Impact of Recent New York Laws, Wage Recharacterization, Stock Awards to Subsidiary Employees, and Unused Leave Contributions

Focus On Employee Benefits
09.21.09

Health & Welfare: Watch Out for Recent New York Laws

Garrett Fenton, Susan Relland

The State of New York recently enacted two laws that will dramatically impact insured employee benefit plans, and the group health insurance industry as a whole, in the Empire State. The first law effectively extends the maximum length of federal COBRA and state-mandated continuation coverage to three years, while the second law allows certain children to continue coverage under their parents’ employer-based group health plans through age 29. Perhaps as important as the provisions of the new laws themselves is the possibility that other states may follow suit in the near future.

The first law, effective for policies issued, renewed, modified or amended after July 1, 2009, requires commercial group health insurers, as well as certain non-profit corporations and HMOs, to effectively extend in all cases the maximum period of available federal COBRA and state continuation (“mini COBRA”) coverage, for employees who terminate employment, to 36 months. Under federal COBRA, and prior New York State continuation statutes, terminated workers who would otherwise lose their employer-provided group health coverage may generally continue to purchase such coverage for themselves and their families for a maximum period of time that varies depending on the circumstances (generally 18 to 36 months). Federal COBRA applies, in general, to employers with 20 or more employees, while New York State mini COBRA applies to smaller employers.

Under the new law, the maximum period of state mini COBRA coverage is simply extended to 36 months for all purposes. In addition, individuals entitled to less than 36 months of federal COBRA coverage who, in fact, exhaust such COBRA benefits, must be given an opportunity to continue their coverage for an additional period, up to a maximum of 36 months from the date that their federal COBRA coverage initially began. For example, if a former employee is entitled to continuation coverage under federal COBRA for a maximum period of 18 months, he or she will also be entitled to extend that coverage, under New York State law, for up to an additional 18 months (assuming the individual has otherwise remained eligible for continuation coverage). The legislation was motivated, in part, by the dramatic disparity in premiums between coverage purchased in the individual market and comparable group health continuation coverage in New York, as well as the recent rise in the national and New York State unemployment rates.

The second law requires commercial group health insurers, as well as certain non-profit corporations and HMOs, to provide an option to continue dependent coverage, through age 29, to unmarried children -- regardless of their financial dependence -- that “age off” of their parents’ group health policies, provided that they do not obtain other group coverage and are not eligible for Medicare. Furthermore, if a dependent child’s coverage terminated before July 1, 2009 (the law’s effective date), the dependent or the applicable employee will have until July 1, 2010 to elect the extended coverage on a prospective basis. Finally, the new law requires insurers to discount the premium rate for this extended coverage, which may be borne entirely by the employee or dependent, to reflect the favorable claims experience and low morbidity of the qualifying dependents. This is expected to cause the coverage to be significantly less expensive than comparable federal COBRA or New York mini COBRA coverage.

The New York law was largely modeled after similar legislation that New Jersey enacted in 2006. The New Jersey law resulted in a 20-40% reduction in premium rates for young adults in that state, as compared with the standard COBRA continuation premiums.

Going forward, plan sponsors of insured group health coverage offered to New York employees must amend their relevant plan documents and policies as soon as possible, to ensure compliance with both of the new laws. The laws did not include any specific requirements to provide notice of the availability of these new benefits. In addition, it remains to be seen how many other states will enact similar laws in the near future. We will continue to monitor any developments in this regard.

 

Fringe Benefits and Payroll Tax: Wage Recharacterization and Accountable Plans

Tom Cryan, Marianna Dyson

On June 26, 2009, the IRS released Information Letter 2009-0119, addressing the issue of the tax treatment of per diem payments made to employees under various fact patterns. Specifically, the Information Letter addresses the circumstances in which per diem payments may be treated as non-taxable reimbursements under an accountable plan. To qualify as an “accountable plan,” the reimbursement arrangement must satisfy three requirements: (1) business connection; (2) substantiation; and (3) return of any excess payments. Included within the discussion of the business connection requirement of the accountable plan regulations is a specific reimbursement requirement that prohibits employers from taking advantage of the accountable plan rules through the mechanism of cash options or recharacterization of part of the employee’s wages as per diem payments. Treas. Reg. § 1.62-2(d)(3)(i) provides that per diem payments and other expense allowances may be paid only to reimburse anticipated expenses, and thus may not be paid regardless of whether the employee incurs (or is expected to incur) such expenses.

For years, employers with large mobile workforces have been concerned that this “wage recharacterization” prohibition would prevent them from restructuring a traveling employee’s compensation arrangement by reducing the employee’s taxable wages and adding a nontaxable per diem. Taxpayers have noted that: (1) a general prohibition on restructuring compensation arrangements would put existing employers and staffing companies at a competitive disadvantage; and (2) the regulations ignore the economic reality that currently exists for employees who travel away from home, in that a local employee, since he or she is not receiving a per diem payment, is generally paid a higher wage rate for performing the same service as a traveler.

In recognition of these concerns, the IRS notes in Information Letter 2009-0119 that the prohibition against wage recharacterization “does not preclude an employer’s prospective alteration of its compensation structure to include reimbursement of substantiated expenses under an accountable plan . . . .” However, the IRS has not completely conceded the “wage recharacterization” issue. The General Information letter goes on to note that employers cannot:

“. . . use an alternate method to get the same amount of gross pay to employees when qualifying expenses are not incurred or reasonably expected to be incurred and subsequently substantiated (e.g., increased compensation, bonus, reduction in wages for the reimbursement ‘amount’ with subsequent increase once the ‘reimbursement’ is complete). The presence of wage recharacterization is based on the totality of facts and circumstances.”

Thus, it remains unclear whether the IRS will challenge employer arrangements that pay traveling employees a smaller wage than similarly situated employees who are not in travel status. Please let us know if you have any questions regarding this General Information letter or the application of the accountable plan rules.

 

Executive Compensation: Stock Awards to Subsidiary Employees

Layla Asali, Fred Oliphant

Employee benefits professionals may want to alert their corporate tax counterparts to complications that new tax regulations may have if employees of subsidiaries have stock options or other stock awards involving parent stock. The complications are on the corporate tax side and potentially affect how the tax basis in the particular subsidiary will be computed. These computations are potentially relevant, for example, in determining the taxation of dividend distributions to the parent or the taxation on sale of subsidiary stock.

On January 21, 2009, IRS and Treasury issued proposed unified basis regulations that provide a comprehensive framework for the allocation of boot and basis in corporate transactions and for stock basis recovery. Because these proposed regulations apply to stockless Internal Revenue Code (Code) section 351 transfers and capital contributions, they affect numerous everyday transactions, and in particular, may have an unanticipated effect on stock options or other stock awards.

For example, employees of subsidiaries frequently receive options to purchase stock of the parent corporation. For federal income tax purposes, when such an employee exercises a parent stock option the transaction is treated as if the parent contributed cash to the subsidiary in a capital contribution and the subsidiary then purchased parent stock for fair market value and transferred it to the employee. In this way, the subsidiary is not taxed on the value of the parent stock issued to the employee.

Although the proposed basis regulations do not address stock options or other similar stock awards specifically, they nonetheless appear to complicate the determination of the parent's basis in its subsidiary stock if stock options or other stock awards are granted to employees of subsidiaries. Under the proposed regulations, when an employee exercises a stock option the parent corporation must calculate the number of shares that the subsidiary should have issued in exchange for the deemed capital contribution. To perform this calculation, the parent must therefore know the value of the subsidiary stock every time a subsidiary employee exercises a parent stock option. Because no subsidiary shares are actually issued, the subsidiary is then deemed to have recapitalized its shares. The result is that with subsidiary employees exercising stock options at different times during the year, the parent will potentially have numerous blocks of subsidiary stock, each with a different basis to track.

 

Qualified Plans: Contributions of Unused Leave Amounts

Elizabeth Drake, Garrett Fenton

The IRS has issued two rulings addressing contributions of unused leave amounts to 401(k) profit sharing plans. The rulings were issued as part of the IRS and Treasury Department’s “Retirement and Savings Initiatives” that, according to senior administration officials, complement legislative proposals that President Obama included in his fiscal 2010 budget proposal. According to the administration’s press release, the rulings are designed to allow millions of workers who leave their jobs every year “and receive substantial payments for unused vacation and other leave” the ability to save these amounts.

The Revenue Rulings describe arrangements under which unused leave may be contributed to a company’s plan as either employer non-elective contributions or employee 401(k) elective contributions, either during the course of the employment or upon termination of employment. In general, the rulings explain that unused leave contributions are permissible, subject to the same requirements and limitations that apply to “regular” employer and employee contributions under tax-qualified plans. For example, amounts contributed as either non-elective or elective contributions are taken into account for purposes of the annual limit on contributions under Internal Revenue Code (Code) section 415 (100% of pay up to $49,000). Amounts contributed as employee elective contributions must be added to the employee’s other pre-tax contributions for purposes of the Code section 402(g) limit (generally, $16,500 for 2009) and the actual deferral percentage (ADP) nondiscrimination test. And because contribution amounts will vary based on each participant’s unused leave, amounts contributed as employer non-elective contributions will, in all likelihood, be subject to general nondiscrimination testing under Code section 401(a)(4). Of course, a company could avoid nondiscrimination testing by allowing contributions of unused leave only for non-highly compensated employees.

Given the limitations, the Revenue Rulings are helpful but not necessarily groundbreaking. Among other things, the general tax-qualification requirements and limitations may create enough of an administrative burden that an arrangement allowing contributions of unused leave - as either employer non-elective or employee elective contributions - may be desirable only where a significant portion of rank and file employees would view this as a valuable benefit.

For Additional Information

For additional information, please contact any of the following lawyers in our ERISA/ Employee Benefits practice:

Garrett Fenton, gfenton@milchev.com, 202-626-5562

Marianna Dyson, mdyson@milchev.com, 202-626-5867

Layla Asali, lasali@milchev.com, 202-626-5866

Fred Oliphant, foliphant@milchev.com, 202-626-5834

Elizabeth Drake, edrake@milchev.com, 202-626-5838

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