, for dual-qualified plans that participate in a group trust described in Revenue Ruling 81-100, the IRS has extended the deadline indefinitely, presumably until after the IRS reaches a conclusion on the ability of a dual-qualified plan to participate in an 81-100 group trust, as described in Revenue Ruling 2011-1.

The decision whether to transfer requires consideration of a number of issues, including the size of the employer’s Puerto Rico employee population, the ability of the employer and the employer’s third-party administrators to comply with dual tax qualification requirements (a concern significantly reduced by the changes made in the 2011 Puerto Rico tax code), and the ability of a Puerto Rico-only plan to participate in a group or master trust with the employer’s U.S.-qualified plans.

Changes to the Puerto Rico Annual Reporting Requirement for Dual-Qualified Plans

The Puerto Rico Treasury Department recently issued guidance (Circular Letter No. 12-02) allowing Puerto Rico-qualified retirement plans, including dual-qualified plans, to file a copy of Form 5500 or Form 5500-SF with the Puerto Rico Treasury as the plan’s annual Puerto Rico return in lieu of Puerto Rico Form 480.7(OE).  For tax years beginning on and after January 1, 2011, employers that maintain plans that both (1) are subject to the provisions of Title I of ERISA and (2) have previously submitted an application to the Puerto Rico Treasury Department for a determination that the plan is qualified under the Puerto Rico Internal Revenue Code may comply with the annual Puerto Rico filing requirement by filing a copy of the corresponding Form 5500 or Form 5500-SF as the plan’s annual return in lieu of Puerto Rico Form 480.7(OE).

Plan sponsors that elect to file Form 5500 must still complete the part of Form 480.7(OE) containing the biographical data of the plan on the first page of Form 480.7(OE) and attach a copy of Form 5500 as the annual filing.  Either Form 5500 or Form 480.7(OE) must be filed by July 31 following the calendar year close or the last day of the seventh month following the fiscal year close of the trust (if Form 480.7(OE) is filed) or the plan year (if Form 5500 is filed), unless a request is filed for an automatic extension to October 15 following the close of the year for a calendar plan year.  Plan sponsors that request an extension of time to file the Form 5500 with the U.S. Department of Labor still must request an extension of time for the Puerto Rico filing separately prior to the filing deadline of the Form 480.7(OE) not including any U.S. Department of Labor extension.