Focus On Employee Benefits
Exec Comp: Amending Split-Dollar Life Insurance Arrangements May Avoid Section 409A Treatment
Tony Provenzano & Adrian Morchower
Employers should review their split-dollar life insurance arrangements ("SDAs") to determine whether such arrangements are subject to, or comply with, Code Section 409A. In reviewing such arrangements, the important first step is understanding which SDAs could be subject to Section 409A. IRS Notice 2007-34 breaks down the various types of SDAs and describes which SDAs are generally exempt from Section 409A. For example, SDAs that provide only death benefits are excluded from coverage under Section 409A. In addition, SDAs treated as loans under Treas. Reg. Sec. 1.7872-15 or treated as loan arrangements under prior guidance (guidance before 2003) generally will not be subject to Section 409A unless the loans are waived, cancelled, or forgiven. However, Notice 2007-34 provides that Section 409A may apply to any SDA, including those entered into before September 18, 2003 (when the split-dollar regulations were issued), if any benefits under the policy were not "earned and vested" as of December 31, 2004 and if the arrangements provide deferred compensation.
If an SDA is subject to Code Section 409A, the next and more difficult step is determining what amendments are required to comply with Section 409A. Generally, the amended SDA should limit distributions to those events permitted under Section 409A (termination of employment, death, disability, change in control, hardship or stated time). For purposes of an SDA, a distribution would generally occur when the SDA is "rolled out" (when the value of the arrangement is transferred to the employee free of any residual claim of the employer). Notice 2007-34 did provide some relief, however, with respect to certain grandfathered SDAs. In the event the SDA currently receives favorable tax treatment because it was entered into prior to September 18, 2003 and therefore not subject to the split-dollar regulations (under Treas. Reg. Sec. 1.61-22), an amendment to the SDA to comply with Section 409A will generally not cause the SDA to lose such favorable tax treatment under the split-dollar rules.
Qualified Plans: New Reporting Requirements for Section 404(k) ESOP Dividends
Fred Oliphant & Veronica Rouse
The IRS recently announced changes in the reporting requirements of dividends paid by a C corporation to an Employee Stock Ownership Plan ("ESOP), which is later distributed in cash to participants and their beneficiaries within ninety days after the close of the plan year in which the dividend was paid, generally known as a Code Section 404(k) dividend.
Section 404(k) of the Code provides that a C corporation is allowed a deduction for applicable dividends made in cash to an ESOP sponsored by the corporation or a related corporation under Code Section 409(l)(4). Generally, whether initiated by the corporation or by an election from a participant or beneficiary, Section 404(k) dividends take two forms: (1) the corporation pays a dividend directly to the ESOP participant or beneficiary; or (2) the corporation pays the dividend to the ESOP and then it is distributed by the ESOP in cash to participants or their beneficiaries within 90 days after the close of the plan year. Section 404(k) dividends are not subject to the 10% penalty on early plan distributions under Code Section 72(t), are not eligible for rollover treatment under Section 402(c)(4), are not taken into account when determining compliance under Section 401(a)(9), and are not subject to withholding under Section 3405(e).
In Announcement 2008-56, the IRS requires that cash dividends distributed on or after January 1, 2009 from the corporation to the ESOP and subsequently to the participant or beneficiary be reported on Form 1099-R. In the past, pursuant to Announcement 85-168, these cash dividends were reported on Form 1099-DIV. The Form 1099-R applicable to this new reporting requirement will include a box 7, which will indicate the special tax treatment and rollover restrictions mentioned above. Additional distributions made in the same taxable year are required to be reported on a separate Form 1099-R.
Dividends paid directly to ESOP participants and beneficiaries will continue to be reported on Form 1099-DIV, and Announcement 85-168 is revoked.
Fringe Benefits & Payroll Tax: Tax-Effective Disaster Relief -- Direct Employer Payments to Employees
In the aftermath of the severe flooding that has recently devastated many areas of the Midwest (and other parts of the country) that have been declared by the President to be federal disaster areas, employers in or close to those areas are looking for ways to help employees who have suffered resulting losses and expenses. There is a tax-effective way to provide such help: by making direct payments to the employees.
Qualifying Payments are Excludible from the Employee’s Income
Code Section 139 allows individuals to exclude from gross income (as well as from payroll taxation if they are employees, and self-employment taxes if they are independent contractors), any "qualified disaster relief payment." As indicated in the legislative history, qualifying payments come from any source, to reimburse or pay reasonable and necessary personal, family, living, or funeral expenses. The payments also may be provided to reimburse or pay reasonable and necessary expenses for the individual’s repair or rehabilitation of a personal residence or for the repair or replacement of the residence’s contents, to the extent attributable to the qualified disaster.
In Rev. Rul. 2003-12, 2003-1 C.B. 283, the IRS confirmed that Code Section 139 allows employees to exclude from gross income (and for payroll tax purposes) qualifying payments received directly from their employers. Specifically, Situation 3 of the ruling concludes that grants for medical, temporary housing, and transportation expenses made to employees by an employer, following a flood in a flood area that is a "presidentially declared disaster area," are excludable under Section 139, provided the expenses are not compensated for by insurance or other sources. The employer in Situation 3 does not require employees to provide proof of actual expenses to receive a grant payment; however, according to the facts of the ruling (but with no explanation of any details), the employer’s program contains requirements in the program documents that ensure that the grant amounts are reasonably expected to be commensurate with the amount of unreimbursed reasonable and necessary medical, temporary housing, and transportation expenses the employees incur as a result of the flood. The grants approved in Situation 3 are available to all employees without regard to length or type of service and are not intended to provide relief for all flood-related losses or to reimburse the cost of nonessential, luxury, or decorative items and services. The ruling concludes that the employees may exclude these payments from gross income (and for payroll tax purposes) under Section 139.
Payments are Deductible by the Employer
The legislative history of Code Section 139 confirms that the employees’ ability to exclude qualifying disaster relief payments from gross income does not affect the employer’s entitlement to deduct the payments as a business expense. The long-standing position of the IRS is that an employer may deduct "amounts expended by way of rehabilitation of employees for injuries and damages sustained in a major disaster." Rev. Rul. 131, 1953-2 C.B. 112, modified by Rev. Rul. 2003-12, supra.
There are indeed other techniques that employers can use to provide disaster relief. But they are generally more complicated and time-consuming to put in place than the expedient of making qualifying direct payments to affected employees, and we will address those other techniques on another occasion.
Health & Welfare: Legislative Activity Affecting Employer Plans
The U.S. Congress is either considering or has recently passed a number of bills likely to affect employers. On May 22, President Bush signed the Genetic Information Nondiscrimination Act of 2008 ("GINA"). Title I of the Act prohibits health plans from restricting enrollment or setting premiums based on genetic information, or requiring or requesting genetic testing; and the Act adds civil penalties under ERISA for violations of the rules. Title II prohibits employers from using genetic information to discriminate in hiring or other employment opportunities; and remedies under the Civil Rights Act would apply to violations, including compensatory and punitive damages. The full scope and application of the Act are somewhat unclear; however many employers are concerned about how the rules will affect health plan administration and the ability to ask for information in connection with wellness programs. Hopefully Department of Labor regulations, which the Act requires to be issued, will provide helpful clarification, but the timeline for issuing guidance has yet to be determined.
An expanded mental health parity bill (H.R. 1424) may be signed into law later this year. The House and Senate are working to reconcile a few conflicting provisions and secure funding for the bill. The legislation would require full parity between all provisions relating to mental health and medical/ surgical benefits in an employer’s health plan (i.e., copays, coinsurance, day/ visit limits, deductibles, out-of-network coverage, and annual/lifetime limits on benefits would have to be no less generous for mental health benefits than for medical/ surgical benefits.) Current law only requires plans to have annual or lifetime limits on benefits that are no more restrictive for mental health benefits than they are for medical/ surgical benefits. If enacted, the bill would likely require almost all plan sponsors to revise the benefits they currently offer under their plans.
On June 25, the House of Representatives overwhelmingly approved H.R. 3195, the ADA Amendments Act of 2008. The bill would ease the definition of disability to those that "materially restrict" a major life activity and would allow for a wider scope of physical and mental disabilities to be covered under the ADA. In addition, the bill would require employers to review their disability plans to accommodate the greater number of possibly qualifying claims. The outlook in the Senate is still unclear. As a general matter, short and long-term disability plans and long-term care insurance are receiving increased focus by politicians. Members of Congress have also discussed and/or introduced proposals affecting COBRA, FMLA, ERISA preemption, and Medicare Advantage plans that coordinate with employer-sponsored retiree health plans.
ERISA Litigation: ERISA Claim Regarding Termination for Smoking
A United States District Court of the District of Massachusetts has ruled that a plaintiff who was terminated from employment because he was a smoker could proceed with a claim under Section 510 of ERISA against the employer. See Rodrigues v. Scotts Company, LLC, 2008 WL 251971 (D. Mass.). In an effort to "save money on medical insurance costs and to promote healthy lifestyles among its employees," The Scotts Company, Inc. ("Scotts") adopted a policy "prohibiting smoking of tobacco products by its employees at any time and at any place, whether or not in the workplace or during work hours." Shortly after Mr. Rodrigues was hired, Scotts required him to submit a urine sample to test for the presence of nicotine. Upon receiving a positive result, Scotts fired Rodrigues.
Rodrigues filed suit claiming that Scotts’ decision to fire him was (i) an invasion of privacy under Massachusetts state law, (ii) an act of wrongful termination, (iii) a violation his civil rights under Massachusetts state law, and (iv) unlawful discrimination under Section 510 of ERISA. In considering Scotts’ motion to dismiss the action, the Massachusetts district court granted the defendant’s motion to dismiss the plaintiff’s wrongful termination and civil rights violation claims. However, the court ruled that Rodrigues could proceed with his invasion of privacy and ERISA claims.
Section 510 of ERISA generally prohibits taking an employment action with the specific intent of interfering with one’s benefits under ERISA (e.g., eligibility to participate in an ERISA plan). Rodrigues’s claim under Section 510 of ERISA is that in terminating his short-lived employment because he was a smoker, Scotts interfered with the attainment of a right to which he would have become entitled -- namely, participation in the Scotts employee benefits plan -- if he had remained employed. Scotts moved for dismissal of the ERISA claim, arguing that (i) Section 510 of ERISA applies only to employment actions taken against existing employees and not to hiring decisions (Scotts claimed the decision to terminate Rodrigues was a hiring decision because his employment offer was conditional on being a non-smoker) and (ii) even if Rodrigues were considered an employee, excluding him from participation in the benefits plan because of his smoking behavior (rather than because he was making or expected to make a claim for benefits) does not violate ERISA. In noting that "Section 510 does not apply to those instances where the loss of benefits was a mere consequence of, but not a motivating factor behind, a termination of employment," the district court ruled that the resolution of the plaintiff’s ERISA claim may depend on what facts the plaintiff may ultimately prove and that the plaintiff could therefore proceed with the claim.
Employers considering a no-smoking policy for after-work hours will want to monitor this case as it progresses.
For further information, please contact any of the following lawyers:
Anthony Provenzano, firstname.lastname@example.org, 202-626-1463
Fred Oliphant, email@example.com, 202-626-5834
Lee Spence, firstname.lastname@example.org, 202-626-5965