Today the IRS release Revenue Ruling 2013-17 generally providing that same-sex marriages would be recognized for Federal tax purposes if they were recognized under the laws of the state in which the marriage occurred. This has generally been referred to as the “place of celebration” rule.
In addition, the IRS released FAQs on both same-sex marriage and domestic partnerships and civil unions. These FAQs provide additional guidance on some relevant issues for plan sponsors, including qualified retirement plans, the tax impacts of health coverage for same-sex spouses, and cafeteria plans.
We’ll provide additional analysis in future posts, so stay tuned!
On August 9, 2013, the Department of Labor (DOL) took its first action in response to the Supreme Court decision in United States v. Windsor, which struck down those provisions of the Defense of Marriage Act (DOMA) prohibiting the treatment of same-sex couples who were legally married under applicable state law as spouses for purposes of federal law. In an e-mail to DOL staff, Secretary of Labor Thomas Perez announced that several guidance documents had been updated to remove references to DOMA and provide that employees residing in states in which same sex marriage is legal would be entitled to leave under the Family and Medical Leave Act (FMLA) to care for a same-sex spouse with a serious health condition. Specifically, a DOL Fact Sheet which describes the qualifying reasons for FMLA leave was revised to provide that a spouse is “a husband or wife as defined or recognized under state law for purposes of marriage in the state where the employee resides, including…same-sex marriage.”
While significant as an explicit statement of policy, the DOL’s action in effect simply confirms the general approach previously taken in the regulations under FMLA, which have always provided that an employee’s spouse is determined under the law of the state of residence. Without the overlay of DOMA, that regulation leaves the determination of who is a spouse for purposes of FMLA with the state where the employee resides. Accordingly, whether this is a signal of how same-sex marriages will be recognized for purposes of rights under federal law, or whether a different approach might ultimately be taken (e.g., based on the state of celebration of the marriage, rather than the state where the employee resides), remains to be seen. In case there was any doubt, further developments can be expected in the near future, as Secretary Perez indicated that this is only “one of many steps the Department will be taking over the coming months to implement the Supreme Court’s decision.”
As noted in this New York Times article, the Office of Personnel Management issued a rule recently that will allow Congressional Representatives and Senators and their staff to receive payments from the federal government to help them defray the cost of insurance through the exchange. This was designed to alleviate some fears of a Congressional “brain drain” that could have occurred if long-time Congressional aides left their posts due to concerns over the cost of insurance. The Obama Administration sought to solve this problem by saying that the Federal Employees Health Benefit Program will provide cash to help offset the cost of insurance purchased through the exchanges.
This is, functionally, a premium-only health reimbursement arrangement run by the Federal government. Interestingly, if a private employer (or even another governmental employer) sought to set up such an arrangement with public exchange coverage, it would expressly be forbidden. Pursuant to FAQ guidance issued by the Departments of Labor, Treasury, and Health and Human Services (see Q2 here), an HRA may not be considered integrated with individual market coverage. This would mean that the employer would be treated as not sponsoring a health plan providing minimum essential coverage, subjecting them to play or pay penalties. The HRA itself would likely violate other provisions of health care reform.
Now employers can achieve a somewhat similar result by creating a private exchange, so it is not as though employers are without options. However, the inherent contradiction here should not be lost on those of us struggling to find ways to work with the Affordable Care Act. The Federal government effectively took a solution that would be beneficial for many employers, and kept it only for itself.
Last year the nation awaited the fate of the Patient Protection and Affordable Care Act (“PPACA”) as the U.S. Supreme Court considered National Federation of Independent Business v. Sebelius. Today, two lesser-known Federal cases threaten to undermine not just the individual mandate but possibly the entire PPACA structure for expanding health care coverage for all Americans.
PPACA requires the creation of a health insurance exchange (“Exchange”) in each State that will serve as a competitive marketplace where individuals and small businesses can purchase private health insurance. If a State refuses to establish an Exchange then the Federal government must implement and operate one.
Section 1401 of PPACA provides that premium assistance is available to taxpayers who are enrolled in coverage through an Exchange established by the State under Section 1311 of PPACA. Nonetheless, the Internal Revenue Service (“IRS”) promulgated a regulation that bases eligibility for premium assistance subsidies on enrollment in coverage through any Exchange, including a Federally-established Exchange. Specifically, the regulation states that subsidies shall be available to anyone “enrolled in one or more qualified health plans through an Exchange,” and subsequently defines an “Exchange” to mean “a State Exchange, regional Exchange, subsidiary Exchange and Federally-facilitated Exchange.”
Pruitt v. Sebelius (U.S. District Court for the Eastern District of Oklahoma) and Halbig v. Sebelius (U.S. District Court for the District of Columbia) challenge the IRS regulation expanding the availability of premium subsidies to individuals enrolled in a Federally-operated Exchange. The plaintiffs claim that the issuance of the subsidies to individuals enrolled in a Federal Exchange is contrary to the specific provisions of PPACA and injures them in several ways, including forcing individuals to either pay a penalty or purchase insurance and subjecting employers to the play or pay penalties under the employer mandate from which they would otherwise be exempt due to the unavailability of subsidies to individuals in their respective State.
Since a majority of the States (34 States) have refused to establish a State Exchange, a ruling in favor of the plaintiffs in Pruitt or Halbig could seriously jeopardize the future of PPACA since the subsidies are key to the operation of other parts of the law, including the calculation and collection of the individual and employer mandate penalties. First, a vast number of lower-income Americans will not be able to afford coverage in the absence of the premium assistance subsidy. Yet, these individuals are unlikely to be subject to the individual mandate penalty due to the exception under Section 1501 of PPACA for individuals who cannot afford coverage. Second, the availability of the premium assistance subsidy triggers the play or pay penalty under the employer mandate. Under PPACA, an employer with 50 or more full-time employees will be subject to a penalty for failure to offer full-time employees the opportunity to enroll in affordable, employer-sponsored health coverage that provides minimum value; provided at least one employee enrolls in coverage through an Exchange and qualifies for a Federal premium assistance subsidy. Consequently, if no Federal premium assistance subsidies are available to employees in a State due to the State having a Federally-operated Exchange, no penalty can be imposed on an employer with respect to employees in that State. Without the revenue collected under the individual mandate and the play or pay penalty, a major source of funding for PPACA is eliminated.
The Obama administration has sought to dismiss Pruitt and Halbig on several grounds. It has taken the position that the penalties are a tax and the Anti-Injunction Act precludes plaintiffs from challenging the imposition of the tax before it is actually assessed. Another argument is that the plaintiffs lack standing due to the speculative nature of their claimed injuries. In addition, following its announcement of the one-year delay of the implementation of the employer mandate, the administration argued that the delay should also delay the courts’ consideration of the cases. These are the same arguments presented by the Obama administration in the recent case, Liberty University v. Geithner, but explicitly rejected by the Fourth Circuit despite that fact that the court upheld the individual and employer mandates as constitutional.
As the cases are currently at the District Court level, the issue of the permissibility of providing premium tax subsidies to individuals enrolled in Federally-operated Exchanges is unlikely to be resolved before the Exchanges’ initial open enrollment period that begins October 1, 2013.
The 409A rules do not provide a clear roadmap to determine what compensation arrangements are subject to their regime of requirements and restrictions. In this brief video, Brian Berglund provides a description of the approach you should take to evaluate whether your compensation arrangement should be structured to comply with the 409A rules regarding deferral elections, timing of payments and other requirements.
(You can also view the video by going here.)
Governance of tax-qualified retirement plans should focus on protecting participants and reducing the risk of liability for plan fiduciaries. In the attached video, Sheldon Smith provides a brief outline of the duties imposed on plan fiduciaries and best practices fiduciaries should follow regarding plan governance.
(You can also find the video here.)
On July 24, 2013, in a case of first impression (Sun Capital Partners III LP vs. New England Teamsters & Trucking Indus. Pension Fund, No.12-2312), the First Circuit held that a private equity fund was a “trade or business” under ERISA as amended by the Multiemployer Pension Plan Amendment Act (“MPPAA”), and thus potentially liable for withdrawal liability incurred by its portfolio company if that company was under common control with the fund.* The court applied an “investment plus” test and found that the private equity fund was not merely a “passive investor” but had sufficient management and operational involvement with its portfolio company so as to make it a trade or business.
Sun Fund IV and Sun Fund III (collectively, the “Sun Funds”) are two funds held by private equity firm Sun Capital Advisors, Inc. Together, the Sun Funds held 100% of the interests of Scott Brass, Inc. and planned to turn around the struggling company within two to five years and sell it. Scott Brass contributed to a multiemployer pension plan. When declining copper prices created a credit crisis about a year and half after its purchase by the Sun Funds, Scott Brass ceased making its required contributions to the pension plan, and was forced into Chapter 11 bankruptcy. Withdrawal liability for Scott Brass was assessed in the amount of $4.5 million, and the pension fund demanded payment from the Sun Funds, which prompted the Sun Funds to seek a declaratory judgment in Massachusetts federal district court that they were not “trades or businesses” under common control with Scott Brass and therefore could not be liable.
The MPPAA imposes liability on an organization other than the organization that is required to contribute to the pension fund only if two conditions are met: the organization must be under common control with the organization required to contribute, and the organization must be a “trade or business.” The district court issued summary judgment in favor of the Sun Funds, finding that they were not “trades or businesses” because they do not have employees or offices and do not report income other than investment income on their tax returns.
There is a dearth of guidance from the Pension Benefit Guaranty Corporation (“PBGC”) on the definition of “trade or business” – so much so that the court lamented, “(w)e express our dismay that the PBGC has not given more and earlier guidance on this ‘trade or business’ ‘ investment plus’ theory to the many parties affected.” No regulations have been issued, and the sole guidance is a 2007 opinion letter in which the PBGC applied a two-part test to determine if a private equity fund is a “trade or business” that could be subject to withdrawal liability. The two elements of the so-called “investment plus” test are whether the fund was engaged in an activity for the primary purpose of making a profit, and whether it conducted the activity with continuity and regularity. The fund that was the subject of the PGBC letter was determined by the PBGC to be a trade or business because the fund had a profit motive and met the continuity and regularity prong due to the size of the fund, the size of its profits and management fees paid to the general partner.
Although the First Circuit found that the PBGC opinion letter was due a limited amount of deference, it essentially disregarded it, employing its own “investment plus” standard in determining whether a private equity fund was a “trade or business.” The court explained that the “plus” portion of the analysis was very fact-dependent, with no one factor being dispositive.
The court noted that the Sun Funds had extensive activity in the management and operation of Scott Brass, Inc., as confirmed in the language of the funds’ partnership agreements (a “principal purpose of the partnership is the management and supervision of its investments”). Employees of Sun Capital Advisors, Inc. “exerted substantial operational and managerial control over Scott Brass,” attending company meetings during which Scott Brass employees were hired and the company’s capital expenditures and possible acquisitions were discussed. Sun Capital Advisors employees were also included in email chains regarding liquidity, revenue growth and potential mergers. Employees of Sun Capital Advisors, Inc. held two of the three director positions at Scott Brass.
Another crucial factor that led the court to conclude that Sun Fund IV was a trade or business was that it was able to offset management fees that it would have otherwise paid its general partner to manage the investment in Scott Brass. This was a “direct economic benefit” to Sun Funds IV that the court noted would not have been available had Sun Fund IV been a passive investor. The court remanded to the district court the question as to whether Sun Fund III was a trade or business due to its inability to determine from the record whether Sun Fund III received an economic benefit from this offset. The court also remanded for a determination as to whether the Sun Funds were under common control with Scott Brass.
The court’s opinion also addressed a policy argument made by the Sun Funds, that Congress never intended this type of result, wherein business owners would be required to “dig into their own pockets” to cover withdrawal liability for a portfolio company. In response, the court wrote, “We recognize that Congress may wish to encourage investment in distressed companies by curtailing the risk to investors in such employers of acquiring ERISA withdrawal liability. If so, Congress has not been explicit, and it may prefer instead to rely on the usual pricing mechanism in the private market for assumption of risk.”
This case serves as an effective admonition to an acquirer that is considering the purchase of 80% or more of the interests in a company which contributes to a multiemployer plan or maintains an underfunded defined benefit plan. Before consummating such a transaction, the acquirer should carefully consider the extent to which other entities in the acquirer’s controlled group might be held liable for any underfunding of the multiemployer or single employer plan.
*The MPPAA requires employers withdrawing from a multiemployer pension fund to contribute a share of the fund’s unfunded but vested pension liability.
Internal citations have been omitted from this article.
In our prior post, we detailed some significant deficiencies in the study that Yale Law School Professor Ayers is planning to release and the far less threatening Yale official response. But what steps, if any, should plan administrators take now to mitigate exposure, even if wrongly asserted, that might result from a breach of fiduciary duty action? And what kind of opportunity does this present for other 401(k) sponsors who are not included in the study? Recognizing that most 401(k) plan fiduciaries must determine, through proper prudence and process, that plan expenses are reasonable in view of the services provided to participants and that those services are necessary for the proper operation of the plan and in the best interests of the participants, now is a good time to revisit “reasonable and necessary.”
Many of our clients’ plan administrative committees avail themselves of the services of competent, independent investment advisors to assist them in performing the “reasonable and necessary” analysis and in making these important decisions. The advisors assist in understanding the 408(b)(2) disclosures, providing cost and service comparisons, negotiating fees, structuring and administering requests for proposal programs, confirming that there are no conflicts of interest with respect to the provisions of investment choices, and providing quarterly reports that assist the committees in fulfilling their duties. Plan administrators that do not use the services of these independent advisors should conduct similar reviews themselves and be certain that they are capable of fulfilling their obligations in doing so.
Whether Professor Ayers follows through on his threats or not, 2013 is a good time to revisit your plan’s investment menu and its fee structure and to make certain that your plan is operating properly in view of what is “reasonable and necessary.” It may also be a good time to review your plan terms and practices to be certain that they understand what is required of them under the plans and ERISA’s fiduciary duty rules so as to protect participants and to minimize grounds for fiduciary liability generally. As a threshold matter, we note that the largest area for improvement in fiduciary governance generally tends to be the clear identification of plan fiduciaries and the delineation of fiduciary functions and responsibilities in order to limit exposure. In addition, it is very important that “plan documents” (e.g., the plan document, summary plan description (“SPD”), committee charters, resolutions, minutes and delegations) are consistent with each other and with actual practice. Therefore, we generally recommend that plan sponsors take steps to (2) clearly identify fiduciaries, their duties and responsibilities; (2) confirm that any delegation of fiduciary functions duties is made pursuant to proper authority and procedures; (3) consistently and accurately document any such delegation of fiduciary responsibility; and (4) conduct fiduciary training to ensure that all appointed fiduciaries fully understand their roles and responsibilities. In addition, we recommend:
- Reviewing fiduciary insurance policies and exclusions to ensure proper coverage
- Establishing a thoughtful fiduciary decision-making process
- Documenting the process and actions used to carry out fiduciary responsibilities
- Hiring service providers to perform certain fiduciary or administrative tasks, as deemed necessary or appropriate
- Implementing, following and documenting a regular, formal review of service providers’ scope of services, quality of services, performance, fees/costs, etc.
- Using experts as appropriate (but evaluating their input pursuant to fiduciary process)
- Identifying provider’s direct and indirect compensation and obtain ERISA 408(b)(2) disclosure
- Evaluating fees and services relative to comparable providers
- Disclosing fees to participants as required by law
- Reviewing and revising plan documents (e.g., plan, SPD, investment policy, trust, committee charters, delegations, etc.) to be consistent with each other and with actual practice
Not all 401(k) plans are alike and not all fiduciary decisions with respect to them mirror image one another. It is, therefore, important to evaluate your plan based on the factors that fulfill your duties to the plan, its participants, and their beneficiaries.
Employee Stock Ownership Plans (“ESOPs”) can be a good choice for the right company because they can generate liquidity for the owners in a tax-advantaged form, allow the owners to retain de facto, if not legal, control, and provide employee ownership and the resultant productivity and retentive benefits to the business. Common uses of ESOPs include can have other uses as well, such as:
- Allowing an owner to exit his or her business but provide an incentive to retain existing management (who may be unable to buy)
- Allowing a shareholder to diversify his or her holdings through a partial (or total) sale to an ESOP;
- Providing a vehicle to efficiently redeem unwanted shareholders;
- Structuring management buy-outs;
- Providing a buyer for an estate holding closely-held stock;
- Closing out a private equity fund by selling a portfolio company to an ESOP; and
- Selling a division to employees.
Using an ESOP has certain advantages over more traditional approaches to address these issues, including:
- Both principal and interest paid on any leveraging required for the ESOP transaction are tax-deductible.
- In many circumstances, owners can rollover the proceeds resulting from a sale of their stock to an ESOP into other corporate securities free of federal (and most often, state) income taxes.
- Even in situations which are not eligible for the tax-free rollover, sellers can get capital gain treatment, rather than dividend treatment, on the sale to an ESOP.
- Unlike private equity, the ESOPs tend to be passive, longer-term investors.
- Since ESOPs can be shareholders of S-corporations, sharing ownership with employees through an ESOP avoids pressure on the limitation on the number of shareholders, as ESOPs are counted as one shareholder for this purpose, regardless of the number of employees participating in the ESOP.
- S-corporations that are owned by ESOPs are exempt from federal, and most state, income taxes.
ESOP companies come in many sizes, although given the costs associated with an ESOP transaction, very small companies are not always the best fit. Some characteristics of companies that may make good ESOP companies are:
- EBITDA of at least $5 million;
- Consistent earnings history;
- At least 10 employees;
- Strong management and employee-oriented culture; and
- Willingness to run company much like a public company (e.g., disclosure of basic financial information, good corporate governance, and avoidance of conflicts of interest).
ESOPs can be complex and require some additional administrative know-how to maintain. There are many qualified administrators who can provide assistance. However, in the right context, they can provide the necessary liquidity and help retain and motivate employees of the company.
Typically, academics do research and then write about their findings and conclusions. However, as has been reported elsewhere, Professor Ian Ayers, the William K. Townsend Professor at Yale Law School, decided to take his findings and conclusions a step further. He sent a letter to some 6,000 401(k) plan sponsors essentially accusing them of potentially violating ERISA fiduciary duties. He then went even further and threatened to publicize their identities and advised them that he would assign each of the 6,000 of them with their own hashtag on Twitter when he publicized his study next year in periodicals including the New York Times and the Wall Street Journal. His threats have been garnering substantial attention in the popular press. Needless to say, Professor Ayers has created quite an uproar in the 401(k) plan advisor and consultant communities. You can read a redacted copy of the letter here.
The Study (and its Flaws)
Professor Ayers indicates in his letter, and in the draft study that he and Professor Quinn Curtis of the University of Virginia School of Law co-authored, that he used 2009 data from Forms 5500 and from 2009 data compiled by Brightscope, Inc. Brightscope has advised ASPPA that it had nothing to do with the study and Yale has confirmed that Brightscope’s 2009 information was used with no direct participation by Brightscope.
The draft of the study posted online is already coming under fire from other sources for a variety of reasons. Based on what we know of the study, it appears to have several significant flaws: (1) although Forms 5500 may, to some extent, reflect actual expenses, the 2009 data does not demonstrate whether the employer is paying some or all of the expenses or the accuracy of plan expenses, (2) there is no qualitative basis in the data to determine whether the amounts paid are reasonable in view of the services provided (in other words, are sponsors getting what they pay for?), (3) there is no basis to determine the extent to which plan fiduciaries have already controlled plan costs in concert with the availability of investment options and share classes available for specific plans, (4) complexity of plan design and operation together with features such as participant education are not factored into the conclusions, and (5) changes that have resulted from the imposition of the 408(b)(2) disclosure regulations are not factored into the study since they occurred after 2009. Even assuming that the 2009 data was sufficient and valuable to reach the conclusions of the two professors, it seems difficult to justify sending letters to 6,000 plan sponsors alleging fiduciary impropriety when their plans may look very different in 2013.
Yale’s Official Release
Professor Ayers has been rather mum following the uproar he created advising many of those who have attempted to contact him that he is “too busy.” In response to a request from ASPPA, Yale Law School’s Director of Communication, Janet Conroy, indicated that:
The letters from Professor Ayres aren’t a precursor to any legal action, and Professor Ayres has no intention of sharing data with plaintiffs’ attorneys. While he intends to publicize the results of his research when the project is published, those results will be presented as aggregate data. He does not intend to publicize company-specific data based on 2009 data.
Of course, this response, while contrary to the threatening nature of Professor Ayers’ letter, leaves the 6,000 plan sponsors with a bit of a dilemma. What steps, if any, should they take now to mitigate exposure, even if wrongly asserted, that might result from a breach of fiduciary duty action? We will cover that in a future post