Understanding Employee Benefits and key developments in the employee benefits field and items of interest to our clients. MORE

On February 26, 2014, the Internal Revenue Service published a final regulation clarifying the meaning of “substantial risk of forfeiture” under section 83 of the Internal Revenue Code.  The new guidance will help taxpayers who receive property, other than money, in exchange for services determine when they must recognize the difference between the fair market value of the property and the price, if any, they pay for the property as income for tax purposes.

Generally, section 83 is intended to allow service providers who have received an uncertain and unalienable property interest in exchange for services to delay recognition of the value of the property (in excess of what the service provider paid for the property) until it is clear the service provider will, in fact, receive some benefit from owning the property.  Thus, under section 83, the difference between the fair market value of the property and what the service provider paid for it is not includable in the service provider’s income until the property is either no longer subject to a substantial risk of forfeiture or not subject to transfer restriction (i.e. is freely alienable).[i]  In the new regulation, the IRS elaborates on when property is subject to a substantial risk of forfeiture.

First, the Service explains, except in limited circumstances, property is only subject to a substantial risk of forfeiture when the transfer of property is subject to a service condition, meaning the service provider’s right to the property only vests upon the performance (or restraint from performance) of services in the future, or the property interest is subject to a condition related to the purpose of the transfer; for example, the recipient of the service maintains a certain level of revenue in the future.  Not only must the service provider’s property interest be subject to a service condition or condition related to the purpose of the transfer for the property interest to be subject to a substantial risk of forfeiture, but the facts and circumstances at the time of the property transfer must establish the likelihood that the condition leading to forfeiture will occur, and that the service recipient is likely to enforce the forfeiture.

Second, the new guidance states that restrictions on the transfer of property alone cannot make that property subject to a substantial risk of forfeiture.  Thus, service providers who receive property subject to onerous transfer restrictions cannot defer recognition of taxable income from receipt of the property unless the property is also subject to a service condition or a condition related to the purpose of the transfer.  This is the case even if violating the transfer restriction results in the service provider losing the property.  The new regulation does, however, grant two exceptions to this rule by providing that if sale of the property at a profit would open the service provider to a suit under section 16(b) of the Securities Exchange Act of 1934, the property is treated as if it is subject to a substantial risk of forfeiture for the period such a sale could result in a section 16(b) suit; and that property subject to a restriction on transfer to comply with the “Pooling-of-Interests Accounting” rules (the so-called “lock-up” period after certain acquisitions or an IPO) is also considered subject to a substantial risk of forfeiture.

The new regulation applies to any property transferred after January 1, 2013.

[i] A service provider may, however, elect to include the difference between the price it paid for the property and its fair market value in its income when it receives the property, in accordance with section 83(b).

The Department of Labor recently issued the Form M-1, an annual report that must be filed by Multiple Employer Welfare Arrangements (MEWAs). In general, a MEWA is an arrangement that offers health or other welfare benefits to employees of more than one employer. Employers that are part of a controlled group of businesses are treated as a single employer for these purposes.

MEWAs must file both the Form M-1 and a Form 5500. The due date for the M-1 is March 1 following the calendar year for which the filing is required. Because March 1, 2014 is a Saturday, the due date for 2014 is March 3, 2014. Extensions of time may be available.

Most of the employers that we represent do not participate in MEWAs and are not required to file the Form M-1. However, the form contains a good self compliance tool on certain provisions of ERISA, including

• HIPAA portability compliance

• pre-existing conditions limitations

• certificates of creditable coverage

• special enrollment rights

• nondiscrimination based on health status

• the Mental Health Parity Act

• the Newborns and Mothers Act

• the Women’s Health and Cancer Rights Act

• the Genetic Information Nondiscrimination Act (GINA)

• Michelle’s Law

• various Affordable Care Act (health care reform) requirements

Although single employer plans do not need to file the M-1, they do need to comply with these laws. The self-compliance tool can be a helpful check to make sure that employer plans meet required standards.

In an opinion released earlier this month, the United States Court of Appeals for the Seventh Circuit held that a self-insured health plan was not entitled to a refund of the nearly $1.7 million it paid to two Wisconsin hospitals for treatment administered to a participant’s newborn child, despite the plan’s ultimately concluding the newborn was never eligible for coverage. Writing for the court in Kolbe & Kolbe Health and Welfare Benefit Plan v. Medical College of Wisconsin, Judge Posner explained a participant informed the plan of his daughter’s serious medical condition on August 2, 2007, but the participant did not submit a form containing information that would allow the plan to determine the daughter’s eligibility for benefits. When the participant did submit the form, he failed to answer a number of questions germane to establishing his daughter’s eligibility. Nevertheless, the plan paid for the daughter’s treatment until June 24, 2008, at which point the plan determined the child was not covered. After deciding the daughter was not eligible, the plan demanded a refund of the amounts paid on her behalf from the hospitals. When the hospitals refused, the plan sued on the grounds that the hospitals’ refusal constituted a breach of the provider agreements between the plan and the hospitals.

The plan acknowledged that the provider agreements were silent on refunds, but argued the agreements contained an implicit term requiring the hospitals to provide a refund under the circumstances. According to the plan, the court should read such a provision into the agreements because it is customary for employer health plans to receive refunds from hospitals when the plan discovers, after the purported beneficiary has begun treatment, the purported beneficiary is not, in fact, eligible for coverage. Judge Posner agreed, as a general principle, implicit contract terms are enforceable if needed to make the explicit terms of an agreement conform to the parties’ reasonable expectations, but found the plan’s contention, that refunds given under similar circumstances in the past created an implied contract term, in this case wanting. Here, because the hospitals were “faultless” and the payment of refunds in the past “could not have lulled the Kolbe plan into thinking it took no risk in conducting a dilatory investigation into the eligibility of a child with a very serious medical condition bound to cost a great deal to treat,” Judge Posner declared that to infer the provider agreement contains an implied refund provision “is to infer absurdity.” Consequently, the court denied the plan’s claim.

The outcome of this case serves as a warning to plan sponsors of the dangers of failing to make eligibility determinations quickly. Plans should ensure that their dependent eligibility provisions are carefully drafted and that the procedures used to verify dependent eligibility are communicated to participants. Those plans that require participants to provide the plan with information to verify the status of a dependent should explain these requirements in the plan document and summary plan description and should ensure that they have internal processes in place to review submitted documentation promptly. Plans may also wish to ensure that their provider agreements contain explicit provisions for refund or offset when plans determine that coverage was improperly extended. These actions will help minimize the amounts ultimately paid by plans for ineligible dependents.

 

In Cigna v. Amara, the U.S. Supreme Court held that the plan document is the governing document for an ERISA plan and that in a conflict between the plan document and the summary plan description (SPD), the plan document must be enforced. A participant misled by an SPD may be able to bring various claims based on the incorrect SPD; however, enforcement of the SPD itself is not one of them.

Cigna v. Amara involved a pension plan. Pension plans typically have long, complicated plan documents and short, easy to understand SPDs. In contrast, many employers who sponsor welfare benefit plans, such as health plans, do not have formal plan documents separate from the certificate of coverage (for an insured plan) or the SPD (for a self-funded plan). In fact, administrators of self-funded plans are reluctant to develop comprehensive and accurate SPDs for health plans because the exclusions and limitations are difficult to summarize. They prefer providing participants with a single governing document so that there can be no discrepancy in the description of plan benefits between the plan document and the SPD. Thus, in many situations, there is no formal plan document for the SPD to summarize; the SPD provided to the plan participant is the plan document. Since Cigna v. Amara, employers have wondered whether that practice can continue.

In a recent federal district court decision, the court concluded an SPD constitutes the plan document if there is no other plan document. The case involved a health plan participant, injured in a motorcycle accident, whose medical expenses were paid by the carrier for the automobile also involved in the accident. The participant tried to get his employer’s self-funded medical plan also to reimburse him for those expenses, essentially wanting to “double dip.” The plan had no document other than the SPD that described the benefits to the participants and the administrative services contract with the third party administrator which did not describe the benefits. The SPD precluded double dipping; the administrative services contract did not address the issue.

The participant claimed that under Cigna v. Amara, the SPD could not be the plan document and that the plan document therefore had to be the administrative services contract. The federal district court disagreed, stating that if there is only an SPD, then the SPD is the plan document and it can be enforced. The district court said the Supreme Court decision was not inconsistent with that position since in that case, there was both a plan document and a summary plan description. The court noted that if the injured participant had a medical claim he wanted covered under the plan, he would have looked to the SPD to determine coverage. In that situation, he would likely be taking the position that the SPD was a plan document and could be enforced. Because the SPD clearly precluded “double dipping,” the participant could not recover the expenses.

As mentioned, there has been concern about the extent to which an employer can have a plan document that is also an SPD. This case supports that practice. To bolster its position, an employer could state explicitly that the SPD is also the plan document. Alternatively, an employer could adopt a plan document that incorporates by reference the SPD for a description of the benefits.

Of course, this is a district court opinion that could be overturned by the court of appeals. Employers should watch developments in this area to determine whether now-standard practices with respect to health plan SPDs will need to change.

Individuals are permitted to roll over amounts in one IRA to another IRA only once in a 12 month period. The rollover must be completed within 60 days. A tax lawyer at a major New York law firm recently tripped on this rule to his detriment. The tax lawyer had several different IRAs. He took rollover distributions from two of them and redeposited the amounts within 60 days. The IRS claimed that the second rollover was invalid because it was made within 12 months of the first rollover, thereby resulting in a distribution of the amount. The tax lawyer claimed that the 12 month rule should apply separately to each IRA. The IRS countered that all IRAs should be treated as a single IRA for this purpose and the tax court agreed. Therefore, the lawyer had to include in income the amount of the second rollover distribution since it was not a proper rollover.

A few other points relating to the decision:

·      Because the amount of the failed rollover exceeded 10% of the lawyer’s gross income for the year, the lawyer was also subject to a substantial underpayment penalty of 20% of the amount involved. The substantial understatement penalty is not imposed if the taxpayer has substantial authority for the tax position taken or if the taxpayer discloses the position to the IRS. The lawyer claimed that because he was an experienced tax practitioner and had analyzed the issues he had substantial authority for his position. The tax court judge looked at it differently and essentially said that because of his tax knowledge the tax lawyer should have known better and so was liable.

·      Although not mentioned in the court’s opinion, in its Publication 590, Individual Retirement Arrangements for use in preparing 2013 tax returns, the IRS embraces the tax lawyer’s position regarding the 12 month limit on rollovers. The Publication gives the example of an individual rolling amounts from IRA-1 into IRA-3 and being unable for 12 months to make any additional rollover from either IRA-1 or IRA-3. However, according to the Publication, that rollover “does not prevent you from making a tax-free rollover from IRA-2 into any other traditional IRA.” The outcome of the case – particularly with respect to the imposition of penalties – may have been different had the tax lawyer brought this publication to the attention of the court.

·      The attorney’s wife had also made a rollover from a single IRA. She deposited the money in a rollover IRA on the 61st day after she took the IRA distribution. That, of course, is one day after the 60 day limit. Her rollover too was declared invalid so the couple’s taxable income was increased by her failed rollover as well as his failed rollover. Because she was not yet 59½, she also had to pay the additional 10% tax imposed on early withdrawals from IRAs.

·      The IRS automatically waives the 60 day rule in circumstances where a financial institution has been properly directed regarding a rollover, but fails to follow that direction. There is also a private letter ruling program where under limited circumstances (e.g., death, disability, foreign government restrictions), the IRS will waive the 60 day limit on completing a rollover. The taxpayer must request the IRS to issue the ruling and must pay a user fee, the amount of which relates to the size of the rollover. For 2014, the user fee ranges from $500 to $3,000. The attorneys’ wife had not made such a waiver request.

·      The court opinion did not discuss another possible result of the failed rollover. Because the tax lawyer had in fact deposited the money in an IRA, and because the amount deposited was well in excess of the annual contribution limit for an IRA, the amount of the rollover could be considered an excess contribution to the IRA. Excess contributions, if not removed from an IRA by the tax return due date for the year in which the amounts were contributed, result in a 6% excise tax for each year that the excess remains in the IRA. In addition, the excess amount will also be subject to tax when it is distributed from the IRA. In other words, if the excess is not corrected in a timely fashion, the taxpayer will pay tax twice on the excess contribution – once when the deduction is disallowed and once when the taxpayer takes a distribution from the IRA. This is in addition to the annual 6% excise tax on the excess contribution.

 

The moral of the story: Pay close attention to the rollover rules because the IRS strictly enforces them. Remember, however, that the IRA rollover limits can be avoided by using direct transfers where an IRA custodian works with another custodian to move an account from one institution to another. IRA holders who use the direct transfer approach will not run afoul of the rollover limits.

 

 

Terminating employees who lose coverage under an employer’s group health plan are frequently entitled to continue that coverage under the federal law commonly known as COBRA. Employers are required to provide a former employee with a notice at the time of termination of employment describing the employee’s rights to continue coverage and the cost of doing so. A court can impose on an employer a penalty of up to $110 a day for failure to provide that COBRA notice. In a recent decision of the U.S. Court of Appeals for the Second Circuit, the court affirmed the dismissal of a former employee’s claim for penalties against an employer who failed to provide the COBRA notice.

The former employee’s claims were largely employment discrimination claims. The COBRA violation was one small piece of the lawsuit. The employer claimed that it had notified its COBRA administrator of the employee’s termination of employment and that the COBRA notice was sent. The former employee denied receiving the notice. About a year after termination, the former employee’s attorney raised the issue of a violation of the COBRA notice requirements and the administrator finally sent the notice showing a monthly premium of $1,942. A few months later, the administrator sent information about a less expensive health plan. The former employee claimed that she tried to learn the differences between the two plans but did not receive any information and so remained without health insurance for approximately 19 months until she started a new job. She claimed that during that time period she and her husband had accumulated hundreds of dollars in unpaid medical bills and had postponed expensive medical treatments.

The court found that neither the employer nor the COBRA administrator had any malicious intent in failing to provide the information. The court also noted that the former employee could not prove substantial damages as a result of the notice failure. According to the court, although the former employee and her husband had incurred unreimbursed medical expenses, the cost of those expenses was substantially less than the cost of the premiums that the former employee would have had to pay for coverage. The court also said that the former employee had provided no evidence of the health care that she would have sought had she had health insurance. Therefore, because there was no bad intent on the part of the employer and no real damage to the former employee, the appeals court determined that the district court had not abused its discretion in failing to award any COBRA notice penalties.

Not all courts would be as generous to the employer as was the district court in this case. Courts will sometimes impose penalties, although frequently much less than $110 a day, in order to send a message to employers that the COBRA notice requirements should not be ignored. Therefore, although in this case no statutory penalties were imposed, an employer should not be complacent about sending notices. Employers should make certain that they have good processes in place to show that proper COBRA notices are sent.

The bloggers who bring you BenefitsNotes.com are attorneys at Leonard, Street and Deinard. We are proud to announce that we will merge with Stinson Morrison Hecker on January 1, 2014, to form the firm of Stinson Leonard Street. You can learn more about our new firm at http://stinsonleonardmerger.com/.

We welcome guest blogger Sam Butler, an associate at Stinson Morrison Hecker and soon to be an associate at Stinson Leonard Street, on a topic of interest to those responsible for benefit plans.

Have You Told the IRS that Your “Responsible Party” Has Changed?

By Samuel Butler IV

Beginning on January 1, 2014, any entity with an employer identification number (EIN) issued by the Internal Revenue Service (IRS) must report a change in the identity or address of its “responsible party” within 60 days of the change by filing a Form 8822-B. Although we as lawyers do not typically obtain EINs for qualified retirement plan trusts, we understand that such trusts often obtain an EIN separate from the plan sponsor’s EIN.  While the IRS tracks the identity of a qualified plan using the plan sponsor’s EIN and a plan number, the trust often wants a separate EIN to use in opening plan accounts so that the income is reported to the EIN of the tax exempt trust, rather than the EIN of the plan sponsor. Entities – including qualified plan trusts – must name their responsible party when applying for an EIN using IRS Form SS-4.  Filing a Form 8822-B will allow entities to update the information they provided regarding their responsible party when requesting an EIN.

In the instructions for Form 8822-B, the IRS takes the position that any entity with an EIN must file the form if its responsible party has changed.  Despite describing the form as mandatory in these circumstances, the instructions also state that a failure to file the form will not result in penalties.  Nevertheless, taxpayers should consider alerting the Service of any change in the identity of their responsible party or its contact information because if the IRS does not have the most current information, it is possible that the taxpayer will not receive notices of deficiency or notices of demand for tax.  Despite the failure to receive such notices, penalties and interest will continue to accrue on any tax deficiencies.  Furthermore, complying with the Form 8822-B mandate should be relatively easy, as the IRS estimates the average time needed to complete and file the form is 18 minutes.

Entities that experienced a change in responsible party prior to January 1, 2014, have until March 1, 2014, to file a Form 8822-B disclosing their new responsible party.

I blogged earlier this year about a tax court decision in which taxpayers used assets in their IRA to finance a new business in a structure sometimes known as ROBS or Rollover for Business Startups. Unfortunately, because of personal guarantees provided by the taxpayers at the time that the business owned by the IRA was sold, the IRA was held to have engaged in a prohibited transaction, thereby subjecting the value of the IRA, including the sales proceeds, to immediate taxation. Another recent tax court decision finds prohibited transactions in a similar situation but for a different reason.

In the recent tax court decision, an individual taxpayer rolled over proceeds from a prior employer’s plan into an IRA which then purchased the membership units of an LLC organized to operate a used car business. The IRA owed 98% of the LLC units. The LLC then elected to be treated as an association taxable as a corporation. That allowed the entity to avoid paying unrelated business income taxes which would have passed through to the IRA. The IRA owner was also the general manager of the business and was paid compensation for those services. The IRS claimed that the payment of that compensation constituted a prohibited transaction on the theory that the amounts paid to the individual constituted the use of plan (IRA) assets for the use of the IRA owner. The court determined that the taxpayer was the individual for whose benefit the IRA was established and controlled the investments within the IRA. Therefore, the taxpayer was a fiduciary of the IRA and in that capacity ultimately had discretionary authority to determine the amount of his own compensation. The court found that ability to be a form of self-dealing that was prohibited under the tax code.

The taxpayer argued that an exemption from the prohibited transaction rules allowed the payment of reasonable compensation for services rendered and that the amount of compensation he received was reasonable. The court concluded that the taxpayer could not rely on the reasonable compensation exception because that exception applied to reasonable compensation for services performed for the plan/IRA and the taxpayer’s services were not performed for the plan/IRA, but for the business itself. Therefore the exemption did not apply.

Because the payment of the compensation was a prohibited transaction, the value of the IRA was included in the taxable income of the taxpayer as of the date that the compensation was paid. The taxpayer also owed the 10% penalty tax on early distributions from an IRA since he was not yet 59½. The failure to report the IRA balance as income resulted in a substantial understatement of tax, creating an additional 20% penalty.

Individuals wanting to use their rollover IRAs as vehicles to finance new businesses have another reason to be cautious about proceeding with such an arrangement.

I blogged recently about an ERISA case involving an executive severance plan where the executive sued claiming that his employment termination was effective before the first anniversary of a change in control, thereby entitling him to severance benefits under the plan. The court had concluded that the severance occurred after the first anniversary but allowed the executive to proceed on a claim that the employer had interfered with the employee’s rights under the ERISA severance plan by manipulating the termination date.

The court in that case did not give many facts surrounding the severance plan but accepted the fact that it was governed by ERISA. In contrast, a recent federal district court case from the District of Puerto Rico determined that a severance plan was not an ERISA plan and therefore no claim for benefits could be made in federal court. That plan provided for severance payments over a period of 12, 26 or 52 weeks, plus a continuation of benefits during that time period. Amounts varied based upon years of service and were owed if the employee was terminated involuntarily without cause and signed a release of claims.

In reaching its decision, the court looked to the Supreme Court case of Fort Halifax Packing Co., Inc. v. Coyne, 482 US 1 (1987). That case involved a Maine statute requiring a lump sum payment by employers to employees on certain terminations of employment. The Court concluded that the statute was not preempted by ERISA because it did not create an employee benefit plan due to the lack of administration required to implement the statute (one time lump sum payment in limited events). The Puerto Rican court determined that not much administration was involved in sending severance checks every month and continuing to pay insurance premiums, concluding that the arrangement it was considering did not constitute an ERISA plan.

Although this case found there to be no ERISA severance plan, other courts have reached contrary determinations. In fact, it is difficult to rationalize the decisions in this area. Different courts seem to reach different conclusions about which severance arrangements are and are not subject to ERISA.

So the answer to the question posed in the headline is that not all severance plans are subject to ERISA, but in some cases it can be difficult for an employer to be certain whether its particular plan is or is not an ERISA plan. There are advantages and disadvantages to ERISA coverage. Employers may wish to consult with their benefits attorneys regarding their specific arrangements, decide whether their severance arrangements are or are not ERISA plans, and then report, communicate and document the arrangement in a manner consistent with the conclusion reached about ERISA coverage.