Focus On Employee Benefits
Exec Comp: IRS Issues Additional Guidance on Code Section 162(m)
Anthony Provenzano and Fred Oliphant
The IRS has issued Revenue Ruling 2008-13 which states that otherwise performance-based compensation is not deductible under Code Section 162(m) if the compensation is payable following a termination without cause or by the executive for "good reason." The new guidance confirms a change in the position of the IRS and may cause employers to closely review their executive arrangements.
Code Section 162(m) limits the deduction for compensation over $1,000,000 paid to a "covered employee" (the CEO plus the top 3 paid) in a year unless such compensation qualifies as "performance-based." To qualify as such, the compensation can only be paid upon the achievement of the applicable performance goals, but the regulations provide that such amounts will not fail to qualify as performance-based if such amounts are also payable upon death, disability, or change in control (although any such amount actually paid on such event will generally not be considered performance-based compensation).
Revenue Ruling 2008-13, reaffirming the holding in recently issued Private Letter Ruling 200804004, concerned arrangements whereby the executive was promised payment of an amount that was otherwise intended to qualify as performance-based, in the event of involuntary termination without cause, termination for good reason, or retirement. The IRS stated that the amounts would not qualify as performance-based compensation, even in years when the performance targets were met, since such amounts were potentially payable outside of the attainment of the performance targets (and outside of death, disability, or change in control). The Revenue Ruling (and PLR 200804004) essentially overturn prior private letter rulings that took a contrary position.
By its terms, Revenue Ruling 2008-13 will not be applied to disallow deductions for this particular issue if the performance period for such compensation begins on or before January 1, 2009 or if the compensation is paid pursuant to an employment contract in effect as of February 21, 2008 (without regard to future extensions or renewals, including automatic (evergreen) renewals).
The Revenue Ruling nonetheless leaves open a host of issues. For example, it does not address "double-trigger" provisions requiring both a change in control and a termination of employment. Also, it leaves open the treatment of situations in which the arrangement promises (upon involuntary termination) payment of an amount that is calculated by reference to a multiple of the executive's target bonus for the current year, or to a multiple of a prior year's bonus or average bonuses. These issues remain unclear under the current guidance.
Payroll Tax & Fringe Benefits: Newly Introduced Legislation Addresses Taxation of Cell Phones and BlackBerry Smartphones
Michael Lloyd and Patricia Szoeke
Legislation (H.R. 5450) was recently introduced in the U.S. Congress to update the tax treatment of cell phones and other mobile communication devices (such as BlackBerry smartphones) that are commonly used in today's businesses and to reduce the amount of paperwork required for companies to claim a deduction for costs associated with the business use of these devices.
Under current law, cell phones and other communication devices are among a handful of items that, due to their easy susceptibility for personal use, are classified as "listed property" under Code Section 280F(d)(4). Such classification means that where an employer provides an employee with cell phone service, strict business use substantiation requirements must be met if income imputation to the employee is to be minimized. In order to substantiate the business use of listed property, the following elements must be proved: (1) the amount of each expense, (2) the amount of each business use, (3) the time of the use, and (4) the business purpose of the use. This requires the collection and storage of an extensive amount of documentation (e.g., monthly cell phone invoices for each device with each call identified as either business or personal, etc.). Thus, the employer must require the employee to keep records that distinguish business from personal use and satisfy these four requirements. Employers who deduct expenses associated with these devices without maintaining the required documentation to support such deduction face increased taxes and penalties upon audit, which can be substantial. The newly introduced legislation would remove cell phones and other communication devices from the category of "listed property" under Code Section 280F(d)(4). As a result, the strict substantiation requirements applicable to "listed property" would no longer apply as business cell phones would be treated similar to a desk phone.
Health & Welfare: Tax-Free Long-Term Disability Benefits
Susan Relland and Patricia Szoeke
Many employers offer long-term disability benefits to their employees with premiums paid on a pre-tax basis. Typically either the employer pays the premiums, which are tax free to the employee under Code Section 106, or the employee pays the premium on a pre-tax basis via salary reduction through a cafeteria plan under Code Section 125 and the pre-tax premium is also tax-free to the employee under the same Section. Under these arrangements, though, the disability benefits received by the employees are taxable at the time of receipt. Generally, however, employees receive these benefits after they have incurred a disability, are no longer receiving their full income from the employer, and may be incurring additional medical expenses. At such a time, individuals are likely to need all available income.
Instead of paying the long-term disability premiums with pre-tax dollars and having the benefits be taxable upon receipt, employers can offer their employees the opportunity to pay premiums with after-tax dollars and receive the disability benefits on a tax-free basis. Many employees may prefer this arrangement because it enables them to pay taxes at a time when they may have more available income. Alternatively, the employer may continue paying the disability premiums on the employees' behalf but impute the value for employees to include in income, thus making the character of the contributions after-tax. In addition, employers can provide their employees with a choice between pre-tax or after-tax payment of disability premiums. A common plan design today is to offer employees a choice of employer-paid tax-free premiums or employee-paid after-tax premiums. (See Rev. Rul. 2004-55 where the IRS considered such a choice.)
An employer who wishes to provide its employees with the opportunity to make after-tax contributions and receive their disability benefits on a tax-free basis needs to prospectively amend its cafeteria plan to permit payment of the premiums on an after-tax basis and communicate this option to employees. Note that under the proposed cafeteria plan regulations that were published in August 2007, the plan document must be amended before the change may take effect or plan participants may make elections.
Qualified Plans: Adopting Automatic Enrollment Mid-Year
Fred Oliphant and Elizabeth Drake
PPA provided a number of provisions to enhance automatic enrollment, including the alternative design-based safe harbor for CODA in Sections 401(k)(13) and 401(m)(12), which is called a qualified automatic contribution arrangement (QACA), and also special relief from Section 401(k) distribution restrictions in Section 414(w), which is referred to as an eligible automatic contribution arrangement (EACA). In order to take advantage of these provisions, eligible employees must receive a notice within a reasonable period before each year, pursuant to Sections 401(k)(13)(E) and 414(w)(4).
IRS guidance on QACAs and EACAs was issued late in 2007 in the form of proposed regulations. As a result, a number of companies that were interested in implementing automatic enrollment were not able to give the required notices prior to the start of the January 1, 2008 plan year. While some comments have been filed with the IRS requesting relief from the advance notice requirements, it remains unclear whether the IRS will respond favorably. In the meantime, companies that are interested in implementing automatic enrollment in 2008 may want to consider going forward with a more limited form of automatic enrollment (i.e., without taking advantage of the new safe harbor in Sections 401(k)(13) and 401(m)(12) or of the distribution relief under Section 414(w)). In this connection, the PPA provisions did not repeal the prior guidance on automatic enrollment, which may be looked to in these circumstances.
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
Michael Lloyd, firstname.lastname@example.org, 202-626-1589
Elizabeth Drake, email@example.com, 202-626-5838