401 Chaos

Can you have different distribution schedules (e.g., 6 month vs. 12 month) for deferred compensation amounts that are distributed upon a separation from service but vary depending upon whether it is an involuntary termination by employer versus a voluntary termination by the individual. Treas. Reg. 1.409A-3© would seem to prohibit such distinctions to the one time and form of payment rule but I am trying to determine exactly what 1.409A-3©(3) means in this regard. It seems to open the door very broadly to permit distinctions based on any sort of separation from service. Would appreciate any thoughts on how to parse that language.

Plan sponsor has determined it prefers to have fiscal plan year end rather than calendar plan year end. Is it possible to extend an initial plan year for a newly adopted plan (provided the plan year does not go beyond 12 months)? Situation involves plan adopted mid-2009 with a calendar plan year end. Can plan sponsor now amend the Plan to extend the Plan Year out to 12 months after the effective date so that it has fiscal plan year end and the first Plan Year is a full 12-month plan year rather than the short plan year ending 12/31 as originally drafted? What if the match component (or other components) have some last day of plan year requirement? If plan sponsor is willing to give match credit for anybody there on 12/31 that subsequently leaves before the end of the extended plan year, could that work?

I see where Treas. Reg. 1.105-11(g) seemingly carves out from the general exemption coverage for dependents. Do I read this correctly to provide that if an employer pays for executive physicals / medical exams for a select group of top hat executives and their spouses, then the amounts paid for executives can be paid by the employer and excluded from the executives' income; however, the amounts paid for spouses will be essentially considered a discriminatory self-insured health plan benefit and thus result in the value / cost of the exam being deemed taxable income to the executives?

So, what about not only discriminating by paying for long-term care insurance for an executive group (line drawn solely on basis of position w/out regard to impermissible discrimination factors) as well as for their spouses. Are the emounts paid for LTC insurance on behalf of spouses deductible / not included in income as well? Seems that is generally doable with regular health insurance arrangements covering dependents so should extend to long term care insurance as well. Thoughts?

Thanks XTitan. Unfortunately we inherited the mess from folks no longer on the scene so it's unclear why the delay. My guess is that it was just an administrative goof rather than any sort of collusion as there were two pots of funds under the plan and all of one pot (the bigger pot) got paid out in 2005 as required with the second pot coming later. The recipients of these amounts had large income / other distributions in both 2005 and 2006 so it's not obvious to me they would have gained anything from a tax liability perspective by delaying. Not sure I follow the good faith compliance point? Is it just that they tried to do this and came close and seems like an administrative goof so should not blow whole plan? If so, I like that argument and think that's probably what happened here but my concern is that the Notice provision seems so clear on needing to pay out in year of termination that it would seem difficult to point to anything short of that as being good faith compliance (i.e., other than the possible company tax year argument, this seems one of the clearer 409A provisions out there). Many thanks.

Company decided it didn't want to deal with 409A--was going to undergo a change in control in early 2006--and so decided it would go ahead and terminate it's deferred comp plan in 2005 and distribute the amounts in accordance with Q&A 18© of 2005-1. Company adopted resolutions terminating plan in 2005 and apparently paid out and reported all distributions in 2005 except for a couple of relatively small amounts. Those amounts for whatever reason did not get paid until mid-January 2006. Company reported distributions as income in 2005 or 2006 as they were made. Question is what to think of the failure to make all distributons prior to 2006 under the Plan and how to read the deadline requirement included in 18©. 18© says that all the amounts deferred under a plan be paid and reported as income in the taxable year in which the termination occurs so as not to have the amendment treated as a material modification. I read the "taxable year" portion here to mean the employee's taxable year so that all amounts are paid and distributed to employees in the year of termination. Here that would require all distributions to have been made in 2005 and recognized and reported in income in 2005 since employees are all on a calendar tax year. (Note, however, that the company is on a September 30 fiscal year so all amounts were paid out within the same year as termination if looking at the company's tax year.) If having termination and pay out within the company's tax year argument does not work, what does the failure mean. All of the distributions under the Plan (including those paid in 2005) were paid out in violation of 409A and would be subject to 20% excise tax? Alternatively, only those amounts not paid in 2005 would be in violation? What are the risks to the company here where it timely reported and withheld on the distributions. Since it doesn't have duty to withhold on the 20% excise tax (if applicable) is risk simply that maybe it should have reported all distributions in income in 2005 rather than a couple in 2006?

Thanks. I think that's my assumption as well. So, in a case like the one here where you go from installments to lump sum, that would seem to go in the wrong direction and be an acceleration however if you had a lump sum and wanted to go to installments, maybe you could if you complied with the 1 / 5 year rule. It is interesting situation because my understanding is that if you had an unvested severance right that didn't comply with 409A (e.g., failed to include a 6-month holdback) you have some additional relief until end of 2009 to make a correction there. Seems though that you would only be permitted to change or correct problematic provisions with that relief and not change a compliant term in a way that adjusted the payment terms. Does that seem correct?

If you have a 409A-compliant employment agreement that provides for severance to be paid out over 2 years, can you amend that mid-term to provide for payment in a lump sum in a case where there has not been a separation from service and no separation of service is anticipated (i.e., although there is a legal right to the severance if terminated, the severance has not vested)? Seems to me that this would arguably create an impermissible acceleration of the severance benefits even though not vested at the time of amendment. If the answer is no, could you amend the agreement at the end of the regular term and/or prior to automatic renewal to provide for different payment terms going forward?

J Simmons, Thanks, I'm no divorce lawyer either and so had (have) the same thought. What the lawyer tells me is that death really does moot the divorce action but not necessarily the action for equitable distribution. Apparently it used to be that you had to have a divorce decree entered before you could get equitable distribution so if you had death before divorce decree was entered, there was no equitable distribution. Our legislature (North Carolina) apparently changed that law a few years ago so that equitable distribution and divorce operate on somewhat separate tracks. You can apparently get equitable distribution before you get actual divorce and that carries over to equitable distribution after death of a spouse so long as some equitable distribution proceeding was started prior to death. So, there apparently was no post-death divorce here, just post-death equitable distribution which sought to divide all 401(k) and pension amounts. Not sure that is really relevant from a plan / ERISA perspective though as the second wife clearly died prior to any final equitable distribution being entered?

Thanks for these thoughts. The facts continue to evolve a bit. Jpod, I don't believe the plan has yet informed the spouse's estate that the 401(k) money is not there. Spouse's estate, however, is aware that participant had 401(k) account and has asked for information regarding the account pointing to the Equitable Distribution provisions. Plan's initial response was to say that the Equitable Distribution provisions were not enough to act on and that the plan would need a QDRO to consider any transfer to spouse. The QDRO has not been obtained yet but I think one thing the Plan hoped was that having this addressed in a separate QDRO might raise the issue on whether the court really had authority for trying to assign the plan assets after both deaths--sort of along the lines J Simmons thoughts about the court having exceeded its authority. Also, it appears that the participant had a pension plan in addition to the 401(k) Plan. The Pension Plan provides that in the event a participant dies without a spouse, the benefits go to the participant's estate. On that basis, I'm thinking any attempt to get at those amounts via a QDRO / equitable distribution would arguably be too late as well since there was no real basis for dividing the benets at the time of the participant's death. (Although I suppose if the court has sufficient authority to divide the participant's estate through a post-death divorce, the deceased spouse's estate may get some of the plan benefits after they pass from the plan to the estate. That seems like a non-plan issue at that point though?)

Wow! Would appreciate any thoughts on proper analysis under these remarkable facts: 1. Participant and second wife take steps toward divorce 2. Wife dies shortly after divorce action starts and before divorce is final 3. The Participant, a month after second wife's death, files new 401(k) beneficiary designation indicating he is single and names his son as the 401(k) beneficiary. 4. 5 months later, participant dies without any final action on the prior divorce proceedings 5. 2 months after participant's death, plan distributes 401(k) account to son named as beneficiary 6. 4 months after participant's death and 10 months or so after deceased second wife's death, the court enters an Equitable Distribution Judgment dividing participant's rights in the 401(k) 50/50 with deceased second wife. (Equitable Distribution was in response to continued efforts to prosecute the divorce by the estates of both the wife and the participant). 7. Plan is being pressured to provide deceased wife's estate 50% of the participant's 401(k) account. 8. Plan requests QDRO in addition to provisions in equitable distribution judgment. So, we have not only a possible post-death QDRO but a post-death divorce. Plan presumably had no reason to know of pending divorce at time of participant's death since there was no divorce or draft QDRO, etc. at that point. Plan knows participant was a widower and has what it assumes to be a fully valid and recent beneficiary designation naming son as beneficiary of 401(k) and so pays that out in ordinary course. Does deceased wife's estate have any interest in the 401(k) plan by time divorce and QDRO are provided? Can Plan even accept QDRO under these facts?

jpod, Thanks. I guess that I wouldn't envision explaining it quite that way but I don't disagree that it is an unusual position to have to take. I wouldn't at all mind the DOL deciding to give the subsidy in that case though--as others note, that puts the issue to rest in a way that should leave the employer in the clear. Thanks.

jpod, Thanks. What you raise is part of the reason for my question. My understanding is that the insurer has punted on the issue and basically said it is the employer's call and they will go along with either decision. They have apparently advised the employer that due to the uncertain nature of the gross misconduct exception they are willing to provide COBRA election even though there may be clear grounds for gross misconduct. I am not sure that is clearly the same as everybody making a determination that there is no gross misconduct so you have to give COBRA--instead it is a decision not to press on that or make a decision. Seems to me that as long as the insurer is on board with that decision, you might still run into a situation (albeit unlikely) where there could be an issue with the ARRA subsidy. I guess it's your thought that if a plan makes a decision to provide COBRA, then the gross misconduct issue is gone. I just worry that where before the government really had no concern with employers / insurers being more generous than they had to be they might strike a different tone when its the government's dime. Oriecat, Thanks for your response. I was thinking there had been some informal guidance suggesting that a denial due to gross misconduct was not subject to the appeals rules but I'll have to dig to find that. GMK, Thanks also. Just to be clear, we absolutely agree that the plan should give notice if COBRA is going to be denied but I was not aware that it was legally required. The EBIA manual I see suggests that a notice should be sent for the reasons you suggest as well but it does not seem to say it has to be sent. It seems to me the fact that the unavailability notice here is discussed in the context of a response for a request of coverage leaves the issue of whether it is legally required a bit up in the air. Again, I think plan is to send notice anyway so probably not a big deal but I just had never heard DOL say it was indeed legally required which is apparently what was said over the phone.

A couple of questions related to COBRA's gross misconduct exception which I've seen discussed some in general on the board but have not been able to find definitive answers. 1. Realizing the lack of a clear definition of "gross misconduct" for COBRA purposes and other risks associated with denying COBRA coverage, assume a plan sponsor is determined not to provide COBRA and has fairly reasonable grounds for invoking gross misconduct, is there any legal obligation to notify the terminated participant that they are not being offered COBRA due to gross miscoduct? For example, by sending a modified notice of unavailability of coverage indicating that gross misconduct is being invoked? Although I certainly think it best practice and serves many useful purposes to provide participants some timely notice that they are not being offered COBRA, I am not aware of an actual legal requirement to notify the individual. An insurance carrier, however, has indicated that they called DOL (don't know who or where) and the DOL said the plan MUST inform the individual in writing that they are being denied COBRA due to gross misconduct. 2. What if the plan sponsor decides that relying on the gross misconduct exception is too risky even though they think they have clear grounds for gross misconduct. Are they legally required to deny eligibility for the ARRA COBRA subsidy even if they are willing to be more generous than COBRA requires and let the terminated individual elect COBRA without the subsidy? Thanks.

Quick question for someone over their head on Form 5500 questions. If you have a wrap plan that has several fully insured benefit programs (group health, dental, life, disability, etc.) as well as a self-insured health FSA / medical reimbursement arrangement, do you have to pull in and report data on the various insured programs on Schedule H or can Schedule H simply be limited to information related to the health FSA. (As I understand it, if it were not for the health FSA, the plan would not have to file a Schedule H at all.) Thanks.

Thanks for everyone's responses. The plan has definitely had some participants leave mid-year. Not sure how many have rolled their accounts elsewhere but assume at least some have done so. If so, then it sounds like short of terminating at the end of the month for a short plan year the company would have to seek a return of some of the former participants' match amounts to get to a uniform percentage? I'm afraid that is probably a non-starter even though they need the money badly. A related / follow-up question: is this uniform percentage for the entire year a legal requirement or something that might have been thought advisable from a testing perspective? I'm not sure I've seen such a provision in a plan document before. Last question, if this provision is deleted from the plan, could they add a match mid-year without issue if they started 2010 without one? Also, could they also eliminate the match later in 2010 after reinstating if they found they had to stop it again due to an emergency? (I'm assuming they will start 2010 without a match but may decide to add it back later on if things improve. If they do add it back though, I think they would want to have flexibility to stop with a little notice if possible.)

K2, Thanks for the reply. Could you elaborate on what sort of adjustment would be required at year-end. They have already made all prior matches on a payroll period basis. If a participant who had been partcipating for the first 9 months at 3% deferrals in order to get full match stopped elective deferrals altogether after the elimination of the match and so had no deferrals for the last 3 months of the year, what sort of adjustment would be required? Thanks

Employer has learned of loss of major contract and is facing severe cash crunch. It currently matches 401(k) deferrals 100% up to first 3% of compensation. Employer needs to eliminate matching contribution effective October 1st. Even though there are only 3 months left, the employer needs to conserve this cash rather than simply start with the 2010 Plan Year. The 401(k) plan document provides as follows: "The Employer may make discretionary Matching Contributions. The percentage of Elective Deferral Contributions matched, if any, shall be a percentage as determined by the Employer. Elective Deferral Contributions that are over a percentage of Compensation won't be matched. The percentage shall be determined by the Employer. Matching Contributions are calculated based on Elective Deferral Contributions and Compensation for the payroll period. Matching Contributions are made for all persons who were Active Participants at any time during that payroll period. Any percentage determined by the Employer shall apply to all eligible persons for the entire Plan Year." I am wondering about the effect and intent of the last sentence. The provisions seem to make very clear that the match is discretionary and thus the employer could set any percentage or no percentage at all for the match at the outset of the Plan Year. However, does the last sentence work to make that discretionary match a fixed match for the entire Plan Year once the match percentage is set / used for the initial payroll period? I have reviewed several prior posts on this board and other discussions regarding the elimination of discretionary matching contributions mid-year and have not found a discussion of a provision exactly like this one. Those discussions have also frankly left me confused about just how much discretion employers have in reducing clearly discretionary matches given my understanding that plans eliminating or reducing matching contributions must pass current availability testing since participants entering the plan after a match is reduced or eliminated will be entitled to a different rate of matching contributions than participants in the plan the entire year. In addition, my understanding is that such reductions in matching contributions create non-uniform formulas for the plan year and thus will need to pass the general nondiscrimination test in addition to ADP / ACP testing. We are not worried so much about the plan being able to pass these tests if required under our facts--there are not likely to be many new entrants to the plan nor would I think discrimination in favor of HCEs under our facts would likely be a problem. The phrasing of the plan provisions, however, suggests that the rate of the match must be the same for the entire Plan Year regardless of whether testing concerns are an issue. Thus, it seems to me any elimination of matching contributions for the remainder of 2009 would violate that last sentence and that any amendment of the Plan now to delete that last sentence effective prior to 2010 would be problematic. I would appreciate any thoughts or guidance.

Unfortunately, the regulations are not always as clear as they might be on some of these issues but i guess my understanding has always been in asset deals the COBRA obligations would go on seller even if the subsidiary or division that held the assets being sold is dissolved. I think it is fairly common in asset deals for the entity holding the assets that are sold to disappear which is the reason the rules focus on the selling group (i.e., the entire controlled group containing the seller) and not just the seller itself (i.e., not just entity Y in this case).

cjsmith, Given the absence of other responses, I wanted to offer a few general thoughts off the top of my head with the benefit of any research or verification. COBRA does contain some special "merger and acquisition" rules so to the extent you have not reviewed those, I would urge you to study those rules in some detail. See Treas. Reg. § 54.4980B-9. As a general matter in an asset sale, my understanding is that the selling group generally retains responsibility for providing COBRA coverage to employees. In this case, Y's plan will end which would generally eliminate the COBRA responsibility of Y but the M&A rules look to the broader selling group--i.e., the controlled group to which Y belongs, if any, thus in this case I believe X will have an obligation to provide COBRA coverage to the Y employees assuming X continues some group health plan. (Note, it is possible under the COBRA M&A rules to negotiate around some of this if the hospital were to contractually accept responsibility but legally I think X has that obligation. Also note that it is possible for the COBRA obligation to shift to the Hospital (Buyer) here if the Selling group were to completely eliminate all group health plans.) Finally, note that I believe in some cases X (as part of the selling group) could have to provide COBRA coverage options to the Y employees (or former employees on COBRA) even if they end up working for the hospital and eligible for coverage under the hospital plan. That is to say, they Y employees would arguably experience a COBRA qualifying event because they (1) would have employment with Y terminated, and (2) would lose coverage under the Y plan. Finally, it occurs to me there could be broader issues with the X and Y arrangement here if the groups were split up to provide discriminatory benefits. The ERISA rules, particularly for qualified pension plans, are generally applied on a controlled group basis and so would seem to treat employees of X and Y as working for one large employer for various nondiscrimination and coverage purposes.

Are general post-separation expense reimbursement amounts that are structured to be compliant with 409A but not necessarily exempt from 409A included in items that cannot be paid to specified employees within the first 6 months of separation? For additional information, we have a specified employee who, in addition to severance or separation pay, is receiving reimbursement for certain moving expenses and continued health benefits, is there a prohibition on paying those reimbursements during the first 6 months? I know the regulations provide for some exemptions when reimbursements are made as part of a separation pay plan (including apparently voluntary separation plans) provided certain rules are followed (see 1.409A-1(b)(9)(v)). In particular, those rules require that the reimbursements be provided within a limited period of time--e.g., reimbursement for moving expenses incurred within 2 years following the year of separation. In our situation, the moving reimbursement provisions are not expressly limited to expenses incurred within 2 years following year of separation. Instead, they generally envision a one-time moving expense reimbursement being provided for any move at any time following termination for the life of the former employee. As such, I do not think they are exempted under the separation pay plan exemption discussed above. I do believe they comply with the general reimbursement rules / provisions under 409A so I think they are generally compliant if not exempt with the exception concerning application of the 6-month delay requirement.

I guess the one caveat to that is that it is ok to stack and exempt provided the $400,000 otherwise complies with the separation pay plan exemption--in particular that the $400,000 is not more than 2 times prior year's annualized compensation.

We have a 401(k) plan which defines "compensation" generally using the safe harbor definition of compensation under 1.415©-2(d)(4). That is to say, compensation is defined to include wages as defined in Code section 3401 plus all other payments of compensation to an employee required to be reported under sections 6041, 6051 and 6052. I am confused as to how income from "disqualifying dispositions" of incentive stock options (ISOs) is handled under this definition. My understanding is that when an employee has a disqualifying disposition of an ISO, the employer is generally required to report the income associated with the disqualifying disposition in Box 1 of the employee's W-2 even though the employer is not required to withhold taxes on the income amount. Under that interpretation, it seems these disqualifying disposition amounts should be counted as compensation under the safe harbor definition. That is to say, even though they are not wages subject to withholding under 3401, they are other amounts of compensation subject to reporting and seem to be squarely covered. In looking through various 401(k) treatises, etc., however, I am finding conflicting information. In one, they appear to say that the income amounts from disqualifying dispositions of ISOs are to be included as compensation when using the "wages reported on W-2" safe harbor but should be excluded when using the "wages subject to withholding." That generall seems correct to my basic reading of the definition. However, I have seen 2 or 3 other treatises and manuals basically say that "amounts realized from the sale, exchange, or other disposition of qualified stock options" are to be excluded from compensation under all the various Code Section 415 definitions / safe harbor definitions. That seems to me to suggest that disqualifying dispositions of ISOs are not counted for compensation purposes under our definition even though the employer may be required to report the income earned on the disposition on Form W-2. Can anybody verify whether the exclusion of amounts from the disposition of incentive stock options from the general definition of 415© comp carries over to the safe-harbor definitions as well?

Nathan, I'll take a crack at this although I have very limited experience with COBRA and these issues in particular. 1. I believe COBRA does typically end if the individual becomes eligible for other group coverage that does not impose exclusions for certain pre-existing conditions the individual has. Accordingly, one may have to review the coverage available to the individual under the new plan to determine whether COBRA coverage is cut short. Seems like here there is probably a good chance the individual's COBRA coverage would terminate and they should probably check their old plan re provisions about early termination. 2. Assuming the individual's COBRA coverage can be continued and eligiblity for the new plan does not terminate COBRA (or in situations where an individual has COBRA and is not eligible for a new plan), my understanding is that pretty much anybody can pay the COBRA premium on behalf of the individual. For example, hospitals might be inclined to pay some COBRA premiums on behalf of eligible individuals if failure to pay means the individual is uninsured--i.e., much better financially for the hospital to eat some COBRA premiums and be able to seek reimbursement from the plan. Also, there are situations where a COBRA eligible individual may take a job with another employer that does not offer group health. In some of those cases, the new employers may be talked into paying COBRA premiums for the new employee--cheaper than establishing whole new health plan. I think the big question in those cases then becomes whether the employer's payment of COBRA premiums on behalf of the employee is taxable. I have not researched but I believe a good argument could be made under code sections 105 and 106 that an employer's payment of COBRA premiums on behalf of an employee are not generally taxable--i.e., that they are akin to employers picking up the cost of regular group health plan premiums on behalf of employees. Some thought must also be given to whether an arrangement in which the employer picks up the COBRA premium costs in itself essentially creates a group health plan subject to ERISA, etc.

Jpod, Thanks for your email. I cannot speak to the reason other employers don't respond. I suppose it could be somewhat cumbersome to pull together records in some cases. In our particular case the issue isn't about difficulty in responding. In our case we are dealing with the former CEO. Company clearly believes that CEO was terminated prior to eligible period and could easily provide documentation of that. Some in the company, however, do not want to respond because that likely would result (under any reasonable interpretation of the facts) in a denial of his subsidy. So, thought was they wouldn't respond at all. That way the company doesn't offer up contradictory evidence to employee's claim. Instead they would just let DOL make its decision without the employer documenting the facts. Who knows what the employee has actually told the DOL or provided as back up. There is reason to believe that he may not have been particularly forthcoming. So, question was what happens if you just ignore the DOL's request for information, particularly if you may have reason to believe the employee has not given the DOL full facts. Most of the employers I know get a bit anxious about ignoring requests from the DOL for answers. And most get a bit anxious in arguably assisting employees in taking benefits under false pretenses. In addition to those issues, I think there is some general thought too that some small portion of President Obama's money to pay these subsidies comes out of everyone's pocket (including the company's pocket).