401 Chaos

Would appreciate thoughts on the following. Suppose employer has old deferred comp plan that has not yet been amended for 409A. (Company has not gotten around to it yet but plans to amend before year-end.) One of the provisions that presents compliance issues is provision which provides for certain pro-rata portion of participants' deferred comp account in the event they die while employed by company and have not attained age 65. Plan provides for death benefit to be paid to designated beneficiary but does not provide for specific time for payment. If participant died (say now) and was entitled to get benefit, could the amount just be paid out (say within 90 days) and be considered compliant with 409A? Alternatively, could the agreement possibly be expressly amended by the participant's estate or possibly the participant's designated beneficiary to provide for payment within specified period that complies with 409A (say within 30 days of death) without violating 409A? There is no problem here with the company paying out amounts within reasonable timeframe or with estate / beneficiary agreeing to whatever provisions might be required to avoid excise taxes; however, due to the death, there is obviously no way that the company and the original participant can actually amend the original agreement to comply with 409A.

Just wanted to bump this up for reality check and brief revisit of issue as it relates to payment of future accounts receivables (AR) for a departing physician separate and apart from any equity interest or stock interest. First, I agree with Everett Moreland's post on a similar thread regarding physician agreements when he noted that the risk is just too great to not structure agreements to pay out on some fixed payment schedule per 1.400A-3(i)(1)(iii) when you have accounts receivables trickling in over extended period of time. Although it is not absolutely clear that the contingent nature of ARs would not in some cases give rise to a SRF argument that might let you comply with a short term deferral exemption, the lack of clarity on the issue is just too great to risk that, particularly if compliance can be fairly easily obtained. I have a physician who is reading the regulations (bad sign already) and has raised similar question to that raised by Masteff below. Namely in the preamble quoted by KJohnson it talks about the need for the physician not to have been in effective control at the time the payment is due. In most situations we would expect payment for a physician's medical services (the services giving rise to the future AR payments) to first be due and payable when the services are rendered and thus at a time the physician was very much employed with (and possibly in control of) the practice group. Of course, all involved realistically understand that actual payment is likely not to happen for an extended period such that the Dr. rendering services could depart and be long gone by time payment is received (or even when normally expected). Thus the preamble language about being in effective control at time payment becomes due is seemingly troublesome. Perhaps it really means though at the time payment is collected? If I read Masteff's posts correctly, Masteff seems to go beyond simply noting a problem with the timing issue raised in the preamble. He seems to argue that the AR amounts should not be viewed as deferred copensation subject to 409A at all if the physician was in control (or I guess generally connected with the practice) at the time payment was due. I do not read the preamble provisions KJohnson quoted to really provide or support that sort of interpretation but perhaps I am missing something. I see the provisions quoted as addressing whether amounts subject to 409A (which I guess I think vested but deferred AR payments would be) may be structured to comply with the specified time or fixed schedule payment requirements even if they base timing of payment on the time the service recipient's receives the actual payments. Nothing about the quoted provisions seem to me to say that such amounts would be exempted from 409A, just that they may not qualify as being paid on a fixed schedule. I suppose if the timing rule were as Masteff notes and the amounts were subject to 409A, this would raise a question of just how you could comply with the payment requirements under 409A while keeping payment contingent on amounts collected / received by the physician practice group. However, the actual regulations in 1.409A-3(i)(1)(iii)(B) seem to me to eliminate this problem or concern by avoiding the somewhat strange "when payment is due" language and instead suggest there should not be an issue as long as the physician is not in controll of the phyisican group or the patient, etc. at the time the payment is received. That would guarantee that the physician cannot control when the amounts are collected or paid and makes sense to me from a policy standpoint. Just curious if I am missing some aspect of Masteff's argument so that the preamble language might actually prevent complying with 409A by establishing a fixed schedule based on when AR amounts are received when they were arguably first due and payable when the physician was still working with the practice group. Given the differing language in the actual regulations, I'm thinking the preamble provisions are not an barrier to compliance. (Note, I've generally given up on any argument that the preamble provision would somehow support the notion that AR amounts first payable while physician was still employed would somehow fall outside 409A but if I'm missing something there, I would appreciate any thoughts or help understanding the argument.)

Stuartt, Thanks for the response. Just to be sure I understand, are you saying you think it may be ok for a company to file a retroactive wrap plan where there was some history or prior thought that the company had one single plan in the past but simply had not filed (e.g., where the company thought that their Section 125 / Cafteria Plan document was a single plan covering all the individual welfare programs) but not okay where the company never filed and also never really presented all of the various welfare progams as a single plan in the past? If they never filed as separate plans, could you take the position the company always viewed the programs being offered under a single plan but just didn't file? Thanks.

Desperate enough to try bumping this up one more time. Interested in knowing if anybody has any new or different thoughts on adopting a retroactive wrap plan in order to make one DFVC filing for employer that failed to file any 5500s for several welfare benefit plans for several prior years. Because DFVC has no "per plan sponsor" cap, filing DFVC for each individual Plan would require filing 5500s for at least 4 different plans, all capped at per plan cap amount of $4,000. So, without retraocive wrap they owe at least $16,000 under DFVC (4 plans X $4,000 per plan amount) versus just $4,000 for maximum wrap plan filing penalty. We have seen arguments that such retroactive wrap plans may be used for such purposes but have run into a couple of brokers that suggest the DOL is clear this doesn't work. They do not offer up any written guidance to support their claims, just their understanding (maybe based on recollection of informal comments??) that DOL does not allow. Just wondering if I have missed some clear DOL prohibition on use of retroactive wrap plans. Many thanks.

I suspect you get different answers on the investment side (and thus potentially on the fiduciary front) depending on whether you ask Vanguard or a registered investment advisor whose whole purpose in advising the plan is to recommend actively managed funds (or mix of actively managed funds) rather than simply having a group of passive index funds. Our advisors never include any of our plan's index funds in any of their recommended portfolios because the whole idea of the model portfolios is that they should be picked to offer greater diversification, protection in both up and down markets, ect. than a similar passive portfolio. I do not think, however, that necessarily means that a selection of just or mostly index funds could not satisfy 404©.

We've seen some similar arrangements in the past but mostly where key employees agree to a significant reduction in salary with the right to be reimbursed at some future date if certain metrics are hit. In those cases, there were express agreements between the company and the employees stating what new salary was going to be and what triggers were required in order for the amounts to be paid out. The amounts to be paid were to be paid in a lump sum cash amount within 30 days of reaching the targets. In some cases the arrangements were conceived before 409A but we took the position that they were not vested amounts so 409A likely applied. We also, however, made argument that the amounts should satisfy the short term deferral exception since they were to be paid within 30 days of the individuals vesting in the amounts. Not sure if that helps your situation or not but perhaps that would be one way to address it. I suspect in your case though the CEO would like to view the amounts as generally vested and not subject to some milestone or performance criteria. I think in those cases you could have full 409A concerns.

PAL, I think it would be a real mess but yes in general I think it would apply to any shares purchased after the number of registered shares ran out. It should be possible to determine the time of exhaustion of the registered shares and sort of draw a line for all transactions after that. A number of the unregistered shares will have been sold but it should still be possible to determine if those shares were sold at a loss and make participants whole. In essence, the rescission would basically guarantee that nobody would have lost money on the sales. Earthlink (Mindspring) filed an S-3 back in 2004 that goes into extensive detail on how the rescission would be handled for different participants. I do suppose it might be possible for some sort of statute of limitations to apply but I'm still not following how the 1 year statute of limitations QDROphile referenced fits in with the 401(k) plan context. Again, I understand that a fiduciary would have to weigh the pros and cons of such a right but in cases where there is a significant drop in stock price, the effect on the plan would seem to pale in most cases even if the fiduciary had to file suit and litigate the issue on behalf of participants. Of course, the effect on the plan sponsor / employer could be enormous--and might even put them out of business in some cases which could be very bad for active participants--but I am not sure that impact on / cost to the employer should weigh into the fiduciary's analysis with respect to participants' benefits under the Plan. I remain puzzled that there seems to be little to no press on the issue with respect to the Dell 401(k) Plan. If I were a disgruntled former employee who lost money on Dell shares, I think I would be exploring possible class action suits. Maybe that's not possible though. Edit: I just did some digging on the Dell situation since the time of my initial post on this and discovered that Dell filed an S-1 a couple of weeks ago providing a rescission offer to what appears to be those participants purchasing shares since March 31, 2006. The amount of repurchases there was limited because Dell had temporarily halted purchases of their shares in 2007 due to their failure to file current returns and I believe they take the position that the general statute of limitations for rights of rescission lapsing 1 year after the offer is made should mean that no participants would have had a legal right to rescind but for their voluntary offer to do so. That position, however, would not really help in our case since our plan had no blackout on the shares--we just got a new S-8 up as quickly as possible after discovering the issue--and thus had many purchases within the 1 year statute of limitations period. Ignoring the potential rescission rights in hopes that the statute of limitations will run as QDRO suggested brings me back to my initial question / concern with how the plan administrator could really keep silent on this. I do note that the Benefits Committee for the Dell Plan appears to have separate counsel and entered into standstill / tolling agreement with the company to try and preserve participants' rights.

MJB, Regarding Item 2 below, am I assuming correctly that this would only work if the cafeteria plan expressly excluded highly comped from participating in the cafeteria plan at all. What if employer paid 100% of executives' group health premiums but required rank and file to pay 50% of premiums but the employer permitted executives to participate in the cafeteria plan for pre-tax payment of certain other premiums (e.g., dental, vision, life) without any differential. Would fact that the highly compedves had 100% of group health premiums paid by employer and thus had no need to use the cafeteria plan for group health benefits be sufficient? Could the cafeteria plan just exclude / carve out the highly comped from the group health plan. To be able to get around the cafeteria plan rules by providing highly comped employees such a large employer subsidy seems almost too good to be true. Thanks. L: where did you get that health insurance cannot discriminate within a classification? 1. Under IRC 105(h) self insured plans that do not provide for risk shifting are subject to non discrimination rules. Fully insured plans (eg. where the risk of paying benefits is shifted to an insurer) are not subject to any nondiscrimination rules. Therefore the employer can pay 100% of the health insurance premiums for the owners and require that non owner pay part or all of the premium. ERISA does not regulate eligibility for health or other welfare benefits. 2. A cafeteria plan under IRC 125 only requires non discrimination for employee who are eligible to particpate in the plan, e.g.,among those employees who are eligible to pay premiums. If the employer pays 100% of the owners premiums under an insured plan they can be excluded from the 125 plan and there will be no discrimination because only nhces who are eligible to participate will be required to contribute to the 125 plan on a non discriminatory basis. 3. The provider of health insurance may have its own rules for covering or excluding employees under the underwriting rules to prevent anti selection which are separate from the rules in 1 and 2.

Just wanted to bump this up again as have seen no real discussion on this issue recently. I have run into a similar situation previously described and another broker / insurer saying the DOL is very clear that you cannot retroactively adopt a wrap plan. I have yet to have them produce the applicable guidance and have not seen any myself but I was wondering if I had missed it. (I wouldn't disagree with that position but it does seem to fly in the face of what others have done and obviously makes an enormous difference to employer in terms of total DFVC fees.) Thanks.

QDROphile, Thanks again for your thoughts. I appreciate your point about needing to weigh the pros and cons. I guess given the large decline in stock price in recent months I was assuming the value (windfall) associated with a rescission would pretty easily outweigh the adverse consequences on the plan but your point about the fiduciary not assuming that is well taken. FWIW, looks like auditors will likely make company disclose this in its financials so the issue is likely to be disclosed to the public at large and would not be exclusive knowledge of the fiduciary. Still not sure exactly how the fiduciary should think about it's duties / obligations if general disclosure of the issue and potential rescission rights doesn't spark participants to take action--i.e., wonder if fiduciary really needs to push for the rescission on behalf of participants or if it could wash its hands of whole issue by simply having it disclosed and permitting individual participants following up if they desire. What a mess.

My limited experience has been the same as Steelerfan's. I may have some of the history and background confused but I seemed to recall Minnesota used to follow some variant of the source rule (perhaps even more aggressively) but went away from that after the federal statute was passed and after some bad court cases limited their ability to go after former residents. In other words, they seemed to sort of give up on the source rule for a period. Now, however, they are going back so it's more like a return to their original position than a brand-new position. (Again, take all that with a grain of salt as it's been awhile since I've researched this and never looked at Minn too closely.) There is an article in the Summer 2007 edition of The Tax Lawyer, the ABA Tax Section's periodic journal, that discusses relatively new rules in New York and their attempts to clarify allocation of income based on the source rule approach (which appears to borrow heavily on the federal tax rule approach for individuals who change from U.S. residents to nonresidents mid-year). When I called my state's Tax of Revenue to ask if they had clear guidance or directives on this (in either or both a nonqualified stock option or less than 10-year deferred compensation plan arrangement) they seemed clueless. In the end it seems their general rules default to application of a source rule approach much like the other states (which I don't argue is illogical) but there was no very clear or express policy for any of that. This stuff gets to be a real mess for all involved when people retire to different states or move from state to state such that the option vesting is divided among different jurisdictions.

QDRO, I don't really disagree with your comments. Some would have preferred they get rid of the employer stock fund long ago for a host of reasons. I don't know though how the Plan Administrator (knowing of the potential right to rescind) can remain silent about the participants' ability to reverse their losses over the past couple of years given the fiduciary's obligation to act solely in the best interests of the participants. I agree they all got exactly what they wanted / sought and had all the information they would have had if the S-8 had been filed, etc. At the end though it seems this "windfall" would clearly be in the participants best interests and thus the fiduciary's duty might be pretty clear. (If some participant really wanted the stock, they could just elect not to rescind.) I think this is a bit absurd for an immaterial foot fault but am just not seeing a clear way around for a fiduciary that is aware of the issue. While acknowledging that this isn't the best arrangement, if you take as a given that the fiduciary knows about the issue, do you think they really can sit on that knowledge because it only provides the participants a windfall?

thanks QDRO. We are getting counsel involved. By "run for luck through the 1 year statute of limitations" do you mean fix the issue by filing new S-8 for future investments but take no action with respect to past violations and just hope no participant seeks to rescind? If that's the case, it would seem there would arguably be ERISA fiduciary obligations to alert participants to the rescission apart from the securities law issues if not to affirmatively correct. Seems it is also probably impossible for a company to remain silent on these issues in its other securities filings. I see from the most recent Dell 10-K, for example, that they potentially failed to register some 37 million shares over the past several years and that they acknowledge certain participants might have rescission rights and that they may be subject to civil penalties, etc. but didn's see where they had taken any action to correct.

Help! We have a 401(k) plan that originally filed an S-8 a few years ago and has just discovered that it blew through the registered shares a couple of years ago. Of course, the value of the stock has declined considerably during that period as well. We are trying to research possible correction alternatives or at least exploring whether there is any option rather than rescission but we are not finding much information--either in the benefits or securities world--on how to handle in a 401(k) plan. Is anybody aware of good discussion of this issue or have tips on how to sort through. Nobody externally has raised an issue with the lack of registration but we're assuming not correcting past violations is not a viable option. Thanks.

Masteff, Thanks for the links. I promise I did (an obviously deficient) search before posting and came up empty. You make a good point about people doing this by distribution anyway so from a retirement / policy perspective it seems they may end up in the same situation. I guess my only concern would be that the folks that seem to be most interested in these types of arrangements are also the ones least likely to spend money on good counsel and so could find themselves with prohibited transactions and penalties, etc. and not just early distribution costs. Thanks again

I am interested in hearing others' opionions or experience with 401(k) plan products that appear to permit individuals to use their 401(k) plans to invest in / fund the startup of new companies. My understanding is that an individual looking to start his or her own business can transfer or roll over his or her 401(k) plan balance under a former employer's plan to a new 401(k) plan sponsored by a private company newly established by the individual. The new 401(k) plan then presumably uses the funds to invest / buy shares of stock in the new company. The end result is that the account holder (as head of the new company) gets to use his or her 401(k) funds to finance the new company without having to take a distribution from the plan or having to borrow money from the bank, etc. The stock in the new company remains a plan asset. As I understand it, one such program is marketed by Guidant Financial (among others) and is marketed frequently to those wishing to start their own franchise. I haven't discussed the legal aspects of all of this with ERISA counsel but i cannot see how this would not raise a host of at least potential self-dealing and prohibited transaction issues. I am also unclear exactly how the plan holds the investment in the company stock--is that an investment option for all plan participants or is there a way to limit that investment option just to the owner's account? Is that treated as an investment in "employer securities/" or is that some pooled plan investment? Does it make any difference if the 401(k) account holder is the only plan participant? Does it make any difference if account holder the sole owner of the business? My usual instinct is to run from such products but I am intrigued that these appear to continue to be heavily marketed.

Just curious if you had any luck finding such a thing or others might have suggestions. Thanks.

Just curious if anybody has further thoughts on these issues in light of final 409A regulations. I am looking at a physician agreement that provides "severance" pay in the form of a decreasing percentages of the practice's AR for three years following termination. It seems to me the first part of this is more tied to receipt of payments collected for services the doctor rendered or had a hand in but the payments beyond the first year (and I guess even some of the 1st year's payments) really seem to me to clearly be true deferred compensation arrangements. There there is a legally binding right to a certain percentage even though there is no idea how much AR the practice will actually collect. I don't think compliance there is too hard but necessitates making some changes to agreements which seems to open up can of worms. Anybody else seeing similar arrangements or have other thoughts? Also curious if anybody may point me to an article or more detailed discussion of this issue and typical physician employment agreement issues written post-final regulations. Seems there have got to be a lot of physicians (and others) with similar arrangements.

Just curious if anybody has further thoughts on these issues and Masteff's last post concerning possibility that AR tied to period during which services were performed would not be deferred compensation. Also, curious if anybody has thoughts on an earlier post (pre final regulations) I've seen that suggested an argument that the risks inherent in trying to collect the AR may work a substantial risk of forfeiture such that the AR might be exempt from 409A if paid to former employee within short term deferral period after it is collected (vests). I am looking at a physician agreement that provides "severance" pay in the form of a decreasing percentages of the practice's AR for three years following termination. It seems to me the first part of this is more tied to receipt of payments collected for services the doctor rendered or had a hand in but the payments beyond the first year (and I guess even some of the 1st year's payments) really seem to me to clearly be true deferred compensation arrangements. I don't think compliance there is too hard but necessitates making some changes to agreements which seems to open up can of worms. Anybody else seeing similar arrangements or have other thoughts? Also curious if anybody may point me to an article or more detailed discussion of this issue and typical physician employment agreement issues written post-final regulations. Seems there have got to be a lot of physicians (and others) with similar arrangements.

I've struggled with this issue as well. My particular transaction was structured as a statutory merger / stock deal so that Buyer will become legal successor to the seller.

I have a somewhat similar question. What if we have an individual that was properly given chance to enroll in plan and made a deferral election but the employer / plan administrative failed to log in the deferral election so the individual missed out on elective deferrals for the last 6 months. Company just discovered the error and participant is irate that full amount (plus match) was not deferred. Of course, he says he didn't question lack of 401(k) deductions because he didn't look at his paycheck stub. Company would be willing to provide full deferral amount here even though that means a windfall to participant. Company would rather cough up the bucks than argue with participant even if it has basis for not providing full amount. Is there any problem in doing that and not applying the 50% factor or in not using the average deferral percentage instead of participant's actual deferral percentage? (In this case, the participant is a NHCE and his deferral percentage was higher than average for other NHCEs so seems to me correcting him at higher rate would not be a problem.)

I am hoping if I rephrase and add a bit more specific information it might generate some discussion. The Plan provides that an "Hour of Service" inclues each hour for which an Employee is paid or entitled to payment, for the performance of duties of the Employer and "each hour for which an Employee is paid by the Employer on account of a period of time during which no duties are performed due to vacation, holiday, illness, incapacity, layoff, jury duty, military duty or leave of absence" (up to a maximum of 501 hours). Plan provides that an Employee shall be credited with 45 Hours of Service for each week in which the Employee actually works for an hour or more for the Employer. (The 45 Hours per week crediting provision appears to only apply to hours actively worked with credit for vacation or PTO credited as actual hours.) The departing HCE here needs 1,000 Hours of Service in 2008 to get to 30 Years of Service. By my count, that would require him to generally work / accrue hours up until the first week of June 2008 (i.e., 23 weeks). Individual, however, has 46 days (414 hours) of accrued vacation and PTO. As a result, it seems to me if the individual works at least one hour during the first 14 weeks of 2008 (i.e., up until March 31st), he could then essentially stop active employment and use the remaining accrued PTO and get to the 1,000 Hours of Service mark. Both company and individual contemplate individual will continue providing some services to employer but on a much reduced basis from past levels. That is to say, he will be doing substantive work representing the employer and transitioning his projects but probably nowhere near previous full-time work. The actual hours will likely vary a good bit from week to week but should require at least 1 hour per week over next several weeks. Given the plan language and the fact the individual will continue to perform some services for employee, it would seem to me that the company could safely classify and consider the individual an employee through March 31st for purposes of getting credit for active employment under the Plan. My question or concern is whether the fact that the individual may not be providing full-time service a potential risk or concern here or are there other possible problems with say using the accrued PTO for credit in these sorts of situations. How much scrutiny do these sorts of arrangements get and doesnt the plan language provide significant flexibility for such things. Many thanks.

Wanted to bump this up and ask a similar question. I am assuming that this is a dumb question but I do not work with defined benefit arrangements very often and so wanted to make sure I was not assuming away some possible creative approach or interpretation of a plan provision. Situation is as follows; Employer has defined benefit plan with language that defines "hour of service" using language in 2530.202b-2, including description that an hour of service may include each hour for which an employee is paid, or entitled to payment, including certain periods during which no duties are performed. Employer has high ranking HCE that it desires to terminate. HCE currently has 29 years of service. Plan provides much more generous benefit to early retirees with 30 years of service. HCE will get generous severance benefits equal to about 1 year of salary. HCE will also provide some additional transition support and guidance to employer (not totally a fiction) but original plan was to have HCE do this as a consultant or independent contractor and sever the employment relationship. HCE has a large number of accrued vacation and sick leave days to which he will get paid but those don't come close to getting him enough "hours" for one more year of service. Is there any argument that severance pay following termination of employment could count toward Hours / Years of Service in this case so HCE would get to 30 Years of Service. That just seems completely discriminatory and abusive to me. This is not a window program with broader availability, etc.--it's all about trying to provide greater severance / retirement benefits to one HCE than he would receive under terms of the plan as generally applied. Other alternatives--could we argue that the individual was on a paid leave of absence when we know intent is that he will never routine for employment. Do they keep him on as an employee for certain transition period during which he would provide some periodic assistance at a lower level and perhaps lower rate of pay but would not really be actively working the same way--i.e., he would not be coming in every day but also wouldn't be expected to completely disappear from the scene either. Any thoughts or assistance would be greatly appreciated. I cannot seem to find any prior threads that discuss this particular issue in detail.

Regarding employment agreement provisions promising long-term (e.g., say until age 65) continuation of life insurance and disability insurance coverage for executives following a separation from service, I have seen suggested that the broad general exemption for "certain welfare benefits" under Treas. Regs. § 1.409A-1(a)(5) should completely exempt such arrangements as "death benefit plans" and "disability pay." I am curious whether others have reached this same conclusion or heard any formal support for such interpretation. If that is the case, then it seems that some of the discussions / analysis above is unnecessary since any continued life insurance or LTD coverage should be automatically exempted from 409A. I am particularly curious about this result in situations where an employer's regular group life insurance and group LTD plans will not permit continued coverage of former employees / executives so that the company must go out and purchase individual life insurance and LTD coverage for the former executive to make good on its promise. I have been fearful that the purchase of such exclusive individual policies may fall outside the intended scope of this welfare benefits exception.

Stuartt: Not sure whether your last post was for me or Don but the language included on page 21 is pretty much identical to the language in the 2004 letter. My reading of that is that if you are below the requisite 80% level, then you really have little argument for single employer status. Is that your take as well? For what it is worth, I think my situation is fairly distinguishable from the PEO--type arrangements. In my case, there are no leased employees--all three organizations have their own separate employees. The management group does not lease or provide any employees to the practice groups but it does provide typical professional management services and so we think is clearly part of a management ASG for qualified plan purposes. The piece that seems problematic in our case is that regular management ASG rules do not require the percentage ownership levels that is arguably required to avoid MEWA status. Thanks.