401 Chaos

Lori, Could you help clarify your post for me. I understand that the IRS has repealed the separate filing requirement for fringe benefit plans, including 125 plans. However, if the company here has a medical flexible spending account / arrangement (FSA), don't they per se have an ERISA employee welfare benefit plan that would be required to file a Form 5500 (assuming they are above the threshold)? How could you have a medical FSA that would not be an ERISA welfare benefit plan? It seems to me that the IRS's actions mean that there would no longer be two Form 5500 requirements here--one for the 125 and one for the FSA (assuming they were maintained as separate plans); however, they would still have to do a Form 5500 filing for the FSA. Further, to the extent that the FSA is drafted as part of the regular cafeteria plan document rather than as a separate plan, I think that ultimately means that the single cafeteria plan / FSA would have to have a Form 5500 filing (again assuming they meet the threshold or don't fall within the 80/120 exception). Thanks.

SpuddyMom, I agree with Locust that the 5 year rule would likely apply in this situation. Does the executive really need or want the installments over the next 5 years or might they prefer to be subject to the 5 year rule but then have the installments run over a shorter period (15 years, 10 years)? I remain afraid to pursue this approach without further guidance but it is also hard for me to see that additional guidance would waive or extend the deadline for the 12 month / 5 year rule if we delay action.

I appreciate all the thoughts and certainly agree with everyone that more guidance on these issues is desperately needed. I am concerned, however, about delaying any action on my particular plan pending such guidance if amending the plan to allow for a subsequent deferral election would be of assistance. (Again, I acknowledge that there are 457(f) rolling vesting provisions to deal with.) Under the 12 month / 5 year rule, the participant would need to make a subsequent deferral by the end of July 2005--12 months prior to the original distribution (and vesting) date under the plan--in order to push back the distribution. Is there any guidance to support that the 409A transition period for 2005 would allow for subsequent deferrals later in 2005 even if the subsequent deferrals would not meet the 12 month rule. That would seem to run afoul of the good faith compliance requirement. In other words, could the participant make a subsequent deferral election in December 2005 pushing back the distribution date of the July 2006 distribution and still comply with the 409A rules as a result of the 2005 transition period?

E, thanks for your response. Perhaps we are saying the same thing but given the unvested nature of the 457(f) benefits, I don't see any way my plan qualifies for grandfathering for 409A purposes. Thus, if there is no grandfathering option and the Plan is already subject to the 409A rules, then what do I have to lose by making a material modification to the Plan if it helps our cause. Thanks.

Mbozek, Thanks, you hit on a big part of my concern. It does seem clear that any change would be a material modification under 409A but I guess I think that isn't a big concern as long as 409A would allow the particular change. (Seems to me the problem with a material modification adding a haircut provision is not that it's a material modification but that the haircut provision is not allowed under 409A. This plan is already subject to 409A whether or not it is materially modified so I am not concerned about a modification for those purposes.) My argument is that 409A allows changes in the time and form of distribution ("redeferrals") provided they comply with the 12 month / 5 year rules. So you could amend the Plan to allow such redeferrals (admittedly a material modification) and then allow the participant to exercise this new right 12 months before the initial July 2006 payment date and still comply with 409A. Obviously, the other piece is the vesting issue. As others have noted in prior posts, however, 409A does not seem to care so much about vesting and instead focuses on distributions. I believe the IRS has said you can accelerate vesting for certain purposes without causing a 409A problem so why not reduce or delay vesting? That seems to put you squarely back in the position of having to do some type of rolling vesting for 457(f) purposes--again a real concern given the Service's disfavor of those actions--but that does not really put the participant in any worse position than she would have been in outside of the 409A changes and was confronting the need to do a rolling vesting in 2006. I'm not saying any of this works--just trying to get my hands around the various arguments. Mbozek, should I assume from your comments that you think there is really no way to amend or alter this current plan? thanks

Mbozek, Thank you for your helpful response. We have discussed some of the pros and cons of recognizing the amounts in income in 2006 and the participant feels that she is very likley to be in a higher tax bracket in 2006 and over the next 10 years or so and then drop down to a lower bracket with any later employment and retirement. For better or worse, she is also very trusting that the NP will be around and will not change the arrangement later on--the amounts are not terribly large and I suspect the participant could make a real PR issue out of it for the NP if they later balked. I am not sure that AMT would be a concern in 2006 but will investigate. Assuming the participant trusts the NP and wishes to push the tax hit back past 2006 (say until 2017 or so) is the alternative basically to amend the plan to provide for vesting and distribution on January 1, 2017 (or some other fixed date) that the participant feels would approximate commencement of retirement.

Help, this 457(f) / 409A interplay really has me confused. I have been asked to review a 457(f) plan that was put in place by someone else in 2002. It calls for 100% vesting and distribution of benefits on July 31, 2006--the same date the executive's current employment agreement expires. I assume that the general intent was to allow for some rolling vesting provision on the eve of the vesting / distribution date but the plan does not expressly provide for rolling vesting. Based on what I have read here and elsewhere, I am assuming that the plan as currently drafted does not raise major problems. There has been no prior rolling of the vesting to create a potential 457(f) problem and the distribution date for the deferred amounts is already established as a fixed date for 409A purposes. The problem is that the participant does not anticipate retiring in 2006 but instead anticipates entering into another 4 or 5-year employment agreement. As a result, the participant does not wish to receive the deferred amounts in 2006. The amounts being deferred under the 457(f) plan are not that large and so I think the partiicpant is generally fine putting off vesting and distribution until a much later date--say normal retirement age--which is likely to be well beyond her termination of employment with her current employer (although not necessarily a time when she has actually retired from all employment). I would appreciate others' thoughts on common recommendations that make the most sense in terms of vesting and payout dates in such situations given the interplay between 409A and 457(f). Also, given the promise of additional guidance on certain 409A rules, I would prefer to hold off on amending the current plan until late in 2005 to allow for the possibiity that the IRS may provide some additional guidance in the 457(f) area. However, I wonder if there is any thought that the good faith compliance requirement and 12-month / 5 year re-deferral rule requires that any amendment pushing back the distribution date in this case be made by July 31, 2005 (1 year before the current distribution date) and thus cuts short the general December 31, 2005 deadline for making amendments under the 409A transition rules. Thanks in advance for any guidance.

Harry O, thanks for your comments on the constructive receipt issues. The possibility for violations concerns me but I'm having a hard time imagining the IRS enforcing those concepts where an employer relies on the broad powers under Q&A-19 to offer new payment elections. But for the Q&A-19 guidance, the employer would not amend the plan to provide new payment elections. It is not always possible to know when a participant will terminate or a payout otherwise get triggered so the transition relief under Q&A-19 seems of limited value in many cases. I'm just not sure how to square the seemingly broad power in 409A with the risks of constructive receipt violations. Seems this is another area where you cannot act with certainty under the rules.

Existing employee first becomes eligible to defer amounts under company's NQDC plan in February. 409A(a)(4)(B)(ii) allows new participants to defer amounts related to services performed subsequent to the election provided election is made within 30 days of participant first becoming eligible. Thus, newly eligible participant is presumably only able to defer that portion of his 2005 bonus attributable to services following eligibility. The bonus qualifies as a performance-based bonus so participants generally have until June 30, 2005 to make bonus deferral elections. First, I assume the June 30th performance-based deadline would trump the 30 day first year eligibility deadline? Second, assuming he has until June 30th, is there any argument that he can defer ALL of his 2005 bonus since everyone got until June 30th to make deferral elections or is he limited to deferring just that portion of the bonus prorated to account for services after becoming eligible for the deferred comp plan?

Thanks for everyone's thoughts and to KJohnson for posting the corrected Q&A-19 language--I keep mixing up my old (highlighted) copy of 2005-1 with the revised version.

IRS Notice 2005-1, Q&A-19© provides that "with respect to amounts subject to § 409A, the plan may be amended to provide for new payment elections with respect to amounts deferred prior to the election and the election will not be treated as a change in the form and timing of a payment under 409A(a)(4) provided that the plan is so amended and the participant makes the election on or before December 31, 2005." I am curious if others interpret this provision as broadly as it appears on its face. I have seen little discussion of this particular provision but read it to give plans that must be amended for 409A broad flexibility in adding new payment distribution options governing prior deferrals. Take for example, a plan that previously paid out in 10-year installments but gave participants the option to elect a lump-sum distribution provided the lump sum election was made at least a year before the 10-year installment began. If this plan is amended for 409A to eliminate this subsequent payment election, could the plan be amended to allow participants to make a new election up front governing prior deferrals subject to 409A with a choice amoung: (i) a lump-sum distribution, (ii) installment payments over a 5 year period; or (iii) simply sticking with installment payments over the old 10-year period?

Seems you could make an argument that paying the deductible is "employer- provided coverage under an accident or health plan" under § 106(a) and thus excludible. I always get confused between 105 and 106 but I think if an employer can pay premiums there should be a way to pay deductibles too.

I agree with Lori that there are substantiation and possible 105(h) discrimination issues but as a general rule this should be covered by 105. What if instead of the employer paying the premiums and deductible the employer paid higher premiums for a policy with a low or no deductible. There would seem to be no issue with that, would there? It's really not that different from what is proposed. Durkin 14, you say that it looks like there is a gain involved. If by that you mean that by paying the deductible the employer is paying more than before or more than most employers for health care, then I agree. But couldn't the same thing be said for an employer agreeing to alter the percentage of premiums paid? I guess what I'm saying is I just don't see an issue as to whether its excluded under 105.

I am not sure I understand your question but assume you are asking if an employee can elect to have premiums for option AD&D and optional life insurance deducted on a pre-tax basis under a Cafeteria Plan / Section 125 Plan. I cannot put my hands on supporting authority but I believe pre-tax deductions for AD&D are generally fine. Pre-tax deductions for life insurance under a cafeteria plan, however, is only available for coverage up to $50,000--after that level the premiums must be taken out on an after-tax basis.

My experience with demutualization situations is limited and mostly involves welfare plans. I second the comment that the Principal and Prudential guides are very good and about the best guidance I was able to find on these issues. For what its worth, I have found the DOL to be pretty flexible in terms of allowing allocation of relatively small demutualization proceeds across all current participants when that makes sense from an administrative standpoint as compared to trying to locate former participants directly connected to the demutualization proceeds. I think to some degree this depends upon the amounts involved but there may be some support in not having to track down the 100 or so separated participants.

JDuns, Could you elaborate on your statement that an SPD is not required for plans with fewer than 100 participants. I am aware of exceptions to SAR requirements for small plans as well as some Form 5500 exceptions but not exceptions to the requirement that an SPD be furnished. thanks

I cannot add anything to the prior discussions on your specific question but did want to buttress Alf's comments. In particular, please note that the Conference Report in discussing Triggers Upon Financial Health notes that "An amount is treated as restricted even if the assets are available to satisfy the claims of general creditors. For example, the provision applies in the case of a plan that provides that upon a change in financial health, assets will be transferred to a rabbi trust." I read this to say that if you establish a rabbi trust for an existing plan and place all assets in the trust up front, then there isn't any specifc guidance but you are arguably ok. However, if you have an existing plan or try to amend a grandfathered plan to provide that assets automatically be transferred to a rabbi trust upon a change in financial health of the company, then the amounts will be treated as restricted amounts included in income and subject to an excise tax even if a shift to the rabbi trust is the only result of the financial trigger. Why is having a provision allowing for transfers to a rabbi trust only upon a financial health trigger any worse than transferring all assets to a rabbi trust up front? Does this differ if the company is experiencing financial problems at the time of the up-front rabbi trust funding? I appreciate that there may be a perception issue with having amounts automatically shift into a trust upon a downturn but as a practical matter an automatic trigger doesn't seem to result in any more potential harm to shareholders / creditors than an up-front transfer to a rabbi trust.

Janet, I think the Plan would / could be drafted so that participation in the plan does not begin until selected for involuntary termination and ends upon receipt of all severance benefits provided under the Plan. I have just seen people try to make this argument where you have a large company with a broad, general severance plan. It does seem strange to me if you have a company with thousands of employees but only say 80 or so receiving severance benefits under a general severance plan to say that the plan has thousands of participants (including both active employees not receiving benefits as well as the terminated employees receiving benefits) simply because many of the thousands would be covered under the broad severance plan if they were terminated in a RIF / layoff action, etc. Using the release requirement just seems one way around the DOL Reg. § 2510.3-3(d)(B) contingency language so that you don't have to count active employees as participants. This could make a big difference in terms of the 100 participant threshold for Form 5500 filing purposes. I have also seen this used as an excuse not to distribute SPDs for the severance plan to hundreds or thousands of the active employees thus causing great alarm and instead restricting SPDs to those active employees selected for involuntary termination. Let me say I have some uncertainty about these arguments and am not necessarily saying they work--just wondered what others thought.

I am interested in others' thoughts but I have seen a technical argument put forth that where the plan requires individuals to sign a general release in order to obtain severance benefits under the plan then only those individuals who are actually terminated, sign a release and get the severance benefits are counted as "participants." As a result, all employees generally eligible to receive severance if they were to be terminated (and then sign a release) would not be considered "participants." While I believe the regs. say something like where an individual would automatically be covered by a plan upon the occurrence of a certain contingency (e.g., termination), then those individuals should be counted as participants, the requirement that the terminated individuals also sign a release eliminates this automatic qualification for benefits upon termination.

For ease of access, I wanted to post the following link to a couple of minor IRS clarifications to Q&A 19 and 20 in Notice 2005-1. This clarification was released on January 5. http://www.ustreas.gov/press/releases/js2180.htm

I heard one high-ranking EPCRS individual informally comment a couple of years ago that you should really assume there is no such thing as a scrivener's error doctrine. That said, the individual did note that if you have ample proof that it was a clear scrivener's error, the IRS might be willing to examine that. Although not expressly stated, I believe it was assumed that any such scrivener's error argument would have to be made through EPCRS. It seems to me the problem with correcting by plan amendment in having the erroneous vesting schedule checked as compared to correcting by plan amendment for allowing loans or hardship withdrawals when the plan document didn't allow them is that those amendments are in participants' favor so it's no big deal to allow retroactive amendments. If there was 100% vesting under the Plan but the document was erroneously drafted to indicate that a 2/20 schedule applied, I doubt the IRS would have a problem with the plan correcting even if proof of the error was slim. Going in the other direction, however, is a different story and a much harder burden to meet. My point is simply that correction by retroactive plan amendment is obviously very fact-specific.

Kirk, Thanks for your post. I appreciate your suggestion of submitting this to the IRS and your perspective on how the process works. I know the IRS folks are swamped with many many questions. I am planning on submitting this issue as well as the severance plan issue, at least informally via email, over the weekend. It has been helpful to me to have others confirm my reading of the Notice and see others' thoughts on these issues. I will attempt to work the various comments and suggestions into the submission. Thanks again.

Kirk, I would love to get IRS guidance on these issues and hope more will be said about discounted options on the January 6th call. In the interim I was just hoping that some of the insiders closer to the process might have more insight or creative thoughts on these issues. Harry O, please forgive me. I was being flip and exaggerative. I simply meant that some equity comp arrangements where participants have no real money of their own at stake are treated very differently from others. Obviously the overall economics of those arrangements vary and I appreciate the distincitions the Service draws with respect to SARs, options, and restricted stock. I just think it is particularly unfair to loop in previously granted but unvested dicounted options under the new 409A rules, particularly where such options were granted as one componenty of multi-faceted compensation agreements put in place years ago. Please excuse my ranting.

Thanks for everyone's comments. If I follow correctly, seems this is where we are: 1. Most ordinary severance benefits paid to non-Key Employees should not be affected much by 409A and plans that benefit only non-Key Employees basically get until the end of 2005 to figure out what, if anything, is required. 2. Severance benefits under plans or agreements paid to Key Employees (whether Key Employees of public or private companies) are potentially covered by 409A effective January 1, 2005. However, lump sum severane benefits paid to Key Employees should presumably escape the definition of a "deferral of compensation" under 2005-1 and thus escape regulation under 409A. 3. Periodic or installment payments of severance benefits to Key Employees, on the other hand, are likely clearly subject to 409A. In a private company context, this may be no big deal but for publicly traded companies this will generally require a 6 month delay in commencement of distribution of installment severance benefits. As Mbozek points out, the practical effect of this would appear to be that installment severance payments to Key Employees of publicly traded companies will largely become a thing of the past. Harry O, I like your idea about trying to take advantage of the short-term deferral exception under Q&A-4 so that installment payments generally completed within 2 1/2 months of the end of the year the benefits vest are removed from the definition of a deferral of compensation. What bothers me about that though is it would appear to allow a Key Employee terminated in January to basically receive severance benefits in installments over 13 1/2 months while a Key Employee terminated in December could only receive 2 1/2 months of installments (assuming both employer and employee are on calendar year). While that may be useful in negotiating individual severance benefits with Key Employees at the time of termination, it is difficult to take advantage of that in drafting plans / agreements in advance or trying to fix previously negotiated agreements that allow for prolonged installment distributions. I also have a question with respect to the 6-month delay on distributions to Key Employees of publicy traded companies. Since that requirement only appears to apply to distributions made upon a separation from service under 409A(a)(2)(A)(i), would severance benefits paid to a Key Employee upon termination (separation from service) following a Change in Control Event be excepted from the 6 month delay requirement so that they could be paid in installments or would such a double trigger still be subject to rules applicable to distributions upon a separation from service? Kirk, I would like to pose these questions to the IRS and may make a formal submission along those lines down the road. Unfortunately, my client is facing some immediate termination issues and needs guidance now. As expected, I believe the good folks here have provided useful confirmation and insight in the interim. I know the JCEB website received some severance questions for the last conference call that the IRS didn't have a chance to cover. Maybe they will cover some of these on January 6th but I'm not holding my breath. Thanks again.

I would also appreciate thoughts and clarification regarding coverage of severance plans or severance arrangements under 409A and Notice 2005-1. Unfortunately, the discussion in Q&A-19(d) does not add much clarification to me on what arrangements are clearly covered or what is required of covered arrangements. For example, assume a company provides, either under an employment agreement or an executive severance plan, the continuation of an involuntarily terminated employee's salary for a period of 18 months. Assume the benefits are provided to key employees among other non-union employees involuntarily terminated in a Reduction in Force so the transition relief provided in Q&A-19(d) is not applicable. For cash-flow reasons, the company is forced to make the severance payments on a monthly basis rather than provide the severed employee 18 months of severance benefits in a lump sum upon termination. In this case, the employee arguably has a legally binding right during a taxable year to "compensation" that has not been actually or constructively received and included in gross income, and that, pursuant to the terms of the agreement is payable to the employee in a later year. The severance amounts cannot be unilateraly reduced or eliminated by the employer. I assume this arrangement constitutes a "deferral of compensation" under Notice 2005-1, Q&A-4? If so, what does 409A require? The payouts of these severance amounts are to be made on a fixed schedule--basically at the time monthly payroll is paid to active employees so there will be 18 checks paid out to the terminated employee over the next 18 months. There is no option for the terminated employee to accelerate distribution of these amounts. The terminated employee never made an "election" with respect to such severance benefits except to sign the initial employment agreement and/or any general release required. The amounts are not funded so the rabbi trust and offshore rules are not applicable. Assuming the above-described arrangement is subject to 409A, does it really need to be amended to comply with the new rules? Are there issues that I am missing. If the employer is publicly traded, would the 6-month delay on distributions to Key Employees apply to "distributions" of severance benefits as well? Doesn't that in many cases defeat the whole purpose of offering the severance benefits. Also, what if the severance benefits are all to be paid out in the same taxable year--say over 6 months--would that avoid 409A? What if it is only a 6-month payout but it starts at the end of one year and finishes early the next year--different result? Any thoughts would be appreciated.