2009 Forecast Alert
Focus On Employee Benefits
Benefits professionals can expect to be busy in 2009, and it will be important for them to keep their eye on the ball with so many developments taking place. To aid our clients and friends in this process, we have summarized below some of the developments we are expecting to require attention in 2009. These are broken down by four areas retirement plans, health and welfare plans, executive compensation, and payroll tax and fringe benefits.
Gary Quintiere, Elizabeth Drake, Mindy Leeds, Garrett Fenton
Don’t think that passage of the Pension Protection Act in 2006 marked the beginning of a hiatus in pension regulations. Sponsors and administrators of tax-qualified retirement plans should expect having to contend with continued compliance requirements and legislative/regulatory initiatives that may well be both very broad and technical at the same time. Greater compliance complexity inevitably leads to plan design and operational errors which, in turn, create circumstances that are ripe for litigation.
Plan Amendment Requirements
In 2009, plan sponsors will need to amend their plans to reflect the final regulations under Internal Revenue Code section 415 and to comply with the Pension Protection Act of 2006 (“PPA”). The 415 amendments generally need to be made by the due date of the sponsor’s 2008 tax return, while PPA amendments are generally required by the end of 2009. Among the required PPA amendments are those dealing with interest rate assumptions and mortality tables, accelerated vesting for defined contribution and cash balance/hybrid plans, and qualified optional survivor annuities. Because plans were required to comply with many of these changes in 2008, sponsors will need to ensure that the amendments accurately reflect the plan’s past administration.
Plan Design Decisions
The Worker, Retiree, and Employer Recovery Act of 2008 (“WRERA”), signed into law on December 23, 2008, contains a number of provisions in addition to PPA technical corrections affecting both defined benefit and defined contribution plans. For example, due to the recent downturn in the financial markets, WRERA allows defined contribution plans to suspend required minimum distributions for 2009. Plan sponsors will need to quickly decide if they want to suspend these distributions and if so, update their communications to participants and beneficiaries.
Plan sponsors should also be alert to design decisions that will likely be required in 2009 as the IRS finalizes its regulations regarding automatic enrollments in 401(k) plans and issues guidance relating to the Heroes Earnings Assistance and Relief Tax Act of 2008.
Form 5500 Fee Disclosures
This year, new disclosure requirements on the Form 5500, Schedule C, will become effective. Beginning with the 2009 Form 5500 (filed in 2010), all direct and indirect compensation paid to service providers, as well as compensation paid to service providers by certain third-parties, must be reported. There is no limit on the number of service providers for whom reporting is required, although an exception exists for providers who receive less than $5,000. The definition of service provider and the types of indirect compensation that must be reported is broad, and the onus is on plan administrators to obtain this information and include it on Schedule C. Therefore, plan administrators who have not already done so will need to work with their service providers and ensure that this information will be provided in sufficient time to file the 2009 Form 5500.
Legislation and Regulations
Defined Benefit Plan Funding
WRERA has been billed, in large part, as providing relief from what would otherwise be unanticipated and prohibitive funding requirements for defined benefit plans. While welcome, the consensus is that further relief is necessary to avoid the funding nightmare that has been exacerbated by the economic downturn and restricted cash flow many businesses are now facing. We expect to see large-scale efforts, some of which are already underway, to persuade Congress to enact further pension funding relief as it considers broader economic stimulus proposals.
On the IRS’s agenda for defined benefit plans are final regulations under Code section 430, regarding PPA funding requirements, as well as the funding-based restrictions on benefits and benefit accruals under Code section 436. We also expect the IRS to continue to devote attention to the benefit accrual rules as they apply to hybrid plans and so-called “greater of” benefit formulas.
Defined Contribution Plans and Retirement Security
As the baby-boomer generation reaches retirement, retirement security is likely to be a front-burner item for the 111th Congress. Potential legislative changes may include, for example, income guarantees, annuitization options, and other features intended to strengthen the retirement benefits of defined contribution/401(k) plans while allowing them to maintain characteristics that distinguish them from defined benefit plans.
The IRS will also devote considerable attention to defined contribution plans in 2009, according to officials with the Office of Employee Plans. As noted, regulations on automatic enrollment 401(k) plans, as well as diversification rules for employer stock plans, are likely to be finalized in the coming year. The IRS is also expected to issue further guidance, including an updated “Special Tax Notice,” in response to the many changes relating to direct rollovers and distribution notices and elections.
Fee Disclosure Initiatives
Service providers and plan sponsors had been anticipating DOL final regulations requiring certain disclosures from service providers to plan fiduciaries. These regulations have now been delayed due to concerns from OMB regarding the cost of implementing the rules. It is unclear whether DOL will seek to have the OMB under President Obama’s administration approve the regulations or whether they will be withdrawn completely. If they are withdrawn, legislation seems highly likely as Congress is also concerned about ensuring that service providers are providing adequate information regarding direct and indirect fees, services, and conflicts of interest.
Given the recent turmoil in the financial markets, we anticipate a new wave of litigation alleging breaches of fiduciary duty and testing the limits of ERISA section 404(c) protections for participant-directed plans. This will involve not only investments in company stock, but also challenges to investing in financially distressed companies. Plaintiffs’ lawyers have already targeted giants such as Lehman Brothers, Bear Stearns, AIG and Wachovia. Thus, it is critical that plan sponsors and fiduciaries review their ERISA section 404(c) compliance, if applicable, and establish and follow a formal plan governance program in order to protect themselves against any future challenges.
Health and welfare plan sponsors and service providers are likely to have a busy year. Specifically there are already a number of plan changes that sponsors will need to make before 2010, there are several significant regulations expected to be issued in 2009, and comprehensive health reform is likely to be a topic of serious discussion and debate on Capitol Hill for the first time in 15 years.
Mental Health Parity Act
Almost all health plan benefits will need to be revised to comply with the greatly expanded Mental Health Parity Act requirements that were passed as part of the Emergency Economic Stabilization Act of 2008. The changes are effective for plan years beginning after October 3, 2009 (with special effective date rules for collectively bargained plans). While some employers have reported that their plans are already in compliance, this is unlikely to be true for the majority of health plans. As a general rule, mental health benefits, and now substance use disorder benefits, must be offered under the same terms as apply to medical or surgical benefits (e.g., the same co-payments, coinsurance, deductibles, out-of-pocket maximums, in and out-of-network benefits, etc.). In addition, plans may not have any separate cost-sharing or treatment limitations (which are common today) that apply only to mental health or substance use disorder benefits. Plan sponsors should review their benefit plans this spring to determine what plan design changes will need to be made and then amend plan documents and participant materials by the end of this year.
“Michelle’s Law” is effective for plan years beginning after October 9, 2009. The law amended ERISA to require a health plan that covers college students to maintain coverage for up to 12 months for any student who takes a medical leave of absence. A typical health plan may cover dependent children up to age 18 or full-time students up to age 23. If a 22 year old dependent who was a full-time college student takes a medical leave of absence, the plan will now have to continue coverage for 12 months. Plan documents, participant materials, and any documents regarding a requirement to certify student status will need to be amended.
Medicare Secondary Payer Mandatory Reporting
The Medicare, Medicaid, and SCHIP Extension Act, enacted in December 2007, established mandatory reporting requirements for group health plan arrangements that took effect January 1, 2009. The new reporting is designed to provide additional information to the Centers for Medicare and Medicaid Services (“CMS”) because the agency often lacks current or complete records for Medicare Secondary Payer enforcement (despite improvements from Voluntary Data Sharing Agreements). Insurers, third-party administrators, and administrators or fiduciaries of self-funded and self-administered group health plans must make quarterly submissions. While most of the reporting will fall to the service providers, plan sponsors may need to collect and/or provide additional information that is required to be submitted, such as participant social security numbers if plans currently provide random identifiers instead of social security numbers.
Americans with Disabilities Act Amendments
The Americans with Disabilities Act (“ADA”) Amendments Act was signed into law in September 2008 and took effect January 1, 2009. The law redefines the standards that “materially restrict” a major life activity and allows for a greater number of physical and mental impairments to be covered under the ADA. Many are questioning the extent to which the amendments will affect employer-sponsored disability plans. Neither the ADA nor ERISA requires an employer to provide disability benefits. However, the broad language of the ADA does prohibit “disability-based” discrimination in employee benefits. A distinction based on disability is prohibited, but a distinction that applies equally to all employees is not. One issue created by the new ADA legislation is whether an employer that provides long-term disability benefits has discriminated against an employee if it does not provide benefits, and therefore denies a claim, for a condition that now qualifies as a disability under the ADA. The Equal Employment Opportunity Commission has the authority to issue regulations, but is not required to do so by the Act. Employers may want to review, and possibly amend, their disability plans in light of these amendments.
Form 5500 Disclosures
Finally, as noted above in Qualified Plan Queries, beginning with the 2009 Form 5500, plan sponsors will be required to report all direct and indirect compensation paid to service providers, as well as compensation paid to service providers by certain third-parties.
Cafeteria Plan Regulation
The cafeteria plan regulations that were proposed in August 2007 are expected to be finalized in 2009 with compliance required for plan years beginning on or after January 1, 2010. However, on January 20, President Obama’s Chief of Staff issued a memo to all federal agencies delaying or stopping Bush-era regulatory projects to give the new administration time to review them. At this time it is unclear exactly what effect this review will have on either the substance or timing of anticipated regulations
Once the regulations are issued, we anticipate that almost all plan sponsors will likely need to amend their cafeteria plan documents. Other plan design or administrative changes may also be necessary. Finally, the nondiscrimination rules are expected to include much more information than was in the proposed regulations. These regulations are expected to be significant regulations both in terms of volume and impact
Genetic Information Nondiscrimination Act
The Genetic Information Nondiscrimination Act (“GINA”) was enacted in May 2008. Title I prohibits employer-sponsored group health plans from restricting enrollment or adjusting premiums based on genetic information, or requiring or requesting genetic testing. Title II prohibits employers from using genetic information to discriminate in employment activities (and also includes provisions specific to certain wellness policies that are not considered group health plans). GINA provisions are effective for group health plan years beginning after May 21, 2009. Final regulations implementing Title I are required to be issued by May 21, 2009. In November 2008, a formal request for information was issued in advance of future regulations, but no proposed regulations have been published to date. Therefore, it will be difficult to have regulations finalized by May, but plan sponsors should expect to see GINA regulatory activity this year and may also need to amend their plans.
Fee Disclosure Initiatives
The service provider to plan fiduciary regulations discussed in Qualified Plan Queries would also apply to health and welfare plan service providers.
Legislation and Litigation
Health Reform Debate
Health reform is a top priority for President Obama and key members of Congress. Generally speaking, there is already consensus on the need for reform and that the goals are to improve health care cost, quality, and coverage. The open questions are exactly how to achieve these goals and when these goals can be accomplished. It is very likely that Congress will seriously consider, and perhaps enact, legislation addressing health information technology, better quality transparency, comparative effectiveness research, focus on prevention, disease management programs, paying providers based on value not volume, and premium assistance for low-income individuals to purchase coverage. The more controversial items that are still open for debate include whether all individuals should be required to have health coverage, whether to require employers to “play or pay,” how to create a new source of coverage for the uninsured, what tax changes should be made (especially for employer-provided health care), whether states should be allowed to regulate employer-sponsored (ERISA) benefit plans, and how to pay for reform.
The process for enacting reform is unclear. An open question is whether there will be one comprehensive package or several smaller bills. The timing is also uncertain, particularly given the recent emphasis on stimulating the economy. Finally, it is unclear whether President Obama will drive the process or focus his attention (and political capital) elsewhere. While there are many open questions, the combination of the need for reform, Democratic control of the White House and Congress, and the commitment to passing legislation, make health care reform much more likely this time around than it was under President Clinton’s administration.
A final area for health and welfare plan sponsors to watch is what is happening with state mandates. During 2009 the Ninth Circuit Court of Appeals is expected to decide whether to rehear en banc the decision in Golden Gate Restaurant Ass’n v. City & County of San Francisco, No. 07- 17370, 2007 U.S. App. LEXIS 20574 (Sept. 30, 2008). On September 30, 2008, a three-judge panel of the Ninth Circuit held that the San Francisco Health Care Ordinance (the “Ordinance”) is not preempted by ERISA because the Ordinance does not create ERISA plans and does not “relate to” an ERISA plan. If the Ninth Circuit denies the request for an en banc rehearing, or the decision is upheld upon rehearing, the case could go to the U.S. Supreme Court. This case has important implications for all ERISA plans. As almost half the states are currently considering some kind of health care reform, this is a major development indicating that, at least in the Ninth Circuit, ERISA plans will have to comply with health expenditure mandates that state and local governments adopt. With the current focus on health reform by President Obama and the 111th Congress, it is likely that most states will defer their action for now and wait to determine what action, if any, the federal government takes. However, plan sponsors should continue closely monitoring the progress of this case and any activity by state or local governments to impose health care mandates on employers.
2009 could be the year that the complicated anti-executive tax rules of the last few years collapse from their own weight, and the administrative and legislative branches of our government come to realize that such provisions are futile and will not succeed in reducing the compensation paid to executives. Our forecast, however, is that this will not happen in 2009, but, instead, that the government will continue to target executive compensation in 2009 by issuing ever more complex rules in an attempt to shut down perceived executive compensation abuses. Thus, not only will taxpayers be required to continue to expend significant resources digesting and applying to their facts the myriad tax rules that already exist in the executive compensation area, but it is very possible that both the administrative and the legislative branches of government will layer on new rules during 2009
In 2009, our expectation is that the basic cycle of corporate activity in the 162(m) area will continue as usual. The compensation committee will meet early in the year to set performance goals for executive compensation intended to meet the performance-based compensation exception from section 162(m). These compensation committee meetings will be followed shortly by annual shareholder meetings at which many companies will seek shareholder approval of the material terms of their performance plans (both bonus and equity compensation plans), which generally is required every five years under Code section 162(m). For those companies who have not yet amended their bonus plans and employment agreements to comply with Rev. Rul. 2008-13, regarding the definition of performance-based compensation, bonuses for performance periods beginning on January 1, 2009 are the last bonuses that are grandfathered from the new requirements in Rev. Rul. 2008-13 (unless there is a written binding contract in place as of February 21, 2008). Thus, where this has not yet been done, consideration will need to be given to amending bonus arrangements to comply with Rev. Rul. 2008-13 for bonuses with performance periods beginning after January 1, 2009.
Additionally, although the critical section 409A plan drafting was required to be completed last year, for some taxpayers, there could be continuing “clean-up” work to do under Code section 409A. For example, those companies who have not already amended their equity plans for section 409A (as opposed to the grant documents) to add section 409A compliant definitions may choose to do so this year, so that future equity grants that are subject to section 409A can be made more streamlined and easier to read through the use of defined terms from the plan document. Similarly, companies that are planning to continue allowing employees to make deferral elections using the six-month rule for performance-based compensation will need to take a careful look at their bonus plans to be sure they do not pay target awards in the case of disability and change in control without defining those terms in a section 409A compliant manner. (See M&C Focus on Employee Benefits newsletter dated September 18, 2008 for further discussion of this issue.) Other “clean-up” work may be necessary to clarify or perfect documents that on their face may raise section 409A compliance questions.
Finally, with regard to the operation of section 409A arrangements, we expect for taxpayers to spend a considerable amount of time in 2009 determining the outer reaches of Reg. § 1.409A-3(g) (“the disputed payments and refusal to pay regulation”), which treats both intentional and unintentional late payments of deferred compensation as having been timely paid for section 409A purposes under certain circumstances. Additional time will need to be spent reconciling conclusions about the reach of the disputed payments and refusal to pay regulation with the failures the IRS treats as failures requiring correction under Notice 2008-113, the revised IRS correction program. We also expect for taxpayers to spend considerable time deciphering the recently proposed income inclusion and penalty calculation regulations. Of particular interest is the idea recently informally communicated by IRS and Treasury attorneys that, under the proposed regulations, as long as an individual does not vest in an amount under a plan (defined using the plan aggregation rules) by the end of 2009, a flaw in the plan document can still be corrected in 2009.
Finally, also on the operational side, we expect that companies will continue to struggle with the issues under Code sections 83, 409A, and 3121(v)(2) raised by allowing bonuses and other awards to “continue to vest” when an employee retires. (See M&C Focus on Employee Benefits newsletter dated January 9, 2008, for further discussion of this issue.) We also anticipate that a number of companies will have to confront the question of whether both their section 162(m) and workforce wide bonus programs represent a liability that can be accrued at the end of the performance period under the all events test and, if not, whether they should they amend the programs or, if necessary, file an accounting method change, which is now eligible for automatic consent under Rev. Proc. 2008- 52. (See Tax Accounting and Employee Benefits Alert dated September 4, 2008.)
On the administrative guidance front, companies (and their advisors), which are already staggering under the weight of the present regulatory regime in the Code section 409A and section 457A area, will likely have more of the same piled on them in 2009. Even if well intentioned, the addition of new rules designed to aid in compliance can have the opposite effect for example, when companies have to sort out which definition of deferred compensation, short-term deferral, substantial risk of forfeiture, and performance-based compensation, under Code sections 83, 162(m), 409A, 457(f), 457A, and 3121(v)(2) applies in their situation. One issue that has come to the forefront as a result of Code section 409A is the tax treatment of executive retiree health benefits. Taxpayers can expect to see guidance on discriminatory self-insured health benefits under Code section 105(h), if not in 2009, then shortly after 2009. In addition, it would not be surprising if the new Administration were to make recommendations regarding additional limits, rules, and penalties on executive compensation. The President has spoken negatively about “golden parachutes” during his campaign and, in The Audacity of Hope (at p. 62), indicated that that soaring executive compensation levels should draw the same level of moral outrage as dirty rap lyrics. It is possible that this moral outrage will be expressed in 2009 by including anti-executive compensation proposals in the Administration’s budget recommendations and elsewhere.
We also expect that Congress will dust off any number of its previous proposals regarding executive compensation. The primary candidate for enactment in 2009, however, would be an expansion of the definition of “covered employee” for section 162(m) purposes. Other possibilities, although perhaps less likely, may include more drastic changes to section 162(m), such as the removal of the exception for performance-based compensation. Additionally, we could see in 2009 a return of the proposal for a $1 million annual cap on deferred compensation or some of the other changes to section 162(m) and 280G (such as application of section 162(m) to private companies), that were included in the Emergency Economic Stabilization Act of 2008 and applied to taxpayers in the Troubled Asset Relief Program.
Tom Cryan and Michael Lloyd
Entertainment Use of Corporate Aircraft
Corporate aircraft continue to be in the forefront of the news. Not only are they a lightening rod for critics of executive compensation, they are also in the crosshairs of the regulators. On October 25, 2007, the IRS held a public hearing to discuss the proposed regulations relating to the deduction disallowance under Code section 274(e)(2) for the entertainment use of aircraft. During that hearing, the comments were primarily focused on two issues: (1) the application of Code section 274(e)(2) to a spouse accompanying an employee on a “business trip”; and (2) whether the IRS and Treasury Department should develop a “charter rate safe harbor” that could be used by taxpayers in lieu of the cumbersome recordkeeping and calculations required by the proposed regulations. We expect that the IRS will release some sort of guidance during 2009 that addresses these two issues.
With regard to spousal travel, both the preamble and the proposed regulations are silent on the application of the deduction disallowance where a spouse is accompanying an employee on a flight where the employee is flying for bona fide business purposes. Presumably, if the spouse is not performing any of the activities during the trip that traditionally fall under the definition of entertainment, e.g., relaxing at the beach, but is instead merely attending “boring” business functions (including various forms of business entertainment), the spouse’s flight should not be considered “entertainment” for purposes of Code section 274(e)(2). Several commentators suggested that a “tag along” rule should be applied whereby the spouse’s flight mirrors the characterization of the employee’s flight. However, until the IRS releases additional guidance, the application of Code section 274(e)(2) to spousal travel on corporate aircraft remains open to interpretation.
The second issue that received attention during the hearing was whether the IRS and Treasury Department should develop a “charter rate safe harbor” for purposes of determining the expenses potentially subject to the deduction disallowance under Code section 274(e)(2). Under the proposed regulations, taxpayers must keep detailed records of the total expenses associated with the operation of the aircraft and then perform three different calculations (i.e., the seat-per-hour method, the seat-per-mile method and the flight-by-flight method) to determine the potential deduction disallowance under Code section 274(e)(2). The application of a safe-harbor charter rate would save taxpayers hundreds of hours in compliance costs and potentially reduce the total expense subject to disallowance, particularly in the case of new aircraft, because, due to the accelerated deprecation schedule for aircraft, charter rates do not typically capture the full tax expense of operating aircraft during the first several years of operation.
Payroll Tax Audits
The current buzz word on the Hill is the “tax gap,” and the IRS and Treasury are increasingly viewing employment tax withholdings as the easiest way to collect additional taxes. Moreover, since both 2007 and 2008 marked significant increases in corporate losses, the IRS will be forced to look to payroll tax collections, which are not impacted by a corporation’s NOLs, as a means to increase tax revenue. Therefore, we anticipate a significant increase in payroll tax audits for 2009 and beyond, as these “loss years” come under audit.
Tinkering with the Withholding Tables
The Obama Administration has already indicated that is will be looking to reduce income tax rates for lower income workers in 2009 as part of its overall stimulus package. Therefore, employers can anticipate a midyear change to the current income tax and withholding tables. In a recent letter to President Obama, the American Payroll Association (“APA”) recommended that a change in the income tax withholding rates and the Social Security tax rate would be the most efficient method in delivering economic stimulus to workers. The reduction in the income tax withholding rates for lower wage brackets would have to be countered with a higher withholding rate for higher wage brackets to reflect the anticipated phase-out of the economic stimulus for higher income individuals.
Cross-Border Withholding and Reporting
In the New Year we anticipate that the IRS will focus additional resources on withholding and reporting issues involving payments to nonresident aliens and U.S. citizens working abroad. On the heels of a very successful voluntary compliance program (“VCP”) directed toward financial institution withholding issues (Rev. Proc. 2004-59 and extended under Rev. Proc. 2005- 71), the IRS has identified withholding tax compliance during 2008 as a means to narrow the international tax gap. In addition to informal comments urging taxpayers to quickly tighten their procedures for withholding taxes, in July of 2008, the IRS issued new examination guidance for examiners to perform U.S. withholding agent audits under Internal Revenue Manual (“IRM”) 4.10.21. The IRM instructs examiners to perform a functional review of the withholding agent’s operating procedures and training materials, and explains that the absence of procedures or poor procedures may indicate that the taxpayer is noncompliant. The IRM encourages examiners to perform statistical sampling of the data within the taxpayer’s databases with the assistance of IRS’s data processing personnel.
Two other developments demonstrate the IRS’s commitment to improve withholding and reporting compliance in 2009. First, the IRS has also published a series of fact sheets to identify and explain issues that contributed to the international tax gap over the past year.
The fact sheets can be found here. A number of these fact sheets focus on withholding and reporting of payments of U.S. source income to foreign persons. Perhaps most importantly though, IRS Commissioner Douglas Shulman stated on December 8, 2008 that “the IRS will add withholding taxes to the Tier I list of issues.” Adding a withholding tax issue to the Tier I list of issues demonstrates the high priority the IRS plans to give to this issue during 2009.
For further information, please contact any of the following lawyers:
Gary Quintiere, email@example.com, 202-626-1491
*Former Miller & Chevalier attorney
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