The guidance, known as Administrative Determination No. 14-16 (or AD 14-16), addresses ambiguities in provisions of Puerto Rico’s Internal Revenue Code (PR Code) and provides a window period for the prepayment of Puerto Rico income taxes on retirement account balances and accrued benefits under qualified and nonqualified retirement plans.
Specifically, the guidance relates to ambiguities in the Tax System Adjustment Act, or Act 77-2014, which amended the PR Code to give plan participants a window from July 1 to October 31 to voluntarily prepay the Puerto Rico income taxes on their accumulated and undistributed plan account balances. The new AD 14-16 clarifies that this prepayment may be made on all or part of both the participant’s account balance in the case of a defined contribution plan or the present value of the participant’s accrued benefit in the case of a defined benefit pension plan. In addition, the election to prepay may be made on a per plan basis in the case of participation in more than one plan.
The AD also clarifies that an 8% tax rate is applicable for the prepayment in the case of plans qualified under the PR Code, and a 15% tax rate is applicable for nonqualified plans. For purposes of the prepayment, AD 14-16 provides that a qualified plan includes plans that have been submitted with the PR Treasury for qualification under the PR Code as of the time the prepayment is made.
In terms of prepayment of tax and the plan sponsor options, the brief explains that the prepayment may be made with the participant’s own funds or with funds distributed from a plan, and cannot exceed the participant’s account balance or accrued benefit as of the date the prepayment is made.
The brief also notes that according to AD 14-16, a plan is not required to either keep track of the prepayment or allow distributions from the plan for the prepayment. This means the plan fiduciaries have not only the discretion whether to allow distributions from a plan for the prepayment, but also the discretion whether to maintain or not maintain recordkeeping of the prepayments.
Plan sponsors should also note that allowing distributions from a plan for the prepayment will most likely require a plan amendment. However, AD 14-16 provides that such an amendment would not be considered a qualification amendment and would not be required to be filed with the PR Treasury, and the PR Treasury will not be issuing any determinations with respect to such amendments.
The brief also touches upon prepayment by the plan participant, prepayment by the plan, tax treatment of the prepayment, distributions during the window period, and a no-prepayment tax refund.
As for what sponsors of plans in Puerto Rico should do now, the brief explains that they must decide if the plan will keep track of any prepayments elected by plan participants. Before making such a determination, a plan sponsor must first confirm that the plan, or its provider, would be able to maintain such tracking. If the answer is yes, then procedures must be established on how to comply with the requirements of AD 14-16. A determination must also be made as to whether a plan amendment would be required.
In addition, a notice about the prepayment, and the related PR Treasury and any operational plan rules (including instructions for distribution requests), should be provided to participants.
A copy of the Groom Law Group brief on AD 14-16 can be found here.