LTD insurance -- election of tax vs. pre-tax coverage -- allow for executives only?

[jpod]

Rev. Rul. 2004-55 (along with a handful of private letter rulings) explains how you can give employees a choice of treating their employer-paid LTD coverage either as pre-tax or post-tax. (If post-tax, disability insurance proceeds would be paid to the employee on a tax-free basis.) The facts in the Rev. Rul. are that all employees eligible for the coverage would have the right to make the election. Is there any reason why this is a critical fact? For example, can you limit the right of the election only to those executives to whom you wish to give this right? Employer does not want to be burdened of having to explain and administer the election to hundreds of employees every year.

[Belgarath]

Big caveat - I'm not at all sure I know what I'm talking about! With that in mind, I did look into a similar question some years ago, and from memory...

Although the situation you describe shouldn't fall under the nondiscrimination testing for Section 125, I do believe that this is a fringe benefit subject to ADEA and EEOC. Also, I believe a state's disability insurance laws are not preempted by ERISA, so you may have to check the state laws re nondiscrimination requirements for such a plan, if any.

[jpod]

At the moment I am only concerned about the ability to flip the tax consequences as described in the Rev. Rul. I am not finding the logic in requiring that the offer be made available to all eligible employees, yet I have found no IRS private ruling or other guidance suggesting that the offer can be limited to certain employees.

[jpod]

I've had 65 views but only one reply. If you think my question is stupid and the answer is obvious but don't want to humiliate me, don't worry, I can take it!

[Belgarath]

Certainly not a stupid question, but I think a difficult one since it seems the majority of us on these boards have more expertise in qualified plans. I'm not aware of any IRS mandate for covering all "eligible" employees - therefore my mention of non-ERISA nondiscrimination rules, etc.

At a guess, this ruling was written with the specific facts in mind, and it is possible/likely that the plan itself specified that that all "eligible" employees would be covered?

Again, I'm not sure I'm even remotely correct in my thoughts here. Good luck!

[leevena]

Well as one who has viewed this twice, I will chime in. I came back to see what others had posted. What did go through my mind was how the employer is viewing this as a burden. With the wide acceptance of Section 125 and 401(k) plans, I suspect most people know about pre and post tax. The amount of eduction should be very little.

Additionally, why would an employer want to create the impression of favoritism within their organization. At some point someone is going to cause an issue with it.

Just my two cents.

[Chaz]

Most of my clients avoid the administrative burden altogether by not giving any employees a choice. These employers generally provide that all participants are taxed on LTD premiums so that any benefits are paid out without being taxed. The reason is likely not to avoid any administrative issues but instead they are just being paternalistic.

I would not be so sure that the scenario you envision would pass the benefits portion of the cafeteria plan nondiscrimination tests, particularly if HCEs can elect to receive a benefit pre-tax while the hoi polloi have to receive it post-tax. I have not looked at this, however, and it may not be the case, but it certainly is not a slam dunk.

In any event, Leevena raises a good point that the education would not be that onerous. It probably would take just a paragraph or so in the enrollment materials/SPD to adequately explain the choice.

[jpod]

Chaz, two points in response:

1. Per the ruling this election does NOT have to be offered under a 125 Plan, and what I am proposing would not be done under a 125 Plan.

2. To all of a sudden start taking additional withholding taxes out of employees' pay and having then to explain why - even though the amounts would be extremely small - is likely to cause a riot (figuratively speaking), so that approach is impossible as a practical matter in this case.

3. The problem with giving everyone an election is not giving them an election and the disclosure materials, it's dealing with employee inquiries upon receipt of the election notice and disclosures, and dealing with mistakes, both those made by the employees and those made by the employer.

[jpod]

Counting is not one of my specialties.

The fourth response is, frankly, that the employer saves FICA/Medicare tax money by doing it pre-tax.

[hr for me]

[Putting on my payroll hat] While the employer may save in FICA currently on premium amounts, it might regret when there is an actual claim and a third party is paying out disability payments that are now taxable to both the employee and employer ( and FICA has to be considered at that time)......so more headaches from a payroll/W-2/tax form standpoint than a benefits standpoint. So you need to weigh current FICA savings with future FICA payments to truly see if there is a savings.

If communicated well, the current taxes paid on premiums will be much smaller than the taxes paid on the wage payments should they then be taken. I would wait until an open enrollment and make the change as part of all that year's benefit changes/communications.

That said, allowing a choice does mean that payroll has to have one taxable and one non-taxable deduction setup for a single benefit. Not tough, but can lead to mistakes, etc. So I tend to lean on doing it one way for all employees.

[CaliBen]

Following up on the FICA issue - if instead of giving the employees a choice, the employer imputes the value of the premium (similar to group term life imputed income), does FICA still apply? I am thinking yes, that imputed income is considered wages for FICA tax purposes.

[hr for me]

Yes, FICA still applies on the imputed income of the premiums, but not on any future payout of benefits.