Metlife v. Glenn, Foreign Deferred Comp Arrangements, Post-Death Stock Option Exercises, Pensions for Rehires, Retiree Health

Focus On Employee Benefits

ERISA Litigation: Supreme Court Ruling in MetLife v. Glenn

Tony Shelley & Susan Relland

Today the Supreme Court issued its decision in MetLife v.Glenn affirming the Sixth Circuit Court of Appeals' decision in favor of Glenn. The Court, in an opinion written by Justice Breyer, held that if an administrator or fiduciary having discretionary authority is operating under a conflict of interest, that conflict must be weighed as a factor in determining whether there has been an abuse of discretion. However, the Court rejected the idea that a conflict of interest should automatically change the standard of review from deferential to de novo.

MetLife was the administrator and insurer of a Sears, Roebuck & Company long-term disability plan governed by ERISA. The plan gave MetLife discretionary authority to decide when to award benefits and provided that MetLife, as insurer, would pay the claims. MetLife denied Glenn's disability claim based in large part on a statement from her physician that she was able to do sedentary work. Finding that MetLife had not appropriately considered additional information that had been available, the Sixth Circuit set aside MetLife's benefits denial. The court used a deferential standard of review, even though it concluded that there existed a conflict
of interest because MetLife both determined an employee's eligibility and paid for benefits.

The Supreme Court had earlier addressed the appropriate standard of judicial review under ERISA in Firestone Tire & Rubber Co. v. Bruch, 489 U.S. 101 (1989), holding that a deferential standard of review is appropriate where the plan grants the administrator or fiduciary discretionary authority to determine eligibility. The opinion also observed that, if the administrator or fiduciary is operating under a conflict of interest, the conflict must be weighed as a factor in determining whether there is an abuse of discretion. In the Supreme Court's opinion in MetLife v. Glenn, the Court stated that a plan administrator's dual role of both evaluating and paying benefits claims creates the kind of conflict of interest referred to in Firestone. The Court explained that such a conclusion is clear where it is the employer itself that both funds the plan and evaluates the claim, but a conflict also exists where the plan administrator is an insurance company.

The Court declined to overturn Firestone, but also rejected the claimant's argument that the existence of a conflict of interest necessitated de novo review. The Court stated that it is not necessary or desirable for courts to create special burden-of-proof rules, or other special procedural or evidentiary rules, just because of an evaluator/payor conflict. Rather, the Court held that a conflict of interest is a factor to be weighed with the other case-specific factors. The Court determined that the Sixth Circuit followed such a standard by giving the conflict of interest some weight but also focusing on other factors and, therefore, upheld the decision in favor of Glenn.

Justices Scalia and Thomas, in a dissenting opinion, agreed that MetLife had a conflict of interest in the case at hand but found fault with the Court's conclusion that an employer who administers its own ERISA-governed plan clearly has a conflict of interest. In criticizing the Court's adoption of a "totality-of-the-circumstances" test in which "the existence of a conflict of interest is to be put into the mix and given some (unspecified) ‘weight,'" the dissent stated that such a standard would result in the outcome of each case being "unpredictable -- not a reasonable position in which to place the administrator that has been explicitly given discretion by the creator of the plan, despite the existence of a conflict."

Despite the ruling in favor of the claimant, the Supreme Court's decision contains good news for plan administrators as well. The Court remarked that administrators can minimize any loss of deference ("perhaps to the vanishing point") by establishing structures designed to separate plan decisionmakers from those concerned with finances and by imposing management checks that penalize inaccurate decisionmaking irrespective of whom the inaccuracy benefits. Thus, for employers and insurers going forward, the most important aspect of its decision is the guidance for setting up internal safeguards for accurate decisionmaking free from actual conflicts, which should preserve the right to a robustly deferential review. [Note: Miller & Chevalier drafted an amicus brief on behalf of Blue Cross Blue Shield Association that the Court cited in the majority opinion on page 11.]


Exec Comp: Proposed Legislation Would Tax Foreign Deferred Compensation Arrangements

Fred Oliphant & Adrian Morchower

Congress is considering proposed legislation that would impose new taxes on workers covered by deferred compensation arrangements of "nonqualified entities." While the scope of the legislation has been described as targeting deferred compensation arrangements of hedge funds operating in tax havens, the proposed tax rules in their current form could potentially reach (i) deferred compensation arrangements of a foreign affiliate of multinationals if the affiliate operates in a country that does not have a tax treaty with the U.S. or that does not, in the judgment of the U.S. Treasury, have a "comprehensive income tax" system (referred to herein as a "nonqualifying country") or (ii) deferred compensation arrangements of a partnerships if a significant portion of its income is allocated to tax-exempt partners or to foreign persons in a nonqualifying country.

H.R. 6049, the Renewable Energy and Job Creation Act of 2008, was passed by the House of Representatives on May 21, 2008, and sent to the Senate for its consideration. Section 401 of H.R. 6049 adds new Section 457A to the Code, relating to deferred compensation from certain tax indifferent parties. Under the provision, compensation deferred under a nonqualified deferred compensation plan of a "nonqualified entity" generally would be includible currently in gross income when there is, for purposes of this provision, no substantial risk of forfeiture of the rights to such compensation regardless of whether such compensation otherwise meets the requirements of Section 409A (or any other provision of the Code or general tax law principle).

Although the proposed deferred compensation legislation is opposed by the Administration, the amount of revenue it raises makes it an attractive provision for Congress. The Chairman of the Senate Finance Committee has introduced his own "tax extender" bill, S. 3125, the Energy Independence and Tax Relief Act of 2008, that includes the provision. Given the revenue requirements imposed by the "pay-go" rules, there is a high probability that the provision would be included in the legislation that is passed by the Senate. The estimated amount of revenue to be raised by the provision for fiscal years 2008-2018 exceeds $24 billion. Assuming the provision is ultimately included in the extenders package sent to the President, it is unclear whether the President would sign the bill given the Administration's public opposition to the provision.


Payroll Tax & Fringe Benefits: Income, Reporting and Employment Tax Rules for Post-Death Exercises of Nonqualified Stock Options

Lee Spence

The tax rules applicable to the exercise by a deceased employee's personal representative or beneficiary of nonqualified stock options (not subject to a Section 83(b) election) held by the employee at time of death in unexercised form are not simple, though they do have a certain Byzantine logic. Here are the basic income, reporting and employment tax rules (for purposes of illustration it will be assumed that the beneficiary exercises the options but the same basic rules apply if the option is also exercised by the deceased employee's personal representative):

Income Tax Treatment

The employee's tax year ends upon his or her death, and the subsequent option exercise by the beneficiary is not income to the employee, regardless of whether the beneficiary's exercise occurs in the calendar year of the employee's death or in a later calendar year. Instead, the income -- the amount of which is determined under the rules of Section 83 -- is Section 691 "income in respect of a decedent" ("IRD") to the beneficiary. Although the value of the option at death is includible in the employee's estate for estate tax purposes, it does not acquire a fair market value basis at the date of death. To relieve this "double tax," the beneficiary is allowed to deduct against the IRD a proportionate part of the estate tax and generation skipping transfer tax attributable to the inclusion of the value of the option in the employee's taxable estate.

Income Reporting

The employer must report the beneficiary's income on Form 1099-MISC, whether the option was exercised by the beneficiary during or after the year of the employee's death. Income tax withholding does not apply to the beneficiary. The gross amount of the payment is reported in Box 3 (Miscellaneous Income), not in Box 7 (Nonemployee Compensation), and the name, address, and social security number of the beneficiary are entered on the form. This reporting applies regardless of whether the employer is required to withhold and report amounts for Social Security ("OASDI") and Medicare taxes, as discussed below.

FICA and FUTA Taxes

If the option is exercised after the calendar year in which the employee dies, the payment is not subject to FICA (Social Security and Medicare) or FUTA taxes with respect to the deceased employee.

If the option is exercised during the calendar year of the employee's death, whether FICA and FUTA taxes apply with respect to the employee depends upon the terms of the option plan and, of course, for the social security portion of FICA taxes and for FUTA taxes, whether the employee had reached the respective annual wage bases for that year prior to death.

  • If the employee could have exercised the option during his or her lifetime, the FICA/FUTA exceptions for payments made to a dependent of the employee "because of" death of the employee "and that would not have been paid if the employee's employment relationship had not been so terminated" do not apply. Therefore, the option gain is potentially subject to FICA and FUTA taxes. If the respective annual wage bases have not been reached for the year during the employee's lifetime, FICA taxes must be withheld by the employer from the beneficiary in some manner upon payment pursuant to the option exercise and FUTA taxes must be paid by the employer. The Medicare portion of the FICA tax will have to be withheld in any case since there is no wage base limitation for Medicare withholding.
  • However, if the employee's death triggers the beneficiary's right to exercise the option, FICA tax withholding is not required and FUTA taxes are not applicable.

W-2 Reporting

If FICA taxes have to be withheld as described above, the employer also has an obligation to report this on the employee's final Form W-2 using the employee's name, but only for the purpose of ensuring that proper Social Security and Medicare credits are received. The employer should report the option exercise income as social security wages (Box 3) and Medicare wages (Box 5) and the social security and Medicare taxes withheld (Boxes 4 and 6, respectively). But since the payment is not FIT wages of the employee, the amount is not entered in Box 1.


Qualified Plans: Offsetting Pensions of Rehired Employees

Gary Quintiere

Most pension plans that credit prior service in the calculation of a benefit for rehired employees also provide for an offset for any prior benefits payments made to such employees. Such a practice may be illustrated as follows: Assume, Smith retires from ABC at age 55 after 20 years of service and receives his full accrued benefit from the ABC Pension Plan in the form of a $100,000 lump sum payment. Two years later, Smith returns to ABC and remains for another eight years. Upon his second retirement, the ABC Pension Plan calculates his pension benefit based on 28 years of credited service, but offsets his prior $100,000 lump sum.

This is a common practice, but one that many sponsors get wrong by failing to provide for the offset, or to describe fully its application, in the plan, the SPD and the participant benefit statements. As Xerox Corporation found out, such failures could lead to major litigation headaches.

Xerox confronted class actions in several jurisdictions as a result of its plan's use of a so-called "phantom account" in calculating the offset. Layou v. Xerox Corp., 238 F.3d 205 (2d Cir. 2001); Berger v. Xerox Corp. Retirement Income Guarantee Plan, 338 F.3d 755 (7th Cir. 2003); Miller v. Xerox Corp. Retirement Income Guarantee Plan, 464 F.3d 871 (9th Cir. 2006) (cert. denied, 127 S. Ct. 1829 (2007)); Frommert v. Conkright, 328 F. Supp.2d 420 (W.D.N.Y. 2007). Although the courts generally agreed that Xerox was entitled to impose an offset, they nevertheless penalized Xerox for failing to fully describe its application. The 9th Circuit in Miller went even further, ruling that the Xerox's offset was not based on an actuarial equivalence of the prior payment and therefore violated ERISA's anticutback rule. 464 F.3d at 875.

Based upon Xerox's experience, we urge plan sponsors to review their offset arrangements to assure that they are properly set forth in all relevant documents, i.e., the plans, the SPDs and the participant benefit statements. Failure to do so may result in a loss for the plan and an unintended "windfall" benefit to the participants.


Health & Welfare: Vested Retiree Health Benefits

Susan Relland & Veronica Rouse

In March, the Sixth Circuit Court of Appeals ruled in Noe v. PolyOne Corp., No. 07-5068 (6th Cir. 2008) that an intent to vest retiree health benefits was evidenced by collective bargaining agreements that linked health benefit eligibility with pension benefit eligibility, and general durational clauses typically used in employee benefit agreements ("EBAs") were not sufficient to combat that interpretation. The plaintiffs were retirees from B.F. Goodrich Co., which later became PolyOne Corp. B.F. Goodrich negotiated a series of EBAs with unions regarding retiree health benefits. Subsequently, the company revised the cost sharing for retirees. Plaintiffs claimed B.F. Goodrich violated Section 301 of the Labor Management Relations Act. The Western District Court of Kentucky found in favor of B.F. Goodrich determining that the company did not intend for the benefit to extend indefinitely to the plaintiffs because they were only introduced to the benefit through an agreement that held a general durational clause.

The Sixth Circuit disagreed and held that, despite the general durational clause, the language in the agreement never specified the vesting rules of the health benefit as expiring upon termination of the agreement. The court also held that general durational clauses in the EBAs did not indicate anything about the vesting of the health benefit because the clause never specifically referred to the health benefit. However, the EBAs did promise that once a retiree reached age 65, that retiree would receive a special Medicare benefit until and upon death and the retiree's surviving spouse would continue to receive the benefit until death or remarriage. This led the court to find an intent to vest the retiree health benefit. However, the EBAs did promise that once a retiree reached age 65, that retiree would receive a special Medicare benefit until and upon death and the retiree's surviving spouse would continue to receive the benefit until death or remarriage. This led the court to find an intent to vest the retiree health benefit.

This is a significant case because, as noted by Judge Sutton in a separate opinion concurring and dissenting in part, "Unless a company can point to explicit language in the relevant agreement that ‘retiree benefits' terminate at a particular date or do not vest, the benefits seem to vest as a matter of law." In light of this ruling, employers should review their collectively bargained agreements and potentially other agreements affecting employee benefit plans, such as in the merger and acquisition context. Best practice is to specifically include language indicating which benefits are and are not vested.

For further information, please contact any of the following lawyers:

Anthony Shelley,, 202-626-5924

Fred Oliphant,, 202-626-5834

Lee Spence,, 202-626-5965

Gary Quintiere,, 202-626-1491

Adrian Morchower

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