FORFEITURE FREEDOM

Some of our employer client sponsors of pre-approved 401(k) plans have contacted us regarding plan amendment notices received recently from their prototype or volume submitter plan document sponsors relating to the expanded use of forfeitures in their plans. An employer is informed either that an amendment has already been made for all employers that have adopted the plan form or requests or suggests that they adopt the amendment for their particular plan. The amendment specifically allows amounts in forfeiture accounts to now be used to fund qualified nonelective contributions (“QNECs”) and qualified matching contributions (“QMACs”) and, for safe harbor plans, to fund safe harbor plan contributions. Bottom line: the news is all good, and the amendment should be welcome and/or adopted for virtually all plans.

This mass amendment of plans stems from Proposed Treasury Regulations issued by the IRS in January of this year which reverse a multi-year position taken by the IRS to the effect that QNECs and QMACs had to be fully vested when first contributed to the plan, rather than when allocated to the accounts of participants.  QNECs and QMACs are primarily used by non-safe harbor 401(k) plans to meet the ADP and ACP nondiscrimination tests for plans that do not use distributions of excess contributions to remedy a failed test.  After much lobbying by benefits lawyers, actuaries and accountants, the IRS has finally accepted the view that the better reading of the Internal Revenue Code and the Treasury Regulations is that nonforfeitability conferred by the plan sponsor when such contributions are allocated to accounts is what matters.  The new right to use forfeitures for QNECs and QMACs also extends to 401(k) safe harbor matching or nonelective contributions, which must also be fully vested when allocated.  Taxpayers may rely on the regulations for periods preceding the date the regulations eventually become final. If the Final Regulations are more restrictive than the Proposed Regulations the Final Regulations will not be applied retroactively to create a noncompliance problem for any plan amended in reliance on the Proposed Regulations.  Lingering remaining questions, however, are whether forfeitures could be used for safe harbor 401(k) contributions made for the 2016 year or even whether forfeitures arising in 2016 could be used in 2017.  We are not aware that the IRS has yet clarified with any formal or informal comments.

Such an amendment is a discretionary plan amendment, meaning if the employer wants to reallocate forfeitures under the new regulations at a time in 2017 prior to making the amendmentthen it must adopt the amendment before the 2017 plan year end.

Finally, if you are an adopter of an individually-designed 401(k) plan, you will very likely wish to make this amendment to your plan.  Feel free to contact Jackson Lewis so we may help you with an amendment suited to your plan.

The FICA Tax Exemption for Non-Resident Aliens in the U.S. Under F, J, M, or Q Visas

A common issue for employers of non-resident aliens authorized to work in the U.S. is whether (and when) such individuals are exempt from FICA taxation.   Under the Internal Revenue Code, a nonresident alien (“NRA”) in the United States under a teacher, researcher, trainee, or student visa is exempt, within certain limitations, from FICA taxation.

A teacher, researcher, or trainee is an individual (other than a foreign student) “admitted temporarily” to the U.S. as a nonimmigrant under Code §§ 101(a)(15)(J) or (Q) of the Immigration and Nationality Act and who substantially complies with the requirements of being admitted. These individuals are in the U.S. under a J-1, Q-1, or Q-2 visa.

A foreign student is any individual “admitted temporarily” to the United States as a nonimmigrant student under Code §§ 101(a)(15)(F), (M), (J), or (Q) of the Immigration and Nationality Act and who substantially complies with the requirements of being admitted. These individuals are in the U.S. under an F-1, J-1, M-1, Q-1, or Q-2 visa.

The determination of whether an F-1, J-1, M-1, Q-1, or Q-2 visa holder is a resident alien or a non-resident alien is set forth under the Code’s residency rules. If any of these visa holders becomes a resident alien under the rules, that individual loses the nonresident alien FICA exemption.  These rules provide that:

  • A teacher/researcher/trainee visa holder is not exempt for the current year if for any two calendar years during the preceding six years the person was exempt as a teacher/researcher/trainee or as a foreign student.
    • If the teacher or trainee received compensation from a foreign employer, the person is no longer exempt if for any four years during the preceding six years the person was exempt as a teacher/trainee or as a foreign student.
  • A “foreign student” is no longer exempt after five years.

An individual will be deemed a resident during any calendar year in which the person is 1) lawfully admitted for permanent residence (i.e., has a green card, married to a U.S. citizen or a U.S. resident); 2) makes an election in the first election year to be treated as a resident of the U.S. for that year; or, 3) meets the “substantial presence test.” The substantial presence test requires an analysis of days present in the U.S. over the past three years.

If an individual meets the substantial presence test, the person is deemed a U.S. resident for tax purposes and is no longer exempt from FICA taxes. If a foreign student or teacher/researcher/trainee does not meet the substantial presence test, the person remains exempt (assuming the individual has not been lawfully admitted for permanent residence nor made an election to be treated as a resident in the first election year).

For more information on how to determine whether your employees with F, J, M, and Q visas qualify for the non-resident FICA tax exemption, please contact Amy Peck (Amy.Peck@jacksonlewis.com), Kathy Barrow (BarrowK@jacksonlewis.com), or Amy Thompson (Amy.Thompson@jacksonlewis.com) — our team would be happy to assist you.

Loss of COBRA Subsidies – A Marketplace Conundrum

While helping employers craft severance packages, we have often cautioned that a well-meaning offer by an employer to subsidize a former employee’s COBRA coverage for a period of time can result in unintended consequences. Namely, when that subsidy ends, that former employee may find himself or herself with a very high COBRA premium and no opportunity to seek individual coverage through one of the Affordable Care Act’s exchanges (the “Marketplace”) until the next Marketplace open enrollment period. This position—that loss of an employer COBRA subsidy is not an event that creates eligibility for mid-year special enrollment period (“SEP”) in the Markteplace—is one that has been supported by the available guidance, including the ACA’s regulations regarding SEPs and the Marketplace website, www.healthcare.gov. That is, until late last year….

Around October 2016, practitioners began to notice a change on the Marketplace website. Specifically, healthcare.gov currently provides in a couple of different spots that loss of an employer-provided COBRA subsidy does entitle an individual to a SEP. Notably, however, no change has occurred to the underlying regulations, nor has there been any formal communication from any of the agencies that are responsible for administering the ACA acknowledging or explaining this change.

We recently spoke with representatives at Health and Human Services—the folks actually responsible for enrolling people in individual coverage via the Marketplace—who indicated confusion over the change on the website and stated that their enrollment system is still not set up to provide a SEP to an individual in such circumstances. In particular, they noted that the information on the healthcare.gov website is not binding upon them and that they must process enrollments according to the way their system is set up.

It is also important to note that a position handed down from the federal Marketplace via healthcare.gov may or may not be picked up by the states. For example, we’ve learned anecdotally that the New York State exchange will allow a SEP for the loss of an employer subsidy only if the employer was paying the subsidy directly to the insurance carrier, not if the employer was providing reimbursement directly to the employee. Other state exchanges may take a different position.

We continue to investigate this issue, but in the meantime recommend that employers design their severance packages without any reliance on the idea that a former employee will qualify for SEP when their employer-provided COBRA subsidy ends.

Court Rules that Company Discretionary Offer of Voluntary Separation Agreements Does Not Create an ERISA-Covered Severance Plan

It always has been difficult to give a consistent answer as to whether informal severance arrangements have created an ERISA-covered severance plan. In Mance v. Quest Diagnostics Inc., 2017 WL 684711 (DC NJ 2017), the U.S. District Court held that Quest’s decision to provide some departing employees with severance benefits under a voluntary separation agreement (“VSA”) process was provided on such a discretionary basis that it did not establish a plan under ERISA.

By way of background, the U.S. Department of Labor and the courts uniformly have held since the 1980’s that severance pay benefits are covered by ERISA if the severance benefits are provided pursuant to a “plan, fund or program.” Under the test most commonly applied by the courts including the District Court here, a “plan, fund or program” will be established for purposes of ERISA if, from the surrounding circumstances, a reasonable person can ascertain (1) the intended benefits, (2) a class of beneficiaries, (3) the source of financing, and (4) procedures for receiving benefits.  The courts have applied these factors to find that the existence of an ERISA plan can be established from written guidelines set forth in internal policy statements or corporate manuals or by descriptions in employee handbooks or from an employer’s consistent past practice of awarding severance benefits to involuntarily terminated employees.

But to make the determination more confusing, the Supreme Court has added the requirement that a plan, fund or program subject to ERISA will not exist unless it is necessary to establish an “administrative scheme” to provide the benefits. Fort Halifax Packing Co. v. Coyne, 482 U.S. 1 (1987).  The court decisions understandably have not established a hard and fast rule regarding how much administration is too much.

Interestingly, the District Court found that Quest had established a separate administrative scheme to determine both eligibility for and the type of VSA benefits that might be offered to an employee. However, the District Court found that having an administrative scheme by itself did not establish an informal ERISA-covered severance plan.  Applying the factors described above for determining whether a “plan, fund or program” existed, the Court found that a reasonable person could not determine the class of intended beneficiaries, the intended benefits or the process to request VSA benefits.  Accordingly, Quest did not create an informal ERISA plan.  (Note that the VSA benefits at issue were separate from the benefits provided by Quest under its ERISA-covered severance pay plan).

COMMENT: It is important to note that the application of ERISA to severance pay benefits is more favorable to employers than state law:

  • An employer may design a severance plan under ERISA that specifically provides the employer with the discretion to make determinations that affect an employee’s eligibility for benefits. Further, a deviation from a plan’s written terms for particular individuals does not prohibit the employer from again applying the written terms to other individuals.
  • A participant who sues for benefits is entitled only to the actual benefits – unlike state law, ERISA does not permit consequential or punitive damages or provide for tort remedies. (In egregious cases, a court may award attorney’s fees.)
  • ERISA does not provide for jury trials and claims for benefits may be removed to federal court.
  • If a severance plan is properly drafted, company decisions will be reviewed by a court only to determine whether the decision is “arbitrary and capricious” (or an “abuse of discretion”).

New Bill Could Add Safe Harbor to Definition of Employee

In the employee benefits world, a lot can hang on an individual’s classification as an employee. Whether someone is a leased employee, an independent contractor, or a member of the rank and file can have a dramatic impact on a retirement or welfare plan. While employers typically attempt to create relationships that comply with the law, the IRS might not always agree. And it’s a bit more complex than one might expect at first. ERISA attorneys joke about the unhelpful and circular nature of ERISA §3(6) (“[t]he term ‘employee’ means an individual employed by an employer”). At the same time, tax practitioners will readily rattle off a list of twenty (yes, 20!) factors that can go into the determination.

A bill newly introduced in the U.S. Senate aims to change the complex analysis. Senate Finance Committee member John Thune, R-S.D., has introduced the New Economy Works to Guarantee Independence and Growth (NEW GIG) Act of 2017. By adding a safe harbor, the bill would “would ensure that the service provider (worker) would be treated as an independent contractor, not an employee, and the service recipient (customer) would not be treated as the employer,” according to the press release. The bill focuses on three elements: 1) the relationship between the parties, 2) the location of the services or means by which services are provided, and 3) a written contract.

Of course, we can’t throw out our twenty factors test just yet. The bill would merely provide a safe harbor. For relationships that don’t meet the criteria, the common law tests would still apply. While passage of the bill is yet to be determined, and its application to ERISA is also a bit murky (this is a tax provision aimed at collecting income and employment taxes), the legislation will be welcome news to many employers who have a difficult time discerning where the line is between independent contractor and employee.

THE FULL FIFTH CIRCUIT WILL RE-VISIT THE STANDARD OF REVIEW IN DENIAL OF BENEFITS CASES

On July 10, the Fifth Circuit Court of Appeals announced that the full Court would re-hear a recent case concerning the applicable standard of review in an ERISA denial of benefits case – which is often outcome-determinative in favor of insurers and benefit plans.

As we previously reported, in Ariana M. v. Humana Health Plan of Tex., Inc., 2017 U.S. App. Lexis 7072 (April 21, 2017), a three-judge panel of the Fifth Circuit reviewed a summary judgment in favor of a Plan Administrator who denied benefits to a claimant with eating disorders.  Even though the plan in question did not call for deference, the Court, bound by its prior decision in Pierre v. Conn. Gen. Life Ins. Co. of N. Am., 932 F.2d 1552 (5th Cir. 1991), applied an abuse of discretion standard.  Not surprisingly, the panel affirmed the District Court’s grant of summary judgment.  However, a separate concurring opinion (joined by all three judges), called Pierre into question and set the stage for a reversal.

The concurring opinion noted that the Fifth Circuit is the only circuit that applies a deferential standard to factual determinations made by an Administrator when the plan does not vest the Administrator with that discretion, and pointed to the growing number of state laws prohibiting discretionary clauses in insurance contracts.  Based on these factors, the panel opined that Pierre has not withstood the test of time:  “This question concerning the standard of review for ERISA cases is not headline-grabbing.  But it is one that potentially affects the millions of Fifth Circuit residents who rely on ERISA plans for their medical care and retirement security.”  The panel concluded that, given the “lopsided split” in the circuits and the potential for conflicting standards across different jurisdictions, further review of Pierre is warranted.

So, just as the outcome in Ariana M. v. Humana Health Plan was no surprise, it is not the least bit surprising that the Fifth Circuit has decided to re-examine the standard of review it applies in ERISA denial of benefits cases.  And it is probably not too difficult to guess that the Court, en banc, will reverse Pierre, and align with other circuits holding that a de novo review is called for when reviewing decisions made by retirement and health plans during some of life’s most difficult times.

 

 

An Update on the DOL’s Fiduciary Rule

The DOL’s much anticipated (or maligned depending on the audience) Fiduciary Rule expands the definition of what constitutes investment advice under ERISA and thereby increases the number and types of retirement plan service providers that are considered ERISA fiduciaries (see our prior coverage of the Fiduciary Rule here, here and here).  It also imposes stringent compliance and disclosure requirements in order for those service providers to avoid breaching their ERISA fiduciary duties.

Reaction to the Fiduciary Rule has been mixed, and many hoped that the new DOL leadership would repeal the Rule.   That did not occur, and the Rule went into effect on June 9, 2017.  However, there is a phased implementation period for compliance with new prohibited transaction exemptions (e.g., Best Interest Contract Exemption; Principal Transactions Exemption).  During that phase-in period (which expires on January 1, 2018), service providers must only comply with more limited impartial conduct standards in order to take advantage of the exemptions. This means that from June 9 until January 1, service providers that wish to take advantage of the exemptions will generally need to provide advice that meets the best interests of the investor (without regard to the adviser’s financial or other interests), charge only reasonable compensation (as described in the rules under ERISA 408(b)(2)), and avoid making materially misleading statements. The prohibited transaction exemptions allow service providers to receive compensation for certain investment advice that they would otherwise be prohibited from receiving under ERISA’s prohibited transaction rules.

The DOL previously noted that it would continue to review the Fiduciary Rule and seek public comments on potential changes (see here for further information).  Consequently, on July 6, 2017, the DOL published a Request for Information seeking public input on several aspects of the Fiduciary Rule, including the following:

  • Whether the applicability date (currently January 1, 2018) for certain prohibited transaction exemptions, such as the Best Interest Contract Exemption, should be delayed.
  • Whether the Principal Transactions Exemption can be revised to better serve investors and provide greater market flexibility.
  • Whether certain requirements related to service provider contracts should be eliminated or changed.
  • Whether service provider disclosure requirements can be simplified.
  • Whether recommendations to make or contribute to a retirement plan should be expressly excluded from the Rule’s definition of investment advice.
  • Whether there should be an amendment to the Rule (or streamlined exemption) for certain investment transactions involving bank deposit products and Health Savings Accounts.
  • Whether the exclusion from the Rule for certain arms-length transactions with independent plan fiduciaries that have financial expertise should be expanded or changed (including whether additional relief should be provided through a prohibited transaction exemption).
  • Whether a streamlined exemption or other change to the Rule could be developed for investment advisers that comply with or are subject to updated standards of conduct that may be adopted by the SEC or other regulators.

Comments on delaying the applicability date for prohibited transaction exemptions are due on July 21, 2017, and all other comments are due on August 7, 2017.

Separation Agreement Drafting Error Corrected by Michigan Appeals Court

A Michigan appellate court denied an attempt by an employee to receive a severance jackpot based on a drafting mistake made by his former employer. Notwithstanding the employee’s entitlement, based on the terms of his separation agreement, to receive approximately $81 thousand dollars per week for 34 weeks, the State of Michigan Court of Appeals upheld the lower court’s decision to reform the contract, resulting in the employee receiving a total of $81 thousand over 34 weeks. The case highlights, among other things, the importance of proofreading.

The employee was employed for 28 years. In 2014, following the sale of the company, he was permanently laid off in a reduction in force. He was given a separation agreement providing separation pay for 34 weeks, among other benefits, which were consideration for a general release and a covenant not to compete. The employee eventually signed the separation agreement and returned it to the Company.

His execution of the agreement was not surprising. The agreement provided that the employee, who was then earning approximately $125 thousand per year, was to receive $80,805.97 per week for 34 weeks! This amount, which totals approximately $2.7 million dollars, represented more money than the employee had earned over his entire 28-year career with the company.

When the company discovered the error and declined to honor its “promise”, the employee sued to enforce the agreement. The trial court found that a unilateral mistake had clearly occurred, supported by both the testimony of the company’s director of human resources (who stated that she mistakenly inserted the total amount to be received over the 34-week payment period, or $80,805.97, as the weekly payment amount) and the reference to certain separation pay guidelines in the agreement (which provided for a continuation of the employees’ “gross monthly salary” for the specified period.) Accordingly, the trial court reformed the contract to correct the error.

The appellate court affirmed, based in principal part on the employee’s conduct in ignoring the seemingly obvious mistake. Not surprisingly, the Court did not ascribe much credence to the employee’s affidavit, in which he stated his belief that severance pay in excess of $80 thousand per week was “fair based on my 28 years of service.”

The case highlights the importance of proofreading legal documents for easily avoidable drafting errors. The company’s failure to do so here resulted in the expense and aggravation of trial and appellate litigation, and nearly cost the company $2.7 million dollars! It presents a cautionary tale and states a good case for multiple levels of internal review, not to mention the involvement of counsel.

Tenth Circuit Follows Majority of the Circuit Courts and Holds Plaintiff Bears the Burden of Proving Causation in ERISA Breach of Fiduciary Duty Cases

On June 5, 2017, in Pioneer Centres Holding Co. Employee Stock Ownership Plan & Trust v. Alerus Fin., N.A., Case No. 15-1227, the U.S. Court of Appeals for the Tenth Circuit held that the plaintiff bears the burden on each element of its breach of fiduciary duty claim under ERISA.

Plaintiff brought suit for breach of fiduciary duty against the independent transactional trustee in connection with a failed employee-stock purchase transaction which would have allowed the ESOP to become the 100% owner of the car dealerships. The ESOP purchase transaction failed because one of the car manufacturers, whose contract required that it approve any change in ownership of the dealership, had stated that it would not approve the transaction if it gave the ESOP 100% ownership. Plaintiff asserted that Defendant failed to sign the transaction documents and send them to the car manufacturer. As a result, the car dealership sold its assets to a third party for a significantly higher price.

The Tenth Circuit recognized that the Fourth, Fifth, and Eighth Circuit Courts of Appeals have adopted a “burden-shifting” framework which requires that once an ERISA plaintiff has proven a breach and prima facie case of loss, the burden shifts to the trustee to prove that the breach of duty did not cause the loss. However, the Court rejected this analysis and found that the statute’s plain language did not support “burden-shifting.” In addition to holding that Plaintiff had failed to demonstrate that Defendant’s alleged breach caused the Plaintiff to suffer damages, the Court concluded that the statute’s plain language limited liability to losses “resulting from” a breach of fiduciary duty. The Court determined that because causation is an element of the claim, the burden remains with the plaintiff at all times. This holding follows decisions from the Second, Sixth, Ninth, and Eleventh Circuit Courts of Appeals.

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