Employee Benefits Law Report

Final fiduciary rule creates implications for plan sponsors and financial advisers

After a drawn out and controversial regulatory review process, the United States Department of Labor (DOL) on April 6, 2016, issued final guidance that expands the definition of a “fiduciary” under the Employee Retirement Income Security Act (ERISA) and the Internal Revenue Code regarding persons or entities that render investment advice for compensation, received directly or indirectly, with respect to assets held in retirement plans or individual retirement accounts (IRA). This rule replaces the original fiduciary rules that were adopted in 1975 shortly after ERISA was enacted, and reflects the DOL’s belief that the retirement industry has evolved significantly since then considering the explosive growth in participant-directed 401(k) plans and in IRA’s nationwide. The rule extends the fiduciary standard contained in ERISA to investment advisers who until now have not been required to adhere to those standards or to contend with ERISA’s related prohibited transaction rules. While the final rule retains the basic structure and approach as the DOL’s proposed rule, which was released in 2015, the final rule includes significant changes and clarifications that the DOL hopes will make the rule more useable and will reduce compliance burdens. The scope of the DOL’s revisions suggests the agency carefully considered the extensive comments received in response to the proposed rule.

The final rule could threaten common arrangements that financial advisers have with ERISA-covered plans and IRAs under ERISA’s fiduciary duty rules or under related prohibited transaction rules. To provide relief, the DOL also released several related pieces of guidance, including:

  1. The final form of the new best interest contract exemption (BICE).
  2. An amendment to and a partial revocation of Prohibited Transaction Exemption 84-24.
  3. A mendments to Class Exemptions 75-1, 77-4, 80-83 and 83-1.

Upon the satisfaction of express conditions, the BICE provides conditional relief for common conflicted compensation arrangements, including commissions and revenue sharing, that advisers historically have received in connection with rendering investment advice. The BICE is available to both plans and IRAs and provides needed relief from the otherwise applicable prohibited transaction provisions in ERISA that would otherwise apply if a participant is deemed to be a fiduciary. The BICE outlines the steps to be taken in order to gain relief (as covered below, those necessary steps have been significantly streamlined in the final rule). The other pieces of guidance are aimed at allowing certain broker-dealers, insurance agents and other vendors that act as investment fiduciaries to continue to receive various forms of conflicted compensation that otherwise may be prohibited under ERISA.

While the final rule is aimed primarily at financial advisers, it also affects plan sponsors considerably. Plan sponsors need to review and understand the nature of the relationships they have with their advisers, including whether their advisers should be considered ERISA fiduciaries and whether the fees they pay their advisers are reasonable. Failure to do so could subject the plan sponsors to potential ERISA fiduciary violations. Moreover, plan sponsors should expect to receive new disclosures and amended contracts from their advisers. Continue Reading

U.S. Supreme Court invalidates Vermont health care reporting law Under ERISA preemption doctrine

The United States Supreme Court ruled on March 1, 2016 in Gobeille v. Liberty Mutual Insurance Company that a Vermont state statute that requires health care plans to file informational report with the state is preempted by ERISA to the extent it is intended to apply to self-funded plans. Writing on behalf of the Court in a 6-2 ruling, Justice Anthony Kennedy noted that reporting, disclosure and record-keeping are central to and an essential part of ERISA’s regulatory scheme and thus concluded that ERISA preempted state efforts to impose other reporting obligations.

ERISA expressly preempts any state laws insofar as they may now or hereafter relate to any employee benefit plan. The Court has over the years established principles for dealing with preemption. Under a threshold standard, where either a state law acts immediately and exclusively upon ERISA plans or the existence of ERISA plans is essential to the law’s operation that law will be preempted. Under an alternative test, the Court has ruled that ERISA preempts state laws that have an “impermissible connection” with ERISA plans (i.e., this test focuses on state laws that attempt to govern a central matter of plan administration or that interfere with nationally uniform plan administration). This second alternative was at issue in the Gobeille case. Continue Reading

IRS previews qualified plan determination letter changes in new guidance

The Internal Revenue Service (IRS) issued guidance on Jan. 4, 2016, that clarifies certain implications of its previously announced changes to the employee plans determination letter program. These clarifications, announced in Notice 2016-03 (Notice) are necessary to cover open issues raised from prior guidance that in effect shuts down the determination letter program for most amendments to individually designed plans.

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IRS Notice 2016-4 extends due dates for 2015 information reporting under the ACA

The IRS yesterday released IRS Notice 2016-4, which extends the due dates for certain 2015 information reporting under the Affordable Care Act (“ACA”). This notice relates to due dates for the 2015 information reporting requirements (i.e., both furnishing to individuals and filing with the IRS) for insurers and self-insuring employers. Specifically, Notice 2016-4 extends the due date for (a) furnishing to individuals the Form 1095-B, Health Coverage, and the Form 1095-C, Employer-Provided Health Insurance Offer and Coverage, and (b) filing with the IRS the Form 1094-B, Transmittal of Health Coverage Information Returns, the Form 1095-B, Health Coverage, the Form 1094-C, Transmittal of Employer-Provided Health Insurance Offer and Coverage Information Returns, and the Form 1095-C, Employer-Provided Health Insurance Offer and Coverage. The extension for the Forms 1094-B and Form 1095-B is from February 1, 2016, to March 31, 2016, and the extension for the returns submitted to the IRS is from February 29, 2016 to May 31, 2016 (if not filing electronically) and from March 31, 2016 to June 30, 2016 (if filing electronically). That being said, the IRS indicates it is prepared to accept filings of the information returns on Forms 1094-B, 1095-B, 1094-C, and 1095-C beginning in January 2016 and is encouraging employers and other coverage providers to furnish statements and to file the information returns as soon as they are ready (of course, the IRS always says that). Employers or other coverage providers that do not comply with these extended due dates are subject to penalties imposed under the ACA for failure to timely furnish and file, and so these extended deadlines must be taken seriously.

Final regulations issued by the IRS in 2014 specified the deadlines for information reporting required by the ACA. Generally, those regulations provide persons providing minimum essential coverage to individuals during a calendar year must file with the IRS information returns on or before the following February 28 (March 31 if filed electronically) and must furnish to the individuals identified on the return a written statement on or before January 31 following that calendar year. Since in 2016, the January 31 and February 28 due dates fall on weekend days; in 2016 these two due dates were supposed to February 1 and February 29, respectively (yes, 2016 is a leap year). The IRS designated Form 1094-B and Form 1095-B to meet the requirements of the regulations. In addition, the regulations generally require applicable large employers to file with the IRS information returns on or before February 28 (March 31 if filed electronically) of the year following the calendar year to which it relates and to furnish to full-time employees a written statement on or before January 31 following that calendar year. For this purpose, the IRS designated Form 1094-C and Form 1095-C as transmittal forms to meet the requirements of the regulations. The preambles to the final regulations state that for 2015 coverage the IRS will not impose penalties on reporting entities that can show that they have made good faith efforts to comply with the information reporting requirements, and that this relief applies only to furnishing and filing incorrect or incomplete information and not to a failure to timely furnish or file a statement or return. The preambles also note that generally the penalties may be waived if a failure to timely furnish or file a statement or return is due to reasonable cause (i.e., the reporting entity demonstrates that it acted in a responsible manner and the failure is due to significant mitigating factors or events beyond the reporting entity’s control).

This news, while perhaps a bit tardy, should be very useful for many.

Protecting Americans from Tax Hikes Act of 2015

Leaders in the U.S. Congress reached a deal on Tuesday night to permanently extend many of the 52 provisions of the Internal Revenue Code that expired on Dec. 31, 2014. The full Congress approved the bill on Dec. 18, 2015 and President Obama signed the bill into law. The Protecting Americans from Tax Hikes Act of 2015 (the PATH Act) extends the popular research and development credit, bonus depreciation deduction, and the enhanced Section 179 depreciation deduction. Congress had previously approved an extension of these provisions—colloquially known as “extenders”—in the years 2012 and 2014 by legislating the extenders to apply retroactively to the past year.  Congress had not made these provisions permanent before.

Together, the provisions of the PATH Act address a diverse group of interests from that of the low-income individual taxpayer to the small business taxpayer. We will address the highlights:

Permanent extensions

  • The R & D Credit: Congress extended and expanded the research & experimentation tax credit for businesses.  Small businesses with gross receipts below $5,000,000 for the taxable year will now be able to offset payroll taxes with the credit.  This valuable addition allows new businesses to utilize the credit even though they may not have federal income tax liability.
  • Section 179 Depreciation Deduction: This deduction encourages businesses to expand by allowing a deduction for a portion of business investment purchases and investment costs.  Congress restored the deduction and income phase-out limits to $500,000 and $2,000,000 respectively.  Further, under the bill, the limits are indexed to inflation instead of depending on periodic amendments to the law.  Congress had allowed the deduction and income limits to fall to $25,000 and $200,000.
  • S Corp Built-In Gains Recognition: Congress shortened the term of the corporate-level tax on the disposition of appreciated assets by an S corp to five years from the S Corp conversion date, instead of ten years under previous law.  This change reduces one of the drawbacks of a C corp’s conversion to an S corp.
  • Itemized Deduction of State and Local Sales Taxes: Congress will allow taxpayers to take an itemized deduction for state and local sales taxes instead of deducting state income taxes. This provision is very useful to taxpayers in states that do not have a state income tax. These no-income tax states often have high sales taxes, which taxpayers can then deduct.
  • Earned Income Tax Credit, Child Tax Credit, and American Opportunity Tax Credit: Congress returned these refundable credits to their previous levels and, in some cases, increased the value of the credits by either increasing the income level that the credits phase-out at or by decreasing the earned income amount needed to receive the credit. The credits allow low-income and middle-class taxpayers to eliminate much of their tax liability and often to receive refunds.
  • Miscellaneous: Congress also made provisions such as the educator expense deduction, some narrow charitable giving exemptions, and abbreviated cost-recovery timelines, permanent.

Non-permanent extensions

  • Bonus Depreciation: Congress extended the immediate deductibility of a portion of asset acquisition until the end of 2019. However, the bonus deduction will only permit the usual 50% expensing of asset acquisitions until the end of 2017. After that, the deductible percentage will be 40% in 2018 and 30% in 2019.
  • New Markets Tax Credit: The new markets tax credit was extended until the end of 2019.
  • Delay of Cadillac Tax: The start of the Affordable Care Act’s tax on high-cost employer-sponsored health insurance will be delayed from 2018 to 2020.
  • Delay of Excise Tax on Medical Devices: The Affordable Care Act’s 2.3% excise tax on certain medical devices will be delayed until 2018. The health care industry has heavily lobbied for this change because of its potential negative impact on the industry.

The importance of permanency

Understanding the importance of the permanent extension to the economic incentive provisions requires a brief detour into the legislative brinksmanship that has governed Congress throughout the past few years. Congress has allowed these tax provisions to periodically expire and then—usually very near the end of the year—Congress often passes a one-year extenders package that applies the legislation retroactively.  For example, a taxpayer can still take advantage of bonus depreciation for a purchase it made in January of a year, even though the extenders package did not pass until December of that year. In theory, a tax incentive to invest may push a taxpayer who is sitting on the fence about investment to make a deductible purchase when the taxpayer otherwise wouldn’t, which in turn stimulates the economy. Further, if a taxpayer has less tax liability, the taxpayer may put excess funds to an efficient use.

However, the brinksmanship and periodic renewals in Congress defeated the purpose of the economic incentive-type provisions. If a taxpayer has no certainty over whether it will realize a tax benefit for purchasing an asset or investing in research, then it may delay or decide not to make that purchase. Permanent extenders allow a taxpayer to make and execute investment plans without worrying that Congress may not renew the tax benefit. This new certainty should encourage new investment in the American economy.

Conclusion

The PATH Act is an important piece of legislation for taxpayers to monitor. The certainty that the Act provides should allow taxpayers to realize the full benefit of these tax provisions.

Fiduciaries in stock-drop suits should be evaluated on real-time conduct, not 20-20 hindsight—Sixth Circuit decision Pfeil, et. al. v. State Street Bank & Trust Co.

ERISA fiduciaries of employee stock ownership plans (ESOPs) and plans with employer stock funds increasingly find themselves in a Catch-22. If they continue to invest in employer stock and the stock price falls, the fiduciaries could be sued for violating their duty of prudence. If they stop investing in employer stock and the price rises, the fiduciaries could be sued for failing to follow plan terms. Many circuit courts previously addressed this situation by applying the Moench presumption of prudence to fiduciaries of ESOPs and other plans that required an employer-stock fund. That is, fiduciaries of plans that required investment in employer stock were presumed to have acted prudently, and that presumption generally was overcome only if plaintiffs could demonstrate that the fiduciaries abused their discretion by continuing to invest plan assets in employer stock. The Supreme Court in Fifth Third Bancorp v. Dudenhoeffer, however, held last year that no special presumption of prudence applied in these circumstances. Instead, fiduciaries of these types of plans were subject to the same ERISA prudence standards that applied to fiduciaries of any other plan. The Court did acknowledge that the separate standard of asset diversification did not apply top ESOPs (although it would apply to other plans with employer stock funds).

After Dudenhoeffer, many commentators expressed concern about what the loss of the presumption of prudence would mean for ESOP fiduciaries.  The Sixth Circuit, however, may have restored a sense of calm in a recent decision.  In Pfeil, et al. v. State Street Bank & Trust Co., the Sixth Circuit held that an ESOP fiduciary’s investment decisions satisfy the ERISA duty of prudence so long as the fiduciary uses a prudent process when the decisions are made. Further, a public company stock’s current market price is deemed to be a reliable indicator of the stock’s value, absent a showing of special circumstances by the plaintiffs as to why that price is not reliable. This is true even if in hindsight stock losses occur.

This case represents good news for fiduciaries of plans that require investment in employer stock—even though the days of a presumption of prudence are gone. This case demonstrates that if fiduciaries use a prudent process then attacks from plaintiffs will be much tougher to sustain even if hindsight shows the outcome of the decision to be a bad one. This blog will explore the decision and its implications.

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Nonqualified deferred compensation plan guidance from the IRS appears to be on the horizon

Ever since the series finale of “Mad Men,” I’ve been thinking a lot about old commercials. One commercial in particular involves Heinz ketchup. In the ad, someone would turn the bottle upside down, and the ketchup would take an extremely long time to pour out of the bottle and onto a sandwich. An announcer would then say the slogan: “The best things come to those who wait.” Apparently, Heinz wanted us to believe that patience was a virtue—rewarded by its ketchup.

Marketing gimmicks aside, the IRS has taken a similar view (towards patience, not ketchup) with respect to tax guidance that impacts executive compensation arrangements. In a notice published in 2007, the IRS announced its intent to issue new regulations under Code Section 457(f) in an attempt to harmonize Code Sections 457(f) and 409A. Over eight years later, we are still waiting for that guidance. The wait may soon be over, however, because IRS officials informally have indicated that this guidance is “very, very close” to be released, probably by the end of this year or early in 2016. The two pieces of guidance presumably will not be issued at the same time. Continue Reading

The view from Washington — we have a budget!

In perhaps the last big legislative push of 2015, the Bipartisan Budget Act of 2015 (the “Act”) was passed by the House of Representative on a 266-167 vote on Wednesday, October 28, 2015 — in the waning moments of outgoing Speaker John Boehner’s tenure. In the vote, 79 Republicans joined 187 Democrats to pass the package — which means a fairly large number of Republicans voted against the Act suggesting the days of the political turbulence in the House may not completely be over.  Subsequently, the Senate also voted to approve the Act by a 64-35 vote (overcoming objections from a group of conservative senators, including a few presidential candidates). On Monday, November 2, 2015, President Obama signed the bill into law at a brief ceremony at the White House.

The Act encompasses a compromise two-year budget bill that was negotiated between House leadership and the White House, and it raises spending caps on domestic and defense spending over the next two years by an aggregate amount of $80 billion. Generally, the additional spending is split evenly between domestic and defense concerns — thus allowing all participants in the negotiations to declare themselves winners. The Act also makes changes to the Social Security disability program. In addition, the Act extends the federal borrowing limit through March 15, 2017 — at which time there will be a new Congress and a new president. The days of crisis governing in Congress may be over—at least we are taking a welcome break.

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New IRS Equity-Based Compensation Audit Guide Highlights Importance of Documenting Compensation Practices

The IRS recently released an audit techniques guide (the “Guide”) to advise its internal auditors who are examining cases involving equity-based compensation (i.e., compensation based on the value of specified stock). Examples include stock transfers, stock options, stock warrants, restricted stock, restricted stock units, phantom stock plans and stock appreciation rights paid to an employee, director or independent contractor. The Guide provides a general discussion of potential tax issues that could arise with respect to these arrangements (e.g., disqualifying dispositions of incentive stock options, Code Section 83(b) elections for restricted stock). Interestingly, the Guide devotes a fair amount of detail to explaining where auditors may find these documents, encouraging them to review Securities and Exchange Commission (“SEC”) filings as well as internal documents. As such, the Guide serves as an important reminder to employers to be mindful that the IRS (or other third parties) someday could seek to review their corporate documents. That will be the focus of this blog.

SEC Documents.

The Guide advises auditors that a good place to start an examination is by reviewing SEC documents (at least with respect to publicly-held entities). In particular, the Guide explains that a public company’s annual report (Form 10-K), definitive proxy statement (DEF 14A), and Statement of Changes in Beneficial Ownership (Form 4) can be particularly pertinent. These documents will identify the types of plans an employer sponsors and provide compensation data under the plans for the named executive officers and the directors. The Guide directs the IRS auditors to compare the compensation data on the SEC forms with information reported on the individual’s Form W-2 or 1099-MISC, as applicable, and confirm that the appropriate amount of taxes has been withheld and paid. If the information on the tax documents and SEC forms do not reconcile, the Guide recommends that the auditor consider expanding the scope of the audit.

Internal Documents.

The Guide also instructs auditors to review an employer’s internal corporate documents, including employment contracts, Board of Director meeting minutes and Compensation Committee meeting minutes. The Guide adds that auditors should request reports “issued by the compensation committee and presented to the board of directors” because these reports may provide additional insight into equity compensation practices.

Employers should be aware of these instructions. Often times, it is easy for someone to prepare internal documents using jargon or short-hand that is familiar among people at the company but that may be difficult to explain to a third party or worse could be misleading. The Guide demonstrates that internal documents may not be restricted to internal personnel. Instead, the IRS very well could review these internal documents. As such, employees and advisers who prepare these documents should be mindful of both the information contained in the documents and how they present that information.

Key Takeaways for Employers.

While the IRS prepared the Guide to assist its internal auditors, the Guide also helps employers understand how the IRS could conduct a potential audit of equity-based compensation plans. One takeaway for employers is to review its compensation practices and make sure that as a matter of substance they comply with the applicable tax rules. The other takeaway is a matter of form or style. Specifically, when employees of a company or its outside advisers prepare internal documents or documents to be filed with the SEC, they should keep in mind that the IRS very possibly will review some or all of these documents (particularly the SEC filings). Thus, when preparing these documents, they should do so in a way that demonstrates compliance with the applicable tax rules and that avoid any ambiguities. Doing so will help make a potential audit less burdensome and less risky.

Bright lines getting blurrier: Recent Ohio Supreme Court decision changes factors for determining who is an Ohio resident for state tax purposes

Cunningham v. Testa, Slip Opinion No. 2015-2744 (July 8, 2015)

Recently, the Supreme Court of Ohio issued an opinion in Cunningham v. Testa which significantly alters the application of a statute for determining non-Ohio domicile for state tax purposes. Prior to the ruling, the statute seemed to set forth two factors which, when verified, would create an irrebuttable presumption of non-residency for state income tax purposes:

  1. too few contact periods; and
  2. an abode outside of Ohio.

Following this ruling, a taxpayer may now be forced to prove sufficient additional facts to show that he would legally be considered domiciled outside the state. The change represents a partial reversion back to a prior structure which existed at common law, a structure which was amended over 20 years ago due to its complexities. The case of Cunningham v. Testa casts serious doubt on the future validity of any bright-line test for determining Ohio domicile and will create uncertainty for taxpayers in the coming years.

Background
The taxpayer, Kent Cunningham, owned homes in both Ohio and Tennessee for the entirety of the 2008 tax year. Also, Cunningham undisputedly had fewer than 182 contact periods with the state of Ohio for that year. He filed a Form IT-DA, an “Affidavit of Non-Ohio Domicile,” for the 2008 tax year. In the affidavit, he declared that he “was not domiciled in Ohio at any time during taxable year 2008” and affirmed that he “had fewer than 183 contact periods in Ohio during the taxable year.”

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