IRS 401(k) Compliance Check Questionnaire; Application of Section 162(m) in Acquisition Context; HIRE Act Social Security Exemption; Guidance on Grandfathered Health Plans

Focus On Employee Benefits

Qualified Plans: IRS 401(k) Compliance Check Questionnaire Goes Beyond Just the Facts

Elizabeth Drake and Adrian Morchower

The IRS is conducting a compliance check of 401(k) plans that involves a comprehensive look into approximately 1,200 plans selected at random from plans that filed a Form 5500 for the 2007 plan year. The 401(k) compliance check is designed to determine (1) potential compliance issues, (2) any plan operational issues, and (3) additional education and outreach guidance that may be helpful for the IRS to provide to plan sponsors top improve compliance. The IRS notes that a previous study indicated that 401(k) plans are by far the most non-compliant plan type in the retirement plan universe.

A sponsor whose 401(k) plan is selected for the compliance check is provided with an online 401(k) Compliance Check Questionnaire (Form 14146) and is requested to submit the electronically completed Questionnaire within 90 days from the date of the accompanying IRS letter. The Questionnaire contains a wide variety of questions within the following categories:

  • Demographics
  • 401(k) plan participation
  • Employer and employee contributions
  • Top-heavy and nondiscrimination rules
  • Distributions and plan loans
  • Other plan operations
  • Automatic contribution arrangements
  • Designated Roth features
  • IRS voluntary compliance programs
  • Plan administration

Most of the questions request factual information regarding the sponsor's 401(k) plan. Some questions, however, require information regarding the existence of other plans, including the number of the sponsor's nonqualified deferred compensation arrangements, which could involve certain compensation arrangements that are imbedded in various employment contracts. In addition, the Questionnaire asks for an opinion regarding the importance of various factors, including recent financial conditions, on participation in, and operations of, the 401(k) plan.

The IRS states that its contact with a sponsor regarding the Questionnaire is a compliance check, which is not an audit or investigation under Code section 7605(b), an audit under section 530 of the Revenue act of 1978, or a review of an organizations books and records. In its letter accompanying the Questionnaire, the IRS states that failure to respond or to provide complete information will result in further action which could include a full examination of the 401(k) plan. In Publication 3114, the IRS states that a person may refuse to participate in a compliance check without penalty and states further that the IRS has the option of opening a formal investigation, whether or not the business owner agrees to participate in a compliance check.

The paper copy of the Questionnaire circulated by the IRS does not require a signature or verification that the Questionnaire is completed under penalties of perjury, but it does require information about the position of the person or persons who completed the Questionnaire. Nonetheless, we highly recommend a legal review of the completed Questionnaire, not just because of the scope of information provided, but because certain multiple choice questions, if answered accurately, may indicate a plan qualification failure.

For those interested in reviewing the Questionnaire, a copy can be found here.


Executive Compensation: IRS Changes Position on Application of Section 162(m) in Acquisition Context

Anne Batter

A relatively recent development in the IRS' interpretation of section 162(m) has received little attention, notwithstanding that it will often result in an additional deduction disallowance when a public company is acquired. The issue has to do with the application of section 162(m) to the year before a public company is acquired.

In the past, the IRS had concluded that a company was not a "publicly-held corporation" and, consequently, was not subject to deduction disallowance under Code section 162(m), not just for the short year ending with the acquisition, but also for the last full fiscal year before it was acquired in cases where the merger occurred prior to the deadline for the company filing an SEC proxy statement for that year. In such a case where the merger occurred before the proxy would be filed, there would be no summary compensation table filed with the proxy for the last full fiscal year (because no such proxy was filed) and there generally (at least in past years) would not be a summary compensation table filed elsewhere. Companies in this situation had obtained favorable private rulings from the IRS that they were not public for the last full fiscal year before a merger after representing that they would not be required to file a summary compensation table with the proxy statement or a Form 10-K for either the last full or the short-year before the merger. See e.g., PLR 200519035 (May 13, 2005); PLR 200519-34 (May 13, 2005); PLR 200519033 (May 13, 2005); PLR 200419013 (May 7, 2004).

The IRS has more recently changed the position outlined in these PLRs with respect to the last full year before the merger, while continuing to issue PLRs concluding that a company is not a public company subject to Code section 162(m) for the short-year before the merger. In CCA 200923030 (June 5, 2009), the IRS explained that, even in the case of a merger that occurs before the proxy statement is filed, the SEC rules require the filing of a summary compensation table with the Form 10-K covering the company's last full year. Apparently, however, the SEC does not always enforce this filing requirement, presumably because the acquired company will be wholly-owned by the new parent company, rather than by the public, by the time the Form 10-K would be required to be filed. Because the filing is nonetheless required by SEC rules, the IRS in CCA 200923030 concluded that, under the definition of publicly held corporation in Reg. § 1.162-27(c)(1)(i)(A), a company is public for the last full year before such a merger because it is "required to be registered under section 12 of the Exchange Act." This is true, even if it does not actually file a Form 10-K containing a summary compensation table for its final full year.

Notwithstanding its change in position with regard to the last full fiscal year before a merger, the IRS has maintained its position that a company is not a public company for the short fiscal year ending with a merger. In private rulings post-dating CCA 200923030, acquired company taxpayers have represented that they were not required to disclose under the securities rules for the full year in which the merger occurred or for the short-year ending with the merger. See PLRs 200951006 (December 18, 2009); PLR 200945010 (November 6, 2009); PLR 200916012 (April 17, 2009). On the basis of these representations, the IRS has concluded that the merged company is not a public company for section 162(m) purposes for the year of the merger (including for the short-year ending with the merger). This makes sense because the merged company would begin filing for that year for SEC purposes with the new parent company and the status as a public company for section 162(m) purposes should depend on the new parent company status for that year.

In summary, beginning with CCA 200923030, the IRS position is that a public company remains subject to Code section 162(m) for the last full fiscal year before it is acquired, but does not remain subject to Code section 162(m) for the short-year ending with the merger.


Employment Taxes: HIRE Act Social Security Exemption Available on Forms 941 for Second Quarter of 2010

Marianna Dyson and Tom Cryan

The HIRE Act (P.L. 111-147) includes two provisions that encourage employers to hire workers who have been previously unemployed or underemployed. The incentives are in the form of a Social Security tax exemption for the employer-half of the Social Security tax (6.2 percent) and a new-hire retention tax credit that gives employers the lesser of $1,000 or 6.2 percent of wages paid during the pervious year if the employee remains employed for a full year. The first of these two benefits, the Social Security tax exemption, can be claimed on the employer's Form 941, beginning in the second quarter of 2010.

The Social Security tax exemption applies to all "qualified employees" hired after February 3, 2010 and before January 1, 2011, and applies to the employer-half of Social Security taxes paid from March 19, 2010 through December 31, 2010. A "qualified employee" is any individual who has been unemployed, or employed less than 40 hours during the 60-day period ending on the date the employment begins. The statute specifically uses the term "employed" when describing this 60-day period, and therefore, services as an independent contractor during this period should not disqualify a new hire from qualifying for the exemption.

The IRS has released new Form W-11, Hiring Incentives to Restore Employment (HIRE) Act Employee Affidavit, to assist employers in tracking and documenting eligible employees. Since the hiring period eligibility for the FICA tax credit pre-dates the enactment of the statute and the release of this form, employers have an incentive to verify if employees hired during the early part of the qualifying period are "qualified employees," and if so, require them to sign Form W-11. Although the IRS website FAQs on the Hire Act warn that the exemption will not apply to "wages paid to an employee who is hired to replace an existing worker," the FAQs provide that this limitation does not apply if the employee terminated employment voluntarily, was terminated for cause, or terminated because of lack of work. In addition, an individual who has not previously worked, such as a recent graduate, also qualifies for the exemption. Accordingly, there are few instances in which the Social Security exemption would not apply to a new hire that otherwise meets the definition of a "qualified employee," provided the employer did not terminate an employee for the purpose of hiring an employee to take advantage of the incentives. 

Please let us know if you have any questions regarding the new Social Security tax exemption or retention credit.


Health & Welfare: Guidance on Grandfathered Health Plans: "If you like your coverage, you can keep it." Really? 

Tess Ferrera and Garrett Fenton

The Patient Protection and Affordable Care Act ("PPACA"), Section 1251, as amended by section 2301(a) of the Health Care and Education Reconciliation Act of 2010 ("HCERA"), provides that certain group health plans and health insurance coverage in place as of March 23, 2010 are exempt, or "grandfathered," from several market reform provisions in subtitles A and C of Title I of PPACA. On June 14, 2010, the Departments of the Treasury, Labor ("DOL"), and Health and Human Services ("HHS") released an Interim Final Rule on grandfathered health plans (the "IFR"), which was published in the Federal Register on June 17, 2010. The IFR has the same practical effect as final regulations, but the public still has an opportunity to weigh in with comments. The comment period for the IFR closes on August 16, 2010.

The regulations define a grandfathered plan as a group health plan, or group or individual health insurance coverage, in which at least one person was enrolled on March 23, 2010 and at least one person (not necessarily the same person) has been enrolled at all times since March 23, 2010. The IFR provides guidance on the very important question of how to maintain grandfather status, by describing the type of activity that will cause a plan to cease to be grandfathered.

PPACA Provisions That Do Not Apply To Grandfathered Plans

Many of PPACA's "market reform" provisions are not effective until the first plan year (policy year in the individual market) beginning in 2014. Some are effective for the first plan or policy year beginning on or after September 23, 2010, six months after PPACA was enacted. Grandfathered plans are exempt from some, but not all, of these new market reform requirements. Listed below are the relevant market reform sections of the Public Health Service Act ("PHSA"), enacted under PPACA, that do not apply to a grandfathered plan, including a notation regarding each provision's general effective date and applicability to insured only, versus insured and self-funded, plans:

  • 2701: Premium rating standards (plan/policy years beginning in 2014) (insured plans)
  • 2702: Guaranteed availability of coverage (plan/policy years beginning in 2014) (insured plans)
  • 2703: Guaranteed renewability (plan/policy years beginning in 2014) (insured plans)
  • 2705: Prohibited discrimination based on health status (plan/policy years beginning in 2014) (insured and self-funded plans)
  • 2706: Prohibited discrimination against health care providers (plan/policy years beginning in 2014) (insured and self-funded plans)
  • 2707: Comprehensive health insurance coverage (for the individual and small group markets) (plan/policy years beginning in 2014) (insured and self-funded plans)
  • 2709: Coverage for individuals participating in clinical trials (plan/policy years beginning in 2014) (insured and self-funded plans)1
  • 2713: Preventive coverage without cost-sharing (plan/policy years beginning on or after September 23, 2010) (insured and self-funded plans)
  • 2715A: Provision of additional information (plan/policy years beginning on or after September 23, 2010, but likely delayed in connection with the establishment of the exchanges) (insured and self-funded plans)
  • 2716: Prohibited discrimination by insured plans in favor of highly compensated employees (plan/policy years beginning on or after September 23, 2010) (insured plans)
  • 2717: Ensuring quality of care (plan/policy years beginning on or after September 23, 2010, but likely delayed pending guidance on reporting requirements, which must be issued by March 23, 2012) (insured and self-funded plans)
  • 2719: Appeals process (plan/policy years beginning on or after September 23, 2010) (insured and self-funded plans)
  • 2719A: Patient protections (plan/policy years beginning on or after September 23, 2010) (insured and self-funded plans)

PPACA Provisions That Apply To Grandfathered Plans

Listed below are the relevant market reform sections of the PHSA, enacted under PPACA, that still apply to grandfathered plans:

  • 2704: Prohibition on pre-existing condition exclusions (plan/policy years beginning in 2014, but plan/policy years beginning on or after September 23, 2010 for individuals under age 19) (insured and self-funded plans)2
  • 2708: Prohibition on excessive waiting periods (plan/policy years beginning in 2014) (insured and self-funded plans)
  • 2711: Prohibition on lifetime and annual limits (insured and self-funded)
    • Lifetime limits: The prohibition applies to all grandfathered plans (plan/policy years beginning on or after September 23, 2010)
    • Annual limits: The prohibition applies to grandfathered group coverage (plan/policy years beginning on or after September 23, 2010, with restricted annual limits permissible before plan/policy years beginning in 2014), but not grandfathered individual coverage
  • 2712: Prohibition on rescissions (plan/policy years beginning on or after September 23, 2010) (insured and self-funded plans)
  • 2714: Extension of dependent child coverage to age 26 (plan/policy years beginning on or after September 23, 2010) (insured and self-funded plans)3
  • 2715: Uniform explanation of coverage documents (plan/policy years beginning on or after September 23, 2010, but likely delayed pending the issuance of guidance) (insured and self-funded plans)
  • 2718: Medical loss ratio (plan/policy years beginning on or after September 23, 2010) (insured plans)

Activity That Can Cause a Loss of Grandfather Status

The IFR discusses a number of actions that can lead to a loss of grandfather status. Three general observations can be gleaned from the IFR in this regard: (1) the agencies appear to have approached the question of losing grandfather status subjectively, asking whether a participant would perceive a real change in his or her benefits when examining a particular activity; (2) a decrease in benefits or increase in cost to participants that is more than insignificant will often result in a loss of grandfather status; and (3) grandfather status will be very difficult to maintain.

The following actions, among others, will lead to a loss of grandfather status.

  • Eliminating all or substantially all benefits to diagnose or treat a particular condition
  • Eliminating benefits for any necessary element to diagnose or treat a condition
  • Any increase in a percentage cost-sharing requirement, such as a deductible or out-of-pocket limit
  • Any increase in fixed amount cost-sharing (other than a copayment) that exceeds the "maximum percentage increase"
  • An increase in a fixed-amount copayment that is higher than (1) $5 adjusted for medical inflation, or (2) a percentage that exceeds the "maximum percentage increase"
  • Decreasing the employer contribution rate toward the cost of any tier of coverage for any class of similarly situated individuals by more than 5% below the rate that was in effect as of March 23, 2010
  • Adding an overall annual dollar limit to a plan or coverage that had no annual or lifetime dollar limits on March 23, 2010
  • Adding an annual limit to a plan or coverage that had a lifetime limit (but no annual limit) that is lower than the lifetime limit that was in effect on March 23, 2010
  • Decreasing the annual limit for a plan or coverage below the annual limit (if any) in effect on March 23, 2010
  • Changing insurance policies

PPACA also includes anti-abuse provisions which, if violated, will cause a loss of grandfather status. Generally, moving employees to other plans will not cause a loss of grandfather status, unless the reason for the moving around is to evade the health reform requirements. If employees are transferred from a plan they were covered under on March 23, 2010 to a receiving plan which, if it was treated as an amendment to the transferor plan, would cause the transferor plan to lose its grandfather status, then the receiving plan will cease to be grandfathered. Similarly, if the principal purpose of a merger, acquisition or similar business restructuring is to cover new individuals under a grandfathered plan, the plan will lose grandfather status.

The list of activity described in the regulations that can cause a loss of grandfather status involve routine annual or more frequent occurrences in most welfare plans, which is why, unless significant changes are made to the IFR, no one expects grandfathered plans to last very long.

Other Notable Points

1. Administrative Requirements. Grandfathered plans must comply with specific disclosure requirements to participants and beneficiaries that clearly inform them that the plan is grandfathered and not subject to many of the new PPACA requirements. In this regard, the IFR provides model language that may be modified in future guidance.

Plans and/or insurers must maintain records documenting the terms of the relevant plan or insurance coverage in effect on March 23, 2010, and any other necessary documentation to ensure that they can prove their grandfather status. Those records must be available to the agencies, participants, and beneficiaries upon request.

2. Special Rules for Collectively Bargained Plans. Coverage under an insured collectively bargained plan is grandfathered at least until the last CBA relating to the coverage that was in effect on March 23, 2010 terminates. Only fully-insured collectively bargained plans are eligible for this special grandfather status. The same PPACA exemptions apply to an insured, collectively bargained plan under the special grandfather status as apply to all other "regular" grandfathered plans.

3. Transitional Issues. Changes to the terms of a plan or coverage are deemed effective as of March 23, 2010 (even if they are not effective until later), and will not cause a loss of grandfather status, provided certain specified actions were taken on or before March 23, 2010. Namely, the changes must be made pursuant to a legally binding contract entered into on or before March 23, 2010, a filing with a state insurance department on or before March 23, 2010, or written amendments to a plan that were adopted on or before March 23, 2010.

The IFR also provides for a grace period to revoke or modify changes made to the terms of a plan or coverage after March 23 and before June 14, 2010, if the revocation or modification is done by the first day of the first plan year beginning on or after September 23, 2010. The agencies may also take into account any good-faith attempt, before June 14, 2010 (the date the IFR was initially made public), to comply with a reasonable interpretation of the grandfather statute -- despite the plan or coverage technically running afoul of the grandfather requirements -- provided that the IFR's parameters are only modestly exceeded.

4. Retiree-Only and HIPAA-Excepted Benefit Exemptions. The preamble to the IFR confirms that the agencies interpret the exemptions for retiree-only health plans and limited, "HIPAA-excepted" benefits from many of the requirements imposed upon group health plans (including the new PPACA market reform provisions) as continuing to apply. Before the IFR was issued, there had been a question as to whether these exemptions -- which had previously been contained in the Internal Revenue Code, ERISA, and Public Health Service Act ("PHSA"), and were deleted or largely eliminated from the PHSA (but not the Internal Revenue Code or ERISA) by PPACA -- ceased to exist under a technical reading of the statute.

The preamble to the IFR acknowledges that the exemptions were deleted from the PHSA, and therefore a technical argument could be made that they do not apply to health insurance policies and non-federal governmental plans (which are subject to the PHSA). However, the preamble states that HHS will effectively treat the exemptions as not having been deleted from the PHSA. We caution, however, that individual states -- not HHS -- generally have primary enforcement authority with regard to the PHSA. In addition, the states generally have the authority to impose stricter requirements, as long as they do not "prevent" the application of a standard contained in the PHSA. Therefore, although HHS is encouraging states to interpret the retiree-only and HIPAA-excepted benefit exemptions as effectively continuing to exist under the PHSA, there is no guarantee that each state will actually do so.

1 There are now technically two sections 2709; one is former section 2713 (relating to disclosure of information), which still applies to grandfathered (insured) plans.
2 Grandfathered individual insurance coverage is exempt from this requirement.
3 For grandfathered group coverage, for plan years beginning before 2014, the mandate does not apply with respect to dependent children eligible for other employer-sponsored coverage (other than through their parents’ employers).

For more information, please contact:

Elizabeth Drake,, 202-626-5838

Marianna Dyson*

*Former Miller & Chevalier attorney

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