401 Chaos

Just wanted to bump this up. Does anybody have thoughts on discounted option modifications? Thanks.

E, Thanks for forwarding the IRS materials. The materials specifically refer to "certain benefits provided by the employer such as disability insurance." I think one could make a reasonable argument that the inclusion of the word "insurance" in the discussion rather than simply referring to "disability benefits" or the like means that short term disability benefits paid by a third-party insurer should be exempted from the definition but self-funded short-term disability benefits provided through a payroll practice of the employer would not be excluded. I suppose that would make sense from a W-2 reporting perspective as well although if the company pays the insurance premiums for the short-term disability coverage the amounts would still be taxable to the participants.

Not my idea and I suspect this is a strange question but what if somebody wants to modify discounted stock options subject to 409A in order to comply with the new 409A requirements rather than convert them to fair market value options. I assume that in order to modify you would have to make exercise mandatory either on a fixed schedule or one of the various 409A distribution / payment events (e.g., change of control, termination of employment, death or disability). In order to comply with 409A, would not the exercise have to be mandatory upon the stated payment event? If so, what happens from a tax standpoint if the option is underwater at the time of the stated event and the optionee does not exercise. How would the IRS assess taxes and penalties in that event? Also, can you grant new discounted stock options given 409A? Obviously, I assume any discounted options would need to be subject to the specified distribution events as discussed above but would there also be a 409A issue in terms of the "deferral election"--i.e., if you received the grant of a discounted stock option would you automatically violate 409A if the grant was made without a "deferral election" the year prior to the option grant. Thanks for any thoughts or guidance on these issues. I cannot imagine wanting to use discounted options in the current environment but have a client that wants to know exactly how this plays out and have not seen anything discussing these issues.

Another thought has occurred to me--should the term "welfare benefits" be considered in light of the terminology under 419A? If so, would that impact how insured short-term disability benefits are handled?

1.414(s)-1c(3) provides a safe harbor alternative definition of compensation excluding certain fringe benefits and other special compensation items, including "welfare benefits." Is the term "welfare benefits" for such purposes defined anywhere? If not, is it generally interpreted to mean benefits provided under an employee welfare benefit plan? More to the point, how should short term disability benefits be viewed in plans that exclude "welfare benefits" under the safe harbor alternative definition? I notice that several common reference charts comparing the various definitions of compensation note that short term disability payments will be excluded from compensation under this provision only if they constitute a "welfare benefit." However, I have found very little explaining when short term disability benefits constitute a "welfare benefit." I assume that short term disability benefits will be considered "welfare benefits" if they are provided under an insured short term disability plan or program such that they are considered to be provided under an ERISA employee welfare benefit plan. On the other hand, I assume short term disability benefits provided under a self-funded short term disability or sick pay program which is regarded as a payroll practice rather than ERISA welfare benefit plan might not be considered a "welfare benefit"? Does that sound correct?

Stevena. I am interested in whether you can point me to any materials that examine this on a state-by-state or nationwide basis. Also, does automatic enrollment where participants are given notice and opportunity to opt out clearly equate to wage garnishment? There seems to me to be a big difference between having 3% of your pay deducted from pay and cotnributed to a 401(k) plan account after you've been given ample opportunity to avoid it (as well as the ability to immediately stop it) versus having an employer garnish your wages due to an IRS levy or court order which the participant cannot stop (other than by paying the obligation some other way) but I do not know anything about NC laws.

It's certainly troublesome and would beg significant discrimination testing issues; however, I suppose some such provisions might pass. For example, if you allowed higher limits for those with more service and the employer happened to have a high number of NHCEs with lots of years of service, it might pass. I suspect, however, that you'll tell me that all the HCEs have a lot of years and only some NHCEs do. Doing it by position strikes me as even tougher to pass but again it might depend on the actual makeup of the group. Overall I suspect you would have real problems and would just be creating an enormous headache even if it would work.

I do not work with SEPs very often and am always confused by controlled group questions so am hoping others can help me out. Two unrelated business partners each establish their own single member LLCs and each establish a SEP in the name of their single member LLC. (Obviously the single member LLC is disregarded so the SEPs, I assume, are basically treated as if established by a sole proprietor?). The two business partners, in turn, use their single member LLCs to each take a 50% interest in an S corp. which is their principal business venture. The S corp has no employees--just the two owners--and has been operating for several years in this form. In addition, the two individuals recently decided to each take a 36% individual interest (not through the S Corp or their LLCs) in another, well-established corporation that has several employees. Although the 2 individuals each individually own 36% of the company, the remaining 28% is owned by various unrelated individuals or entities. Accountant seems to think that the employees in the new company must be counted as controlled group employees and allowed to participate in the SEPs previously set up by the individuals through their single member LLCs. Given that the 2 individuals do not effectively control 80% of the new company, I cannot see how there is any argument that the new company employees would have to be included or covered under the SEP. (Even if the two individuals did own a combined 80% of the new company, I'm not sure the new company employees would have to be counted.) What am I missing?

Austin, We are facing a similar issue regarding the possible amendment of our plan's vesting schedule and I am curious if Mr. Tripodi's discussion cites specific IRS authority or rulings for their interpretation that a participant's vesting percentage must be protected even for new employer matches made after amendment. Also, can you point me to a cite to the ERISA Conference Report or other comments you mention by Congress that contradict the IRS's interpretation. Reading 411(a)(10) alone, I can see where one could question the IRS's apparently expansive interpretation of this requirement. Thanks.

I'm not a HIPAAolic but I agree with Steve 72 here that the absence of a covered entity here means HIPAA and PHI are not an issue (at least outside of a state privacy law context). But I think the spirit of concern running through other comments should not be lost. We should not lose sight of the fact that there are probably very good legal and other reasons for the employer not to delve into the employee's detailed medical history or conditions even though it may be legally allowed to do so. Does the employer suspect that the emplolyee's Dr. would lie as to the individual's condition and ability to work, particularly over a long-term basis. If not, then seems all the employer really needs is a statement from the Dr. that the individual was prevented from working due to a medical condition for which they received treatment. Is such a statement that a particular individual received medical treatment considered PHI from the Dr's perspective? I don't know but suspect it could very likely be tagged as PHI. However, that's not the employer's issue and the Dr. can have the employee sign a consent covering this without a significant problem. Having the employer receiving that limited bit of (arguable) PHI info is far better than the employer knowing all of the employee's medical conditions. If the employer suspects the Dr. is repeatedly lying or covering for the participant, then I think that's a different story.

For an excellent article on the interplay between 409A and 457 and related subjects see Al Bianchi's article in the September 2005 BNA Tax Management Compensation Planning Journal. (A link to a copy of that article was included in the BenefitsLink daily update a couple of days ago.

Some additional Q&A guidance on situation raised above taken from the IRS's July 2005 Tax Talk Today webcast program on 409A Q-11. Can you explain if the 2005 calendar year transition relief applies to re-deferrals or subsequent deferral elections generally subject to the 12 month / 5 year rule. Specifically, if a participant wishes to make a subsequent deferrals for a deferred compensation payment originally scheduled to be paid out in early 2006. If a plan is not amended until late 2005 after additional guidance is released, is it still possible to allow a participant to make a subsequent deferral in late 2005 of the compensation initially scheduled to be paid out in early 2006 even though the participant would not comply with the requirement that such re-deferrals must be made at least 12 months in advance of the initial distribution date or does the good-faith compliance requirement mean that the re-deferral would have had to have been made in early 2005. A. Under Q&A 19© of Notice 2005-1, with respect to amounts subject to section 409A, a plan may be amended to provide for new payment elections with respect to amounts deferred before the election and the new election will not be treated as a change in the form and timing of payment under section 409A(a)(4) or an acceleration of payment under section 409A(a)(3). Therefore, if the plan is timely amended to provide for the new election, the participant can make the election without being required to comply with the 12 month and 5 year rules in section 409A(a)(4)©. However, prior law rules concerning constructive receipt will continue to apply. Q-25. You previously touched on rolling vesting and substantial risk of forfeiture as well as the interplay between section 83 and 409A. Is it be possible for a 457(f) plan that was originally intended to rely on the use of a rolling vesting or a rolling risk of forfeiture to further delay vesting of deferred amounts upon an extension or renewal of an employment agreement to comply with both sections 83 and 409A? A. Such a plan could satisfy the requirements of section 409A by complying with the requirements of section 409A(a)(4)©. Whether a “rolling” risk of forfeiture would be effective to defer taxation under section 457(f) is beyond the scope of this program.

I agree with Kirk that the Plan's best option is to obtain and follow advice from ERISA counsel as to appropriate course of action in light of the applicable facts and circumstances. (Perhaps AEA is counsel seeking to provide just such advice?) At any rate, the Plan needs to have a clear understanding of its jurisdiction's take on applying federal common law of waiver principles as done in Keen v. Weaver or other federal common law principles that arguably alter the general Egelhoff ERISA preemption analysis. If there is support for applying such federal common law principles in this jurisdiction, I think the Plan may be wise to go the next step and see if the divorce decree provided for a waiver of the spouse's rights in the Plan.

I agree with Mbozek. We've made corrective contributions by "reopening" closed accounts with several large recordkeepers as part of larger EPCRS corrections and never had this issue.

I agree with Alf. The most recent one we closed was submitted in mid-May 2004 and was concluded in mid-June 2005. That one did not include a determination letter request but did involve several defects over multiple years and was pretty complicated. Things moved fairly fast once it was assigned for review and the individual agent began working on it but it sat in a black hole for 11 months. I understand that the IRS is seriously backlogged with requests and limited in resources for the program. It is also my understanding that the nature of the defect / correction does not significantly impact the overall time involved as they take the applications in pretty much the order they are received. For example, a discrete defect with a clear, by-the-book correction such as the exclusion of eligible employees will likely take just as long to conclude as a very complex application because the easy ones don't get flagged or screened out along the way. I would appreciate hearing if others have had a different experience.

A couple of useful "treatises" include: 1. Henry Smith's Nonqualified Deferred Compensation Answer Book--in Aspen Publisher's "Answer Book" series (see link below); and 2. Bruce J. McNeil's Nonqualified Deferred Compensation Plans published by West Publishing http://www.aspenpublishers.com/Product.asp...t_id=0735523703 http://west.thomson.com/store/product.asp?...cookie%5Ftest=1 There are many other guides, including a ton of informal guidance and publications by interested groups on the new 409A rules. Good luck.

AEA, While I, of course, cannot provide any definitive guidance, we were in a similar situation earlier this year. In that deal, counsel on both sides generally concluded that 2005-1 basically allowed termination of all nonqualified plan amounts--both pre and post-409A accounts--without any real distinction. In that case, all amounts were to be paid out in a lump sum upon termination of the plan under the grandfathered amounts while the 2005 deferrals were presumably to be subject to standard post-409A terminations. The Plan was never formally amended to incorporate the 409A provisions. I think everybody's generally take on 2005-1 there was that it basically gave the company carte blanche to terminate and distribute amounts upon a termination during 2005 as transition relief provided all the distributed amounts were included in income for 2005. I believe this interpretation was driven largely by a general assumption that the IRS would ideally prefer that all these plans be terminated and disappear thus they likely would not insist on a plan delaying distribution to comply with post-409A distribution triggers if a company and participants all agreeed to terminate. Not sure that helps any. I will be interested if others have taken a different view.

I have a similar question which may be along the lines of what the original poster was asking. I would appreciate the group's thoughts. What if a small client, presumably due to ignorance and bad advice, never had a Fidelity Bond. They consistently answered "No" on the Form 5500 for a couple of years but recently got contacted by the DOL asking why they had no bond. They took steps to seek advice and acquire a Fidelity Bond immediately upon the DOL's inquiry and now have a bond in place. Is the DOL likely to impose any penalties for prior non-compliance or take other action where the plan is cooperative and takes immediate steps to do the right thing? Like Belgarath, I have not found a specific monetary penalty that applies other than the blanket fiduciary breach penalty. Would appreciate hearing from others with similar experience.

I agree that the issues raised by others are real concerns; however, I think there is still an argument to be made that the additional vesting should not constitute discounted options if the performance criteria and corresponding vesting percentages are spelled out at the time of grant. What if instead of the 140% vesting terminology there was simply a chart provided at grant that showed number of options to be received based on the scaled performance criteria. Nobody knows what will ultimately be distributed but the maximum grant amount is clearly spelled out. Perhaps this answer depends on the nature of the performance criteria and how objective they are. I certainly agree that if it is to be based on subjective criteria that there is potential for abuse and manipulation but I would not easily concede this if the criteria were truly objective. This just seems to me to be something of a different issue than the classic discounted option situation where a participant has an income spread beginning with the initial grant. In the end, however, I am not sure it is possible to receive a definitive answer based on current guidance.

Justin, I have not seen a 409A analysis of this particular type of performance-based arrangement before but my initial thought is that the fact that the options are granted at FMV at the date of grant should exempt them from 409A. It seems to me the chief difference between this arrangement and a standard nonqualified stock option plan is the fact that the total number of options ultimately received by participants in this plan may vary depending upon performance. At no point, however, does it seem that any options are actually granted as discounted options. Using the example you provided, it seems that if you originally granted 140 options at the $4 FMV and had no performance component then you should not have any 409A concerns. I am not sure that the fact that the exact number of options ultimately vested is unknown on the grant date is critical if the general range of total options that may be granted is spelled out at grant. This plan seems to be roughly equivalent to agreeing to grant a participant 140 options at FMV at grant but then including vesting requirements (or forfeiture / clawback provisions) to decrease options if certain performance goals are not met along the way. I would not think that type of arrangement would raise 409A issues and so wonder if your arrangement would as well. I will be interested in others' thoughts.

First, special thanks to QDROphile for correcting my past post. I meant to say that COBRA premiums may be paid by a cafeteria plan but my mind was in Health FSA mode. My apologies for the confusion. (I will try and edit my prior message to read correctly). AEA, I believe the prohibiition on paying COBRA amounts from a Health FSA comes from the Proposed Treasury Regulations under Code Section 125 rather than a specific plan prohibition. Proposed Treas. Reg. § 1.125-2, Q&A-7(b)(4) prohibits a health FSA from reimbursing participants' premium payments for other health coverage. This prohibitiion would generally extend to COBRA and Medicare premiums. I believe this prevents any COBRA payments through the Health FSA regardless of the terms of the employer's particular plan or the employment status of the participant. That said, however, I believe the employer should be able to allow the employee to pay the remaining 20% of the COBRA premiums pre-tax through the cafeteria plan although it make require an amendment specifically allowing the payment of COBRA premiums for continuing employees. Hope that helps.

AEA, A couple of follow-up questions in response to your post: 1. Are you certain that the plan, as a church-related plan, is subject to COBRA rules. There may be an argument that it is exempt from COBRA although you may still be subject to state continuation coverage rules. You could of course voluntarily provide COBRA benefits but I believe you would want to term it something else if you are exempt. 2. Do you intend to provide employer contributions only for the COBRA period? What happens after 18 months and the individual has to get an individual policy or some other form of coverage. If you intend to limit it to just the COBRA period, you will want to be very clear that employer contributions are in no way intended to alter or extend the maximum COBRA coverage period--i.e., you don't want the employee to say that they should get 18 months of COBRA from the time all employer contributions stop. 3. You can in many cases pay for COBRA premiums through a cafeteria plan providied the covered employee continues working for the employer and is eligible for the cafeteria plan. For example, a full-time employee dropping down to part-time status may lose group health insurance as a result but would still be working for the employer and probably eligible for the cafeteria plan. In that case, COBRA premiums generally could be made under the cafeteria plan. However, if the change in coverage begins 9/1 but the cafeteria plan is on a calendar year, you need to be sure that the change in group health coverage here qualifies as a change in status under the Section 125 ruels and the terms of the cafeteria plan and that the employee makes a new cafeteria plan election. Both EBIA and Thompson Publishing have helpful COBRA guides that can provide more detailed information on many of these issues.

Becky, Thanks very much. That makes me feel somewhat better... I think. Although I suppose there could be still be something about this plan that has gotten flagged for audit as part of the new program rather than their selection being completely random. Interesting breakdown of the number of auditors and plan audits they perform. Reading between the lines, it would seem that there are roughly 1,763 or so auditors out there that perform between 5 and 100 plan audits which is where I believe our auditor generally falls although I'm not sure exactly how many they do. Thanks again.

We have a client who received an Audit Letter from the DOL's Office of Chief Accountant in Washington, D.C. requesting copies of all audit workpapers and other documents within the independent auditor's possession that support the audit procedures performed with respect to investments, contributions, benefit payments, participatn data, plan obligations, and prohibited transactions. The letter simply notes that the request is being made as part of an "ongoing program" by the DOL to ensure compliance with ERISA's plan audit requirements. I am curious if others have received similar requests and this is likely just an ongoing program and the client got audited at random or whether it is likely that something on the Form 5500, a participant complaint, or other issue triggered this request. Other audits we have seen that have been sparked by participant complaints have generally originated from the DOL's Regional Office and the client is not aware of any problems or complaints that would have sparked this. Thanks in advance for any thoughts.

My general experience is that the DOL prefers that you mark the last individual plan Form 5500s as the "final" filing for the plan and indicate that the plan had 0 participants at the end of the Plan Year. Assuming you established a brand new plan (brand new plan number, etc.) for the Wrap rather than just taking over the plan number of one of the existing plans, then I think you have technically terminated all the individual plans and established a new plan which is regarded as a separate legal entity. I would be interested in the experience of others in this area.