401 Chaos

This is more in the realm of executive compensation than some of the other posts with regard to Notice 2005-1 but I am curious about everyone's thoughts on curing discounted stock options. I cannot say I found the broad definition of deferred compensation or the lack of grandfathering for previously granted but unvested discounted options a surprise given earlier IRS discussions but I think it is unfair to loop in unvested discounted options granted before 2005. Okay if you want to do away with that going forward but rewriting the rules for previously granted options raises a lot of questions and concerns. I also appreciate the IRS allowing us to cure this by letting companies reissue options as fair market value options and giving us until the end of 2005 to get that done but am curious if others have thought of other alternatives that cure this problem without setting a fixed exercise / distribution date. Also, is there any variation on the general rule in Q&A-18(d) where the current stock price is less than the FMV of the shares at the time of grant? Is there any consideration for discounted options held by executives in very thinly traded companies that are not able to immediately sell all their shares received from options, etc? I see the distinction the Service draws between stock-settled SARs and discounted options but it seems highly unfair for individuals with discounts on options (some not that great) to be so heavily penalized compared to SARs that in many ways equate to 100% discounted options.

Including the joint venture employees in an existing company's benefit plans can create multiple employer plans, including possible multiple employer welfare arrangements (MEWAs). That can create real issues. Susan Serota published an article on benefits in joint ventures in the Spring 2001 edition of the American Bar Association Tax Section's publication, The Tax Lawyer, that is worth reviewing. ERISA counsel will likely be familiar with these issues and should definitely be consulted in this area.

I cannot provide a definitive answer but would agree a combined plan should be possible. However, a well-written Wrap Plan will likely require the addition of extensive provisions beyond a typical cafeteria plan document (e.g., HIPAA Privacy provisions, detailed COBRA discussions to comply with the new COBRA rules, etc.). In addition, a Wrap Plan will very likely cover a number of welfare programs beyond the pre-tax programs covered by the cafeteria plan. As a result, drafting (and using and interpreting) a combined wrap / cafeteria plan can be tricky and could prove potentially problematic. I also wonder what advantages it provides if you have to create the plan from scratch rather than using existing stand-alone prototypes, particularly if you use different TPAs for your cafeteria and flex plan work that may be used to working with their standard prototype plan documents and able to help with ongoing amendments. I have seen some general cafeteria plan documents that were intended to serve as a Wrap Plan but were basically just a cafeteria plan document. The plan sponsors and TPAs felt that because the cafeteria plan basically pulled the various other plans together for section 125 purposes that it was the same thing as a wrap plan which is not the case.

GBurns, I do not mean to say there are no potential problems with using combined 457 and 401(a) plans as discussed above--there appears to be a lack of real guidance from the IRS in this area--but the Service appears to have approved 401(a) plans designed to provide matching contributions to 457 plans. One thing I did want to point out which I think is confusing for all is that there are a couple of different types of 457 plans--457(b) and 457(f) plans. The 457(b) plans in use here by governmental entities are generally open to all employees, not a select group of management or HCEs as Mbozek's post implies.

FWIW, I have heard at least one IRS Audit cap person informally agree with Mbozek that amounts clearly placed in the trust in error (and not a mistake in fact) should not be considered plan assets and therefore the rules regarding distributions or reversions of plan assets should not apply. Of coure, this IRS official could not point me to any specific guidance or clear guidelines for documenting and reporting such reversals. Like R. Butler, I agree that the key here is for the plan sponsor to carefully document the correction. If the IRS or DOL have real problems with how plans are handling these situations, they should provide more detailed guidance.

Paipa, I think you do raise a valid concern and don't mean this to sound cavalier but in the face of uncertainty it seems any good group of lawyers ought to be able to come up with some reasonable, good faith arguments as to why their new firm is different from the old firm and why the same desk rule ought not to apply if they really prefer to move their money. Furthermore, in the seemingly unlikely event (I cannot imagine the govt. suing a law firm over this) it were challenged, seems a competent law firm would have a strong chance at winning the case.

Harwood and QDROphile, I would be interested in your opinions on some of the preferred or best-practices methods for handling such vesting issues in QDRO procedures. Do you find there are particular approaches that work best from a longer-term adminstrative perspective?

Cldula, Gifting to one's self as attorney-in-fact under a PoA can raise complicated legal issues outside of the ERISA context that vary from state to state. While ERISA preempts certain state laws, preemption does not seem to be an issue here. Afterall, you are basing your initial right to these benefits on your use of the very statutory PoA rules you would preempt. If you preempted the state PoA laws, then you would have no authority for having changed the beneficiary designation on behalf of your grandfather. Rather, the real question seems whether the change in designations made are valid under Illinois law. If the switch in beneficiary designations are valid actions under the PoA, then I suspect the Plan Adminstrator will honor them (or could be forced to do so). The trick is for you to provide the Plan legal support for your right to gift to yourself as attorney-in-fact under the PoA at issue here. States, however, often restrict the statutory ability of attorneys-in-fact to make gifts under PoAs to themselves and are also particular about changes to pension plan beneficiary designations. If there are significant amounts involved, you would be wise to seek assistance from a law firm that has experienced ERISA and estate administration attorneys. It could also be that the benefits pass to you any way even if the change in beneficiary designations is not recognized. If there is no valid beneficiary designation on file (because your change in beneficiaries under the PoA is not recognized and the beneficiary named in the earlier, valid designation is dead), the benefits would generally pass to your grandfather's estate. From there, distribution would be governed under the terms of his will, likely as part of his residuary estate. If there is no will or the will doesn't provide for distribution of these assets as part of the residuary estate or in some other manner, then they would generally pass under Illinois' intestacy laws.

Just to be sure we are clear on the situation, I assume from your post that the client acquired the company as part of a stock deal and thereby assumed the cafeteria plan as a matter of law rather than having simply acquired the assets of the other company and thus likely not assuming the cafeteria plan. If you have a stock sale, i believe Code § 125(g)(4) and Code § 414(t) generally require you to include all employees of the controlled group as determined under Code § 414 when performing various cafeteria plan eligibility and nondiscrimination tests. The controlled group rules can get very complicated when trying to apply them to unusual fact patterns or new corporate reorganizations and generally benefit from the advice of experienced tax counsel used to dealing with these issues.

I generally agree that the POA may provide sufficient authority to allow this but just wanted to point out that there generally is no legal requirement that you recognize or honor a POA. I routinely run into banks, brokerage houses, etc. that refuse to honor these in estate planning settings. And while I usually find that very frustrating, I think it pays to go slow and to err on the side of caution if you have any qualms about the authenticity or scope of the POA or the situation in general. I understand plans do not want to go out of their way to be difficult on these issues but at the end of the day the PA is the one bearing the risk.

Jon, I know the initial notice of resignation here (in October) was early but if Slu was professional about this and gave only a 2-week notice, Slu could have still been forced to resign on the 30th. Other than giving the boss more time to line up a replacement, there does not really seem to be anything about the "early" nature of the resignation that caused the problem. The problem here was that the boss was a jerk. In hindsight I suppose Slu should have waited until Jan 1 to give notice and then could have stayed only the bare minimum that seemed absolutely necessary. Slu, Given that you've already had a California lawyer review this, I'll admit that the case does not sound promising. I seriously doubt the email correspondence you have regarding your January 1 resignation date (or agreements to extend that) could give rise to an argument that somehow you were employed in anything other than an at-will status. In such cases, an employer can fire you pretty much any time for pretty much any reason. Although the motivation for the timing here may seem pretty obvious, you just ran into a real jerk of a boss. If you haven't gotten anywhere on the ERISA front so far, I doubt you will find anybody at EBSA or other federal governmental groups willing to take up your cause. The only other thing I can think of might be to push more at the state level regarding the threat to withhold your final paycheck if you did not sign the resignation. Did your witness hear that part as well? I feel certain the actual withholding or reduction of final paychecks for certain amounts is illegal, particularly in California, and that the Dept. of Labor would frown on any employer threat to withhold a final paycheck. Since you received the check, however, it is unclear what if anything the California Department of Labor might do in response to a complaint about this. Were there any other potentially problematic practices that you noticed with your former employer (e.g., wage and hour / overtime compliance issues, etc.)? If so, perhaps you could use some of these as another shot at leveraging some additional amounts albeit not under the Plan. It's a long shot I think but if you've got the time and are already burning bridges it may be worthwhile.

K Man, I agree that this is an error in amount and not participation. And I will also admit that you may be correct that such an error may not run afoul of the plan provisions. Also, as a practical matter, I think the risk of disqualification, if applicable, is so remote as to be almost moot. However, I am not comfortable saying that just because a plan document does not expressly set out the deferral / change procedures in detail that there would not be an operational error. Are you saying a plan can neglect (or even refuse) participants' deferral elections (or changes to existing deferrals) without any consequence? ("Hi gang, I'm afraid we are just now getting around to processing those election changes you submitted at the beginning of the year. Sorry. If some of you had complained sooner, we might have looked into it sooner. Oh well, Tough luck." If you take that to the extreme, doesn't that basically mean an employer could refuse to ever honor a participant's election changes without any consequences?) As to the posts noting participants' responsibility to notice a failure to implement deferral changes, I think this is a fair point, particularly where the change would result in a significant (and thus obvious) change in pay but as a general rule I still think the Plan needs to correct such errors. I have no real authority for this except that it is the right thing for the plan to do where the Plan has screwed up. Just because the participant may not be as on the ball as we would like and may not alert the plan to the failure to make the change seems to me to just be blaming others for our own mistakes. As my mother always said, two wrongs don't make a right.

Slufoot2000, Afraid I do not have much new to add to the others' advice except to say that it may be worth pursuing with a plaintiff's attorney whether they would be willing to follow up on your denial (assuming your appeal is denied) by writing a letter on law firm letterhead requesting copies of the plan document, the SPD version distributed to you, the corrected or current SPD language, and other relevant information generally available to participants of ERISA plans. The law firm would not have to stake itself out to any particular argument or theory at that point, just send a letter showing the employer that you are still willing to pursue this issue. Crafting such a letter shouldn't require that much in legal fees or copying expenses and may get more attention than if you requested the documents or made follow up inquiries. I do not know much about California wage and hour law either but the threat of not providing a paycheck without signing the resignation letter sounds like something your lawyer might want to ask about as well or throw in as a possible California Department of Labor complaint. I would think that might be particularly true if all the facts are as you indicated and somebody higher up in the company or their counsel reviews these issues. If you cannot find a lawyer to do this for you at a reasonable rate, it may still be worth your time following up directly with somebody else and raising various of these issues including threats of going to the California Dept. of Labor and the EBSA even if they are not likely to take up your cause. Sounds like you don't have much to lose at this point. You may even want to suggest that you would be willing to drop this if they make you whole for the amounts outside the plan so you don't get tied up on the last day of the year requirement.

As a general rule, I agree with Brian that the employer should try and find some way to correct this error rather than telling the employee tough luck, particularly if the error went unnoticed for an extended period or involved a significant amount. The employer's failure to make the requested change is presumably a failure to operate the plan in accordance with its terms and thus an operational error which could potentially result in disqualification. The bigger issues, though, are the ill feelings of the affected participant. I believe there is a rule (sorry I do not have a cite but it may be discussed in Rev. Proc. 2003-44 section on corrections for excluded employees) that basically says you do not have to correct the exclusion of an eligible employee if the excluded employee is brought into the plan in time to participate for at least 9 out of the 12 months. If exclusion goes beyond 3 months, however, it seems the Plan definitely needs to correct for the excluded amounts. It seems the correction here might be easily handled using the same general excluded employee correction principles set forth under 2003-44 by making a QNEC to the participant's account for the missing deferral percentage, as adjusted for earnings. (Both the missing percentage and earnings amounts should be very easy to calculate.) It also seems to me this error could be classified as an insignificant operational error if limited to one isolated case and thus could be self-corrected at any point without requiring IRS approval.

I'm not really a fan of this but they might also consider implementing a negative election (automatic enrollment) for those that do not affirmatively opt out of participation.

I have never had occassion to explore these issues from a benefits perspective but find the nonprofit's efforts unusual to say the least. From a tax-exempt and state nonprofit corporation law perspective, it seems to me that providing such benefits could possibly shift the directors from classification as noncompensated to compensated or otherwise personally benefiting from their service. Such a change could possibly impact or destroy potential state charitable immunity and indemnfication rights of directors as well as potentially require additional IRS disclosures and accountings if the group is a charitable organization.

Kirk & Jeanine, What if everybody that participates in the wellness program gets an incentive regardless of results and the results are not shared with the employer. Any problem there?

Blinky, I'm not at all sure it is. As you note, the lack of a tax deduction is obviously a huge concern but, depending on the amounts and deferral periods involved, there could be situations where a nonqualified plan is worth considering when factoring in the time and expense involved in trying to get a more exotic qualified plan in place. I simply wanted to add the possibility to the mix for consideration, particularly if the situation would not allow for a qualified plan for some reason.

Agree we need more information here on what is trying to be accomplished but the owner might want to consider a simple nonqualified deferred compensation plan. While the rules on such plans may become more restrictive, a basic plan can be pretty quick and easy to put in place. The ease in both design and administration of a nonqualified plan may override some of the disadvantages as compared to qualified plans.

Smillard, This is not my area but I believe there really is no way around having the IRA pay the mortgage. There are several prior links that touch on this and related issues. Bottom line is that you must pay the mortgage from the IRA and are limited in what you can contribute to an IRA annually so you can run into real problems. Owning real estate in an IRA can create lots of other problems. Although you may see various "schemes" saying you can do this and get around the issues, my sense is such arrangements are just asking for trouble. http://benefitslink.com/boards/index.php?s...hl=mortgage+ira

QDROPhile, Could you elaborate on why the IRS is wrong in allowing Buyer's plan to accept direct rollover of loans from Seller's plan if the plan documents provide for it. Thanks

I agree with Harry that there is no clear answer. To be completely safe, you generally would want to lock in the election prior to deferral as noted above. Other plans allow changes to prior distribution elections shortly before taking a distribution provided the participants are penalized or take a "haircut" on the amounts distributed. As a practical matter, much of this depends on how high-up the executive is and thus how much pull they have to force the company to take an aggressive position. There is a Nonqualified Deferred Compensation Answer Book (in the Panel Series I believe) as well as a nonqualified deferred compensation plan book by Bruce McNeil from West's Employment Law Series that may be helpful. There are also reems of caselaw discussions on nonqualified plans in general that are well summarized in the BNA Tax Management Portfolio.

Mbozek, Thanks for the additional information.

I do not do much governmental plan work so don't know the nature of the market but is it really such that governmental employers cannot find non-ERISA, governmental prototype plans out there rather than using private employer prototypes? Although the market for governmental plans is limited, it would seem there would still be enough employers to support a range of prototype providers at competetive prices. It just seems to me many of these questions (and potential future problems) could be avoided by using an appropriate prototype.

The Medicare folks put out some helpful guidance on this issue. Afraid I do not have the link handy but basically Medicare-eligible spouses of active employees must be treated the same as any other spouse of active employees. While some employers attempt to "nudge" Medicare eligible folks into selecting Medicare coverage or even "bribe" them by agreeing to pay Medicare premiums, etc. in order to get these folks off the group plan, employers must be very careful to avoid such actions or risk running afoul of the Medicare rules. Thus, while an employer might provide medicare-eligible spouses a notice of their medicare rights and discuss medicare secondary payer rules, etc., the employer should not coerce any decision to drop group coverage in favor of Medicare.