Category Archives: 401(k) Plans

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

Death, Taxes, and DOL Audits Persist

What this means for benefit plan sponsors and the professionals who advise them is that compliance with plan reporting and disclosure rules, and with the plan documentation duties that underpin them, must remain a priority. This is particularly the case with regard to health and welfare plans offering group medical, dental, vision, life, disability and similar forms of coverage, as opposed to 401(k) and other retirement plans.

That is because retirement plan service providers supply plan documentation to employers who engage their services, whereas insurance companies only provide benefit summaries designed to comply with state insurance laws rather than with the disclosure duties mandated under ERISA.

It is often left to benefit brokers and other third parties to the insurance (or self-funding) relationship, to bridge the gap, by drafting Summary Plan Descriptions and/or “wrap” documentations containing required ERISA disclosures, and by ensuring that they are properly delivered to plan participants and beneficiaries under Department of Labor protocols for hard copy and electronic distribution.

If you or your clients have any questions on what ERISA requires around plan documents and their delivery to the folks that they cover, please don’t hesitate to give me a call.

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Filed under 401(k) Plans, DOL Audit, ERISA, Fiduciary Issues, Plan Reporting and Disclosure Duties, Self-Insured Group Health Plans, Summaries of Benefits and Coverage, Wrap Documents

California Wildfires: Congress Grants Expanded Access to Retirement Savings

The recently-signed Bipartisan Budget Act of 2018 (the “Act”) expands access to 401(k) and other retirement plan savings for those impacted by the California wildfires that occurred late last year in federally-declared disaster areas including Santa Barbara and Ventura counties. The expanded access is available to individuals whose principal residence is or was located in the “California wildfire disaster area” at any time between October 8, 2017 to December 31, 2017 and who sustained an economic loss – whether personal or business – as a result of the wildfires, and whose employer agrees to amend their plan by December 31, 2019 to include the special rules (retroactive to 2018).   Those taking IRA withdrawals should check with their IRA custodians or trustees re: availability of the new measures.

As to whether the relief extends to those affected by flooding, mudflows, and debris flows directly related to the wildfires, there is some uncertainty in the wording of the Act. As mentioned above, eligible individuals are determined based on their residence on or before December 31, 2017, a date which preceded the January 9, 2018 flooding, mud and debris flow.  However, the Act defines “California wildfire disaster area” as the area subject to Presidential disaster declarations made between January 1, 2017 through January 18, 2018.  The original California wildfire disaster declaration was made January 2, 2018, and was amended on January 10 and 15 to incorporate damage from flooding, mudslides and debris flow directly related to the wildfires, which would suggest that those related types of damage would come within the scope of the relief. More guidance from the government would be helpful on this point.

There are three main types of expanded access:

  • Special withdrawal rules

-Eligible individuals may take plan or IRA withdrawals of up to $100,000 without application of the 10% penalty tax that ordinarily applies before age 59 ½.  Although California’s Franchise Tax Board generally follows federal disaster relief, a California early withdrawal penalty of 2.5% may apply, so check with your CPA.  The withdrawal must take place between October 8, 2017 and December 31, 2018.  The tax impact of the withdrawal may be spread over up to 3 years from the date of the withdrawal, or tax may be avoided entirely by repaying the full amount to the plan, or an IRA, within the same 3 year period.

  • Retirement plan loan relief

– An extension of up to one year applies to repayments due on a plan loan that was outstanding on or after October 8, 2017.  The one year extension does not cause the loan to exceed the maximum five-year repayment period.  Interest continues to accrue during the extension.

– New plan loans may be taken out on or after Feb. 9, 2018, through Dec. 31, 2018 in an amount up to the lesser of $100,000, or 100% of the vested retirement plan account (increased from $50,000 or 50%).   The limit is reduced by an amount equal to the highest outstanding balance of all loans during the prior twelve months.

  • Repayment of amounts taken out to buy or build a home in the disaster area

  –Persons who took hardship withdrawals from their plans after March 31, 2017 and before January 15, 2018 in order to buy or build a personal residence can re-deposit their withdrawals, or roll them to an IRA, by June 30, 2018, if the purchase or construction could not go forward as a result of the wildfires. The same relief is available to first-time homebuyer IRA withdrawals made during this time.

In earlier guidance, the IRS extended the filing deadline for personal and business income taxes by two weeks for those affected by the California wildfires, and California’s Franchise Tax Board granted equivalent relief for state returns. The new deadline for personal returns is April 30, 2018.

Note:  a version of this post was published in the Pacific Coast Business Times on February 23, 2018.

 

 

 

 

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Filed under 401(k) Plans, 403(b) Plans, Disaster Relief, ERISA, IRA Issues, Profit Sharing Plan

New Year Brings New, (Sometimes) Lower VCP User Fees

Effective January 2, 2018, the IRS has materially lowered the user fees required to be paid in order to participate in the Voluntary Compliance Program (VCP) under the Employee Plans Compliance Resolution System or EPCRS.  VCP is a way for sponsors of qualified retirement plans to get IRS approval of voluntary correction of operational errors and other plan errors that jeopardize the plan’s tax-qualified status.  Under old user fees, which were based on the number of plan participants as of the last day of a plan year, most applicants fell within the 100 – 1,000 participant range, which in 2017 carried a fee of $5,000.  The new fees, set forth in Appendix A to IRS Revenue Procedure 2018-1, are based on plan assets as of the last day of the plan year and are as follows:

User Fee               Plan Assets

$1,500                   $500,000 or less

$3,000                   Over $500,000 to $10,000,000

$3,500                   Over $10,000,000

As many if not most plan sponsors will fall in the over $500,000 to $10,000,000 range, this will result in a $2,000 reduction in the applicable user fee.

Lowering the price barrier to participation in VCP is a positive for plan sponsors.  Obtaining a compliance statement from IRS through the program is the equivalent of insurance against penalties and interest that would be assessed if the plan problems were discovered on audit.  The VCP compliance statement is also crucial in the event the plan sponsor sells its business or merges with another entity, as plan problems must be disclosed in the pre-deal due diligence stage, and unresolved plan problems can slow down or even derail a sale or merger transaction.  Speaking of insurance, some fiduciary liability insurance carriers will cover, and provide reimbursement for, the VCP user fee and professional services used in preparing the application (although generally amounts that are owed to the plan are not covered).

There is a downside to this new fee schedule, namely in the loss of reduced fees (as low as $300) for submissions that were limited to participant loan errors, failures to make required minimum distributions, and SEP and SIMPLE plan submissions.

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Filed under 401(k) Plans, 403(b) Plans, EPCRS, ERISA, Profit Sharing Plan, VCP

IRS Announces New Benefit Limits for 2018

olga-delawrence-386839On October 19, 2017 the IRS announced 2018 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 $18,500, but other dollar limits remained unchanged, including the compensation threshold for highly compensated employee status. Specifically, an employee will be a highly compensated employee (HCE) in 2018 on the basis of compensation if he or she earned more than $120,000 in 2017.  Citations below are to the Internal Revenue Code.

In a separate announcement, the Social Security Taxable Wage Base for 2018 increased to $128,400 from $127,200.

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

You Just Formed a New Business Entity. What Could Possibly Go Wrong?

What if a somewhat arcane area of tax law had potentially serious ramifications for attorneys and other tax advisors across a broad range of practices, but was not consistently identified and planned for in actual practice? That is an accurate description of the rules surrounding “controlled group” status between two or more businesses, which I have seen arise in business formation/transactions, estate planning, employment and family law settings.  The purpose of this overview is to briefly survey controlled group rules for non-ERISA practitioners, so that they can become aware of the potential complications that controlled group rules can create.

  1. Why Do Controlled Groups Matter?

The main reason they matter is because the IRS treats separate businesses within a controlled group as a single employer for almost all retirement and health benefit plan purposes. In fact, annual reporting for retirement plans (and for health and welfare plans with 100 or more participants) requires a statement under penalty of perjury as to whether the employer is part of a controlled group.  Therefore controlled groups are most frequently a concern where business entities have employees and particularly when they sponsor benefit plans, whether retirement/401(k), or health and welfare plans.  Note, however, that creation of a business entity that has no employees can still create a controlled group issue when it acts as a conduit to link ownership of two or more other entities that do have employees.

Being part of a controlled group does not always mean that all employees of the member companies have to participate in the same benefit plan (although it can sometimes mean that). However it generally means that separately maintained retirement plans have to perform nondiscrimination testing as if they were combined, which not infrequently means that one or more of the plans will fail nondiscrimination testing.  This is an event that usually requires the employer sponsoring the plan to add more money to the plan on behalf of some of the additional counted employees, or to pay penalty taxes in relation to same.  Similar complications can arise in Section 125 cafeteria or “flexible benefit plans,” and for self-insured group health plans, which are subject to nondiscrimination requirements under Code § 105(h).  Nondiscrimination rules are meant to apply to insured group health plans under the Affordable Care Act (“ACA”), so additional complications could arise in that context when and if the rules are enforced by the IRS, following publication of regulatory guidance.

Controlled group status can also mean that several small employers together comprise an “applicable large employer” subject to the ACA “pay or play rules,” and related annual IRS reporting duties. Small employer exceptions under other laws, including COBRA and the Medicare Secondary Payer Act, reference controlled group status when determining eligibility for the exception.

  1. How Do I Identify a Controlled Group?

 Determining controlled group status requires synthesizing regulations and other guidance across multiple Internal Revenue Code (“Code”) provisions and therefore is a task for a specialized ERISA or tax practitioner.  What follows are very simplified definitions aimed at helping advisors outside that specialized area flag potential controlled group issues for further analysis.

Strictly speaking, the term “controlled group” refers to shared ownership of two or more corporations, but this article uses the term generically as it is the more familiar term.  “Ownership” in this context means possession of the voting power or value of corporate stock (or a combination thereof).  Shared ownership among other types of business entities is described as “a group of trades or businesses under ‘common control.’”  Ownership in this context refers to ownership of a capital or profits interest in a partnership or LLC taxed as a partnership.   Controlled groups can also arise in relation to tax-exempt entities, for instance if they own 80% or more of a for-profit entity, or even between two tax-exempt entities where there is substantial overlap of board membership or board control.

Complex interest exclusion rules mean that not all ownership interests are counted towards common control; exclusion may turn on the nature of the interest held (e.g., treasury or non-voting preferred stock) or on the party holding the ownership interest (e.g, the trust of a tax-qualified retirement plan).

The two main sub-types of controlled group are: parent-subsidiary, and “brother-sister,” although a combination of the two may also exist.  A parent-subsidiary controlled group exists when one business owns 80% or more of another business, or where there is a chain of such ownership relationships. As that is a fairly straightforward test, I will focus on the lesser known, but more prevalent, brother-sister type of controlled group.

A brother-sister controlled group exists when the same five or fewer individuals, trusts, or estates (the “brother-sister” group) have a “controlling interest” in, and “effective control” of, two or more businesses.

  • A controlling interest exists when the brother-sister group members own, or are deemed to own under rules of attribution, at least 80% of each of the businesses in question.
  • Effective control exists when the brother-sister group owns or is deemed to own greater than 50% of the businesses in question, looking only at each member’s “lowest common denominator” ownership interest. (So, a group member that owed 20% of one business and 40% of another business would be credited only with 20% in the effective control test.)
  • In order to pass the 80% test, you must use the interests of the same five or fewer persons (or trusts or estates) used for purposes of the greater than 50% test.  See US v. Vogel Fertilizer, 455 US 16 (1982). Put otherwise, the two tests consider only owners with a greater-than-zero interest in each of the businesses under consideration. If, under this rule, you disregard shares adding up to more than 20% of a business, the 80% test won’t be met and that business generally won’t form part of the controlled group. (Although the remaining businesses may do so.)

The controlled group attribution rules are quite complex and can only be touched on here. Very generally speaking, an ownership interest may be attributed from a business entity to the entity’s owner, from trusts to trust beneficiaries (and to grantors of “grantor” trusts as defined under Code § 671-678), and among family members. Stock options can also create attributed ownership under some circumstances.  The attribution rules can have surprising consequences. For instance, a couple, each with his or her wholly-owned corporation, will be a controlled group if they have a child under age 21 together, regardless of their marital status, because the minor child is attributed with 100% of each parent’s interests under Code §1563(e)(6)(A).  Community property rights may also give rise to controlled group status. Careful pre-marital planning may be necessary to prevent unintended controlled group status among businesses owned separately by the partners to the marriage.

This is the first part of a two-part discussion that was first published as an article in the Santa Barbara Lawyer Magazine for October 2017.  The second half will address a variation of these rules that are specific to businesses formed by doctors, dentists, accountants, and other service providers.

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Filed under 401(k) Plans, ADP and ACP Testing, Affordable Care Act, Benefit Plan Design, Cafeteria Plans, COBRA, Common Control Issues, Employer Shared Responsibility, ERISA, Health Care Reform, Nondiscrimination Rules for Insured Health Plans, Nondiscrimination Testing for Qualified Retirement Plans, Plan Reporting and Disclosure Duties

The Emerging Benefit Trend of Student Loan Assistance

Employers are by now familiar with the scary statistics on mounting student loan indebtedness, including that approximately 71% of 2015 college seniors graduated with a student loan, and almost 80% of millennials believe that student loan debt will make it harder for them to meet their financial goals.  Per Mark Kantrowitz of Cappex.com, the average student loan balance increased by almost 50% between 2005 and 2015, and now hovers around $35,000 per graduate.

Large student loan debt impacts current employees and prospective new hires in many ways: it may cause rejection of a desired position or promotion due to income needs, it may postpone retirement plan participation due to cash flow needs, and it may delay or even rule out home ownership or starting families, leading to a less stable and community-involved workforce.

Employers want to be able to help mitigate some of the downside of high student loan debt among their employees, but their efforts are hindered by the fact that employer loan payments on behalf of an employee are currently taxable to the employee.

Several pieces of new legislation proposed for the 2017-2018 Congressional term encourage or facilitate employer assistance with student loan repayments through tax incentives. A survey of some of these measures follows:

The Higher Education Loan Payments (HELP) for Students and Parents Act (H.R. 1656)

  • This measure would permit employers to make up to $5,250 per year in tax-free student loan repayments on behalf of employees, and provide an employer tax credit based on 50% of contributions made within that dollar limit.
  • It would also permit employers to make up to $5,250 per year in the form of “qualified dependent 529 contributions” direct to employees’ tax-exempt tuition savings accounts set up on behalf of their children (up to age 19; students up to age 24), and would provide a corresponding 50% employer tax credit.
  • If passed it would thereby double the current $5,250 limit on employer education assistance under Internal Revenue Code (“Code) § 127.
  • Significant for smaller employers, the HELP for Students and Parents Act would treat sole proprietors and partners as employees for purposes of the excludible contributions.

The Student Loan Repayment Act (H.R. 615)

  • This bill would offer employers a 3-year business tax credit equal to 50% of startup costs for a student loan program (up to $500 per participating employee) under which the employer matches employees’ student loan repayments, up to $2,000 per year.
  • The startup costs are program creation costs, not amounts used for employer matching contributions.
  • The bill would also allow employers who hire “qualified student loan repayers” to claim the Work Opportunity Tax Credit, which encourages hiring of select populations such as veterans and recipients of certain types of public assistance. A “qualified student loan repayer” must have at least an associate’s degree, and outstanding education loans of at least $10,000.

The Student Loan Repayment Assistance Act (H.R. 108)

  • This bill would amend the Code to allow businesses a tax credit for employer-paid student loan repayments made direct to the lender, equal to 10% of the amounts that the employer pays on behalf of any employee, not to exceed $500 per employee per month.
  • The credit would be refundable for small businesses and non-profits who cannot use the credit against taxes.
  • The bill would require a written plan document, notice to employees, annual reporting to IRS and must be made “widely available” to employees (not discriminate in favor of “highly compensated employees”).

The Retirement Improvement and Savings Enhancement (RISE) Act of 2016

  • This measure took the form of a discussion draft in the 2014-2016 Congress but likely will be re-introduced in the current 115th Congress.
  • It would permit employers to make matching contributions to an employee’s 401(k) or SIMPLE IRA account based on his or her student loan repayments, essentially treating employee student loan repayment as equivalent of a 401(k) salary deferral.
  • Its retirement provisions would also curtail currently permissible IRA strategies including “mega Roth IRAs” and stretch IRAs, and would permit IRA contributions after reaching age 70 1/2.

As legislative efforts progress, vendors are already stepping in to the breach. Tuition.io provides a software interface that permits employer money to go direct to repay student loans, without going through employee pay.  The average employer contribution per paycheck is $50 – $200.   Other vendors include Student Loan Genius, PeopleJoy, Peanut Butter, and Gradifi.

One compliance question that these programs raise is whether student loan repayment programs would comprise ERISA plans, subject to trust and reporting requirements, or simply be viewed as “payroll practices” exempt from Title I of ERISA.  They do not provide retirement income or defer compensation to retirement age, thus would not likely be an ERISA pension plan, and do not provide benefits within the definition of ERISA “health and welfare” plans, so probably would not fall within ERISA’s scope.  This should help encourage formation of these programs by employers, as ERISA compliance burdens can be complicated and costly. Employers may still need to meet certain requirements in order to ensure tax-qualified status, however, as in the case of the Student Loan Repayment Assistance Act, which imposes documentation, notice and reporting duties.

Employers that want to address their employees’ student loan debt through workplace financial assistance can take the following steps to help select the program or policy that best suits their needs:

  • Talk to your recruiters and use other methods to estimate the student loan burden faced by your staff and new hire candidates.
  • Carefully evaluate various student loan aid vendors and identify those with the best fit for your organization.
  • Invest time in plan design and scheduling a roll out.
  • Remember that communication and ease of use are both key success factors.
  • Continue to monitor legislation for new assistance options.

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Filed under 401(k) Plans, Benefit Plan Design, IRA Issues