Skip to main content

Investment Advice Prohibited Transaction Exemption; COBRA Subsidy Extended and Expanded; GID Expenses as Medical Expenses; Required Form 1099 Reporting

Focus On Employee Benefits

Qualified Plans: Investment Advice Prohibited Transaction Exemption - Proposed Regulations

Tess Ferrera

On March 2, 2010, the United States Department of Labor ("DOL") re-released proposed regulations on the giving of investment advice to participants in defined contributions plans and owners of IRAs. The regulations implement the prohibited transaction statutory exemption under ERISA §§ 408(b)(14) and 408(g) and Internal Revenue Code parallel provisions under §§ 4975(d)(17) and 4975(f)(8) relating to eligible investment advice arrangements that were added to ERISA and the Code as part of the Pension Protection of Act 2006 ("PPA"). After a series of extensions and requests for additional comments, the Obama administration withdrew the Bush final regulations.

In general, ERISA prohibits fiduciaries from using the authority that makes them a fiduciary to take an action that results in the payment of additional fees to themselves or their affiliates. Without an exemption, this prohibited transaction rule against self-dealing bars vendors serving as a plan's financial vendor from also providing investment advice to participants for an additional fee. The proposed regulations are almost identical to the Bush 2008 proposed rule and allow a plan service provider to provide investment advice to participants if the advice is given by a "fiduciary adviser" under an "eligible investment advice arrangement." 75 Fed. Reg. 9360, 9366 (March 2, 2010). The proposed rule differs from the final regulations most notably in the withdrawal of the controversial administrative prohibited transaction class exemption.

The term fiduciary adviser means a fiduciary within the meaning of ERISA because he or she provides investment advice and, among others, is a registered investment adviser under the Investment Advisers Act of 1940 or under a similar state law; a bank or similar financial institution, an insurance company, or a person registered as a broker or dealer under the Securities Exchange Act of 1934. The term "eligible investment advice arrangement" is defined differently depending on whether the investment advice is provided through a level-fee arrangement or certified computer model.

Level-fee arrangements

For purposes of advice provided through a level-fee model, "eligible investment advice arrangement" ("EIAA") is defined as one that provides that the fiduciary adviser, including any employee, agent, or registered representative, shall not receive, directly or indirectly any fee, including commissions, salary, bonuses or other things of value that varies depending on the participant investment selection, referred to as the "level fee" requirement. To meet the definition of an EIAA, the arrangement must also provide advice (i) based on generally accepted investment theories; (ii) take into account investment management and other fees and expenses attendant to the recommended investments; and (iii) take into account information relating to age, time horizons, risk tolerance, current investments in designated investment options, other assets or sources of income, provided such information is furnished to the adviser.

Computer Model Arrangements

For purposes of the computer model, an EIAA is defined as one that provides investment advice that is generated by a computer model, and, among other things:

(a) applies generally accepted investment theories that take into account the historic returns of different asset classes over defined periods of time;

(b) utilizes relevant information about the participant, which may include age, risk tolerance, other assets or sources of income, and preferences as to certain types of investments;

(c) utilizes prescribed objective criteria to provide asset allocation portfolios comprised of investment options available under the plan; and

(d) operates in a manner that is not biased in favor of investments offered by the fiduciary adviser or a person with a material affiliation or contractual relationship with the fiduciary adviser.

The computer model must also be certified by an "eligible investment expert," defined as a person that has the expertise necessary to review the model and certify that it meets all of the many requirements for the computer model to constitute an EIAA.

Other Requirements and Notable Mentions

The Bush final regulations also included an administrative class exemption that was vilified because it limited the level-fee requirement to the individual adviser and not the adviser's employer. The class exemption also allowed individual advice to participants following the receipt of general recommendations generated by the computer model. The class exemption was withdrawn entirely.

The proposed regulations include many additional requirements, all of which were in the Bush final regulations. They include the following notables. The EIAA must be authorized by a plan fiduciary independent from the financial vendor. At least annually, the plan fiduciaries must engage the services of an independent auditor to conduct an audit for compliance with the statutory exemption and issue a report stating his or her findings. If the auditor finds that the arrangement is non-compliant, the auditor must report those findings to the DOL. The regulations also clarify that that neither the statutory amendment or the proposed regulations modify or affect prior exemptions or guidance as outlined in DOL Advisory Opinion 2001-09A (SunAmerica) and a couple of other DOL pronouncements.

The last notable point is that the DOL has invited comments on a series of specific questions concerning the types of acceptable investment advice that might be appropriate under an EIAA. This invitation for comments on investment advice has raised concerns because some people are questioning whether the DOL has the expertise to weigh any such options or, even if it has the expertise, whether there should be any restrictions imposed on the giving of investment advice through government rulemaking. The argument against regulating investment advice, at least with respect to those questions raised in the regulation, is that the adviser should not be restricted in the advice he or she provides since the adviser is in the best position to determine the needs of the person to whom the advice is provided. Another key difference between the Bush regulations and the re-released Obama regulations is a new requirement that the computer model arrangement not "[i]nappropriately distinguish among investment options within a single asset class on the basis of a factor that cannot confidently be expected to persist in the future." In discussing this proposal in the preamble, the DOL stated:

[w]hile some differences between investment options within a single asset class, such as differences in fees and expenses or management style, are likely to persist in the future and therefore to constitute appropriate criteria for asset allocation, other differences, such as differences in historical performance, are less likely to persist and therefore less likely to constitute appropriate criteria for asset allocation. Asset classes, in contrast, can more often be distinguished from one another on the basis of differences in their historical risk and return characteristics.

This language in the proposed regulations has raised concerns that the DOL, perhaps inadvertently, may be favoring passively managed investment options over actively managed investment options with higher fees. Thus, inappropriately, and perhaps unintentionally, regulating investment advice without understanding all the factors that might lead an adviser, who is in the best position to understand the needs of a particular investor, to suggest an actively managed investment.


The comment period is open until May 5, 2010. The DOL has already received and considered comments on the bulk of the language in the re-released proposed regulations since, for the most part, the re-released regulations are identical to the Bush 2008 proposed regulations. Therefore, it is unlikely that much will change in the final regulations on those aspects of the regulations. Whether some of the issues pertaining to investment advice that are raising concern survive after the comment period is an open question that will have to await the issuance of the final regulations.


Health and Welfare: COBRA Subsidy Extended and Expanded

Susan Relland and Amy Healy

On March 2, President Obama signed into law the Temporary Extension Act of 2010 (the TEA), extending and expanding the COBRA premium subsidy. Initially enacted by the American Recovery and Reinvestment Act of 2009, the subsidy is available to individuals who lose group health coverage because of an involuntary termination. Such individuals who elect COBRA continuation coverage pay only 35 percent of the COBRA premium. The employer covers the remaining 65 percent and is reimbursed from the federal government via a payroll tax credit. The subsidy period, initially nine months, was extended to fifteen months at the end of 2009. The TEA does not affect the length and amount of the subsidy.

The TEA extends the eligibility period for the COBRA subsidy for an additional month, through March 31, 2010. Individuals are eligible to receive the premium subsidy if they incur an involuntary termination of employment during the period beginning September 1, 2008, and ending March 31, 2010. Only the termination of employment, not the loss of coverage, must occur by March 31, 2010.

The TEA also expands the group of assistance eligible individuals to include individuals who lose health coverage due to a reduction in hours and then experience an involuntary termination of employment. If an individual loses group health coverage because of a reduction of hours that occurs during the period beginning with September 1, 2008, and ending with March 31, 2010, and that individual does not elect (or elects and discontinues) COBRA coverage, a subsequent involuntary termination between March 2, 2010 and March 31, 2010, will constitute a qualifying event. The maximum period of COBRA coverage will be measured from the reduction of hours of employment that caused the initial loss of coverage, while the length of the subsidy period runs from the date of involuntary termination. An individual may not be required to pay for COBRA coverage between the reduction of hours and the involuntary termination of employment, and any gap in coverage will be disregarded for purposes of the preexisting condition limitation.

Employers will need to update all COBRA notices and forms to reflect the changes to the COBRA premium subsidy provisions, and the Department of Labor recently released updated model notices. Congress is considering legislation that would further extend eligibility for the subsidy to involuntary terminations through the end of 2010.


Health and Welfare: Treatment of GID Expenses as Medical Expenses

Gary Quintiere

Employers sponsoring medical plans for their employees are often confronted with questions whether certain expenses may be covered by the plan as medical expenses and reimbursed on a tax-free basis. Whether such expenses may be covered on a tax-free basis turns on whether the expenses are expenses for medical care as defined in section 213(d). In Rhiannon G. O'Donnabhain, 134 T.C. No. 4 (Feb. 2, 2010), the Tax Court confronted the issue of whether gender identity disorder (GID) is a disease within the meaning of Code section 213 and, if so, whether the petitioner's expenses for hormone replacement treatment, sex reassignment surgery (SRS) and breast augmentation were deductible. Dealing with this issue for the first time, the majority ruled that petitioner's expenses for hormone therapy and SRS were deductible, while her expenses for breast augmentation were for a procedure that was cosmetic in nature and therefore not deductible. The parties stipulated that the case, if appealed, would be heard by the U.S. Court of Appeals for the First Circuit.

The petitioner was born a genetic male and, as Robert Donovan, served on active duty in the U.S. Coast Guard, was married for 27 years and fathered three children. The record indicates, however, that since childhood, petitioner was uncomfortable in the male gender. Several years after his marriage had ended, petition sought professional assistance and, as a consequence, this led to his name and gender change.

GID is a condition listed in the Diagnostic and Statistical Manual of Mental Disorders published by the American Psychiatric Association. Seemingly, based upon this fact, the IRS stipulated that GID was a recognized mental disorder and, although it contended that a disorder does not necessarily a disease make, the Court was not convinced. Writing for the majority, Judge Gale concluded that GID was a disease and that, in the petitioner's case, hormone therapy and SRS were treatments for the disease, thus making her expenses for such treatments deductible under section 213. Judge Gale disallowed a deduction for petitioner's breast augmentation expenses finding that such procedure amounted to cosmetic surgery.

The Court clearly did not speak with one voice on these matters of first impression. Five judges wrote separate opinions, manifesting strong differences of opinion within the Court. For example, Judge Holmes stated that "[o]n this record, for this taxpayer, and on the facts found by the Judge who heard this case", he agreed with the majority's conclusions that petitioner's expenses for hormone therapy and SRS were deductible, but those for breast augmentation were not. However, he strongly disagreed with the majority's extensive analysis concluding that SRS is the proper treatment for GID. In his view, this analysis was "not essential to the holding and drafts our Court into cultures wars in which tax lawyers have heretofore claimed noncombatant status".

This case will undoubtedly be appealed to the First Circuit, but even if it is affirmed, the IRS will likely continue to deny deductions in similar cases in hopes of having the issues considered differently by one or more other Circuits, leading to a hearing before the Supreme Court. In the meantime and until the relevant issues are decided definitively, plan sponsors may want to consider not amending their health plans to cover such procedures since doing so would only create tax problems for participants and the sponsor.


Tax Reporting: Required Form 1099 Reporting on Payments to Corporations

Michael Lloyd

Section 9006 of the Patient Protection and Affordable Care Act (PPACA) dramatically expands business information reporting requirements with respect to Form 1099 by modifying the language of Code section 6041. Historically, corporations have been considered "exempt payees" for most types of business payments, and businesses have not been required to report payments to corporations on Form 1099. Further, payments for the purchase of property (including equipment and inventory purchases) have not been considered reportable payments for 1099 purposes. PPACA changes these longstanding rules. Beginning on January 1, 2012, for-profit corporations are no longer exempt payees for 1099 reporting purposes, and payments for purchases of property are reportable on Form 1099 if aggregate payments to the vendor exceed $600. This expansion has a collateral effect on backup withholding requirements for businesses. Code section 3406 requires businesses to withhold Federal tax at the applicable backup withholding rate (currently 28%, increasing to 31% effective January 1, 2011) from reportable payments if the payee has not provided its taxpayer identification number (TIN) or if the IRS instructs the business to impose backup withholding. Businesses that fail to withhold tax are strictly liable for the tax, and the failure may result in personal liability for responsible employees under Code section 6672. This change in the law means that businesses must change their vendor intake procedures to insure receipt of Forms W-9 from corporate vendors before making payments and to backup withhold whenever required, including for situations involving property purchases.

Also, it is noteworthy that the changes do not define the term "property" for purposes of Code section 6041. As a result, it is prudent to interpret the term to include not only payments for tangible property but also payments for intangible property. Note that Code section 6041(i) provides that the IRS and Treasury may issue regulations regarding these changes to the reporting rules, including regulations to prevent duplicative reporting.


For Additional Information

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

Gary Quintiere,, 202-626-1491

Michael Lloyd*

Amy Healy*

*Former Miller & Chevalier attorney

The information contained in this communication is not intended as legal advice or as an opinion on specific facts. This information is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. For more information, please contact one of the senders or your existing Miller & Chevalier lawyer contact. The invitation to contact the firm and its lawyers is not to be construed as a solicitation for legal work. Any new lawyer-client relationship will be confirmed in writing.

This, and related communications, are protected by copyright laws and treaties. You may make a single copy for personal use. You may make copies for others, but not for commercial purposes. If you give a copy to anyone else, it must be in its original, unmodified form, and must include all attributions of authorship, copyright notices, and republication notices. Except as described above, it is unlawful to copy, republish, redistribute, and/or alter this presentation without prior written consent of the copyright holder.