Blockchain Tokens as Compensation

By Yana S. Johnson and Kayla Rathjen on

Blockchain is a revolutionary technological tool in the way it tracks and stores data, decentralizes information, establishes trust in electronic files, and dispenses of intermediaries. This technology powers virtual currencies, also known as cryptocurrency or virtual tokens. Companies are raising money using “initial coin offerings” (ICOs) and using tokens to compensate and incentivize founders, directors, employees, and consultants. This raises legal questions as to how the tokens will be viewed and regulated by the Internal Revenue Service (IRS) and the U.S. Securities and Exchange Commission (SEC).

How are employers using tokens in an employment context? They are being used like equity or phantom-equity awards, granted as compensation for past or future services. They may be subject to vesting based on continued service or achievement of performance targets, and acceleration of vesting can be triggered based on designated events, such as the occurrence of a change of control transaction, the termination of an employee without cause, or the achievement of technical milestones. If an employee quits, the employer has the right to repurchase any remaining restricted tokens that have not yet vested.

Token-based awards tend to copy traditional equity-based awards. The standard token award grants tokens outright to the recipient or gives the recipient the right to ­­­buy tokens. “Restricted tokens” are not accessible until vested. “Token options” provide the employee the right, but not the obligation, to purchase a pre-determined number of tokens at a pre-set price, which can be subject to vesting. Finally, employers can issue “restricted token units,” which are promises to pay property (typically, tokens) to the employee in the future, usually after time or performance-based vesting conditions are met.

As with any form of innovation, there are challenges. The IRS has released guidance indicating that tokens issued to individuals in exchange for services would generally be treated as compensation subject to income and payroll taxes under the Internal Revenue Code and reported on Form W-2. Therefore, employers issuing tokens to employees and other service providers must determine the fair market value of the tokens in US dollars to properly report it.

However, it is interesting to note that the IRS does not treat tokens as currency; rather, the IRS views tokens and other cryptocurrencies as property. Therefore, depending on the type of award, the recipient may want to file an election with the IRS to tax the award at the time of grant (an “83(b) election”), although this can be risky if the tokens are later forfeited or fall in value.

The IRS has not issued guidance regarding whether token options are subject to Section 409A of the Internal Revenue Code, so issuers should assume that token options are subject to Section 409A, and should comply with Section 409A. Restricted token units should also be designed with Section 409A compliance in mind.

In addition, the SEC broadly categorizes all token offerings issued to raise money as securities. Therefore, employers who issue token-based compensatory awards should follow Rule 701 or other exemptions from registration under the Securities Act, as well as applicable state securities laws.

The takeaway is that the same tax, securities, and other rules that apply to compensatory equity awards may apply to compensatory tokens.

Arbitration of ERISA Claims – Update

By René E. Thorne on

Some of you may remember that back in 2015, we published an article entitled Arbitration of ERISA Claims – Yes You Can!  A link to that article can be found here.  In that article, we suggested that one key reason for adding ERISA claims to your arbitration agreement was to avoid class actions through the inclusion of a class action waiver in the arbitration agreement.  Particularly on the pension side, ERISA class actions can involve millions of dollars of exposure and litigation costs.

Last week, the Supreme Court confronted head on whether the inclusion of a class action waiver in an arbitration agreement violated the National Labor Relations Act.  Ultimately, the Court concluded that class action waivers in employment arbitration agreements are enforceable under the Federal Arbitration Act.  (See our article here for an in-depth discussion of the Supreme Court’s decision).

Based on this decision, employers can be even more confident that class or collective action waivers in arbitration agreements are permissible.  Be on the lookout, however, for our post on the upcoming decision from the Ninth Circuit in the ERISA class action against USC, Munro v. University of Southern California.  The Ninth Circuit heard argument on May 15 on whether a class action waiver in an arbitration agreement is enforceable to prevent a class claim brought on behalf of the plan under Section 502(a)(2) of ERISA.

Excessive Executive Compensation and the Tax Cuts and Jobs Act of 2017: Widening the Net of Negative Tax Consequences for For-Profit and Non-Profit Corporations

By Jackson Lewis P.C. on

With all the national press coverage about tax savings, tax cuts and company bonus payments associated with the Tax Cuts and Jobs Act of 2017 (the “Tax Act”), it is easy to miss the changes in federal tax laws that impose substantial negative tax consequences on employers that pay certain executives an amount of compensation that Congress has deemed “excessive.” In this particular area, the changes brought about by the Tax Act do not cut taxes. Rather, for many for-profit and non-profit corporations, the Tax Act creates new taxes.

For example, the Tax Act provides for a new Section 4960 of the Internal Revenue Code. This statutory provision creates an excise tax that will be imposed upon certain tax exempt organizations that pay their covered employees remuneration in excess of $1 million annually or that make an excess parachute payment to a covered employee. This new excise tax impacts 501(a) tax exempt entities (i.e., charitable organizations); farmers’ cooperative organizations; states, political subdivisions and public utilities with income excluded from taxation under Code section 115; and political organizations as defined by Code § 527(e)(1). “Covered employees” are the five highest compensated employees of the organization for the tax year, or a person who was a covered employee for any preceding tax year beginning after December 31, 2016.

The Code § 4960 excise tax payment may be triggered by an excess parachute payment. The term “excess parachute payment” is a payment, triggered by a covered employee’s separation from employment, that is equal to or greater than the base amount determined under the golden parachute rules of Code § 280G(d)(3). Tax exempt organizations may also be surprised to find that they can become liable for excise tax under Code § 4960 because the $1 million compensation threshold is exceeded due to the vesting (rather than payment) of ineligible deferred compensation under Code § 457(f). Thus, a covered employee need not actually receive payment of compensation for a tax exempt organization to incur excise tax liability under the new law.

The excise tax under Code § 4960 is 21% of the sum of the remuneration received by the covered employee in excess of $1 million, plus any excess parachute payment paid to a covered employee.

For-profit corporations may be surprised by the Tax Act’s additions to Code § 162(m), which broaden both the application of the excessive employee remuneration rules in terms of what type of entity is subject to Section 162(m) and in terms of who is a “covered employee under” that statutory provision.

Code § 162(m)(1) provides that a publicly held corporation may not take a deduction for any applicable employee remuneration with respect to any covered employee that receives such remuneration in excess of $1 million annually. The Tax Act expands the scope of the terms “publicly held corporation” beyond those entities that issue classes of common equity securities that must be registered under Section 12 of the Securities Exchange Act of 1934 (the “Exchange Act”). Code § 162(m) now also applies to corporations that are issuers as defined in Section 3 of the Exchange Act, and are required to file reports under Section 15(d) of the Exchange Act. Consequently, any company that is an “issuer” required to file a registration statement for debt or equity securities is subject to Code § 162(m), whether or not they are listed on an exchange. As a result, the $1 million deduction limit on remuneration paid to covered employees now applies to foreign companies that are publicly traded through American depository receipts as well as all domestic publicly traded companies. Certain large private corporations may also fall within Code § 162(m).

The term “covered employee” has also been expanded under Code § 162(m) beyond the CEO or the four most highly paid officers of the company. Under the Tax Act, Code § 162(m) applies to the CEO, the CFO and the three other highest compensated company officers for the tax year.

The Tax Act’s provisions do not apply to remuneration paid pursuant to a written binding agreement in effect on November 2, 2017, and which has not been substantially modified in any material respect on or after that date. Contracts that are subject to cancellation by either party, or which expire on or before November 2, 2017, and are renewed on or after that date, will likely be treated as a new agreement subject to the amended Code § 162(m), according to the Committee Reports commentary under the Tax Act.

Given the new and broadening regulation of excess compensation under the Tax Act, non-profit organizations and large corporations are encouraged to review their executives’ compensation packages with their tax advisors to determine the impact on income received by the executives due to vesting and forfeiture provisions in deferred compensation plans, payments made under severance agreements and compensation packages described in employment agreements.

IRS Reverses the $50 HSA Reduction for 2018

By Melissa Ostrower and Kathryn W. Wheeler on

We recently informed you that the IRS reduced the 2018 health savings account (“HSA”) contribution limit for individuals with family coverage to $6,850.00 despite having previously announced that such limit was $6,900.  Because of compelling comments from stakeholders, the IRS reversed this decision in Revenue Procedure 2018-27 and the contribution limit for individuals with family coverage has reverted back to $6,900 for 2018.  The Revenue Procedure contains helpful guidance regarding how any distributions made in response to the reduced limit published in Revenue Procedure 2018-18 can be undone.

Ultimately, the IRS acknowledged the hardship and cost associated with the lower limit and reasonably reverted to the higher, previously announced, limit.

IRS Issues Guidance FAQs Regarding the Paid Family Leave Federal Tax Credit

By Jackson Lewis P.C. on

This week, the Internal Revenue Service (IRS) issued FAQ guidance regarding the employer tax credit for paid family and medical leave. As a reminder, the Tax Cuts and Jobs Act of 2017 (the Act) provides a tax credit to employers that voluntarily offer paid family and/or medical leave to employees. The FAQs clarify some of the requirements in Section 45S of the Act that an employer’s paid family and/or medical leave policy must include. The FAQs also clarify other details, such as the basis for the credit and the tax credit’s impact on an employer’s deduction for wages paid to an employee who is on a qualifying leave.

For information on how to determine if your company can take advantage of the paid family and medical leave tax credit, read our earlier article on this topic. You can estimate your company’s potential annual tax savings using the Jackson Lewis Paid Family Leave Tax Credit Calculator.

Financial Conflict of Interest in the Eighth Circuit: Trigger of a Less Deferential Standard of Review or Mere Factor in Determining Plan Administrator Abuse of Discretion?

By Stephanie O. Zorn on

It is well-established under the Employee Retirement Income Security Act of 1974 (“ERISA”) that when an employee benefit plan grants the plan administrator discretion to decide questions of eligibility for benefits or to construe plan terms, judicial review of the plan administrator’s denial of benefits is generally limited to the deferential abuse of discretion standard — pursuant to which a plan administrator’s decision is affirmed if it is reasonable, i.e., a reasonable person could have reached a similar decision given the evidence. Earlier this year, the United States Court of Appeals for the Eighth Circuit, in Boyd v. ConAgra Foods, Inc., 879 F.3d 314 (8th Cir. 2018), clarified when a less deferential standard of review might nonetheless apply in the review of denial of plan benefits under ERISA Section 502(a)(1)(B).

In Boyd, a former executive argued his claim for benefits under a severance plan — the terms of which afforded the plan administrator exclusive authority to interpret the plan and decide all questions of eligibility for benefits — had been wrongly denied. The former executive argued a standard of review that was less deferential than the abuse of discretion standard should apply. Specifically, the former executive argued for a “sliding scale” standard of review, in accordance with Woo v. Deluxe Corp., 144 F.3d 1157 (8th Cir. 1998) and its progeny — which held that a less deferential standard of review applied where a claimant showed a conflict of interest or a serious procedural irregularity by the plan administrator that amounted to a breach of fiduciary duty. The former executive predicated his argument on the financial conflict of interest in the case — i.e., ConAgra’s role as both the plan administrator who determined eligibility for benefits and the plan sponsor who was obligated to pay for benefits awarded under the plan — as well as alleged procedural irregularity — a ConAgra human resources employee’s alleged misstatement during the administrative claim review process concerning the former executive’s continued authority over a corporate program.

The Boyd Court noted that pursuant to the holding in Metro Life Ins. v. Glenn, 554 U.S. 105 (2008), a financial conflict of interest is merely a factor that a court should consider in determining whether a plan administrator has abused its discretion — not a basis for applying a less deferential standard of review. The Court explained that — although apparently substantially similar — a less deferential standard of review versus consideration of financial conflict of interest in conjunction with an abuse of discretion standard of review were distinct concepts. The Court explained that Glenn abrogated Woo to the extent Woo allowed a less deferential standard of review based on a mere financial conflict of interest. Finally, the Court noted that the Eighth Circuit had yet to resolve the impact of Glenn on Woo to the extent the latter allowed a less deferential standard of review based on procedural irregularity. The Boyd Court did not reach that issue, based on its conclusion that the alleged misstatement by the human resources employee to the former executive did not implicate the plan administrator’s procedures in reviewing the claim for severance benefits.

Importantly, the Boyd Court explained that the weight afforded to a financial conflict of interest would depend on the facts of the case, with the conflict being afforded little weight — perhaps almost no weight — where the record contained evidence concerning the procedural safeguards surrounding administration of the plan in question.

Best Practices: Plan sponsors should have employee benefits counsel provide annual fiduciary training to plan administrative committees. Plan sponsors who can show their administrative committees have been trained to administer a plan in accordance with its terms for the sole benefit of participants — and without regard to any consideration of plan sponsor financial liability — will be in the best position to have denied claims reviewed under the deferential abuse of discretion standard, with any financial conflict of interest treated as a mere factor that is afforded minimal weight.

Was Your Employee Benefit Plan Selected For Examination? Don’t Panic!

By Monique Warren on

Each year, hundreds of retirement plans are examined by the Internal Revenue Service (IRS) and Department of Labor (DOL).  The agencies also examine other kinds of employee benefit plans for compliance with statutes and regulations with respect to which they have enforcement authority.  In particular, the DOL has increased its examinations of group health plans in recent years in connection with the Employee Benefit Security Administration’s Health Benefits Security Project.  The agencies are particularly focused on compliance issues that pose the greatest potential risk to the largest numbers of employees.

Be Prepared

As with any situation you’d rather avoid, being prepared is always the best way to ensure that an examination isn’t any worse than your worst expectations.  With enough preparation, even your worst expectations shouldn’t be so bad.  A significant element of being prepared is self-auditing.  Regularly.

Focus particularly on the most common compliance issues.  For tax-qualified retirement plans examined by the IRS, these tend to involve failures related to (among other things) timely amending plan documents, administering compensation and eligibility rules consistent with plan terms, and making impermissible distributions.  Even if your plan financials are audited annually by a third party (for example, ERISA-covered retirement plans), do your own spot-checking for common trouble-makers like misinterpretations of eligibility rules and misapplication of the definition of compensation.

Both the IRS and the DOL publish self-audit tools.  The IRS’ compliance checklists, guide to common plan requirements, and “fix-it” guides are practical resources for 401(k) and 403(b) plan sponsors.  These include lists and explanations of specific Internal Revenue Code requirements for retirement plan tax-qualification and step-by-step ways to correct certain mistakes that could otherwise cause a plan to be disqualified.  The DOL’s self-compliance tool for group health plans may be especially helpful for plan sponsors who’ve not had a group health plan examination in the last couple of years.

Understand the Examination Process

Both the IRS and DOL publish examination guides.  The IRS’ examination process guide includes links to fairly detailed explanations of each of eleven stages of a typical examination.  The DOL’s initial investigation guidelines for group health plans are also readily available and will give group health plan sponsors some insight into the examination process.

Depending on whether your plan was selected for examination based on purely random selection, participant complaint(s), referral from another government agency, an anomaly in the plan’s annual report, or a particular market segment focus the agency’s national office has at the time, the examination process might veer significantly from the usual.  Also, if your plan has previously corrected failures under the IRS’s Employee Plans Compliance Resolution Program, be prepared to demonstrate that the full correction was made, including corrective action taken to prevent recurrence of the same failure.

Some examinations will involve on-site visits and others will not.  Also, some agents will want to communicate solely via fax or regular mail and others will permit email communication.  Many agents these days do not work out of an office every day and, therefore, will be difficult to reach by telephone.  Be prepared to be flexible and accommodating but do not hesitate to ask for the same from your assigned agent – for example, if you need more time to respond fully to an information or document request.

The examination will conclude with either a clean bill of health or (more likely) identification of one or more errors that need to be corrected.  Make sure you fully understand the error(s) identified as well as the proposed correction(s) and any penalties.  If you disagree with the agent’s conclusions, understand your appeal rights and those procedures.

Keep It In Perspective

The government’s objective in any plan compliance examination is to identify compliance failures.  It never pays to deliberately ruffle the feathers of a public servant whose job it is to find your mistakes.  Be professional and considerate and expect the same conduct from the agent.  Among other things, this means responding by whatever deadline is given (extended or otherwise) with documents and information organized in a way that makes it easy for the agent to do his or her job.

In any event, keep in mind that total compliance is virtually unheard of and every failure has a resolution.

IRS Reduces HSA Contribution Amount for Current Year

By Kathryn W. Wheeler and Melissa Ostrower on

In 2017, the IRS released the 2018 inflation-adjusted figures for contributions to Health Savings Accounts (HSAs).  The contribution limits for HSAs associated with High Deductible Health Plans was increased to $3,450 for individuals with self-only coverage and to $6,900 for individuals with family coverage.  In December, the President signed the tax reform bill commonly known as the Tax Cuts and Jobs Act (the Act).  The Act included a change in the method used to calculate inflation.  As a result of that change, the IRS recently released Revenue Procedure 2018-18 which provides for a small reduction in the 2018 contribution limit for individuals with family coverage.  The 2018 contribution limit for individuals with family coverage has been reduced to $6,850, down $50 from the number released in 2017.  The individual limit did not change.

 

Excess HSA contributions are subject to a 6% excise tax imposed on the holder of the HSA, the employee, if not corrected and refunded before the last day for filing the employee’s federal income tax return (including extensions) for that calendar year.  Plan Sponsors and healthcare vendors should update their enrollment materials and confirm new enrollees do not contribute more than the maximum limit for 2018.  In addition, payroll departments and vendors should adjust the limits in their systems to reflect the lower contribution limit.  Finally, we recommend that payroll departments and vendors audit their systems to locate participants who may have already contributed more than the maximum amount for 2018 and make arrangements for corrective refunds.

IRS Announces Heightened Scrutiny for Tax-Exempt Entities

By Amy M. Thompson on

The IRS division tasked with ensuring tax-exempt entities comply with relevant tax laws has announced that beginning in fiscal year 2018, it will focus on examining charitable organizations that show indicators of “private benefit or inurement.” Consequently, non-profit entities will want to review their business operations, hiring practices, and compensation packages to ascertain whether indicators exist and take steps to address any problematic characteristics apparent in such transactions or practices.

Private Benefit or Inurement = Loss of Tax-Exempt Status

Code § 501(c)(3) corporations and entities, operated exclusively for charitable purposes, are exempt from federal taxation under Code § 501(a) if no part of the net earnings of the corporation 1) inures to a private shareholder or individual who is in a position to control the charitable entity or 2) benefits a private individual or class of individuals. The private benefit and inurement prohibitions preclude employees and officers of an organization, as well as private individuals or entities, from unfairly or unreasonably benefiting from a charity’s benefits, income, or assets.

A finding of private benefit or inurement — no matter how small — jeopardizes the tax-exempt status of a charitable organization. In addition, the IRS imposes significant financial penalties upon those who approve and/or benefit from a prohibited inurement. The following examples illustrate the types of transactions that have proven fatal to an organization’s exempt status:

• Excessively large salaries to officers or employees. While salary may have been reasonable, other payments in the form of loans, disguised distributions, and benefits from net earnings made to the individual and his family disqualified the organization for tax-exempt status. 823 F.2d 1310 (9th Cir. 1987)

• The provision of facilities or office space to private corporations at less than fair market value. IRS Private Letter Ruling 201017078

• Charitable hospital corporation’s payment of administrative, service, medical, and professional expenses of physician medical practice. Tax Court Memo 1974-273

• Interest-free, unsecured loans and payment of personal expenses on behalf of family in control of school. 228 Ct. Cl. 902 (1981)

• Federal income tax advantages and property tax reductions that indirectly benefited non-exempt partners with charitable organization providing affordable housing for low income and disabled individuals because the non-exempt partners were relieved of maintaining rents at a level sufficient to cover operating expenses that would otherwise have to be paid out of partnership capital. 58 F.3d 401 (9th Cir. 1995)

• Two-thirds of retired teachers’ legal defense fund membership were not low-income or disabled persons. 78 Tax Court 280 (1982)

• Charitable hospital restricting the use of its facilities exclusively to one physician group. Revenue Ruling 56-185

Ensuring Compliance for Maintaining Tax-Exempt Status

The most common type of inurement is the payment of excessive compensation to an employee or an officer. The inurement prohibition requires that the total compensation paid to an employee or officer be fair and reasonable. “Reasonable compensation” as defined by the IRS is “the value that would ordinarily be paid for like services by like enterprises under like circumstances.” Compensation items taken into account by the IRS when determining reasonableness include:

• All forms of cash and noncash compensation, including salary, fees, bonuses, severance payments, and deferred and noncash compensation;
• Payment of liability insurance premiums;
• All other compensatory benefits, whether or not included in gross income for income tax purposes;
• Taxable and certain nontaxable fringe benefits; and
• Foregone interest on loans.

The IRS will presume a compensation arrangement is reasonable if the compensation arrangement is:

1. Approved by an independent, authorized body of the organization;
2. Based upon appropriate comparability data on compensation paid by comparable organizations — exempt and taxable — for equivalent positions in the same or similar communities for similar services; and,
3. Adequately documented throughout the process — see Form 990 Instructions for detailed requirements.

As noted above, the IRS’s radar is currently programmed to find indicators of inurement and private benefit in the non-profit sector. Tax-exempt entities should carefully evaluate the potential implications that inurement and private benefit issues have on their operations. Internal evaluations into the fairness and reasonableness of compensation paid to the organization’s key employees and officers should encompass detailed documentation requirements set forth by the IRS. In addition, charitable organizations should examine any transaction with private individuals or with entities that involve the rental, sale, purchase, or use of the organization’s assets or facilities.

If you have questions concerning whether your organization shows indicators of inurement or private benefit, or for more general information on best business practices for non-profit entities, our team of experienced attorneys can assist in ensuring that your organization maintains its tax-exempt status.

DEDUCTIONS AND W-4S: EARLY 2018 RESPONSES TO TAX REFORM

By Raymond P. Turner on

The Tax Cuts and Jobs Act signed into law on December 22, 2017 is prompting some prudent early tax 2018 actions by both employers and employees related to employee benefits. Many employers are electing to make additional employer qualified plan contributions for the 2017 tax year when the employer’s tax rate may be higher and thereby yield a bigger tax benefit.   C corporations, in particular, whose federal income tax rate in 2017 was as high as 35%, may find worthwhile to make further 2017 plan contributions, such as discretionary profit sharing contributions, if permitted under their 401(k) plans (up to the general defined contribution plan limit of 25% of compensation), rather than make the same contributions for 2018 when the company’s tax rate is a flat 21%.  But in order to secure the deduction for the 2017 tax year, the deduction must be made by the April 17, 2018 deadline for filing the Form 1120 corporate tax return.  Provided, however, if the corporation timely files by April 17 for a 6 month extension, it can make a deductible qualified plan contribution for the 2017 year as late as October 15, 2018.

Pass-through entities such as partnerships, limited liability companies (LLCs) and S corporations may be less inclined to accelerate plan contribution deductions to 2017 since the individual tax rates that apply to their partners or shareholders were not dramatically lowered by the new Act.  But if they do desire to accelerate then they must make the contributions by the March 15, 2018 deadline for their Form 1065 (or Form 1120S for a S corporation), unless they similarly obtain a 6 month extension of the filing deadline.  If the 6 month extension is obtained timely, then a 2017 contribution would be due by September 15, 2018.

Note that the deadline for deducting a contribution allocable to 2017 for deduction purposes is based on the actual company tax return due date (as extended), rather than the date the company’s tax return is actually filed.   Also, the deadline for making the contribution for 2017 is not the same as the deadline for depositing employer contributions so as to be counted for 2017 under the “Section 415” rules for maximum “annual additions” to a qualified plan.  Under those rules, all annual additions, including employer contributions, must be made and deposited no later than 30 days  following the due date of the company tax return  (with extensions).  Therefore, if a C corporation extends the deadline for the 2017 federal income tax return to October 15, 2018, then the date for depositing its company contribution for purposes of counting it against the Section 415 annual addition limit is November 15, 2018.  In addition, these tax deduction timing rules should not be confused with the timing rules for required and permissive funding of defined benefit plans.

Finally, employees should be encouraged by employers to review and revise their declared W-4 allowances in early 2018 to account for the many individual tax changes made by the Act.  These include the tax rate changes, changes to allowable deductions for state and local taxes and mortgage interest and the elimination of the personal exemption coupled with the near doubling of the standard deduction from $6,500 to $12,000 for singles and from $13,000 to $24,000 for married couples.  To assist employees, the IRS issued new wage withholding tables in January, a new form W-4 on February 28th and an online withholding calculator to assist employees in revising their W-4 allowances (See www.irs.gov/newsroom/updated-withholding-calculator-form-w-4-released-calculator-helps-taxpayers-review-withholding-following-new-tax-law).  An employee’s refiguring of tax allowances and the revising of the net payable wage amount will both take into account, and have an important bearing on, the 401(k) deferral elections and other pretax (and post-tax) employee benefit deductions from pay that an employee may wish, or be able, to make.

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