401 Chaos

Maybe I'm wrong on this but I think even if a 2006 bonus is to be paid in 2007, you need to make the election before the services giving rise to the bonus are rendered under the 409A rules hence the need to prorate for the bonus amount presumably attributable to the services rendered after the election.

Not sure about Janet and Randy's situation but what about plans that merely offer employer stock as one of several investment options but the sponsor does not make any contributions in employer securities. I ageee there is no harm in providing reminders of ability and importance of diversification but am getting serious push-back from plan administrators that do not want to send out a notice unless they absolutely have to do so. I guess I'm thinking it is not absolutely necessary in that case. Thanks

Does anyone have sample cash-out provision or language from a cafeteria plan document and an election form they would be willing to provide. I cannot seem to find a good model form for such language and want to be sure I'm not missing something. Thanks.

My experience has been very similar to Dell's experience. I think there is typically a grace period and compliance time once the DOL spots the lack of an audit and there is usually no problem if a complete 5500 is submitted in responses to the DOL notice. However, there is no guarantee so I suppose technically they could always pursue the initial return as a late / incomplete return if they chose to do so. Although submitting the amended return before the DOL spots the issue can cause some confusion, that is still my preference. If the DOL later writes to ask about the missing audit on the initial return, we just forward them a copy of the amended version and that usually takes care of things.

I just posted this on the Welfare Plan Board in response to another topic title but thought I might post here as well to see if others had thoughts. I have in the past had a couple of occassions to retroactlively adopt wrap plans in order to limit the DFVC filings required for plan sponsors who have never filed Form 5500s. I too have never had any objections from the DOL. In fact, one time I called the DFVC hotline and asked them directly if they had any problem with the use of a retroactive wrap plan in such situations and the person on the other end said no without any hesitation. (While I suspect the person answering the phone is admittedly not a DOL policy maker, it seems other DOL representatives have informally indicated that retroactive wrap plans can be used.) Although the use of retroactive wrap plans has always struck me as a bit suspect and not above challenge, it clearly appears that many plan sponsors have done this without issue. I now have a client who is in a different situation. Basically they have filed a single Form 5500 for all their welfare plans for the last 10+ years or so as if they had a wrap plan in place. (I think they thought their cafeteria plan was a wrap plan which it is not.) Everyone is in agreement that the filings are not technically correct and that a wrap plan is needed going forward. However, when I suggested that they retroactively adopt a Wrap Plan to try and address the prior filings, their benefits broker (an experienced broker with a large national group) said they did not think you could retroactively adopt a wrap plan and did not think that would legally help the situation. If anything, it seems to me the use of a retoactive wrap plan is is less offensive in this type setting than the use of retroactive wrap plans in a DFVC context since at least the plan sponsor filed a return and disclosed the information. The national consulting group did not reference any recent changes or developments on the retroactive Wrap Plan front--they just did not think anything could be done retroactively outside of the remedial amendment period. Again, I don't view retroactive plans as ideal either but they do seem to be accepted by the DOL in my experience. My questions are as follows: 1. Has anyone encountered any problems or resistance from the DOL with use of retroactive wrap plans or seen or heard of any change in the DOL's position on use of retroactive wrap plans since the original post? 2. Anyone see any problems with the use of a retroactive wrap plan to conform to prior 5500 filings without a plan in place as compared to the use of retroactive wrap plans as part of a DFVC filing? 3. If a retroactive wrap plan may work--and, again, I agree it is not perfect but seems like a solution that is worth trying giving the alternatives--does it not make sense to go ahead and put a retroactive wrap plan in place now rather than waiting to see if there is ever a need to produce the plan document and then attempting to put one in place in the midst of a DOL audit, etc.? (Seems to me even though it is late, the "less late" it is adopted, the better.) 4. Finally, if you are going to do a retroactive wrap plan in this type of setting, is it legally necessary to take it all the way back to the beginning of the plan or could you argue that only the 2003, 2004, and 2005 years are techncially open and need to be corrected since a 5500 filing has been made (or is about to be made) for each of those years. While it is tempting to take the wrap back all the way to inception, the benefits provided under the plan and the insurers involved, etc. have changed considerably over the past 12+ years and it would be much easier to only try to get an accurate wrap document in place for the "open" years assuming earlier years have closed.

Just wanted to bump this thread up to check in regarding everyone's most recent experience with the use of retroactive wrap plan documents to fix prior filing problems. Like Kirk and AshleyL, I have in the past had a couple of occassions to retroactlively adopt wrap plans in order to limit the DFVC filings required for plan sponsors who have never filed Form 5500s. I too have never had any objections from the DOL. In fact, one time I called the DFVC hotline and asked them directly if they had any problem with the use of a retroactive wrap plan in such situations and the person on the other end said no without any hesitation. (While I suspect the person answering the phone is admittedly not a DOL policy maker, it seems other DOL representatives have informally indicated that retroactive wrap plans can be used.) Although the use of retroactive wrap plans has always struck me as a bit suspect and not above challenge, it clearly appears that many plan sponsors have done this without issue. I now have a client who is in a different situation. Basically they have filed a single Form 5500 for all their welfare plans for the last 10+ years or so as if they had a wrap plan in place. (I think they thought their cafeteria plan was a wrap plan which it is not.) Everyone is in agreement that the filings are not technically correct and that a wrap plan is needed going forward. However, when I suggested that they retroactively adopt a Wrap Plan to try and address the prior filings, their benefits broker (an experienced broker with a large national group) said they did not think you could retroactively adopt a wrap plan and did not think that would legally help the situation. If anything, it seems to me the use of a retoactive wrap plan is is less offensive in this type setting than the use of retroactive wrap plans in a DFVC context since at least the plan sponsor filed a return and disclosed the information. The national consulting group did not reference any recent changes or developments on the retroactive Wrap Plan front--they just did not think anything could be done retroactively outside of the remedial amendment period. Again, I don't view retroactive plans as ideal either but they do seem to be accepted by the DOL in my experience. My questions are as follows: 1. Has anyone encountered any problems or resistance from the DOL with use of retroactive wrap plans or seen or heard of any change in the DOL's position on use of retroactive wrap plans since the original post? 2. Anyone see any problems with the use of a retroactive wrap plan to conform to prior 5500 filings without a plan in place as compared to the use of retroactive wrap plans as part of a DFVC filing? 3. If a retroactive wrap plan may work--and, again, I agree it is not perfect but seems like a solution that is worth trying giving the alternatives--does it not make sense to go ahead and put a retroactive wrap plan in place now rather than waiting to see if there is ever a need to produce the plan document and then attempting to put one in place in the midst of a DOL audit, etc.? (Seems to me even though it is late, the "less late" it is adopted, the better.) 4. Finally, if you are going to do a retroactive wrap plan in this type of setting, is it legally necessary to take it all the way back to the beginning of the plan or could you argue that only the 2003, 2004, and 2005 years are techncially open and need to be corrected since a 5500 filing has been made (or is about to be made) for each of those years. While it is tempting to take the wrap back all the way to inception, the benefits provided under the plan and the insurers involved, etc. have changed considerably over the past 12+ years and it would be much easier to only try to get an accurate wrap document in place for the "open" years assuming earlier years have closed.

I have a follow-up question. I have always understood, as this post suggests, that termination of a 401(k) Plan immediately prior to closing the transaction would avoid successor plan issues. Here lately, however, I have seen others suggest that such an approach may not work in a merger situation where the target is merged with and into the Buyer. In that case, while it is clear that the Buyer is not the same employer as the target at the time the plan is terminated, it is not clear that the Buyer and the Target are not the same employer once the transaction is completed--the Buyer and Target basically become the same entity by operation of law. Because of the lack of express guidance in this area, I have seen some suggest that it is safer to merge the plans or request a specific ruling on the matter in order to be free from doubt. That additional distinction between mergers and other forms of transactions and the additional steps involved to merge the plans seems to run counter to the general thinking and philosophy noted in the ERISA Outline Book. I am curious whether others see merger situations treated differently from other stock deals because of this issue. Thanks.

I just wanted to bump this up to see if anybody had additional thoughts or guidance on this issue. Although I've seen others assume Zora's interpretation that amounts that would not otherwise be subject to 409A (such as accelerated vesting of nondiscounted options) should not be counted in the severance calculations, there seem to be others that assume the value of accelerated vesting may need to be counted or made to comply with 409A (see March-April 2006 NASPP Advisor suggesting that accelerated vesting of options upon termination may need to be structured to comply with the requirements of severance payments under 409A). Although I take Zora's point that taking accelerated vesting into account creates an argument that other items paid upon termination would need to be included, seems to me the 401(k) amounts, other qualified plan amounts, unused vacation, disability amounts, etc. are likely paid out or triggered by the separation from service or other legal triggers giving the individual the right to receive those amounts rather than having them paid as "severance pay." In many cases I see accelerated vesting included as one additional piece of added compensation or severance benefits to be given to an executive in exchange for a general release against the employer and clearly included as part of a negotiated "severance package" to which the executive would not otherwise have a legal right. Another question, if the value of accelerated vesting is to be taken into account for 409A purposes, how do you deal with the 6-month delay rule when dealing with public companies? Do you have to avoid all vesting and exercise for 6 months, do you allow for accelerated vesting but block exercise for 6 months, or something else?

You may want to check out Atwater v. Nortel Networks, a fairly recent North Carolina District Court case addressing some of these issues, if you haven't already. I think the preemption issue is still an open one but there is also a possible argument that there may be a slayer provision under federal common law. At any rate, I think the interpleader route is clearly the correct choice. http://www.ncmd.uscourts.gov/Opinions/Sep05/04cv503op.pdf

Just to amplify what QDROphile said, you are required to pay off the loan with after tax money. A rollover of the old 401(k) money to a new 401(k)e is beneficial precisely because it allows you to defer taxes on the amounts set aside in the old 401(k) on a pre-tax basis. Once those amounts are distributed from the combined 401(k) plan, they will be subject to income taxes. If you used the rollover amounts to pay off the loan, you would be paying off the loan with pre-tax money and would have already pocketed the loan amount. In short, you would basically be getting a tax-free distribution from the 401(k) and that won't work.

I wanted to bump this thread up in hopes that somebody might be able to provide a definitive answer as to whether or not self-funded short term disability benefits (i.e., basically a salary continuation plan or payroll practice for ERISA purposes) is considered a "welfare benefit" for purposes of the 414(s) exclusions from the definition of compensation. The reference in the IRS's training materials to "disability insurance" rasises some concerns in my mind as to whether such payroll practices can indeed be considered "welfare benefits" and thus excluded under this provision. I feel as if I'm missing some critical piece of guidance here--seems this is too frequent a concern not to be squarely addrssed. If it really is unclear, I would appreciate thoughts on how others commonly handle. Thanks.

Thanks for the response. I agree the options themselves generally shouldn't be subject to 409A, even if vesting is accelerated. My concern is whether some value must be attributed to the accelerated vesting of stock options for purposes of determining whether the individual's total separation pay falls within the safe harbor. I raise that concern because 280G generally does place a value on such accelerated vesting for purposes of determing whether an individual's payout upon a change in control crosses the excess parachute payment threshold. The proposed regulations do not appear to address this but the term "separation pay" would arguably seem broad enough to capture any potential value the IRS might attach to the accelerated vesting of options as part of a severance agreement. In the absence of any express guidance, I'm concerned that the IRS might draw some parallel to the 280G rules and attempt to attach some value to options as a result of accelerated vesting where a terminating employee received the max 2 times 401(a)(17) limit in cash plus accelerated vesting of options. Thanks

This is probably a dumb question but I have not seen much direct discussion of this topic and am hoping somebody can direct me to guidance in the proposed regulations. If a terminating employee receives accelerated vesting of stock options or similar non-cash enhancements as part of a severance package, should the value of such accelerated vesting be calculated basically the same as accelerated vesting be calculated under 280G in the event of a change in control? Is there any argument that such accelerated vesting benefits should be excluded for purposes of determining whether the individual is within the 2 times comp or 2 times the 401(a)(17) limit? Also, am I reading the "in addition to" provision in the proposed regulations correctly that the $5,000 de minimis payment provision in 1.409A-1(b)(9)(iv)© would be in addition to all the other severance benefit and reimbursement calculations? For example, could a terminating employee get 2 times 401(a)(17), continued health care coverage for 6 months, PLUS up to $5,000 in value related to accelerated stock option vesting and still come within the safe harbor? Seems to me the de minimis rule should be that notwithstanding any of the above exceptions any separation pay or benefits that are not more than $5,000 per year would be excluded from 409A regardless whether they are covered by one of the standard exceptions.

So, if a plan--in an attempt to beat the mandatory IRA rollover requirements effective March 31, 2005--cleaned house and made involuntary cashouts to all former participants with accounts under $5,000 in early 2005 (including folks who had their small accounts in the plan for more than two years following termination) the plan would be in violation and a participant would have a right (or be required) to return the cashout?

My research so far suggests that no statutory penalty has been set for a plan sponsor's failure to timely provide Medicare Part D Disclosure Notices to participants. Obviously, Plan has something of a legal and fiduciary duty to do so in order that participants can make appropriate choice as to Medicare Part D. Are there also no penalties imposed for failure to file a Disclosure Notice with CMS other than inability to receive subsidy if that is applicable? I am curious what others' experiences have been where Plan files a Disclosure Notice late with CMS and also provides late notices to participants. thanks

Locust and Harry O, Thanks for your observations. I think you both raise excellent thoughts and concerns. In this case, the options have been granted but the exercise price is not to be established until immediately prior to a "Change in Control." At that time, the exercise price is to be determined by dividing a specific amount of money by the number of outstanding shares immediately prior to the Change in Control. The specific dollar amount was set at an amount significantly greater than the company's current value. The idea was for option holders to only share in proceeds if there is a Change in Control and if they have pushed the value of the company above the minimum floor amount. Nobody ever intended to issue a discounted option--in fact the option is just the opposite and is intended to function as a premium option with an exercise price significantly above the current fair market value. However, the exercise price clearly is not fixed on the date of grant. Given the numbers, it seems highly unlikely that the number of outstanding shares--the variable component in establishing the ultimate exercise price--will increase so much that the ultimate exercise price could ever be below the estimated FMV of the options on the date of grant but I suppose that is not technically impossible. Thus, it seems anybody looking at the exercise price provision would have to conclude that this could be a discounted option and would have to be treated as one out of the gate. That would require significant changes to the exercise / distribution provisions, of course. It seems to me this issue could be solved by adding a provision along the lines of the following to the exercise price provisions: "provided that in no case shall the exercise price be below the fair market value of the options on the date of grant." The company, however, is loathe to amend the grants unless it absolutely has to.

Namealready, Thanks for your thoughts--I think we are on the same page. I was just grasping for creative work arounds in hopes of avoiding a meltdown in an existing program.

I would appreciate others' thoughts on whether an exercise price for an option that is not established until some future date will be subject to 409A if the terms do not clearly prohibit the future exercise price from being below FMV on the date of grant. For example, if an exercise price is to be set in the future in a manner that makes it very very very very very very unlikely (but not technically impossible) that the exercise price could be below FMV at the date of grant, is such an option considered a "discounted option" subject to 409A out of the gate? Is there any ability to withhold judment on the 409A aspect until actual exercise in order to determine if the option really did operate as a discounted option. I note that the preamble to the proposed 409A regulations provide as follows: "Thus, an option with an exercise price that is or may be below the fair market value of the underlying stock at the date of grant (a discounted option) is subject to the requirements of section 409A." Based on that language, it seems any option where the exercise price is not set at grant and could potentially end up below FMV at the date of grant would have to be considered a discounted option when granted no matter how highly unlikely it is that the exercise price would actually end up below FMV on the date of grant.

I would appreciate others' thoughts on whether an exercise price for an option that is not established until some future date will be subject to 409A if the terms do not clearly prohibit the future exercise price from being below FMV on the date of grant. For example, if an exercise price is to be set in the future in a manner that makes it very very very very very very unlikely (but not technically impossible) that the exercise price could be below FMV at the date of grant, is such an option considered a "discounted option" subject to 409A out of the gate? Is there any ability to withhold judment on the 409A aspect until actual exercise in order to determine if the option really did operate as a discounted option. I note that the preamble to the proposed 409A regulations provide as follows: "Thus, an option with an exercise price that is or may be below the fair market value of the underlying stock at the date of grant (a discounted option) is subject to the requirements of section 409A." Based on that language, it seems any option where the exercise price is not set at grant and could potentially end up below FMV at the date of grant would have to be considered a discounted option when granted no matter how highly unlikely it is that the exercise price would actually end up below FMV on the date of grant.

Dash, when you say there's a problem are you referring to the fact that the plan's terms require cash-outs to be made and the plan has not done so?

Gdburns, Thanks for your comments. Point taken on the car allowance not being wages or a taxable fringe but the terminology seems to blur a bit, even in the IRS Pubs. For example, Pub 15 (p. 10) notes that "payments to your employee for travel and other ncessary expenses to your business under a nonaccountable plan are wages . . ." I can certainly see where a general car allowance not tied to expenses might fall outside of the "wages" classification but what about one where the amounts really are intended to help cover significant travel costs incurred by the employee. Also, would there be no car allowance arrangement under a nonaccountable plan that could arguably be classified as a taxable extra or taxable fringe. At any rate, I previously reviewed the various IRS publications and did not find a very good direct discussion of the concept of taxable fringes or taxable extras. Can you provide some additional examples of common items that you would put in this category? (I'm trying to think broadly in terms of what qualifies as a taxable extra as others before me took an extremely broad view.) Many thanks.

Several references including IRS training materials note that both cash and non-cash fringe benefits are excluded by the fringe benefit exclusion under 1.414(s)-1©(3). The IRS materials specifically note that such benefits include "taxable 'extras' such as the personal use of a company car, educational assistance, etc." Can anybody point me in the right direction as to where the IRS draws the line with respect to what is a "taxable extra" for such purposes. For example, would a car "allowance" paid under a non-accountable plan be considered a taxable fringe benefit or should that be more properly thought of as general wages. Similarly, what about large cash employee awards or bonuses as opposed to small achievement type awards. I assume the smaller and less frequent the amounts the more likely these are to be thought of as taxable fringes rather than wages but I am trying to determine where the line should be drawn, especially for amounts that are fairly predictable and easily tracked and accounted for. Thanks for any thoughts or assistance.

Another related question. Several references including the IRS training materials cited by E as in ERISA note that both cash and non-cash fringe benefits are excluded under the fringe benefit exclusion. The IRS materials go on to note that "these are any taxable "extras" such as the personal use of a company car, educational assistance, etc." Can anybody point me in the right direction as to where the IRS draws the line with respect to what is a taxable extra for such purposes. For example, would a car "allowance" paid under a non-accountable plan be considered a taxable fringe benefit or should that be more properly thought of as general wages. Similarly, what about large cash employee awards or bonuses as opposed to small achievement type awards. I assume the smaller and less frequent the amounts the more likely these are to be thought of as taxable fringes rather than wages but I am trying to determine where the line should be drawn, especially for amounts that are fairly predictable and easily tracked and accounted for. Thanks for any thoughts or assistance.

Thanks for your thoughts. With respect to the deferral issue, if you wanted a portion of a discounted option to vest immediately upon grant--do you think that can be accomplished under 409A as well? Seems any grant of a vested discounted option raises deferral election problems.

Harry O, Thanks for your thoughts. We have been talking about that option, particularly for the modification of outstanding options. I'm assuming the fixed delivery date could be drafted to be a change of control so that the executive would receive his money upon a liquidity event. Is there any requirement that the options be exercised at some point in such a situation or could they go unexercised if the FMV of the stock fell below even the discounted exercise price? Also, will such an arrangement work in granting new discounted options going forward rather than just with the modification of new options. For example, how would a discounted option grant comply with the 409A deferral election rules. I am curious whether many others are seeing proposals for grants of new discounted options in light of 409A. Thanks