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

As employers who sponsor cafeteria plans know, flexible spending accounts (FSAs) under those plans have had a “use it or lose it” rule. Under that rule, employees who participate in the spending accounts must make elections at the beginning of the year to set aside amounts to pay medical expenses under a medical FSA or dependent care expenses under a dependent care FSA and must forfeit amounts if insufficient claims were incurred during the applicable period. The applicable period is the end of the plan year or, if the employer has so designed the plan, at the end of a grace period which can be as long as 2½ months after the close of the plan year.

The risk of forfeiture discourages employees from taking advantage of the FSAs, which otherwise allow employees to pay for medical expenses or dependent care expenses on a pre-tax basis. The concern is particularly prevalent among lower paid employees who do not want to assume the risk of loss with respect to the accounts. The IRS recently announced a change in the rule, a change available even for the 2013 plan year.

Under the changed rule, a plan participant can roll over up to $500 of unused amounts from one plan year to the next. The rollover is allowed only for medical FSAs and not for dependent care FSAs. On the other hand, because dependent care expenses are often more predictable, employees have generally had fewer forfeitures of dependent care expenses.

The maximum amount that an employee can elect to contribute to a medical FSA is $2,500 for a year. That limit was imposed effective in 2013 by the Affordable Care Act, the healthcare reform law. An employee who rolls over the $500 can still elect $2,500 the following year, giving that employee an account of $3,000 for the following year. Both the newly elected amount plus the amount rolled over are available for reimbursement for medical expenses incurred during the following plan year. Of course, if the employee terminates employment and does not elect COBRA with respect to the FSA, unused amounts may ultimately be forfeited.

Employers are not required to provide the rollover. Employers that do may not also provide a grace period under the plan, the 2½ month period after the close of the plan year during which a participant can continue to incur claims against the prior year’s election. A plan may offer either the grace period or the rollover provision, but not both.

An employer that wants to add the rollover feature must adopt a plan amendment to do so. The plan amendment must generally be adopted by the end of the plan year in which the rollover will become effective. However, with one exception for the 2013 plan year, the amendment can be adopted by the end of the 2014 plan year so long as the plan is administered in accordance with the new feature. The exception involves the grace period:  If the plan provides a grace period, the plan must be amended to remove it by the last day of the plan year to which it relates. In other words, a grace period associated with the 2013 plan year must be removed by December 31, 2013.

Employers interested in adding this new feature should discuss with their third party administrators how the provision will work in operation and contact their plan document providers about making the change.

The Internal Revenue Service has released the 2014 cost of living adjustments affecting dollar limits on benefits and contributions under qualified retirement plans. http://www.irs.gov/Retirement-Plans/COLA-Increases-for-Dollar-Limitations-on-Benefits-and-Contributions.  The following chart summarizes 2014 retirement plan limits and other benefit plan limits. The 2013 limits are also listed for reference purposes:

2013

2014

 

Elective Deferral   Limit 401(k), 403(b), 457(b)

$17,500

$17,500

 

Catch-up Limit (age   50+)

$5,500

$5,500

 

Defined Benefit Limit

$205,000

$210,000

 

Defined   Contribution Limit

$51,000

$52,000

 

Dollar Limit –   Highly Compensated Employees

$115,000

$115,000

 

Officer-Key   Employee

$165,000

$170,000

 

Annual Compensation   Limit

$255,000

$260,000

 

SEP Eligibility Compensation   Limit

$550

$550

 

SIMPLE Deferral   Limit

$12,000

$12,000

 

SIMPLE Catch-up   Limit (age 50+)

$2,500

$2,500

 

Social Security   Taxable Wage Base

$113,700

$117,000

 

ESOP 5 Year   Distribution Extension

Account minimum

Additional amount for   1 year extension

$1,035,000

$205,000

$1,050,000

$210,000

 

HSA (self/family)

Maximum annual   contribution

HDHP minimum   deductible limits

Out-of-pocket expense   annual maximum

$3,250/$6,450

$1,250/$2,500

$6,250/$12,500

$3,300/$6,550

$1,250/$2,500

$6,350/$12,700

Many employers know that with few exceptions a participant’s benefit in a tax qualified retirement plan is protected from the participant’s creditors. One exception is for court orders, known as qualified domestic relations orders or QDROs, that split a benefit between the participant and a former spouse or dependent in the event of divorce. Another exception is for crime committed by a fiduciary against a plan where the plan can retain the fiduciary’s benefit to reimburse the plan under certain circumstances. However, there is no exception that allows an employer to keep an account balance if the participant has committed a crime against the employer.

A recent federal district court case made that point clear. The case involved an individual participant who embezzled funds while working for the employer. The employer obtained a judgment against the participant for more than $19 million. When the employer terminated its defined contribution plan, the employer retained the participant’s account balance of approximately $22,000 in partial satisfaction of that judgment. The participant sued and the court held that the employer was not permitted to keep the participant’s plan benefit.

Participants can voluntarily direct the trustee or plan administrator to pay another person their plan benefit. However, this case makes clear that even where the participant owes the employer a lot of money and even when the money owed is the result of a crime, the employer is not allowed to keep the participant’s qualified plan benefit.

I blogged here and here about Quality Stores, a case in which the Sixth Circuit Court of Appeals held that severance pay is not subject to FICA (Social Security) taxes if certain requirements are met: The severance payments must be made pursuant to a plan, on account of an involuntary termination, and the result of a reduction in force (RIF), plant closing or similar event. The Sixth Circuit decision conflicts with the views of the IRS, whose position is that severance pay is subject to FICA taxes, and at least one other court, which upheld the IRS’s position.

Not all severance payments meet the criteria under Quality Stores for the FICA exemption. However, employers who have paid (and withheld) FICA taxes from severance payments that meet the criteria may wish to file a protective claim for a refund of those taxes. Generally speaking, the statute of limitations to seek a refund of FICA taxes on severance payments made in 2010 is April 15, 2014. The Supreme Court is likely to issue its decision by June of 2014. The statute of limitations for 2011 and later years is not likely to expire before the Supreme Court reaches its decision.

Employers who have paid significant FICA taxes on severance amounts over the last few years will want to follow this case and file refund claims if the Court upholds the Sixth Circuit decision. Employers with enough at stake in 2010 FICA taxes may wish to file a protective refund claim before that statute of limitations expires on April 15, 2014.

Over the years we have seen some employers, particularly small employers, choose to provide health coverage to their employees by paying all or part of the premium for individual insurance policies that the employees have obtained. Under an old IRS revenue ruling, Rev. Rul. 61-146, that type of premium subsidy could be provided on a pre-tax basis so long as the employer either paid the insurance company directly or reimbursed the employee for the cost of the coverage. Some employers have been considering that model for providing coverage to employees under the Affordable Care Act (“ACA”). Employers were hoping that by providing funds to employees to purchase coverage on the individual market, the employer could avoid the penalty for failure to offer coverage while limiting the employer’s cost. In recently issued guidance, the IRS and the Department of Labor have essentially said no to this alternative.

Under the ACA, employers who offer group health plans must not impose any annual or lifetime limits on essential health benefits. They must also provide preventive health services without copays or coinsurance. Insurance policies in the individual market will provide that first dollar coverage for preventive care and will not have the annual limits. Thus, employers thought that by subsidizing those coverages the employers would meet the requirement for providing health care coverage without those limits. In recently issued guidance the IRS and the Department of Labor (DOL) have made it clear that premium subsidies for individual coverage will not be viewed as meeting those requirements.

The technical way that the IRS and DOL reach this conclusion is by viewing the premium subsidy plan as a health reimbursement arrangement or HRA, which is a type of group health plan funded by the employer. Under an HRA, an employer provides covered employees with a fixed dollar amount annually to be used for health care expenses. Sometimes excess amounts can be carried over from year to year. The reimbursements available under the HRA are limited to the amount in the account. The IRS and the DOL have said that such an arrangement does not need to meet health care reform requirements, such as no annual limits and preventive care coverage, only if it is “integrated” with a plan that provides that coverage. The new guidance says that an HRA can be “integrated” only with a group health plan and not with an individual market plan. Therefore, an employer can continue to pair an HRA with a group health plan but cannot pair the arrangement with an individual health insurance policy and avoid ACA penalties.

The guidance also states that because an HRA is a group health plan, coverage under an HRA is considered minimum essential coverage for purposes of health care reform’s individual mandate. Under the individual mandate, most people in the United States must maintain minimum essential health coverage or pay a tax penalty. Individuals who are not offered such coverage by their employers can obtain premium subsidies through the Marketplace, previously known as the Exchange. Because HRA coverage can be minimum essential coverage, employers offering such coverage must give employees the ability to elect out of the coverage on termination of employment and annually while employed. That will allow employees to forego HRA coverage in favor of coverage under the Marketplace with a premium subsidy. The IRS and DOL reached this result by requiring “integrated” HRAs (which are the only HRAs that meet health care reform requirements) to allow such opt outs.

The IRS did not revoke the 1961 Revenue Ruling permitting pre-tax payment of employee premiums for individual market policies.  Some employers are hoping that they can continue to allow employees to pay for individual market health insurance policies on a pre-tax basis through a cafeteria plan even if the employer provides no subsidy for the coverage.  The recent guidance is not clear on that point.  Small employers are permitted to subsidize policies on the Marketplace through the Small Business Health Option Program or SHOP that is part of the Marketplace. This will allow small employers to establish programs to subsidize coverage that employees choose, but employees will be limited to the plans available under SHOP.

Under the ACA, there is a $100 a day excise tax imposed on employers who sponsor group health plans that fail to meet the annual limit and preventive care requirements.  Small employers are not exempt from this tax.

The new guidance is effective for plan years beginning on or after January 1, 2014. Employers thinking that they could rely on premium subsidies for individual health insurance coverage will need to rethink their strategy for providing health coverage to their employees.

I blogged last year (here and here) about a couple of decisions in which courts concluded that various related companies were part of a controlled group of trades or businesses and therefore liable for the withdrawal liability of one of the companies. As I mentioned in earlier blogs, the courts have noted that to be a trade or business, the taxpayer’s activities must be different from “investment activities or hobbies.” One of the cases was a district court opinion involving a private equity fund that had made an investment in a company that participated in a multiemployer pension plan. The district court had concluded that the equity fund’s participation in the company was consistent with an investment activity so neither the fund nor other businesses owned by the fund were considered to be trades or businesses that were part of a controlled group and therefore liable for the multiemployer withdrawal liability of the company.

The case was Sun Capital Partners III LP v. New England Teamsters & Trucking Industry Pension Fund from the District of Massachusetts. That district court decision has now been reversed by the Court of Appeals for the First Circuit.

The First Circuit noted that the equity fund touted its expertise in turning around troubled companies. The First Circuit used an “investment plus” test, determining that activities over and above mere investment would be required to create a trade or business. The appeals court noted that the equity fund became actively involved in the management and operation of the portfolio company. The activities were sufficient to make the equity fund a trade or business. Therefore, it and the withdrawing company, in which it had a greater than 80% ownership interest, were part of a controlled group of trades or businesses.

This decision increases the risk for equity funds that they will be found to be trades or businesses and part of a controlled group with their portfolio companies. If so, it will increase the potential liability to them if they purchase companies with multiemployer plan withdrawal liability.

The implications could also be broader. Although the statute being interpreted was ERISA, the Internal Revenue Code contains a similar controlled group concept that applies to a number of rules under the Internal Revenue Code, including 401(k) and other qualified plan nondiscrimination testing, certain welfare benefit plan testing and certain executive compensation matters. If this interpretation is held to apply under the tax code as well, a private equity fund may need to pay closer attention to the application of the controlled group rules to the employee benefits of the fund itself and all the portfolio companies that it controls.

I recently blogged (here and here) about a situation involving Verizon withholding US taxes from payments to former employees who never lived or worked in the U.S. The employees attempted to recover the withheld taxes from Verizon on a breach of fiduciary duty claim against the employer and also attempted to have the withholding taxes refunded directly from the IRS but filed the refund claim too late. Another recent withholding case might result in recovery for the former employees.

To understand this case, we need to review the Social Security (FICA) taxation of nonqualified deferred compensation benefits. Nonqualified deferred compensation payments are generally taxed for income tax purposes at the time that the benefits are paid or made available to the individual. In contrast, nonqualified deferred compensation payments are taxed for FICA tax purposes at the earlier of when the amounts are paid or when they vest. Thus, if benefits under a nonqualified deferred compensation plan vest when an employee reaches a retirement age, FICA taxation applies at that time to the present value of the entire benefit. If that taxation occurs in a year in which the employee has already been paid an amount equal to the FICA wage base ($113,700 in 2013), then the individual is required to pay only the Medicare portion of the FICA tax, a relatively small amount. Although there is generally no cap on the wages subject to Medicare taxation, the Medicare tax is only 1.45% of the benefit rather than 6.2%, which is the Social Security portion of the FICA tax.[1]

In a recent federal district court decision, a former employee filed a class action seeking to recover amounts withheld as taxes from his nonqualified deferred compensation benefit. That benefit vested on his retirement and his employer should have withheld and paid FICA taxes on the present value of the benefit at that time; however, the employer failed to do so. A number of years later, the employer determined that it had mishandled the FICA taxes at retirement. Because of that mishandling, under the FICA tax regulations, the employer was now required to withhold FICA taxes from each benefit payment as it was made. The employer paid the back FICA taxes to the IRS and reimbursed itself by reducing the former employee’s monthly benefit payments for several months. The employer also began withholding FICA taxes from each benefit payment.

The former employee sued claiming harm because the amount of FICA taxes to be paid from each benefit payment is quite a bit more than the amount that would have been owed had the FICA taxes been imposed at the time of retirement. The employer claimed that the suit was one to stop withholding which is not permitted under the tax code. The district court disagreed, saying that the suit was one for benefit payments, namely, the full monthly payment which would be owed if the withholding had been properly handled in the first instance. Rather than a suit to stop withholding, it was instead a suit for damages, with the damages being measured by the amount of the withholding. The court allowed the suit to proceed on that basis.

FICA tax withholding from nonqualified deferred compensation plans can be a tricky business. Although we do not know how this case will ultimately be decided, it highlights the risks that employers face if they fail to follow the rules.

[1] Under the Affordable Care Act, beginning in 2013, there is an additional Medicare tax of 0.9% imposed on wages above $200,000 ($250,000 for married taxpayers filing joint returns; $125,000 for married taxpayers filing separate returns).  My colleague Jeff Cairns blogged about this new tax last year.  https://benefitsnotes.com/2012/07/irs-issues-qas-on-collection-of-additional-medicare-tax-in-2013/

I blogged a few months ago about an employer who had to pay more than $83,000 in penalty, attorneys’ fees and costs for failure to give a proper COBRA notice for a dental plan. I warned employers that failure to maintain adequate procedures for COBRA compliance can be costly. That amount pales in relation to a recent federal district court decision awarding a penalty of $1,852,500 to a class of employees to whom timely COBRA notices had not been sent. The amount is to be divided equally among all class members so each class member will receive $2,500. In addition, the class will be entitled to attorneys’ fees yet to be awarded, but likely to be substantial in amount.

In this case, the employer, Visteon Corporation, outsourced its COBRA administration but did little or nothing to audit or monitor the COBRA processes. Visteon’s records were so bad that it took the company seven years to discover that 711 individuals could be excluded from the class because they had in fact received a timely COBRA notice. Although former employees complained about not receiving COBRA notices, Visteon had no process for capturing or following up on those complaints.

During the time period in question, there were different payroll administrators, benefits administrators, and COBRA administrators. There was little coordination among the administrators and no real oversight by Visteon. Visteon did some initial quality assurance testing but never did any follow up testing to make sure that notices were handled properly.

Courts have discretion to impose a penalty of up to $110 a day for failure to provide a COBRA notice. In this case, the court wanted to send a message to Visteon that its failure to monitor its COBRA processes was unacceptable. In the court’s view, the company can afford to pay both the penalty and the reasonable attorneys’ fees.

The lesson for employers:  Administering COBRA is a fiduciary duty of health and dental plan administrators. A failure to maintain adequate COBRA processes or to monitor third parties to whom COBRA processing is delegated can be quite expensive.

Over a year ago I blogged about the situation of former employees of Verizon who had never worked or resided in the United States but who had U.S. income taxes withheld from payments under benefit plans in which they participated while they worked for Verizon. The former employees had brought a claim for breach of fiduciary duty that was dismissed on the grounds that the remedy for improper withholding was to file a refund claim with the IRS.

A recent decision by the U.S. Court of Appeals for the Federal Circuit affirmed a ruling from the U.S. Court of Federal Claims denying that refund to one of the individuals who had brought the breach of fiduciary claim. While the suit against Verizon was brought as a class action, this was an individual refund claim brought by an Italian citizen who never lived or worked in the United States during the 30 years that he worked for Verizon. Unfortunately, the individual brought the refund claim more than three years after the date that a tax return would have been due for the year in which the amounts were withheld. The lower court had found that the claim was not brought within the applicable three year statute of limitations and the appeals court affirmed.

The amount of taxes improperly withheld was approximately $70,000. The IRS, Verizon and the courts all agreed that the amount should not have been withheld. However, because the refund claim was late, that money will not be repaid to the former Verizon employee.

The lesson remains:  If amounts are improperly withheld from benefit plan payments, employees should make certain that they file timely refund claims with the IRS.