Taxable Welfare Benefits

[Guest Guy Incognito]

Question:

Executive has an employment agreement that states that he shall be entitled to continuation of welfare benefits for a period of 3 years following a termination of employment for any reason. Such welfare benefits include taxable welfare benefits (e.g., group-term life over $50k).

Since Executive is entitled to continued taxable welfare benefits following a termination for any reason, such right is not subject to a substantial risk of forfeiture and is considered deferred compensation. Accordingly, the six month delay rule applies (assume Executive is a specified employee).

If Employer does not pay Executive cash in lieu of the taxable welfare benefits, but continues to pay the premiums on the taxable welfare benefits post-employment for 3 years, does the Employer have to wait 6 months before paying such premiums under the six-month delay rule?

Thanks.

[Chaz]

I for one would be interested in knowing if anyone has any thoughts on this. . . .

[Don Levit]

Folks:

Can you explain the 6-month delay rule?

Also, I was under the impfession that welfare benefits are not considered deferred compensation.

Don Levit

[Guest jhall]

I too would be very interested in how folks are handling these situations, including continuation of health insurance benefits for such extended periods. I was thinking there was something in the general reimbursement provisions for the final 409A regulations which indicated that payment within those provisions would be exempt from the 6-month delay rule. Maybe that was just for the health coverage piece that includes the special 18 month continuation exception. At any rate, I was thinking there had been some indication by Treasury that general reimbursements, etc. such as this could be structured to avoid the 6-month delay provision.

Separate and apart from the 6-month rule, however, I find that drafting for such continuation provisions to specify clear reimbursement requirements / time limits / etc. to be very problematic. The difficulty is increased because so many agreements / plans seem to promise these benefits without any clear attempt to address pracitcal realities of inability to continue lengthy coverage under certain plans or the tax impact of all of this.

[Guest CABatty]

I think they can be structured so that at least part of the payments are excluded from coverge under Section 409A and would therefore not be subject to the 6-month delay, so long as the requirements in 1.409A-1(b)(9)(v) are met.

Generally, plans that provide reimbursements and in-kind benefits upon a separation from service (whether voluntary or involuntary) do not provide for the deferral of compensation to the extent the in-kind benefits are provided or reimbursable expenses are incurred by the end of the last day of the second taxable year following the taxable year in which the separation from service occurred, and the reimbursements are actually paid by the last day of the third taxable year following the taxable year in which the separation from service occurred.

Generally, medical benefits reimbursed by the employer are excluded for the duration of the COBRA continuation period.

The way to structure your agreement (in my opinion) is to provide reimbursements that meet the exemption for medical benefits during the COBRA continuation period, provide for other reimbursements that meet the exemption for regular reimbursements during the period ending on the last day of the 2nd taxable year following the year in which the separation from service occurred, and then structure the reimbursements for the remaining time after the end of the above two periods to comply with the rules for reimbursements under 1.409A-3(i)(1)(iv).

[Steelerfan]

I'm still confused. Can an employer continue to pay the premiums for medical benefits or group term life insurance for 3 years after termination of employment without regard to the 6 month delay rule? Based on CABatty's resonse, it seems like you can't. I hope that is not the case.

[Guest CABatty]

Sorry for the confusion and unclear explanation. That's what I get for trying to be brief. Hopefully this is a bit clearer.

Short answer - yes, they can be paid, in general, without regard to the 6-month delay.

Think of the reimbursements as the following separate payments:

(i) reimbursement for medical premiums for the duration of the COBRA continuation period

(ii) reimbursement for certain expenses incurred by the end of the 2nd year following the year in which the separation from service occurred

(iii) reimbursement for medical premiums paid during the period beginning on the day after the end of the COBRA continuation period and ending on the third anniversary of the date of separation from service

(iv) reimbursement for certain expenses incurred during the period beginning on the first day of the third taxable year following the year in which the separation occurred and ending on the third anniversary of the date of separation

Payments (i) and (ii) would be excluded from 409A under 1.409A-1(b)(9). Since they are excluded, they are not subject to the 6-month delay. Payments (iii) and (iv) are not excluded, so they would be subject to the 6-month delay rule. But, there is no delay since payments (iii) and (iv) occur more than 6 months after the Executive's termination of employment.

According to the preamble, separating the reimbursements like this is ok. Check out the section in the preamble titled "Specific Exceptions for Post-Separation Reimbursement Plans." It's on p.19248 in the Federal Register version. Last sentence of the first paragraph says:

"In response to questions from commentators, the final regulations clarify that the exception applies to the qualifying reimbursements available during the limited period of time, even if the plan extends beyond the limited period of time."

So, in the OP, the Executive would not have to wait 6 months to receive his reimbursement of taxable welfare benefits even though the reimbursements continue after the end of his COBRA continuation period and beyond the end of the 2nd year after the year in which the termination occurred.

Does that help clarify, or am I still confusing everyone?

[Guest CMC]

That's helpful, CABatty, and is consistent w/how I've been thinking about some of this. Basically, exempt what you can under 1.409A-1(b)(9)(v)(A) [reimbursements] or (B) [COBRA] and then have amounts that fall outside those exemptions comply w/the special compliance rule under 1.409A-3(i)(1)(iv).

A couple questions for you:

(1) Where are you getting the 3-year limit that you describe in (iii) and (iv) above? My understanding is that under the special compliance rule the "specifically prescribed period" can include the lifetime of the exec.

(2) What are the "certain expenses" that you think come within 1.409A-1(b)(9)(v)(A) [reimbursements]? Specifically, I'm wondering whether continuation of participation in other types of plans an Exec may have participated in while rendering services -- like life insurance and LTD -- during the limited period following termination would be exempt. Although the preamble isn't all that encouraging (see Fed. Register @ p. 19248 expressly declining to be responsive to "certain requests to exempt broad catgories of such arrangements"), the regs themselves seem to leave the door ajar. They speak in terms of "payment by the [employer] of reimbursements that are not otherwise excludible from gross income . . . ." Seems like if they'd wanted to expressly limit the application of the reimbursements provision to certain types of reimbursement arrangements they could have, but it isn't obvious to me they did.

Thanks in advance for any thoughts you (or others) may have.

[Locust]

I'll wade in here with a few brief comments that may reveal the depth of my ignorance on these issues:

1. It was my understanding that nontaxable welfare benefits are not an issue, so payment of COBRA premiums or health premiums would generally not be an issue (unless you had a discriminatory self-insured plan).

2. So far as reimbursements, I thought what was going on there was that the company could reimburse actual expenses that would not necessarily be incurred, and if they were incurred, they would be of an unknown amount until incurred, such as travel, legal expenses. Those can be reimbursed within a certain period of time after being incurred. Those are taxable benefits, but I wouldn't call these welfare benefits.

3. Taxable welfare benefits, such as life insurance that isn't subject to the ss 79 group term life insurance exclusion, would be deferred compensation, unless they fall within some sort of exclusion, such as the 2 x pay/2 year exclusion for separation pay. So for example, if an executive was receiving life insurance that had a value of $1000/month and that was payable for 10 years, that $1000/month would be deferred compensation. That's ok because it's being paid at fixed times, but it may run afoul of the 6 month rule for specified employees.

[Guest CABatty]

(1) Where are you getting the 3-year limit that you describe in (iii) and (iv) above? My understanding is that under the special compliance rule the "specifically prescribed period" can include the lifetime of the exec.

CMC - The three-year limit came from the original post - how to structure reimbursements for three years following a separation from service. You're right - the regs on reimbursements in 1.409A-3 say that any period specifically described would work, including the lifetime of the exec.

(2) What are the "certain expenses" that you think come within 1.409A-1(b)(9)(v)(A) [reimbursements]? Specifically, I'm wondering whether continuation of participation in other types of plans an Exec may have participated in while rendering services -- like life insurance and LTD -- during the limited period following termination would be exempt. Although the preamble isn't all that encouraging (see Fed. Register @ p. 19248 expressly declining to be responsive to "certain requests to exempt broad catgories of such arrangements"), the regs themselves seem to leave the door ajar. They speak in terms of "payment by the [employer] of reimbursements that are not otherwise excludible from gross income . . . ." Seems like if they'd wanted to expressly limit the application of the reimbursements provision to certain types of reimbursement arrangements they could have, but it isn't obvious to me they did.

I think the expenses covered are, like you and the regs say, reimbursements that are not otherwise excludible from gross income. If it's taxable, it's covered.

I think the comment you cite in the preamble is addressing requests to exempt specific, though broad, categories of reimbursements. The example mentioned in the preamble is the continuation of any plan in which the service provider participated while performing services. Very broad, but somewhat specific. What if the employer wanted to reimburse costs of outplacement services? Presumably, these wouldn't have been provided in a plan that the service provider participated while performing services, so the regs would have had to specify a different category that would cover it. Much easier to just say that anything taxable is covered, rather than trying to specify all the different possibilities.

[Steelerfan]

So, in the OP, the Executive would not have to wait 6 months to receive his reimbursement of taxable welfare benefits even though the reimbursements continue after the end of his COBRA continuation period and beyond the end of the 2nd year after the year in which the termination occurred.

CABATTY- thanks for your responses. The way I interpreted the provisions applicable to taxable welfare benefits like group term life insurance is that it is an "in kind" benefit. If I recall correctly the preamble states pretty clearly that after the end of the second year following termination, the 409A exemption ends and thereafter you have to provide for a 409A compliant schedule for such benefits. that seems to conflict with what you said above. Assuming you are kicked back into 409A in the third year and beyond (if applicable), is it as easy as the IRS seems to suggest to provide these benefits in accordance with 409A? As others have suggested there isn't much to go on. But if the employer continues to pay premiums in the manner that it has always done, shouldn't that be enough to comply with 409A? any thoughts on that?

I agree with someome else who said that reimbursements or payments made for non taxable benefits like medical plans are completely exempt from 409A. But what if something goes awry with the taxable treatment down the road? Am I off base here or is this a legimitate concern?

[Guest CABatty]

The way I interpreted the provisions applicable to taxable welfare benefits like group term life insurance is that it is an "in kind" benefit. If I recall correctly the preamble states pretty clearly that after the end of the second year following termination, the 409A exemption ends and thereafter you have to provide for a 409A compliant schedule for such benefits. that seems to conflict with what you said above. Assuming you are kicked back into 409A in the third year and beyond (if applicable), is it as easy as the IRS seems to suggest to provide these benefits in accordance with 409A? As others have suggested there isn't much to go on. But if the employer continues to pay premiums in the manner that it has always done, shouldn't that be enough to comply with 409A? any thoughts on that?

Steelerfan -

Actually, I agree with your comment that the exemption ends after the 2 year period, and then the reimbursements and in-kind benefits have to comply with 409A. I originally thought that, if the reimbursements and in-kind benefits extended beyond the 2 year period, then none of the reimbursements and in-kind benefits could be exempted. But, the sentence I cited before in the preamble on p. 19248 indicates that the exemption still applies, even if the plan continues beyond the 2-year period.

Then, once you're back in 409A land after the end of the 2 year exemption, 1.409A-3(i)(1)(iv) applies. This section sets forth the rules for reimbursements and in-kind benefits to meet the specified date or fixed schedule of payments. These rules require

(1) an objectively determinable nondiscretionary definition of the expenses eligible for reimbursement or of the in-kind benefits to be provided

(2) the expenses incurred or the in-kind benefits must be during an objectively and specifically prescribed period (including the lifetime of the service provider)

(3) the amount of expenses eligible for reimbursement or in-kind benefits provided during a service provider's taxable year may not affect the expenses eligible for reimbursement, or in-kind benefits to be provided, in any other taxable year

(4) reimbursements of eligible expenses must be made on or before the last day of the service provider's taxable year following the taxable year in which the expense was occurred

So, for example, a plan could provide that the employer will reimburse the executive for the monthly cost of country club dues incurred by the executive from 1/1/2008 to 12/31/2013, provided that the reimbursements are paid no later than the last day of the taxable year following the year they were incurred. That would comply (IMO).

But, the above example would not comply if it said that the employer would reimburse the executive for up to $50,000 in monthly country club dues incurred by the executive from 1/1/2008 to 12/31/2013. The 3rd requirement above would not be satisfied because the amount reimbursed in one year would impact the amount eligible in a later year. If the executive incurs $40,000 in expenses in the first two years, he could only get reimbursed for $10,000 in the last 3 years of the period.

[Guest jhall]

Thanks to all. This is a very helpful discussion.

If I can just recap / confirm my understanding of the latest comments, it seems most are in agreement that with proper planning and drafting the 6-month delay rule really should not be an issue with respect to continued health and welfare benefits following an employee's separation from service.

On the health side, we have the express COBRA period exemption which should eliminate any concerns with continued health coverage / reimbursements for the COBRA period which should more than cover the first 6 months following separation.

On the broader welfare and fringe benefit plan front, we have the general exemption for "Reimbursements and Certain Other Separation Payments" which should permit reimbursement of taxable life insurance, LTD, non-COBRA medical benefit premiums, etc. for up to 2 years following the year of termination without having to comply with 409A. Similarly, health coverage reimbursements for the period following expiration of COBRA through the end of the second year following the year of termination should also be exempt from 409A under this general reimbursement exemption. Because this exemption covers expenses incurred up to 2 years following the year of separation, no 6-month delay rule issues should be raised under a properly structured arrangement.

As CABatty notes, after the two year exemption period, reimbursements and benefits can continue to be provided for an unlimited period; however, they must be structured to comply with the more detailed provisions in 1.409A-3(i)(1)(iv). At that point, however, the 6-month delay rule is out of the picture.

Does the above seem a correct summary of the group's thinking on these issues? Does anybody disagree with or can anybody think of typical benefits, reimbursements or other arrangements that could not be covered under one of the exemptions and thus subject to the 6-month delay rule?

(Note to Locust, I agree with your second comment that part of what is going on with the terminology in the reimbursement provision is an effort to exempt certain types of reimbursements for which amounts cannot be determined or predicted up-front. I was not certain, however, whether your comment there was intended to suggest that other, more predictable reimbursements such as continued life insurance could not be covered. I agree with CMC and CABatty that the regulations could be read more broadly to apply to more than just those sorts of reimbursement payments such that life insurance or LTD insurance premiums that may have some predictable and certain premium expenses, at least for some period could continue to be reimbursed during the two year period outside of 409A. That is to say, I read the final regulations (as I believe CABatty does) to more or less provide a broad exemption for separation-related reimbursements so long as they do not exceed the maximum 2-year period rather than trying to set a pretty narrow range of benefits that qualify. Reading the regulations to apply more narrowly as I read your comments to suggest would seem to lead to the rather strange result of having (in my experience, very common provisions calling for) reimbursements of continued life insurance premiums for a couple of years subject to the more onerous 409A compliance requirements, including the 6-month delay rule, while (in my experience, relatively rare) moving expense reimburements get a pass on the compliance requirements. Just curious if anybody else has seen an argument supporting Locust's thought that the benefits covered by the reimbursement provision is to be narrowly construed?)

Note to Steelerfan, I am not sure I follow your earlier comment that continued welfare benefits like group term life insurance are an "in-kind" payment rather than covered under the general reimbursement provisions. Perhaps it does not really make a difference under the regulations which one you call it but was hoping you might expand on your classification of in-kind benefits?

Finally, I agree with comments above that non-taxable benefits escape 409A. When an employer has a fully-insured health plan, the ability to pay COBRA premiums directly, reimburse COBRA premiums, or otherwise provide continued group health benefits (if permitted by insurer) to former or retired employees on a tax-free basis seems acceptable under IRS guidance. When the employer has a self-insured plan; however, the rules change. I am curious if anybody sees any problem with employers with self-insured plans simply promising severed executives that they will pay for comparable group health coverage under fully-insured individual health policies (assuming the Executive is insurable at customary or reasonable rates) and taking the position that the premium amounts paid are not subject to tax and thus also exempt from 409A? Are there any potential discrimination issues with that sort of approach or any reason to think the tax-free treatment would only extend to continued premium payments under an existing fully-insured health plan. Obviously, that sort of benefit can be expensive but I am more worried about missing some 409A or other issue than the expense at this point.

Thanks.

[Steelerfan]

Note to Steelerfan, I am not sure I follow your earlier comment that continued welfare benefits like group term life insurance are an "in-kind" payment rather than covered under the general reimbursement provisions. Perhaps it does not really make a difference under the regulations which one you call it but was hoping you might expand on your classification of in-kind benefits?

I agree with your recap.

I seem to be hung up on group term life because I was thinking (maybe wrongly) that the employer is continuing to pickup the premiums for the executive (in the same manner as during employment) and that that isn't really a reimbursement. The insurance would be "in kind" because the employee is not paying for his coverage and need not seek reimbursement. My understanding of a reimbursement is the employee directly incurs an expense and is reimbursed. Am I off base? Is that too narrow a concept of reimbursement or do most employers actually reimburse the employee for group term life?

As you say tho, it might not make a difference.

[Guest jhall]

Steeler,

Thanks very much. I follow your logic there. I guess I tend to think of in-kind stuff more along the lines of items that wouldn't involve having to pay an insurer or other third-party, whether directly or by reimbursing the former employee (e.g., providing terminated employee continued office space, secretarial support, use of executive dining room, other privileges, etc.) but I'm not getting that from any particular guidance or authority so I think your approach could work. Again, it wouldn't really seem to matter much which way something is classified for this particular purpose. Thanks.

[401 Chaos]

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

[Don Levit]

401 chaos:

I think your concerns are legitimate.

Private Letter Ruling 9834037 states, "The Committee report for the Deficit Reduction Act of 1984 states, No deduction for advance funding is to be allowed with regard to a plan which provides medical or life insurance benefits exclusively for retirees, because such a plan would be considered a plan of deferred compensation rather than a welfare benefit plan. Of course, if a plan maintained for retirees is merely a continuation of a plan maintained currently or in the past for active employees, then the retiree plan would not be considered a plan of deferred compensation because medical benefits would have been provided without the necessity of a retirement or other separation from service."

Don Levit