Category Archives: 401(k) Plans

Bankruptcy Case Highlights Importance of Promptly Transferring Retirement Assets in Divorce

When a couple divorce, it is not uncommon for one partner to have accumulated significantly larger retirement accounts (e.g., in 401(k) plans or IRAs) than the other.  In such cases the parties generally divide IRA accounts pursuant to Internal Revenue Code 408(d)(6) and/or enter into a qualified domestic relations order (QDRO) to divide a 401(k) or other qualified retirement plan.

The importance of moving promptly to divide and transfer title to retirement accounts in divorce was highlighted in a Bankruptcy Court case from 2018, In re Lerbakken, 590 B.R. 895 (8th Cir. 2018).  In the case, the husband’s failure to take formal legal custody of half of his ex-wife’s 401(k) account (through obtaining a QDRO), and the entirety of one of her IRAs, resulted in those amounts becoming available to creditors in the husband’s bankruptcy case.

In Lerbakken, the court’s dissolution order/property settlement directed Lerbakken’s attorney to submit a QDRO with respect to the 401(k) account, and presumably contained language relevant to transferring title to the IRA, for which a QDRO is not necessary.  However no steps towards obtaining a QDRO or transferring title of the IRA were taken.  When Lerbakken filed a voluntary Chapter 7 bankruptcy petition, he claimed his share of the 401(k) account, and the IRA, as exempt retirement accounts.  The bankruptcy court disallowed the exemption on the basis of the Supreme Court’s opinion in Clark v. Rameker, 134 S.Ct. 2242 (2014), which held that a non-spousal inherited IRA (in that case, from a mother to a daughter) was not entitled to the same protection from bankruptcy creditors as are retirement funds that are individually set aside by the person claiming bankruptcy protection; e.g. inherited accounts are more in the nature of a financial windfall than an intended source of retirement living expenses.

On appeal, the Bankruptcy panel of the 8th Circuit court agreed, noting that Clark v. Rameker limits the bankruptcy exemption to “individuals who create and contribute funds into the retirement account,” and disregarding Lerbakken’s claim that he would use the funds for retirement income.  The court’s final summing up suggests that a different result would have obtained,  had Lerbakken obtained a QDRO and moved the IRA funds into his own name, rather than simply having relied on the wording of the property settlement:

            “We recognize that Lerbakken’s interest in the 401(k) and IRA did not arise in the identical manner as the IRA account addressed in Clark.  This distinction is not material to our de novo review.  Any interest he holds in the Accounts resulted from nothing more than a property settlement.  Applying the reasoning of Clark the 401(k) and IRA accounts are not retirement funds which qualify as exempt under federal law.”  (Emphasis added.)

In essence, the result is that without having taken actual ownership to the retirement funds, Lerbakken could not “borrow” the exemption status for the 401(k) and IRA that his wife would have been able to claim, had she been the bankruptcy debtor.  The fact that Lerbakken himself may have been saving money during the marriage to allow for his ex-wife’s 401(k) and IRA contributions simply does not come into play.   The Lerbakken opinion did not address the question of how one of Lerbakken’s creditors (who included his family law counsel) would actually obtain the assets still held in the ex wife’s 401(k) account and IRA, but presumably they would intervene in any attempt to later transfer these amounts over to Lerbakken or to accounts established on his behalf.

As legal precedent, the Lerbakken ruling is limited to states in the 8th Circuit, namely Arkansas, Iowa, Minnesota, Missouri, Nebraska, and North and South Dakota, but it’s invocation of the Supreme Court’s Clark v. Rameker decision could be invoked in other districts.  It is also possible that this concept could influence state courts deciding the rights of non-bankruptcy creditors.  It therefore provides a timely reminder of the importance of moving promptly to obtain a QDRO and to move IRA assets pursuant to Internal Revenue Code 408(d)(6) pursuant to divorce.  Sitting on your rights in such instances could result in loss of the protected status of retirement savings in a bankruptcy or possibly other creditor situation.

The above information is provided for general informational purposes only and does not create an attorney-client relationship between the author and the reader.  Readers should not apply the information to any specific factual situation other than on the advice of an attorney engaged specifically for that or a related purpose.  © 2019 Christine P. Roberts, all rights reserved.

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Filed under 401(k) Plans, IRA Issues, Qualified Domestic Relations Orders

VP of HR Sued Over 401(k) Operational Error

A proposed class action lawsuit in the Northern District of Illinois involving a failure to follow the terms of a 401(k) plan personally names the Vice President of Human Resources for Conagra Brands, Inc. Karlson v. Conagra Brands, Case No. 1:18-cv-8323 (N.D. Ill., Dec. 19, 2018) as a defendant, and, as it happens, the lead plaintiff is the former senior director of global benefits at the company. Other named defendants included the benefits administrative and appeals committee of the Conagra board, both of which committees included the named VP of Human Resources among its members.

Generally, class action litigation over 401(k) plans has alleged fiduciary breaches over plan investments, such as unnecessarily expensive share classes, undisclosed revenue sharing, and the like. However a failure to follow the written terms of a plan document is also a fiduciary breach under ERISA § 404(a)(1)(D), which requires fiduciaries to act “in accordance with the documents and instruments governing the plan” insofar as they are consistent with ERISA.

In the Conagra case, the plan document defined compensation that was subject to salary deferrals and employer matching contributions to include bonus compensation that was paid after separation from employment provided that it would have been paid to the participant, had employment continued, and further provided that the amounts were paid by the later of the date that is 2 ½ months after the end of employment, or end of the year in which employment terminated. Post-severance compensation was included in final regulations under Code § 415 released in April 2007 and is generally an option for employers to elect in their plan adoption agreements.  Note that, when included under a plan, post-severance compensation never includes actual severance pay, only items paid within the applicable time period that would have been paid in the course of employment had employment not terminated.

Karlson was terminated April 1, 2016 and received a bonus check 3 ½ months later, on July 15, 2016, and noted that the Company did not apply his 15% deferral rate to the bonus check and did not make a matching contribution. Because the bonus check fell squarely within the definition of “compensation” subject to contributions under the plan, Karlson filed an ERISA claim and exhausted his administrative remedies under the plan before filing suit.

The complaint alleges that the failure to apply deferral elections and make matching contributions on the bonus check was not a mere oversight on Conagra’s part. Instead, until 2016 Conagra had allowed deferrals to be made from all post-termination bonus checks (provided they were paid by the end of the year in which termination occurred), but in 2016 it limited it to instances where the bonus check was paid within 2 ½ months of termination.  In claim correspondence with Karlson, Conagra referred to this as an “administrative interpretation” of the terms of the Plan that was within its scope of discretion as Plan Administrator, and did not require a plan amendment.

Karlson maintained that the “administrative interpretation” contradicted the written terms of the plan and pursued his claim through the appeals stage. Karlson alleged, in relevant part, that Conagra’s narrowed administrative interpretation coincided with a layoff of 30% of its workforce and was motivated by a desire to reduce its expenses and improve its financial performance.  This, Karlson alleged, was a breach of the fiduciary duty of loyalty to plan participants and of the exclusive benefit rule and hence violated ERISA.  In addition to the fiduciary breach claim under ERISA § 502(a)(2), Karlson also alleged a claim to recover benefits under ERISA § 502(a)(1)(B).

As of this writing, per the public court docket the parties are slated for a status hearing to discuss, among other things, potential settlement of Karlson’s claims.

Although the timing of the layoff certainly adds factual topspin to Karlson’s fiduciary breach claim, the troubling takeaway from this case is that Conagra’s simple failure to follow the written terms of the plan is sufficient for a court to find that it violated its fiduciary duty. The other concern is that operational errors relating to the definition of compensation are among the IRS “top ten” failures corrected in the Voluntary Compliance Program and are also among the most frequent errors that the author is called upon to correct in her practice.

To limit the occurrence of operational failures related to the definition of compensation, plan sponsors should do a “table read” of the definition of compensation in their adoption agreement and summary plan description, together with all personnel whose jobs include plan administration functions (e.g., human resources, payroll, benefits, etc.) Reference to the basic plan document may also be required.  Most important, outside payroll vendor representatives should attend the table read meeting either in person, or by conference call.  All attendees should review, and be on the same page, as to the items that are included in compensation for plan contribution purposes, and on procedures relating to post-termination compensation.

If questions ever arise in this regard, benefit counsel can help.

The above information is provided for general informational purposes only and does not create an attorney-client relationship between the author and the reader.  Readers should not apply the information to any specific factual situation other than on the advice of an attorney engaged specifically for that or a related purpose.  © 2019 Christine P. Roberts, all rights reserved.

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Filed under 401(k) Plans, Benefit Plan Design, ERISA, Fiduciary and Fee Issues, Fiduciary Issues, Profit Sharing Plan

Online VCP Filing System Up and Running

The IRS Voluntary Correction Program, or VCP, generally must be used by plan sponsors who need to fix certain errors in their retirement plans, including document errors such as missed amendments, and “significant” errors in operation of the plan going back more than two years. VCP is a component program of the Employee Plans Compliance Resolution System, the terms of which are outlined in a Revenue Procedure that the IRS updates every few years.  As previously reported, the most recent update, set forth in Revenue Procedure 2018-52, mandates online filing of VCP submissions starting April 1, 2019. The IRS opened the online filing system for voluntary use starting January 1 of this year.  Paper filing is optional through March 31, 2019.  This post reports on first experiences with the online filing system.

  • First, you file online at www.pay.gov, which is also how the applicable VCP user fee is paid electronically. You must have an account established in order to file. The online filing portal at pay.gov is titled “Application for Voluntary Correction Program.” Note that there is a different link at pay.gov called “Additional Payment for Open Application for Voluntary Correction Program” that should not be used for an initial filing. This link is only to be used to make an additional user fee payment for an existing VCP case, which generally would only be at the instruction of an IRS employee.   Plan sponsors and preparers should exercise caution because, when you enter “Voluntary Correction Program” into the pay.gov search engine, this alternative link for the additional payment tends to pop up before the correct link for an initial filing.
  • Form 8950, Application for Voluntary Correction Program, is completed online at www.pay.gov. This version of the form dates to January 2019. Note that the prior version of Form 8950 from November 2017 should not be used as part of the online submission. It can continue to be filed in hard copy through March 31, 2019. Preparers should be careful to follow the Instructions for whatever version of Form 8950 they are working with, as there are differences between them.
  • Any attachments to Form 8950, such as the statement required of Section 403(b) plans, should be part of a single PDF file that contains all portions of the submission (other than Form 8950) that formerly were filed in hard copy (e.g., Form 2848 Power of Attorney, Form 14568 Model VCP Compliance Statement, Schedules thereto, sample corrective calculations, relevant portions of the plan document). The application link at www.pay.gov lists the proper order in which items should go (as does Section 11.11 of Revenue Procedure 2018-52).
  • Items unique to the online filing process that must be included in the PDF file include a signed and dated Penalty of Perjury Statement from an authorized representative of the plan sponsor (formerly this was part of Form 8950), and an optional cover letter to the IRS.
  • Complications ensue when the PDF file exceeds 15 MB. If that is the case, you are to file online and upload as much of your application as fits within 15 MB limit. You and your Power of Attorney then will receive email confirmation of filing from pay.gov. Locate the Tracking ID number that is listed on the confirmation. You then need to prepare one or more fax transmittals that bear the Tracking ID number on the fax coversheet, as well as the EIN, applicant name, and plan name, and fax in the balance of your application to the IRS at (855) 203-6996. Note that the fax (or multiple faxes, if necessary), must be 25MB or smaller to go through the IRS system. Larger files will fail to transmit and no notice of failure will be provided.
  • Either the preparer can provide the PDF to the plan sponsor to upload at www.pay.gov (together with online completion of Form 8950 and payment of the VCP user fee), or the preparer can obtain written authorization from the plan sponsor to use the plan sponsor’s credit card to pay the VCP user fee online, and upload the submission itself. (Hat tip to Alison J. Cohen of Ferenczy Benefits Law Center for input on this latter method, and for other assistance with this post).

This is just a very brief overview of the filing process. More details are found in the January 2019 instructions to Form 8950, and at the online filing portal at http://www.pay.gov

Other than the unfortunate need to separately fax portions of larger VCP applications, the online system operates smoothly and is fairly user-friendly. Time will tell as to whether online filing allows the IRS to process the VCP applications more swiftly than has been possible with paper filings.

 

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Filed under 401(k) Plans, 403(b) Plans, EPCRS, ERISA, Profit Sharing Plan, Voluntary Correction Program

2019 COLA Adjustments: Let’s Do the Numbers

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On November 1, 2019, the IRS announced 2019 cost-of-living adjustments for annual contribution and other dollar limits affecting 401(k) and other retirement plans.   Salary deferral limits to 401(k) and 403(b) plans increased $500 to $19,000, and a number of other dollar limits increased.  Citations below are to the Internal Revenue Code.

In a separate announcement, the Social Security Taxable Wage Base for 2019 increased to $132,900, from $128,400 in 2018.

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Filed under 401(k) Plans, 403(b) Plans, Benefit Plan Design, COLA Increases, ERISA, Nondiscrimination Testing for Qualified Retirement Plans, Profit Sharing Plan, Section 457(b) Plans

IRS Plan Correction Program Goes Digital

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The IRS maintains a voluntary correction program for retirement plan sponsors, called the Employee Plans Compliance Resolution Program, or EPCRS. Plan errors that have occurred within 2 years generally may be eligible for self-correction, whereas older plan errors that are “significant” must be corrected with IRS approval through the Voluntary Compliance Program, or VCP. EPCRS is a very popular way for plan sponsors to resolve plan problems on their own schedule, and without suffering the monetary penalties that likely would apply in the event of a plan audit.

On September 28, 2018, the IRS announced that, effective April 1, 2019, VCP submissions, including payment of “user fees,” must be made electronically through the www.pay.gov website, per the instructions set forth in Revenue Procedure 2018-52. Plan sponsors, or their authorized representatives, may voluntarily use the electronic submission method starting January 1, 2019, but it will be mandatory starting April 1, 2019 and the IRS will reject hard copy VCP submissions postmarked on or after that date.

Revenue Procedure 2018-52 makes extensive revisions to Sections 2, 10 and 11 of Revenue Procedure 2016-51 (and otherwise generally supersedes it) to describe the new electronic user fee payment and VCP submission methods.  Under the new methods, a plan sponsor must either itself submit the VCP application electronically, or authorize a representative to do so via Form 2848, Power of Attorney.  Only third parties designated via Form 2848, such as attorneys, CPAs, or enrolled agents, can sign and file the VCP application on the plan sponsor’s behalf.  (A plan sponsor may use Form 8821 to designate other representatives (such as unenrolled return preparers) to inspect or receive confidential information from IRS about the submission.)

Under the new procedures, the VCP submission process will be as follows (note that links to IRS forms are not provided as they may be changing as a result of the new Revenue Procedure):

  1. Create an account at www.pay.gov, if one does not already exist. If using an authorized representative (AR), confirm that the AR has a www.pay.gov account.
  2. Using www.pay.gov, complete Form 8950, Application for Voluntary Correction Program (VCP).  If using an AR, the AR will complete the form.
  3. Assemble, into a single PDF file not exceeding 15 MB, the following:
  • Plan Sponsor’s signed Penalty of Perjury Statement. (This used to be part of IRS Form 8950 but now will be a separate statement.
  • Form 2848, Power of Attorney, or Form 8821, Tax Information Authorization. If using an AR, you must check line 5a for “Other acts authorized” on Form 2848 and include as a description “signing and filing of the Form 8950 and accompanying documents as part of a VCP submission.”
  • Form 14568, Model VCP Compliance Statement, and any/all applicable Schedules to same (Forms 14568-A through 14568-I), and required enclosures.  Alternatively, a cover letter and separate written narrative could be used.
  • Sample earnings calculations and earnings computations.
  • Relevant plan document language or full plan document when applicable (e.g., non-amender failures).
  • Copy of opinion, advisory, or determination letter, if applicable, pertaining to the plan document.
  • Any other required information, such as statement required for 403(b) plans re: cooperation of all investment providers.

4.  Upload the PDF file at www.pay.gov. If information supporting the submission exceeds the size limit, follow special fax instructions set forth in Section 11.03(7) of the Revenue Procedure.

5.  Use www.pay.gov to pay the user fee, as set forth in Appendix A of Revenue Procedure 2018-4 (and successor Revenue Procedures issued at the beginning of each year). The user fees are now based on plan assets rather than the number of plan participants.

6.  Keep the “Payment Confirmation – Application for Voluntary Correction Program” that is generated on successful filing through pay.gov; the Tracking ID on this receipt serves as the IRS control number for your submission and is official acknowledgement of the submission; if no confirmation is generated call (877) 829-5500 for assistance.

If you discover additional operational errors after submitting your VCP materials, but before the submission has been assigned to an IRS representative, you are directed to call the VCP Status Inquiry Line at (626) 927-2011 (not toll-free) for further information. Although it is currently customary for the IRS to contact the filer once a submission is assigned to an IRS representative, this may not be the case in the future; in the Revenue Procedure the IRS reserves the right to process submissions and issue compliance statements without any prior contact with the filer.  If the IRS gets the jump on you in this manner, you will likely have to pay a new user fee and address the later-discovered errors under a new VCP submission.

Even before the recent increase in VCP user fees, EPCRS was a consistently strong revenue source for the IRS and the new digital streamlining of the program will likely increase its use by plan sponsors over time.

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Filed under 401(k) Plans, 403(b) Plans, EPCRS, ERISA, VCP, Voluntary Compliance Programs

IRS Weighs In on 401(k) “Match” to Student Loan Repayments

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The IRS has approved an arrangement under which an employer “matches” employee student loan repayments by making non-elective contributions to its 401(k) plan on behalf of the employees paying the loans. The guidance is in the form of a Private Letter Ruling (PLR 201833012) that is only citable authority for the taxpayer who requested the ruling, but it is a promising development on the retirement plan front given the heavy student loan debt carried by current millennial employees and the generations following them. The program described in the ruling solves the problem of low 401(k) plan participation by employees who are carrying student loan debt, allowing them to obtain the “free” employer matching funds that they would otherwise forego.

The employer who obtained the ruling maintained a 401(k) plan that included a generous matching formula – 5% of eligible compensation for the pay period, provided that the employee made an elective deferral of at least 2% of compensation for the pay period. The employer proposed establishing a “student loan repayment (SLR) nonelective contribution” program with the following features:

Program Features
• It would be completely voluntary; employees must elect to enroll;
• Once enrolled, employees could opt out of enrollment on a prospective basis;
• Enrollees would still be eligible to make pre-tax or Roth elective deferrals, but would not be eligible to receive regular matching contributions while enrolled;
• Employees would be eligible to receive “SLR nonelective contributions” and true-up matching contributions, as described below; and
• If an employee initially enrolls in the program but later opts out of enrollment, the employee will resume eligibility for regular matching contributions.

SLR Nonelective Contributions
• If an employee makes a student loan repayment during a pay period that equals at least 2% of compensation for the pay period, the employer will make an SLR nonelective contribution equal to 5% of compensation for the pay period.
• Although based on each pay period’s compensation, the collective SLR nonelective contribution will be made as soon as practicable after the end of the plan year. (Because employees may stop and restart student loan repayments or regular elective deferrals, presumably it would not be possible for an employer to know, before the end of the plan year, precisely how much SLR nonelective contributions, and catch-up contributions, each program participant is due.)
• The SLR nonelective contribution is made regardless of whether or not the employee makes any regular salary deferrals throughout the year.
• The employee must be employed on the last day of the plan year (other than when employment terminates due to death or disability) in order to receive the SLR nonelective contribution.
• The SLR nonelective contributions are subject to the same vesting schedule as regular matching contributions.
• The SLR nonelective contributions are subject to all applicable plan qualification requirements: eligibility, vesting, distribution rules, contribution limits, and coverage and nondiscrimination testing.
• The SLR nonelective contributions will not be treated as a regular matching contribution for purposes of 401(m) testing.

True-Up Contributions
• In the event an employee does not make a student loan repayment for a pay period equal to at least 2% of the employee’s eligible compensation, but does make a regular elective deferral equal to at least 2% of compensation, the employer will make a “true-up matching contribution” equal to 5% of the employee’s eligible compensation the pay period.
• Although based on pay period compensation, the collective true-up matching contribution will be made as soon as practicable after the end of the plan year.
• The employee must be employed on the last day of the plan year (other than when employment terminates due to death or disability) in order to receive the true-up matching contribution.
• The true-up matching contributions are subject to the same vesting schedule as regular matching contributions.
• The true-up matching contributions are treated as regular matching contributions for purposes of 401(m) testing.

The specific ruling that the IRS made was that the SLR nonelective contribution program would not violate the prohibition on “contingent benefits” under applicable Income Tax Regulations. Under this rule, an employer may not make other benefits, such as health insurance, stock options, or similar entitlements, contingent on a participant’s making elective deferrals under a 401(k) plan. There are a few exceptions, most notably employer matching contributions, which are expressly contingent on elective deferrals. Because the SLR nonelective contributions are triggered by employees’ student loan repayments, and not by elective deferrals, and because employees who receive them are still eligible to make regular elective deferrals, the IRS concluded that they did not violate the contingent benefit rule. The IRS stated that, in reaching this conclusion, it presumed that the taxpayer had not extended any student loans to employees who were eligible for the program and had no intentions to do so.

Closing Thoughts
Existing vendors who help employers contribute towards student loan repayments will probably move to establish and market versions of the SLR nonelective contribution program described in the private letter ruling, in which case additional, and more broadly applicable, IRS guidance would be welcome. In the meantime, employers wishing to put such a program in place should not assume that reproducing the facts in the ruling is a safe harbor from adverse tax consequences, and should consult legal counsel to assess potential liability.

Note:  The employer who obtained the Private Letter Ruling was later identified as Abbott Labs.

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Filed under 401(k) Plans, Benefit Plan Design, ERISA, Payroll Issues, Student Loans

California’s Dynamex Decision: What it Means for ERISA Plans

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The California Supreme Court ruled on April 30, 2018 that, for purposes of coverage under California wage orders, employers must start with the presumption that a worker is a common law employee, and then may properly classify him or her as an independent contractor only if all of the following three criteria are met:

  1. The worker is free from the control and direction of the hiring business in connection with the performance of the work;
  2. The worker performs work that is outside the usual course of the hiring entity’s business; and
  3. The worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity.

Although the Dynamex ruling is limited to classification of workers under the California wage orders, it’s practical effect is likely to be much broader, as employers are unlikely to use one definition of employee for wage and hour purposes, and another definition for, say, reimbursement of business expenses, or benefit plan eligibility.

Speaking of which, what is the likely impact of the Dynamex ruling on employee benefit plans? Will employers have to offer coverage retroactively to the hire date of the now-reclassified independent contractors? Must they offer coverage going forward?

ERISA plans look to the federal definition of common law employee, which in turn looks to federal case law and an IRS multi-factor test.   So the Dynamex decision does not itself create eligibility under an ERISA plan.   What if individuals who were reclassified as employees under the ABC test were to claim retroactive eligibility under an ERISA plan, however?  As a starting point, it is helpful to look at how most plan documents currently define “eligible employee” and how they treat the issue of workers who were engaged as independent contractors, but later are classified as common law employees.

Most prototype 401(k) plan documents – and some health plan documents in use by “self-insured” employers – contain what is commonly referred to as “Microsoft language” — under which plan eligibility will not extend retroactively to individuals who are hired as independent contractors, even if they later are classified as employees. The language came into common use after the Ninth Circuit ruling in Vizcaino v. Microsoft Corp., 120 F.3d 1006 (9th Cir. 1997), cert. denied.522 U.S. 1098 (1998), which held that long-term, “temporary” workers, hired as independent contractors, were employees for purposes of Microsoft’s 401(k) and stock purchase plan.[1]

For example, a prototype 401(k)/profit sharing plan that is in wide use provides as follows:

“Eligible Employee” means any Employee of the Employer who is in the class of Employees eligible to participate in the Plan. The Employer must specify in Subsection 1.04(d) of the Adoption Agreement any Employee or class of Employees not eligible to participate in the Plan. Regardless of the provisions of Subsection 1.04(d) of the Adoption Agreement, the following Employees are automatically excluded from eligibility to participate in the Plan:

(1) any individual who is a signatory to a contract, letter of agreement, or other document that acknowledges his status as an independent contractor not entitled to benefits under the Plan or any individual (other than a Self-Employed Individual) who is not otherwise classified by the Employer as a common law employee, even if such independent contractor or other individual is later determined to be a common law employee; and  (2) any Employee who is a resident of Puerto Rico.

And a self-insured group health plan document from a well-known provider states as follows:

The term “Employee” shall not include any individual for the period of time such individual was classified by the Employer as an independent contractor, leased employee (whether or not a “Leased Employee” under the Code section § 414(n)) or any other classification other than Employee. In the event an individual who is excluded from Employee status under the preceding sentence is reclassified as an Employee of the Employer pursuant to a final determination by the Internal Revenue Service, another governmental entity with authority to make such a reclassification, or a court of competent jurisdiction, such individual shall not retroactively be an Employee under this Plan. Such reclassified Employee may become a Covered Person in this Plan at such later time as the individual satisfies the conditions of participation set forth in this Plan. (Emphasis added.)

The Microsoft language, if present, may resolve the issue of retroactive coverage. What about coverage going forward? If a worker has provided services as an independent contractor but cannot retain that status under the ABC test, and is hired as a common-law, W-2 employee, does the first hour of service counted under the plan begin the day they become a W-2 employee, or the date they signed on as an independent contractor? The Microsoft provisions quoted above would suggest that service would start only when the common-law relationship starts, however employers are cautioned to read their specific plan documents carefully and to consult qualified employment and benefits law counsel for clarification. If the desire is to credit past service worked as an independent contractor, it may be advisable to seek IRS guidance before doing so, as fiduciary duties require that plan sponsors act in strict accordance with the written terms of their plan documents.

Finally, what about insured group health and welfare documents, such as fully insured medical, dental, vision, disability or life insurance? The policies and benefit summaries that govern these benefits probably won’t contain Microsoft language and may define eligible status as simply as “you are a regular full-time employee, as defined by your [Employer].”

Employers that are “applicable large employers” under the Affordable Care Act must count individuals who have been re-classified as common-law employees under the ABC test toward the group of employees to whom they offer minimum essential coverage; this group must comprise all but 5% (or, if greater, all but 5) of its full-time employees.  Unfortunately, there is potential ACA liability for failing the 95% offer on a retroactive basis. Public comments on the final employer shared responsibility regulations requested relief from retroactive coverage when independent contractors were reclassified as common-law employees, but the Treasury Department specifically failed to grant such relief, noting in the preamble to the final regulations that doing so could encourage worker misclassification.  Whether the customary 3-year tax statute of limitations would apply in such situations is not entirely clear; also unclear is whether employers could successfully argue that workers that fail the ABC test still somehow could classify as non-employees for federal common-law purposes.

Bottom line? Every California employer paying workers other than as W-2 employees should be re-examining those relationships under the ABC test and should be consulting qualified employment law counsel, and benefits law counsel, about the consequences of any misclassification, both on a retroactive basis (particularly with regard to the ACA), and going forward (all benefit plans).

[1] Another Ninth Circuit case, Burrey v. Pacific Gas & Elec. Co., 159 F.3d 388 (9th Cir. 1998), essentially followed the Microsoft ruling, but with specific regard to “leased employees” as defined under Internal Revenue Code § 414(n). A discussion of leased employees is beyond the scope of this post.

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Filed under 401(k) Plans, Affordable Care Act, Benefit Plan Design, Employer Shared Responsibility, Gig Economy, Independent Contractor, PPACA, Worker Misclassification