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Employee Benefits Law Report

Reporting on recent trends and developments affecting employee benefits

IRS Safe Harbor for accepting rollover contributions – Revenue Ruling 2014-9 and Form 5310

Posted in Tax Issues

The Form 5310 Application for Determination for Terminating Plan instructions, updated in December 2013, added an odd and time-consuming new requirement, “Submit proof that any rollovers or asset transfers received [during the year of plan termination and five prior plan years] were from a qualified plan or IRA (for example, DL [determination letter] and timely interim amendments).”

The reason we find this instruction odd is that we are not aware of any requirement for a plan administrator to obtain and retain this proof. Treasury Regulation Section 1.401(a)(31)-1, Q&A-14 provides a safe harbor for the reasonable acceptance of a rollover that is later found to be invalid. Under this safe harbor, an invalid rollover would be treated as valid provided the administrator reasonably concluded the rollover was a valid rollover distribution, and distributes the amount with attributable earnings to the participant within a reasonable time of determining that the rollover was actually invalid. This protects the qualified status of the plan. The regulation set forth examples of how an administrator could make a reasonable determination. None of these examples required the administrator to prove the distribution was from a qualified plan or IRA, or to obtain a determination letter and timely interim amendments. So even if the administrator were attempting to rely on the safe harbor with respect to an invalid rollover, which is not what is happening when the employer requests a determination letter, the administrator would not have that type of documentation.

Subsequently, in Revenue Ruling 2014-9, the IRS set forth additional examples about how an administrator could comply with the safe harbor.  In the first example, for a rollover from one qualified plan to another, the administrator simply went to the DOL website to check the most recently filed Form 5500 for the distributing plan.  The administrator confirmed that Code 3C did not appear on Line 8a, as that would have indicated that the plan was not intended to be qualified. In the qualified plan and IRA rollover examples, the administrator receives a check that indicates the qualified plan or IRA distribution is for the benefit of the employee, and an “attached check stub” indicating the source of the funds. Further, the employee provides a certification regarding the taxable nature of the distribution.  In the event the administrator later learns the rollover was invalid, it distributes the amount with attributable earnings to the participant within a reasonable time of such determination.

Keep in mind, these are just examples. The fact that the guidance does not address more modern day scenarios, like wire transfers, does not necessarily mean that an administrator should  demand a check rather than a wire. Further, this guidance merely sets forth a safe harbor, not a requirement.  Finally, we hope the IRS will strike the qualified plan or IRA “proof” requirement in the Form 5310 instructions, but no word on that yet. In any event, we advise plan administrators to establish solid practices for the acceptance of rollover contributions, to help protect the qualified status of their plans.

Substantial risk of forfeiture guidance clarifies when Section 16 short-swing profit liability can defer taxation of equity compensation awards

Posted in Tax Issues

Legend had it at my law school that one day, a lost student walked into a torts class and asked the professor if this class was wills, trusts, and estates. The torts professor replied, “We haven’t gotten that far yet.” A dry sense of humor on the professor’s part? Perhaps. His point, however, was that the law can be a seamless web, with one area of law often having an impact on another. This point often is true with respect to the tax and securities laws.

We blogged previously that the IRS and Treasury issued final regulations under Code Section 83 to “clarify” the definition of “substantial risk of forfeiture” with respect to restricted stock (and other property) grants. One of the clarifications was that transfer restrictions, in and of themselves, do not constitute a substantial risk of forfeiture. For taxation to be deferred on restricted stock grants, the stock must be both non-transferrable and subject to a substantial risk of forfeiture. An example might help illustrate this point. Suppose that a company grants its CEO restricted stock that vests on the fifth anniversary of the date of grant, provided that the CEO has been continuously employed through that date. Also suppose that the CEO satisfies this vesting condition, but on the vesting date, the company’s insider trading policy prohibits the CEO from selling the shares for several months. The CEO would be taxed on the value of the shares on the vesting date, despite the fact that the CEO is unable to sell the shares.

The Code Section 83 regulations, both before and after the clarification, contain an important exception to the non-transferability rule. This exception arises mostly with stock option grants, rather than restricted stock grants, even though restricted stock grants are more often impacted by Code Section 83. That exception is the subject of this blog. Continue Reading

Supreme Court unanimously holds that severance payments generally are subject to FICA taxes

Posted in Executive Compensation, Tax Issues

Clients frequently ask us if severance payments are subject to tax withholding. The answer is that they clearly are subject to income tax withholding, but there has always been some ambiguity about the circumstances in which they are subject to FICA tax withholding. The IRS has always taken the position that severance payments are not subject to FICA tax withholding only when the severance payments are tied to the receipt of unemployment benefits. When the issue arose in litigation, however, the Circuits were split as to whether to side with the IRS, or whether a somewhat broader FICA exception should apply in certain cases involving bankruptcies or reductions in force.  During the past few years, many employers and employees filed refund claims for FICA taxes withheld on severance payments, with the hope that the Supreme Court would issue a decision in favor of the broader exception.

Last week, the U.S. Supreme Court unanimously held in United States v. Quality Stores, Inc., that the IRS position was correct, dashing the hopes of any refunds.  As such, severance payments generally are subject to FICA taxes. The only exception that the Court preserved was for supplemental unemployment benefit (“SUB”) plans under Code Section 501(c)(17), where severance benefits are tied to the receipt of unemployment benefits. For example, suppose that the employer wants to continue to allow a former employee to receive base salary for period of time after severance. Also suppose that a former employee had been earning $700 a week from the employer, and the former employee now receives unemployment benefits are $300 a week. Under a SUB plan, the former employer would pay $400 a week to make the former employee whole.

The Court also noted that even the limited exception regarding unemployment benefits appeared to be inconsistent with the plain meaning of the tax statutes. As such, we would not be surprised if the IRS later reverses its own position to eliminate this exception and require FICA tax withholding on all severance payments, even when they are tied to unemployment benefits.

For now, there is no immediate action for employers to take. As we said previously, if an employer has filed claims for refunds of FICA taxes withheld on prior severance payment, the IRS almost certainly will deny those claims. Otherwise, the case serves as a reminder that employers need to be mindful of the tax and benefits issues surrounding their former employees.

NLRB classification of athletes as employees highlights a health care reform land mine

Posted in Employment Issues, Health Care Reform

Employers have always been concerned about the potential for worker reclassification, but health care reform and a recent NLRB decision take this issue to an entirely new level.  “Large” employers who offer coverage will be required to offer coverage to “all” of their “full-time workers,” defined as at least 95% of employees working 30 hours per week. An employer that offers coverage to only 94% of its full-time employees, and has one employee who enrolled on an exchange with a premium credit, will be subject to annualized penalties of $2,000 per full-time employee, less the first 30 employees. This draconian penalty applies to all employees, not just the percentage excluded from the offer.

Consider that the NLRB just shocked the college sector with its ruling that Northwestern University students with football scholarships are employees for purposes of the National Labor Relations Act. The immediate result is that if the players with scholarships organize themselves with a labor organization, they can collectively bargain for themselves against Northwestern University. (Of course, we presume there will be further legal challenges.) But think about what this means in the context of taxes and health care reform. Will the IRS deem the students to be employees, liable for taxes, and full-time employees of Northwestern University for purposes of the health care reform employer mandate?

Northwestern University’s website reports that the University has 3,820 full-time faculty and 6,000 full-time staff. Let’s consider a hypothetical: on January 1, 2016, the IRS reclassifies enough students and independent contractors as “full-time employees” so as to cause the University to miss the 95% mark, and at least one employee used a premium credit to purchase coverage on an exchange. It appears that after paying all the health care plan costs, the University could also be liable for a penalty in the neighborhood of $20 million, per year.

Continue Reading

Tax-Exempt Organizations: understanding the proposed Tax Reform Act of 2014’s penalties on excessive executive compensation

Posted in Executive Compensation, Other Articles, Tax-Exempt/Governmental Employers

Recently, we published an article in Bloomberg BNA’s Pension & Benefits DailyTM that provides context for understanding the proposed Tax Reform Act of 2014’s penalties on excessive executive compensation for tax-exempt organizations and offers our thoughts about planning opportunities for the future. This is available for our readers at this link.

Protected health information and health care plan design

Posted in Employment Issues, Health and Welfare Plans

On our sister blog — Employer Law Report – our partner Brian Hall wrote about the likely availability of an Alzheimer’s blood test, and the impact of new genetic testing in the context of employer sponsored group health care plans and wellness programs. Brian spoke of the “imaginary line” that separates protected health information from human resources decision-makers, supervisors and managers, and mentioned a plethora of employee protections, including HIPAA, GINA, ADA, and ERISA Section 510. The Patient Protection and Affordable Care Act also added another set of employee protections. Each of these laws sets forth different standards for burden of proof, and defense, and case law has been developing around these standards.

An employer that is in the process of redesigning its health care plans and realigning its workforce to comply with the 2015 pay or play employer mandate needs to keep in mind that compliance with all these other protective laws is important, too. An employee who is disciplined or reassigned, who has an hours reduction, or who has been terminated from employment, now has a lengthy list of potential discrimination claims. Further, an assortment of federal government agencies now has additional enforcement tools.  Therefore, we encourage employers maintaining health care plans to take a time out to consider how they will defend against this new breed of claims. Taking proactive steps, like shoring up that imaginary line between the health care plan and employment decisions makers if at all possible, will reduce the time and expense otherwise required to defend against these claims.

Below is Brian’s post for your reference:

Brian D. Hall

Recent media accounts (e.g. this report  — Blood Test Predicts Alzheimer’s Disease – by CNN ) suggest that medical researchers have discovered a blood test that will help identify whether people are likely to develop Alzheimer’s Disease in their lifetime with 90% accuracy. So far, the test only has been conducted on individuals who are over 70 years old, but researchers will begin seeing whether these promising results can be obtained on people in their 40’s and 50’s. These research findings are obviously welcome news, but raise many questions assuming the test becomes more universally available. Not the least of these questions will be whether people really will want to know their fate. Any number of factors will likely play into any one person’s decision, but whether obtaining the test will have any impact on his or her employment should not be one of them.

Though it may be a long ways down the road before the Alzheimer’s blood test becomes realistic for employees in the prime of their working years, other medical research advances permitting individuals to learn their medical fate may have a more immediate impact. Indeed, at least one company already offers direct to consumer genetic testing and interpretation services. Should an employer learn of this kind of information as it relates to one of its employees, it could be exposed to potential liability if the information were to ever use it for employment purposes. While I’m convinced that the vast majority of employers would never actually make an employment decision based upon their employees’ genetic or protected health information, mere access to the information will put the employer in the position of having to prove that their decisions were not based on such information. Fortunately, for both employee and employer, HIPAA would prevent the transfer of any protected health information held by the employer’s group health plan to its human resources decision-makers or supervisors and managers. Should information cross this imaginary line, however, the employer faces potential liability not only under HIPAA but under a variety of other federal laws such as GINA (prohibiting the use of genetic information in making employment decisions), ERISA §510 (prohibiting employers from discharging or discriminating against plan participants for the purpose of interfering with the attainment of any right to which the participants may become entitled under a plan) and the ADA (prohibiting discrimination against qualified individuals with a disability.)

As medical advances continue to provide us with more information about our health, it will become increasingly more important for employers to ensure that people who make decisions regarding individuals’ employment do not have access to the individual’s health information. Employers should resist any temptation they may have to access any protected health information held by their group health plan and should ensure that all medical information held by them as employers is segregated from employee personnel files. This definitely is one of those situations where the less known the better.

“Substantial Risk of Forfeiture” Clarification Impacts Restricted Property (Stock) Grants

Posted in Tax Issues

As complex as the Internal Revenue Code is, many people still assume that the rules contain a great deal of specificity and precision, perhaps because of the mathematical nature of calculating taxes. They often are surprised to learn that the Code leaves a lot of room for discretion and subjectivity. A great example of this subjectivity is Code Section 83’s regulations governing the taxation of restricted stock (and other property). The underlying stock subject to these grants generally does not become taxable to the employee until the stock no longer is subject to a “substantial risk of forfeiture.” As you might guess, whether a risk is “substantial” can be quite a subjective determination.

In that backdrop, the IRS and Treasury recently issued final regulations that clarify the definition of substantial risk of forfeiture for purposes of Code Section 83. The final regulations will have the most direct impact on employers who have granted awards of restricted stock or other restricted property on or after January 1, 2013. That is because the regulations stress the need for these agreements to contain a service or performance-based vesting condition that is not substantially certain to be satisfied. The retroactive effective date of may seem strange at first. It is the same effective date that the IRS provided in proposed regulations from May 2012. The good news is that the final regulations generally offer “clarifications” of the former regulations rather than new guidance. Still, it is important that affected employers review their restricted stock arrangements and determine whether they should take additional action.  Continue Reading

Facebook brag underscores the enforceability of confidentiality clauses in settlement agreements

Posted in ERISA Fiduciary Compliance, ERISA Litigation

Settlement agreements are fairly common in the ERISA / employee benefits area. We typically do not need “unique” provisions for these agreements, beyond making sure all the proper parties are named and that ERISA is referenced. But two issues typically require extra attention: confidentiality provisions, and payment method (including tax withholding and reporting). As discussed in our sister blog, a party might quietly violate a confidentiality provision, and get away with it without causing any real harm. But when a party shares settlement information with a child who has both a Facebook page and poor judgment, the ramifications can be significant. Therefore, if an employer wants to prevent disclosure of the existence or amount of a settlement or severance payment, a well written confidentiality clause is essential.

Form 8822-B Responsible Party Deadline for a Few Employee Benefit Plans and Trusts: March 1, 2014

Posted in Other Articles, Tax Issues

What is Form 8822-B, do I need to worry about it with respect to my employee benefit plans and trusts, and do I have a March 1, 2014 deadline? Most benefit plan sponsors/administrators do not have to worry about this, but given that this topic is a little confusing, we thought we would share this explanation.

We need to step back and look at Code Section 6109, which sets forth requirements for taxpayer identification numbers (EINs), which are used for tax reporting purposes. A legal entity, such as a new company, uses a Form SS-4 to request an EIN.  The Form SS-4 indicates a “responsible party” and address for mailing tax notices. Last year, the IRS updated the regulations under Code Section 6109 to require an entity with an EIN to report change in the entity’s “responsible party.” Form 8822-B, Change of Address or Responsible Party — Business, is the form used to report these changes. The filing became mandatory with respect to responsible party changes, and voluntary with respect to mailing address changes, effective January 1, 2014. The filing is done by mail, not electronically, and must be made within 60 days of the change. For any changes that occurred before January 1, 2014 and were not previously reported to the IRS, a Form 8822-B filing is required by March 1, 2014.

What is the penalty for failing to timely file a Form 8822-B?  Nothing at this point. However, if you fail to provide the IRS with your current mailing address or the identity of your responsible party, you may not receive a notice of deficiency or a notice of demand for tax, and penalties and interest will continue to accrue on any tax deficiencies.

Most companies would be aware of the Form 8822-B on an entity level, but its application to employee benefit plans may be flying under the radar. Accordingly, the IRS noted the application to employee benefit plans in its Employee Plans News publication, stating:

For retirement plans, “responsible party” is the person who has a level of control, directly or indirectly, over the funds or assets in the retirement plan. See the instructions to Form 8822-B, page 2, for a detailed definition of ‘responsible party’ and an explanation of who must sign the form.

Keep in mind that “person” is not necessarily a human being. In the context of an employee benefit plan, the responsible party is presumably the plan administrator, which is typically the employer or a committee. This does not mean that the employee who signs on behalf of the plan administrator is a responsible person. Any changes in the plan administrator would presumably have been reported on the applicable tax form (e.g., Form 5500 or 990), and a Form 8822-B may have been filed at the employer level.

But if an employee benefit plan (including any qualified retirement plan) or trust (such as a retirement plan trust or VEBA) uses its own EIN, we need to consider whether a filing is required.  How do you know whether your plan or trust has a separate EIN? We suggest you look at your tax forms (Form 5500 or Form 990), and summary plan descriptions.

What if, years ago, someone filed a Form SS-4 and obtained an EIN for a benefit plan and trust, and that EIN has been abandoned? Those scenarios seem to have driven the regulatory change, but in those cases either the plan has been abandoned (e.g., bankruptcy, where there is no one left to pay tax penalties anyway), or tax forms with contact information for purposes of any tax notices are already being filed. So the Form 8822-B seems redundant in the context of employee benefit plans, but we advise following the guidance anyway. This is also a good time to note that the more common issues with a tax notice we have seen are that the notice lingers in the corporate mail room, or on the desk of an employee who fails to recognize its significance and time sensitivity.

If you need the Form 8822-B and instructions, they are here. If you are reading this after March 1, 2014, know that this is another filing requirement that you should add to your employee benefit plan to-do list if you have a benefit plan and/or trust that maintains its own EIN. Make sure the IRS knows how to find you, and that important tax notices relating to your employee benefit plans and trusts will timely find their way to you.

 

Audits of Benefit Plan Financials – What They Are and Are Not

Posted in Health and Welfare Plans, Other Articles

Department of Labor investigations of employee benefit plans can be challenging experiences for employers. The time demand can be a significant drain on the business, and the employer needs to be concerned about potential issues the investigator may raise. We believe the best defense is a good offense: we like our clients to take their responsibilities seriously well before an investigation. But employers are sometimes surprised that an investigator asks questions that were not asked by the auditors who conducted independent financial statement audits over the years. As a JD/CPA (double geek) I can tell you this audit is only one step in the ERISA fiduciary due diligence process. But, I thought it would be helpful to seek the input of a CPA who has been a member of both the Executive Committee of the American Institute of Certified Public Accountants (AICPA), Employee Benefit Plan Audit Quality Center, and the AICPA Employee Benefit Plans Expert Panel – James E. Merklin, partner in charge of Assurance Services at Bober Markey Fedorovich, an independent CPA firm. Jim was gracious enough to share his perspective, as follows:

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When ERISA was enacted in 1974, one of the provisions required (in general) that plans in excess of 100 participants provide audited financial statements with their annual reports. Some plan sponsors will consider an audit to be akin to an insurance policy that their plan is in good shape and would meet the scrutiny of regulatory authorities if examined. But audits were never intended to serve in that kind of capacity and so there is clearly an expectation gap between what these plan sponsors think they are getting with the annual audit and the service that plan auditors are actually rendering. But – if there are indeed compliance problems, would you rather catch these yourself or let the regulators find them on examination and come in with Thor’s hammer to resolve the problems?

The purpose of an audit of the financial statements is to allow an auditor to express an opinion as to whether the financial statements and related footnotes and supplemental schedules for a benefit plan are prepared in accordance with accounting principles generally accepted in the USA. Auditors are required to follow procedures that are dictated by the American Institute of CPAs and/or the Public Companies Accounting Oversight Board in arriving at their opinions covering the financial statements of the benefit plan. In many cases, the auditor doesn’t even express an opinion on the financial statements – there are provisions within ERISA that allow the plan sponsor to limit the scope of the audit to exclude work on investments, investment income and investment transactions if the investments are certified by a qualified institution (a bank, an insurance company or a regulated trust company.) When the audit is limited as described here, the auditor cannot express an opinion on the financials due to the significance of what has been excluded from the audit scope.

Again, the main focus of the financial statement audit is on the presentation in the financial statements. One of the assertions underlying a financial statement is that the plan is a qualified plan and thus exempt from income taxes, and in support of that assertion auditors will perform some testing to look at compliance with the plan document and regulations. However, this level of testing is not intended to provide absolute assurance that any deviations would pass the scrutiny of the regulators (Internal Revenue Service and/or Department of Labor) but rather to identify for the auditor as to whether there is a sign that the plan is so grossly in violation of terms or law that their tax status would be at risk, or that any material misstatements to the financial statements whether due to error or fraud, are identified and reflected appropriately therein. Remember IRS/DOL penalties are the responsibility of the plan sponsor / administrator and not of the plan itself, so the plan’s financials would not be misstated if there were no mention of such risks within those financial statements.

So – are there risks to the plan that might be reasons to dig in to a plan deeper than a financial statement audit might? Absolutely – following is just a sprinkling of some areas that would be worth paying attention to.

  • What is the correct definition of compensation per plan document? Is the plan actually applying this definition correctly?
  • Are there any instances of late remittances of participant contributions and loan repaymentss?
  • Are there any instances of failure to comply with participant elections?
  • Are there any instances of improper application of eligibility provisions of the plan?
  • Have there been any instances of calculations of improper vesting and employee distributions?
  • Has there been turnover among your employees who have responsibilities relating to the plan, and are the current personnel adequately trained? How do you make certain that the plan is being operated in accordance with the plan document? Who is responsible for making certain that the plan document is timely amended and restated?
  • What oversight does the plan sponsor perform with regard to third party administration of the plan?
  • What is the plan’s stated investment strategy? How is that reflected in the investments offered to participants?

Many benefit plan auditors are capable of helping you with an assessment of these and many other compliance risks to your plans. I would recommend that, if you wish to use your plan auditor to assist you with an assessment, you verify first that they have the qualifications to be positioned to do so. That means that not only are they are doing a lot of benefit plan audit work but also a lot of tax reporting and compliance work. And I also strongly recommend that such assessments be conducted in conjunction with the plan’s qualified ERISA legal counsel; in fact, performance of compliance assessments under the attorney’s privilege would be most protective to the plan’s interests.

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We appreciate the input! James E. Merklin’s biography, and his contact information, are here. DOL guidance on ERISA fiduciary responsibilities is here.