Key Provisions of Public Law 97-248 (TEFRA)

Public Law 97-248, the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA), was enacted in response to a rapidly increasing federal budget deficit. The economic climate of the early 1980s, marked by a recession, created an urgent need for legislative action. TEFRA’s objective was to increase federal revenue by closing tax loopholes and strengthening enforcement, rather than broadly increasing individual tax rates. The law was a comprehensive piece of legislation that also introduced changes to healthcare regulations, designed to stabilize the nation’s finances.

Unified Partnership Audit Procedures

Prior to TEFRA, the Internal Revenue Service (IRS) had to initiate separate proceedings for each partner to adjust a partnership-related item. This process was inefficient and could lead to inconsistent outcomes for partners within the same partnership.

TEFRA introduced unified audit rules requiring the tax treatment of “partnership items” to be determined in a single proceeding at the partnership level. This entity-level determination was then binding on all partners, streamlining the process. The law distinguished between partnership items and “nonpartnership items,” which relate to an individual partner’s circumstances.

A central figure was the “Tax Matters Partner” (TMP), a general partner who acted as the primary liaison with the IRS during an audit. The TMP was responsible for receiving notices from the IRS and keeping other partners informed of the proceedings.

The audit process began with the IRS notifying the TMP, and any proposed adjustments were communicated through a single Notice of Final Partnership Administrative Adjustment (FPAA). This replaced the need for separate notices for each partner. These rules governed partnership audits for over three decades.

They were replaced by a new centralized partnership audit regime under the Bipartisan Budget Act of 2015, effective for tax years after 2017. Under the new rules, the Tax Matters Partner was replaced by a Partnership Representative. This representative has the sole authority to act on behalf of the partnership during an audit.

Major Changes to Retirement and Pension Plans

TEFRA changed the regulation of retirement and pension plans by introducing “top-heavy” rules. These rules were designed to ensure that plans did not disproportionately benefit a company’s highest-paid employees by requiring a base level of benefits for the broader employee population.

A plan is identified as “top-heavy” if more than 60% of its total accumulated benefits or account balances are allocated to “key employees.” Key employees included certain company officers and significant business owners. This 60% test was performed annually, meaning a plan’s top-heavy status could change from year to year.

When a plan was determined to be top-heavy, it was required to meet specific minimum standards to maintain its tax-qualified status. One requirement was an accelerated vesting schedule. This meant that non-key employees had to gain full ownership of their employer’s contributions to their retirement accounts more quickly.

Top-heavy plans were also mandated to provide minimum contributions or benefits for all non-key employee participants. For defined contribution plans, the employer was required to contribute at least 3% of compensation for each non-key employee. For defined benefit plans, the plan had to provide a minimum retirement benefit based on a formula.

Another aspect of TEFRA’s pension reforms was establishing greater parity between corporate retirement plans and those for self-employed individuals, known as Keogh plans. The act largely eliminated previous distinctions, allowing self-employed individuals to establish retirement plans with contribution and benefit limits comparable to those available to corporate employees.

Implementation of Backup Withholding

TEFRA introduced backup withholding as a mechanism to improve tax compliance on certain types of payments. It is not an additional tax but a method of collecting income tax from payees who have failed to provide accurate identifying information to the payer. The entity making the payment deducts a set percentage and remits it to the IRS.

Backup withholding is triggered if the payee fails to furnish a Taxpayer Identification Number (TIN), or if the TIN provided is obviously incorrect. The IRS can also instruct a payer to begin backup withholding if it determines that the payee has underreported interest or dividend income on their tax return.

A wide range of payments can be subject to these rules, including interest, dividends, rents, royalties, and commissions. Payments made to independent contractors for services, certain government payments, and gambling winnings can also fall under the requirements. The current withholding rate is a flat 24%.

For an individual or business subject to backup withholding, the amount withheld is treated as a prepayment of their income tax liability. When filing their annual income tax return, the payee can claim the total amount of backup withholding as a tax payment. If the withholding exceeds the total tax due, the payee is entitled to a refund.

Medicare Secondary Payer Rules

TEFRA introduced the Medicare Secondary Payer (MSP) provisions, which altered the coordination of benefits between Medicare and other health insurance plans. The principle of MSP is that for certain individuals with both Medicare and other health coverage, Medicare acts as the secondary payer, paying only after the other insurer has paid its share.

The most prominent application of the MSP rules relates to the working aged. For employers with 20 or more employees, their group health plan is designated as the primary payer for employees age 65 or older who are covered through their own or a spouse’s current employment.

These provisions had direct implications for employers. They were prohibited from taking any action that would encourage Medicare-eligible employees to opt out of the company’s group health plan in favor of Medicare. The law mandated that employers must offer the same health benefits to employees age 65 and over as they do to younger employees.

For employees, the MSP rules established a clear order of payment for their healthcare services. They present their employer’s insurance information as primary coverage. After the primary plan pays its portion of the bill, the remainder is submitted to Medicare for consideration. This system was designed to reduce Medicare expenditures by shifting costs for working seniors to private employer-sponsored plans.