Category Archives: Benefit Plan Design

Does Your Retirement Plan Incorporate State Law Into the Plan?  Check Your Spousal Benefit Obligations!

jordan-mcdonald-766295-unsplashRetirement plan documents are contracts and generally they contain a “choice of law” provision.  The choice of law provision dictates what laws will govern interpretation of the contract, for instance in the event of a dispute over the contract’s application.  A recent, unpublished Ninth Circuit court opinion held that the Plan’s choice of California law required the plan to provide spousal survivor rights to registered domestic partners, because California law affords registered domestic partners the same legal status as spouses, and because doing so did not conflict with any provision of the plan document, ERISA or the Internal Revenue Code.  In light of the opinion, plan sponsors should examine their plan documents to determine whether or not choice of law provisions carry state domestic partner rights into their plan document, and if this is the case, should consult with counsel as to how that might impact their plan distribution and plan loan approval procedures, and QDRO procedures as well.

In Reed v. KRON/IBEW Local 45 Pension Plan, No. 4:16-cv-04471-JSW (9th Cir. May 16, 2019), plaintiff David Reed entered into a long-term relationship with Donald Gardner in 1998.  Gardner was an employee at KRON-TV and a participant in the KRON/IBEW Local 45 Pension Plan, a union-management sponsored defined benefit pension plan.  In addition to a choice of law provision that invoked California law, to the extent consistent with ERISA and the Internal Revenue Code, the KRON plan document did not limit the term “spouse” or “married” to opposite-sex spouses.

In 2004, Reed and Gardner registered as domestic partners under California law.  Registered domestic partners have had the same status under California law as legally married spouses since the California Domestic Partnership Rights and Responsibilities Act of 2003 went into effect on January 1, 2005.[1]

Gardner retired in 2009 and began receiving pension benefits under the plan.  Prior to retiring he attended meetings with KRON-TV’s human resources department together with Reed.  Although HR knew that the couple were registered domestic partners (Reed, for example, received benefits under the group health plan), the HR personnel did not mention the availability of a joint-and-survivor form of benefit under the Plan.  Gardner accordingly elected a single life annuity form of benefit.  He also designated Reed as his beneficiary under the Plan.

Gardner and Reed married in May 2014, five days before Gardner passed away.  Reed submitted a claim for survivor’s benefits under the plan.  Although the Pension Committee of the Plan never formally responded to Reed’s claim, Reed was deemed to have exhausted his administrative remedies and filed suit in federal court against the Plan, the Pension Committee, and the parent company of KRON-TV.  The federal trial court granted the Plan Committee’s motion for judgment on the pleadings, finding that it did not abuse its discretion in denying Reed’s benefit claim.

On appeal, a three-judge panel of the Ninth Circuit reversed the trial court and remanded the case with instructions to determine the payments owed to Reed.  The panel stated:

“The Committee abused its discretion by denying benefits to Reed. During either time the Committee evaluated the Plan’s benefits in this case—in 2009 or in 2016—California law afforded domestic partners the same rights, protections, and benefits as those granted to spouses. See Cal. Fam. Code § 297.5(a); see also Koebke v. Bernardo Heights Country Club, 36 Cal. 4th 824, 837-89 (2005). Neither ERISA nor the Code provided binding guidance inconsistent with applying this interpretation of spouse to the Plan. See United States v. Windsor, 570 U.S. 744 (2013) (striking down the Defense of Marriage Act’s definitions of “spouse” and “marriage” as unconstitutional); cf.26 C.F.R. § 301.7701-18(c) (as of September 2, 2016, the Code excludes registered domestic partners from the definition of “spouse, husband, and wife”). Therefore, because Reed and Gardner were domestic partners at the time of Gardner’s retirement, the Committee should have awarded Reed spousal benefits in accordance with California law, as was required by the Plan’s choice-of-law provision.”

Despite the fact that the Internal Revenue Code does not recognize domestic partners as equivalent to spouses, this did not limit the terms of the plan document; in this regard Reed successfully argued that federal law established a floor, but not a ceiling, for drafting the terms of the plan.  This case is of particular relevance to plan sponsors in California and Hawaii, as both states fall within the Ninth Circuit, and both states grant domestic partners the same rights as married couples.[2]  As mentioned, if domestic partner rights are imported into the plan document, they may be implicated even in the absence of joint and survivor annuity provisions.  For instance, if the plan document expressly requires spousal consent for a loan or hardship withdrawal, domestic partner approval in such instances may be required, and QDRO procedures may have to be expanded.

For this to be the case, the plan’s choice of law provision must invoke the law of a state which grants to domestic partners rights equal to those of spouses, and the plan must also not define “spouse” in a more limiting way, for instance by limiting the term to legally married couples. These factors are more likely to be present in individually drafted retirement plans, whether in a “Taft-Hartley” plan such as the KRON plan, or in a document drafted specifically for a unique single employer.

The situation posed in the Reed case is not as likely to occur under a pre-approved plan document.  Fidelity’s Volume Submitter Defined Contribution Plan (Basic Plan Document No. 17), for instance, defines “spouse” as “the person to whom an individual is married for purposes of Federal income taxes.”  This, then, would include same-sex and opposite-sex spouses, but would exclude domestic partners, irrespective of the Fidelity plan document’s choice of law provision (which invokes the laws of the Commonwealth of Massachusetts).

By contrast, the Empower basic plan document (formally, the Great-West Trust Company Defined Contribution Prototype Plan and Trust (Basic Plan Document #11)) allows the plan sponsor to define “spouse” in Appendix B to the Adoption Agreement.  If the plan sponsor fails to specify a definition, the basic plan document choice of law clause (Section 7.10(H)) defaults to the law of the state of the principal place of business of the employer, to that of the corporate trustee, if any, or to that of the insurer (for a fully insured plan).  Plan sponsors using an Empower prototype document may want to consult benefits counsel as to the consequences of the default language as applied to their specific factual circumstances.

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, Defense of Marriage Act, ERISA, GINA/Genetic Privacy, Profit Sharing Plan, Qualified Domestic Relations Orders, Registered Domestic Partner Benefits, Same-Sex Marriage, Uncategorized

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

#10YearChallenge for 403(b) Plans

The #10YearChallenge on social media these days is to post a picture of yourself from 2019, next to one from 2009, hopefully illustrating how little has changed in the 10 year interim. For tax-exempt employers who sponsor Section 403(b) plans, however, 2019 brings a different #10YearChallenge – namely, to bring their plan documents – many of which date back to 2009 – into compliance with current law.

The actual deadline to restate your 403(b) plan (technically, the end of the “remedial amendment period”) falls on March 31, 2020, but vendors of 403(b) documents that have been pre-approved by the IRS will proactively be sending clients document restatement packages this year, in order to avoid the inevitable crunch just prior to the 2020 deadline. The restatement deadline is an opportunity to retroactively restate the plan document (generally, to January 1, 2010) to correct any defects in the terms of the plan documents, such as missed plan amendments. It is also the last chance for tax-exempt employers with individually designed plan documents to restate onto a pre-approved document, as the IRS does not now, and does not intend to, issue approval letters for individually designed 403(b) plans

There are significant differences in the 403(b) document landscape in 2019, as compared to 2009. Back in 2009, which was the year the IRS first required all 403(b) plan sponsors to have a plan document in place, there were no IRS pre-approved documents. Now, in 2019, numerous vendors offer pre-approved documents that individual tax-exempt employers can (somewhat) tailor to their needs (for instance, through Adoption Agreement selections). The IRS pre-approved documents are much lengthier than the documents that were adopted in 2009. For instance, the Fidelity Adoption Agreement from 2009 was approximately 6 pages long, including attachments, but the 2019 restatement version, with attachments, is approximately 49 pages long. This difference is down to changes in the laws governing retirement plans, as well as increased sophistication of plan administration and recordkeeping systems over that time.

Due to increasing complexity in plan design and administration, employers may want to take the restatement opportunity to self-audit their plan administration procedures and to confirm that they are consistent with the way the document, as restated, reads. For instance, does the payroll department, whether internal or outsourced, draw from the correct payroll code sources when processing employee salary deferrals and employer matching or nonelective contributions? Does the plan contain exclusions from the definition of compensation that are being ignored when payroll is processed? Are participant salary deferrals and loan repayments timely being remitted to the plan? The self-audit is a good opportunity to catch any operational errors and correct them under IRS or Department of Labor voluntary compliance programs (e.g. Employee Plans Compliance Resolution System, and Voluntary Fiduciary Correction Program).

Pre-approved document vendors (often also the investment providers) will assist employers in migrating their 2009 (or subsequent) plan document provisions over to the new version of the document, but employers should seek assistance from benefit counsel in this process to limit the chance of errors. Benefit counsel can also help conduct a self-audit, or take employers through the voluntary correction programs in the event any operational errors are uncovered.

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Filed under 403(b) Plans, Benefit Plan Design, ERISA, Payroll Issues, Tax-Exempt Organizations

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 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

It’s (Summer) Time for Wellness Plan Re-Design

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Now that summer is here, there are only a few more months until benefit plan open enrollment for 2019 gets underway. Employers who maintain a wellness program that includes biometric testing, health risk assessments (HRAs), or medical questionnaires need to think now about how they will design their plan in the new year, as changes to the rules governing these wellness features go into effect.  This post outlines the changes and discusses the new design landscape for 2019.

What are the Changes?

During 2017 and 2018, final regulations under the Americans with Disabilities Act (ADA) limit the financial incentive employers may offer in exchange for participating in biometric testing, HRAs or medical questionnaires, to an amount equal to 30% of the cost of individual coverage (both the employee and employer portions.) The same limit applies to surcharges or penalties for not taking part.  Companion regulations under Title II of the Genetic Information Nondiscrimination Act (GINA) apply the same cap to completion of an HRA or medical questionnaire by an employee’s spouse, because manifestation of a disease or disorder in a family member comprises genetic information on the employee.  The ADA regulations also disallow the 20% additional incentive tied to tobacco use, if the wellness program includes a blood test for nicotine or cotinine.  The ADA and Title II of GINA apply to employers with 15 or more employees.   We discussed the ADA and GINA rules in a prior post.

The American Association of Retired Persons (AARP) challenged the 30% incentive limit in court on the grounds that the Equal Employment Opportunity Commission (EEOC) failed to prove that this cap was necessary in order for participation in the biometric testing or health risk assessment (HRA) to be “voluntary” and not coercive, which is an ADA requirement.

A federal court agreed with the AARP, and vacated the 30% incentive cap effective January 1, 2019.  (Other provisions of the ADA regulations, including notification and confidentiality rules, remain in effect.)  The court also lifted a requirement that the EEOC publish new proposed regulations on the voluntary standard by August 31, 2018.   The EEOC may issue regulations in the future (and could appeal the court decision), but wellness program design for 2019 must get underway in the absence of clear guidance on the voluntariness standard.

2019 Design Landscape

The chart below illustrates the wellness rule landscape effective January 1, 2019 for employers that are subject to the ADA. Wellness regulations under HIPAA and the ACA will continue to apply, but they do not impose any limit on incentives (or penalties) for biometric testing or HRAs that are “participation only” i.e., that do not require physical activity, or specific health outcomes.

Despite the vacated EEOC standard, employers should exercise caution in setting financial incentives for biometric testing, HRAs or medical questionnaires.  Even prior to issuing regulations, the EEOC had challenged wellness programs in several court actions, ranging from a program that conditioned biometric testing and completion of an HRA on a $20 per paycheck surcharge, to one that conditioned 100% of the premium cost on taking part in an HRA. Although the cases generally were resolved in favor of the employer, they make clear that EEOC may view even modest incentives as failing the voluntary standard.

Employers should also make sure that their wellness program follows up after gathering health data through biometric testing, HRAs or medical questionnaires, with information, advice, or programs targeted at health risks.  A wellness program that fails to do so would not qualify as an employee health program under the ADA and the voluntary wellness program exceptions would not be available.

So what are some options for 2019? There are several design “safe harbors” that do not trigger the ADA voluntariness standard:

1) Eliminating biometric testing/HRAs/medical questionnaires altogether.

2) Keeping biometric testing/HRAs/medical questionnaires, but removing any financial incentive or penalty that applied to them.

3) Offering smoking cessation programs that request self-disclosure as a tobacco user (no blood test for nicotine, cotinine).

Limiting financial incentives/penalties for biometric testing/HRAs/medical questionnaires to an amount that does not exceed 10 – 15% of the individual premium is another option. This range is just high enough to encourage participation, but it is under 20%.  In AARP v. EEOC, the court’s August 2017 ruling on summary judgment cited a RAND study noting that “high powered” incentives of 20% or more may place a disproportionate burden on lower-paid employees.

What about different incentive levels for different groups of employees? First, this may be administratively impractical, and second, it might run afoul of the HIPAA/ACA requirement that the full wellness incentive or reward be made available to all “similarly situated” individuals.  Groupings of employees for this purpose must be based on bona fide, employment-based classifications that are consistent with the employer’s usual business practice, such as between full-time and part-time employees, hourly and salaried, different lengths of employment, or different geographic locations.   For many employers, these criteria may not always neatly overlap with different compensation levels.

In sum, employers who do not wish to eliminate biometric testing and HRAs/medical questionnaires from their wellness programs should anticipate living with some uncertainty about whether their financial incentives meet ADA standards.   Engaging in careful planning in the coming weeks, together with benefit advisors and legal counsel, can help keep the risk to a minimum.

 

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Filed under Affordable Care Act, Americans with Disabilities Act, Benefit Plan Design, GINA/Genetic Privacy, HIPAA and HITECH, PPACA, Uncategorized, Wellness Programs

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