Erwin Kratz – Page 10 – ERISA Benefits Law

IRS Issues Proposed Regulations Clarifying and Modifying the Final 409A Regulations

IRS has issued proposed regulations that would clarify or modify certain specific provisions of the final regulations under section 409A, including revisions to the rules regarding the calculation of amounts includible in income under section 409A. The proposed regulations:

(1) Clarify that the rules under section 409A apply to nonqualified deferred compensation plans separately and in addition to the rules under section 457A.

(2) Modify the short-term deferral rule to permit a delay in payments to avoid violating Federal securities laws or other applicable law.

(3) Clarify that a stock right that does not otherwise provide for a deferral of compensation will not be treated as providing for a deferral of compensation solely because the amount payable under the stock right upon an involuntary separation from service for cause, or the occurrence of a condition within the service provider’s control, is based on a measure that is less than fair market value.

(4) Modify the definition of the term “eligible issuer of service recipient stock” to provide that it includes a corporation (or other entity) for which a person is reasonably expected to begin, and actually begins, providing services within 12 months after the grant date of a stock right.

(5) Clarify that certain separation pay plans that do not provide for a deferral of compensation may apply to a service provider who had no compensation from the service recipient during the year preceding the year in which a separation from service occurs.

(6) Provide that a plan under which a service provider has a right to payment or reimbursement of reasonable attorneys’ fees and other expenses incurred to pursue a bona fide legal claim against the service recipient with respect to the service relationship does not provide for a deferral of compensation.

(7) Modify the rules regarding recurring part-year compensation.

(8) Clarify that a stock purchase treated as a deemed asset sale under section 338 is not a sale or other disposition of assets for purposes of determining whether a service provider has a separation from service.

(9) Clarify that a service provider who ceases providing services as an employee and begins providing services as an independent contractor is treated as having a separation from service if, at the time of the change in employment status, the level of services reasonably anticipated to be provided after the change would result in a separation from service under the rules applicable to employees.

(10) Provide a rule that is generally applicable to determine when a “payment” has been made for purposes of section 409A.

(11) Modify the rules applicable to amounts payable following death.

(12) Clarify that the rules for transaction-based compensation apply to stock rights that do not provide for a deferral of compensation and statutory stock options.

(13) Provide that the addition of the death, disability, or unforeseeable emergency of a beneficiary who has become entitled to a payment due to a service provider’s death as a potentially earlier or intervening payment event will not violate the prohibition on the acceleration of payments.

(14) Modify the conflict of interest exception to the prohibition on the acceleration of payments to permit the payment of all types of deferred compensation (and not only certain types of foreign earned income) to comply with bona fide foreign ethics or conflicts of interest laws.

(15) Clarify the provision permitting payments upon the termination and liquidation of a plan in connection with bankruptcy.

(16) Clarify other rules permitting payments in connection with the termination and liquidation of a plan.

(17) Provide that a plan may accelerate the time of payment to comply with Federal debt collection laws.

(18) Clarify and modify the proposed rules regarding the treatment of deferred amounts subject to a substantial risk of forfeiture for purposes of calculating the amount includible in income under section 409A.

(19) Clarify various provisions of the final regulations to recognize that a service provider can be an entity as well as an individual.

Proposed 409A Regulations

IRS Issues Long-Awaited Proposed 457 Regulations

IRS has issued proposed regulations prescribing rules under section 457 of the Internal Revenue Code for the taxation of compensation deferred under plans established and maintained by State or local governments or other tax exempt organizations.

The proposed regulations include rules for determining when amounts deferred under these plans are includible in income, the amounts that are includible in income, and the types of plans that are not subject to these rules. Significant provisions in the proposed regulations include:

Guidance on what constitutes a bona fide vacation leave, sick leave, compensatory time, severance pay, disability pay, and death benefit plan, which are treated as not providing for a deferral of compensation for purposes of section 457
Guidance regarding plans paying solely length of service awards to bona fide volunteers (or their beneficiaries) that also are treated as not providing for a deferral of compensation for purposes of section 457.
Amendments to existing regulations to reflect statutory changes that allow an eligible governmental plan to include a qualified Roth contribution program, and requiring eligible governmental plans to include provisions that where a participant dies while performing qualified military service, the survivors of the participant generally are entitled to any additional benefits that would have been provided under the plan if the participant had resumed and then terminated employment on account of death

Bona Fide Severance Pay Plans

The rules for a bonafide severance pay plan are very similar to the rules for separation pay plans in the final section 409A regulations.

First, the benefits provided under the plan must be payable only upon a participant’s involuntary severance from employment or pursuant to a window program or voluntary early retirement incentive plan.
Second, the amount payable under the plan with respect to a participant must not exceed two times the participant’s annualized compensation based upon the annual rate of pay for services provided to the eligible employer for the calendar year preceding the calendar year in which the participant has a severance from employment (unlike the 409A regulations, there is no cap on how high this amount can go).
Third, pursuant to the written terms of the plan, the severance benefits must be paid no later than the last day of the second calendar year following the calendar year in which the severance from employment occurs.

Bona Fide Disability Pay Plan

The proposed regulations provide that a bona fide disability pay plan must meet three conditions, which mirror the 409A definition of Disability):

The participant is unable to engage in substantial gainful activity by reason of a medically determinable physical or mental impairment that can be expected to result in death or last for a continuous period of not less than 12 months
The participant is, by reason of any medically determinable physical or mental impairment that can be expected to result in death or last for a continuous period of not less than 12 months, receiving income replacement benefits for a continuous period of not less than three months under an accident or health plan covering employees of the eligible employer; or
The participant is determined to be totally disabled by the Social Security Administration or the Railroad Retirement Board.Short Term DeferralsThe proposed regulations provide that a deferral of compensation does not occur with respect to any amount that would be a short-term deferral under the 409A regulations, substituting the definition of a substantial risk of forfeiture provided under the 457 proposed regulations for the definition under § 1.409A-1(d). There is considerable overlap between the definition of substantial risk of forfeiture for purposes of section 457(f) and the definition of substantial risk of forfeiture for purposes of section 409A.
As with the 409A regulations, under the proposed 457 regulations, if a plan provides that entitlement to an amount is conditioned on an involuntary severance from employment without cause, the right is subject to a substantial risk of forfeiture if the possibility of forfeiture is substantial.

Income Inclusion Under 457(f)

The proposed regulations provide that if a 457 plan of an eligible employer provides for a deferral of compensation for the benefit of a participant or beneficiary and the plan is not an eligible plan (i.e. is is an ineligible plan subject to Code Section 457(f)), the compensation deferred under the plan is includible in gross income as of the later of

the date the participant or beneficiary obtains a legally binding right to the compensation or,
if the compensation is subject to a substantial risk of forfeiture, the date the substantial risk of forfeiture lapses.

The proposed regulations also provide general rules for determining the present value of compensation deferred under an ineligible plan. These rules are similar to the rules for determining present value in the proposed section 409A regulations. One difference is that income inclusion under the proposed 457 regulations is determined as of the date the substantial risk of forfeiture lapses, whereas income inclusion under section 409A is determined as of the end of the service provider’s taxable year.

Proposed 457 Regulations

IRS Information Letters Provide Further Guidance on “Employer Payment Plans”

The IRS has released a series of information letters providing further guidance on the application of ACA group health plan market reforms to various types of employer health care arrangements. These information letters provide further definition to when the IRS will consider an arrangement to be an impermissible “employer payment plan” that does not satisfy the ACA market reforms. As previously discussed here and here and here, adopting an impermissible employer payment plan exposes employers to excise taxes under Code § 4980D ($100 per day per affected individual).

I. Opt-Out Arrangements. In Letter 2016-0023 the IRS indicated that if an employer pays additional taxable compensation to employees who forgo coverage under the employer’s group health plan (opt-out payments), due to having other coverage, the employer will not trigger the 4980D excise tax, as long as the amount of additional taxable compensation is unrelated to the cost of the employee’s other coverage.

II. Small Plans Exception. In Letter 2016-0005 the IRS allowed reimbursement of individual policy premiums provided that there is only one “active” employee in the plan. This is because the ACA market reform rules do not apply to a group health plan if the plan has less than 2 participants who are active employees.

III. Relief For S Corporations. Letter 2016-0021 explains that S Corporations may continue to pay for or reimburse premiums for their “2% shareholders-employees” without being subject to Code 4980D excise taxes, until further guidance is issued (this position was previously stated in Notice 2015-17). This relief does not, however, apply to S corporation employees who are not 2% owners.

IV. Beware of Promoters Promising They Can Structure a Plan to Allow Reimbursement of Individual Policy Premiums. In Letter 2016-0019 the Treasury explains that it has been made aware of a number of what it describes as “schemes”, whereby promoters are marketing products that they are claiming will allow employers to reimburse individual health policy premiums without violating the ACA market reforms. Treasury is looking at the information and warns that it disagrees with the promoters’ claims that their product does not impose an annual limit on essential health benefits. Consequently, their product fails to meet the market reforms.

IRS Publishes Affordable Care Act Estimator Tools

The IRS Taxpayer Advocate Service has posted several useful tools for individuals and employers to help determine how the ACA may affect them and to estimate ACA related credits and payments.

The Employer Shared Responsibility Provision Estimator helps employers understand how the Employer Mandate works and how the penalties for not complying with the Employer Mandate may apply. Employers can use the estimator to determine:

The number of their full-time employees, including full-time equivalent employees
Whether they might be an Applicable Large Employer (ALE)
If they are an ALE, an estimate of the maximum amount of the potential liability for the employer shared responsibility payment that could apply to them, based on the number of full-time employees that they report, if they fail to offer coverage to their full-time employees

Caution: this tool is only designed for use in 2016 and forward (it is not designed to estimate 2015 penalties). Moreover, the tool can only provide an estimate of the maximum amount of potential liability for the employer shared responsibility payment.

IRS Clarifies Tax Treatment of Wellness Program Rewards

The IRS Chief Counsel Advice has issued a Memorandum explaining that an employer may not exclude from an employee’s income under section 105 or section 106:

1) cash rewards paid to an employee for participating in a wellness program; and

2) reimbursements of premiums for participating in a wellness program if the premiums for the wellness program were originally made by salary reduction through a section 125 cafeteria plan.

While coverage by an employer-provided wellness program that provides medical care as defined under section 213(d) is generally excluded from an employee’s gross income under section 106(a), and any section 213(d) medical care provided by the program is excluded from the employee’s gross income under section 105(b), any reward, incentive or other benefit provided by the medical program that is not medical care as defined under section 213(d) is included in an employee’s income, unless it is otherwise excludable as an employee fringe benefit under section 132.

For example, a wellness program that provides employees with a de minimis fringe benefit, such as a tee-shirt, would satisfy the requirements to be an excluded fringe benefit. However, the employer payment of gym membership fees does not qualify as medical care as defined under section 213(d) and would not be excludable from the employee’s income, even if provided through a wellness plan or program, because payment or reimbursement of gym fees is a cash benefit that is not excludable as a de minimis fringe benefit.

In addition, cash rewards received from a wellness program do not qualify as the reimbursement of medical care as defined under section 213(d) or as an excludable fringe benefit under section 132, and therefore are not excludable from an employee’s income.

Finally, the exclusions under sections 106(a) and 105(b) do not apply to reimbursement of a portion of the employee’s premium for the wellness program that was excluded from gross income under section 106(a) (including salary reduction amounts pursuant to a cafeteria plan under section 125 that are applied to pay for such coverage). Accordingly, the reimbursement of such amounts are included in the employee’s gross income.

IRS Chief Counsel Advice Memorandum

US District Court for DC Rules Payment of Some ACA Subsidies are Unconstitutional without Separate Appropriation

The U.S. District Court for the District of Columbia has ruled that certain Affordable Care Act subsidies designed to reduce deductibles, co-pays, and other means of “cost sharing” by insurers cannot be paid unless they are separately appropriated by Congress. U.S. House of Representatives v. Burwell, et al., (2016, DC DC), Civil Action No. 14-1967 (RMC).

The case involves two sections of the Affordable Care Act: 1401 and 1402. Section 1401 provides tax credits to make insurance premiums more affordable, while Section 1402 reduces deductibles, co-pays, and other means of “cost sharing” by insurers. Section 1401 is codified at 26 U.S.C. 36B (in the tax code) and was funded by adding it to a preexisting list of permanently-appropriated tax credits and refunds.

Section 1402 was not added to that list. The court ruled that Section 1402, which is codified in Title 42, which includes federal laws concerning “Public Health and Welfare” cannot be funded through the same, permanent appropriation as Section 1401. Instead, Section 1402 reimbursements must be funded annually.

The Court ruled that by paying out the subsidies without the necessary appropriation, the Administration violated Article I, Section 9, clause 7 of the U.S. Constitution, which provides that “No Money shall be drawn from the Treasury, but in Consequence of Appropriations made by Law . . . .”

The Court enjoined payment of the reimbursements, but stayed its ruling pending appeal. Therefore, the short term effect is that that reimbursements will continue while the case is on appeal. A decision from the US Court of Appeals for the DC Circuit on appeal will likely take months.

More … U.S. House of Representatives v. Burwell, et al., (2016, DC DC), Civil Action No. 14-1967 (RMC).

IRS Announces 2017 Inflation Adjusted Amounts for Health Savings Accounts (HSAs)

The IRS has announced 2017 HSA limits as follows:

Annual contribution limitation. For calendar year 2017, the annual imitation on deductions under § 223(b)(2)(A) for an individual with self-only coverage under a high deductible health plan is $3,400 (up from $3,350 in 2016), and the annual limitation on deductions under § 223(b)(2)(B) for an individual with family coverage under a high deductible health plan is $6,750 (unchanged from 2016).

High deductible health plan. For calendar year 2017, a “high deductible health plan” is defined under § 223(c)(2)(A) as a health plan with an annual deductible that is not less than $1,300 for self-only coverage or $2,600 for family coverage (both unchanged from 2016), and the
annual out-of-pocket expenses (deductibles, co-payments, and other amounts, but not premiums) do not exceed $6,550 for self-only coverage or $13,100 for family coverage (also unchanged from 2016).

Rev. Proc. 2016-28

Plan Administrator Bears Burden to Produce Key Information Regarding Claimant’s Service and Benefits Eligibility

The 9th Circuit Court of Appeals ruled on April 21, 2016 that where a claimant has made a prima facie case that he is entitled to a pension benefit, but lacks access to the key information about corporate structure, or hours worked, needed to substantiate his claim, and the defendant controls this information, the burden shifts to the defendant to produce this information. Estate of Bruce H. Barton v. ADT Security Services Pension Plan (9th Cir., 2016).

The Plan Administrator could not place the burden of producing records establishing which entities participated in the pension plan between 1967 and 1986, and the claimant’s service record, on the claimant where the Plan Administrator had no records of its own.

The Plan Administrator originally denied the claim on the basis of an absence of records establishing eligibility for plan participation, actual participation, or accrual of plan benefits. This was wrong where the Committee rather than the claimant would likely be in possession of such records.

The lesson for Plan Administrators: keep plan documents,service records and contemporary records establishing benefit accruals forever -there is no practical document retention period for these documents.

The lesson for claimants: don’t be deterred from asserting a claim if you have enough evidence to state a prima facie case and the definitive documents or information ought to be in the Plan Administrator’s possession.

Estate of Bruce H. Barton v. ADT Security Services Pension Plan (9th Cir., 2016)

Fiduciaries Ultimately Prevail in Tibble v. Edison

On remand from the United States Supreme Court, which held in May 2015 that ERISA imposes on retirement plan fiduciaries an ongoing duty to monitor investments, even absent a change in circumstances, the 9th Circuit Court of Appeals recently affirmed the district court’s original judgment in favor of the employer and its benefits plan administrator on claims of breach of fiduciary duty in the selection and retention of certain mutual funds for a benefit plan governed by ERISA.

The court of appeals had previously affirmed the district court’s holding that the plan beneficiaries’ claims regarding the selection of mutual funds in 1999 were time-barred. The Supreme Court vacated the court of appeals’ decision, observing that federal law imposes on fiduciaries an ongoing duty to monitor investments even absent a change in circumstances.

On remand, the panel held that the beneficiaries forfeited such ongoing-duty-to-monitor argument by failing to raise it either before the district court or in their initial appeal. While the fiduciaries ultimately prevailed in this case, the lesson for fiduciaries remains clear: You have an ongoing duty to monitor the investment options in your retirement plans.

Tibble v. Edison International (9th Cir., 2016)

Full Text of the Supreme Court Decision in Tibble v. Edison International (2015)

DOL Finalizes Regulations and Related Exemptions on ERISA Fiduciary Definition and Conflicts of Interest in Investment Advice

The Department of Labor (DOL) has adopted its long-awaited final rule defining who is a fiduciary investment adviser, and has issued accompanying prohibited transaction class exemptions that allow certain broker-dealers, insurance agents and others that act as investment advice fiduciaries to continue to receive a variety of common forms of compensation, as long as they adhere to standards aimed at ensuring that their advice is impartial and in the best interest of their customers.

Going forward, individuals and firms that provide investment advice to plans, plan sponsors, fiduciaries, plan participants, beneficiaries and IRAs and IRA owners must either avoid payments that create conflicts of interest or comply with the protective terms of an exemption issued by the DOL.

Under new exemptions adopted with the rule, firms will be obligated to acknowledge their status and the status of their individual advisers as “fiduciaries.” Firms and advisers will be required to:

make prudent investment recommendations without regard to their own interests, or the interests of those other than the customer;
charge only reasonable compensation; and
make no misrepresentations to their customers regarding recommended investments.

I. What Is Covered Investment Advice Under the Rule?

Covered investment advice is generally defined as a recommendation to a plan, plan fiduciary, plan participant and beneficiary and IRA owner for a fee or other compensation, direct or indirect, as to the advisability of buying, holding, selling or exchanging securities or other investment property, including recommendations as to the investment of securities or other property after the securities or other property are rolled over or distributed from a plan or IRA.

A “recommendation” is a communication that, based on its content, context, and presentation, would reasonably be viewed as a suggestion that the advice recipient engage in or refrain from taking a particular course of action.

II. What Is Not Covered Investment Advice Under the Rule?

The final rule includes some specific examples of communications that would not rise to the level of a recommendation and therefore would not constitute a fiduciary investment advice communication, including:

Education about retirement savings and general financial and investment information. For example, education can include specific investment alternatives as examples in presenting hypothetical asset allocation models or in interactive investment materials intended to educate participants and beneficiaries as to what investment options are available under the plan, as long as they are designated investment alternatives selected or monitored by an independent plan fiduciary and other conditions are met. In contrast, because there is no similar independent fiduciary in the IRA context, the investment education provision in the rule does not treat asset allocation models and interactive investment materials with references to specific investment alternatives as merely “education.”
General communications that a reasonable person would not view as an investment recommendation
Simply making available a platform of investment alternatives without regard to the individualized needs of the plan, its participants, or beneficiaries if the plan fiduciary is independent of such service provider
Transactions with Independent Plan Fiduciaries with Financial Expertise. ERISA fiduciary obligations are not imposed on advisers when communicating with independent plan fiduciaries if the adviser knows or reasonably believes that the independent fiduciary is a licensed and regulated provider of financial services (banks, insurance companies, registered investment advisers, broker-dealers) or those that have responsibility for the management of $50 million in assets, and other conditions are met.
Employees working in a company’s payroll, accounting, human resources, and financial departments who routinely develop reports and recommendations for the company and other named fiduciaries of the sponsors’ plans are not investment advice fiduciaries if the employees receive no fee or other compensation in connection with any such recommendations beyond their normal compensation for work performed for their employer

III. Best Interest Contract Exemption

The Best Interest Contract Exemption permits firms to continue to rely on many current compensation and fee practices, as long as they meet specific conditions intended to ensure that financial institutions mitigate conflicts of interest and that they, and their individual advisers, provide investment advice that is in the best interests of their customers. Specifically, in order to align the adviser’s interests with those of the plan or IRA customer, the exemption requires the financial institution to:

acknowledge fiduciary status for itself and its advisers
adhere to basic standards of impartial conduct, including giving prudent advice that is in the customer’s best interest, avoiding making misleading statements, and receiving no more than reasonable compensation.
have policies and procedures designed to mitigate harmful impacts of conflicts of interest and
disclose basic information about their conflicts of interest, including descriptions of material conflicts of interest, fees or charges paid by the retirement investor, and a statement of the types of compensation the firm expects to receive from third parties in connection with recommended investments.
Investors also have the right to obtain specific disclosure of costs, fees, and other compensation upon request.
In addition, a website must be maintained and updated regularly that includes information about the financial institution’s business model and associated material conflicts of interest, a written description of the financial institution’s policies and procedures that mitigate conflicts of interest, and disclosure of compensation and incentive arrangements with advisers, among other information.

IV. Additional Exemptive Relief

In addition to the Best Interest Contract Exemption, the DOL issued a Principal Transactions Exemption, which permits investment advice fiduciaries to sell or purchase certain recommended debt securities and other investments out of their own inventories to or from plans and IRAs. As with the Best Interest Contract Exemption, this requires, among other things, that investment advice fiduciaries adhere to certain impartial conduct standards, including obligations to act in the customer’s best interest, avoid misleading statements, and seek to obtain the best execution reasonably available under the circumstances for the transaction.

V. Effective Date

Compliance with the new rule is required as of April 2017. The exemptions will generally become available upon the applicability date of the rule. However, the DOL has adopted a “phased” implementation approach for the Best Interest Contract Exemption and the Principal Transactions Exemption. Both exemptions provide for a transition period, from the April 2017 applicability date to January 1, 2018, under which fewer conditions apply. This period is intended to give financial institutions and advisers time to prepare for compliance with all the conditions of the exemptions while safeguarding the interests of retirement investors.

During this transition period, firms and advisers must adhere to the impartial conduct standards, provide a notice to retirement investors that, among other things, acknowledges their fiduciary status and describes their material conflicts of interest, and designate a person responsible for addressing material conflicts of interest and monitoring advisers’ adherence to the impartial conduct standards. Full compliance with the exemption will be required as of January 1, 2018.

VI. More…

Regulations and Related Exemptions

DOL Fact Sheet

DOL FAQs