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Employee Benefits Developments August 2006

RULINGS, OPINIONS, ETC.

Calculating prohibited transaction excise tax on late deferrals
When an employer withholds 401(k) contributions from an employee’s paycheck and fails to make a timely deposit of those contributions into the 401(k) plan’s trust, the result is a prohibited transaction. A prohibited transaction arises because a 401(k) contribution is treated as an asset of the 401(k) plan as of the earliest date on which it can “reasonably be segregated” from the employer’s general assets, and there effectively is an impermissible loan of the plan assets by the 401(k) plan to the employer if the employer has not made the 401(k) deposit by that date. Internal Revenue Code (IRC) § 4975 imposes a 15 percent excise tax on the amount involved in a prohibited transaction. In a new ruling, the Internal Revenue Service (IRS) confirmed that the “amount involved” for purposes of calculating the 15 percent excise tax is based on interest on those elective deferrals. Thus, if an employer failed to segregate $100,000 in participant 401(k) contributions from its assets and transmit the contributions to the 401(k) plan on December 8, 2004, and does not do so until March 31, 2005, there is a prohibited transaction for 2004 and a prohibited transaction for 2005. The amount involved for the 2004 prohibited transaction is interest on $100,000 from December 8, 2004 to December 31, 2004. The amount involved for the 2005 prohibited transaction is interest on the new balance owed to the plan after increasing the principal as a result of there not being a correction of the 2004 prohibited transaction and is calculated from January 1, 2005, to March 31, 2005. (Revenue Ruling 2006-38)

Government publishes 2006 Form 5500
On July 13, the Employee Benefits Security Administration, the IRS, and the Pension Benefit Guaranty Corporation released advance copies of the 2006 Form 5500 (the form) and instructions. Notable changes to the form include:

The instructions for lines six and seven have been expanded to describe when an individual no longer is a welfare plan participant. Lines six and seven of the form ask for census information regarding the number of participants and beneficiaries in a plan. According to the new instructions, an individual is not a participant covered under an employee welfare benefit plan on the earliest date on which the individual (1) is ineligible to receive any benefit under the plan, even if the contingency for which the benefit is provided should occur, and (2) is not designated by the plan as a participant.

The IRS no longer requires the filing of Schedule P (annual return of fiduciary of employee benefit trust).

Electronic filing of Form 5500 to be required
The Department of Labor issued final regulations that would require that all Form 5500 filings be made through an electronic filing system. In the final regulation, the effective date was delayed to plan years beginning after 2007. For calendar year filers, these requirements would be in effect for a Form 5500 due in July 2009. In order to accomplish electronic filing, several changes to Form 5500 will be made. It is expected that electronic filings will be made through computer software using internet access. The details of the technological requirements have not been announced. Under the proposed rule, there are no exceptions for small plans to continue to file Form 5500 in paper format. (71 Fed. Reg. 41,359 (July 21, 2006))

Final regulations issued on supplemental wage withholding
The IRS recently finalized regulations governing withholding on supplemental wage payments. Wages affected by the rules include bonuses, restricted stock, severance, nonqualified stock options, deferred compensation, and any other wages paid by an employer that are not “regular” wages. The final rules reflect changes made by the American Jobs Creation Act of 2004 (the act), whereby the supplemental wage withholding rate was increased for supplemental wages in excess of $1 million. Under the act, if an employee’s supplemental wages exceed $1 million for the year, the mandatory wage withholding rate increases from the third-lowest rate for single filers (currently 25 percent) to the maximum tax rate in effect at the time (currently 35 percent). The final regulations adopt, with some modifications, the definitions and procedures outlined in the proposed regulations issued in January 2005 and address certain concerns expressed by employers with respect to the classification of wage payments. Although the new rate for large payments served as the impetus for the issuance of regulations, the new rules provide useful guidance for employers making supplemental wage payments in any amount. The final regulations provide comprehensive guidance for classifying various types of payments as regular or supplemental wages, provide employers with a number of options for tracking the total amount of supplemental wage payments made during the year, and provide detailed procedures for withholding on supplemental wages both below and above the $1 million threshold. The regulations are effective for all wages paid after 2006. (T.D. 9276)

IRS issues final guidance regarding employer HSA contributions
Final IRS regulations issued provide important guidance addressing the comparability requirement applicable to employer Health Savings Account (HSA) contributions outside of a cafeteria plan. The regulations also provide guidance for employers who wish to avoid the compara-bility rules by making contributions through a cafeteria plan. The regulations apply to employer contributions to HSAs made after 2006.

Employers are not required to contribute to HSAs maintained by their employees. However, employers that do so must make comparable contributions to comparable participating employees. Comparable participating employees are employees who are in the same category of employees (e.g., part-time and full-time) and who have the same category of high deductible health plan (HDHP) coverage. If an employer’s HSA contributions for a calendar year fail to satisfy the comparability rules, the employer is liable for an excise tax equal to 35 percent of all employer contributions to HSAs for the year. 

The comparability requirement does not apply if the employer’s contributions are made through a cafeteria plan. Instead, contributions through a cafeteria plan must satisfy the nondiscrimination rules applicable to cafeteria plans. Accordingly, employers who make HSA contributions through a cafeteria plan can avoid the comparability requirement and the risk of liability for excise taxes. As a general rule, the cafeteria plan nondiscrimination rules permit greater flexibility in designing the types and amounts of employer HSA contributions. 

With respect to the comparability requirement applicable to employer HSA contributions outside of a cafeteria plan, the final regulations modify guidance issued in earlier proposed IRS regulations in two important respects:

In determining which employees have the same category of HDHP coverage, participating employees with family HDHP coverage can be subdivided into three categories: Self plus one, self plus two, and self plus three or more. Under the proposed regulations, all participating employees with family HDHP coverage were considered to be comparable participating employees without regard to the level of family HDHP coverage.

If an employer makes HSA contributions for non-union employees, the employer need not make comparable contributions for similarly situated union employees if the union employees are covered by a bona fide collective- bargaining agreement and health benefits were the subject of good-faith bargaining between the employer and union. 

As mentioned, the final regulations provide important additional guidance on how employer contributions are made through a cafeteria plan. Specifically, the final regulations provide that employer HSA contributions are made through a cafeteria plan if the cafeteria plan document affords employees the right to elect to receive cash or other taxable benefits in lieu of all or a portion of an HSA contribution (e.g., the plan authorizes pre-tax salary reduction contributions to HSAs maintained by participating employees). The regulations include several examples that illustrate the application of the cafeteria- plan exception. (71 Fed. Reg. 43057 (July 31, 2006))

CASES

ERISA preempts Maryland’s “Wal-Mart” healthcare law
In January 2006, Maryland enacted the Fair Share Healthcare Fund Act (Fair Share Act), requiring non-governmental employers of 10,000 or more individuals to spend up to eight percent of total wages on health insurance costs or to pay to the state an amount equal to the difference. When enacted, it was anticipated that only Wal-Mart would be subject to the Fair Share Act. However, three other employers met the statutory definitions to be covered by the Fair Share Act. The Retail Industry Leaders Association (RILA) filed suit to overturn the Fair Share Act. The RILA’s motion for summary judgment was granted by the U.S. District Court for the District of Maryland, holding that the Fair Share Act violated the Employee Retirement Income Security Act (ERISA)’s preemption rule. The federal district court found § 514(a) of ERISA preempts “any and all state laws insofar as they may now or hereafter relate to an employee benefit plan …” The court determined the Fair Share Act “creates healthcare spending requirements that are not applicable in most other jurisdictions … and conflict(s) with similar pending legislation in many other states …” The court rejected the argument of the State of Maryland that the act did not mandate health care coverage because employers could comply by providing non-ERISA covered benefits or paying penalties to the State of Maryland. The court found that those alternatives were not rational choices that employers would choose. This decision will be important as many other states and localities are contemplating legislation similar to that of the State of Maryland’s Fair Share Act. (Retail Indus. Leaders Ass'n v. Fielder, D. Md., 2006)

Only say it if you mean it
On June 30, the U.S. District Court for the District of Minnesota ruled the terms of a “faulty” summary plan description (SPD) can be enforced even though they conflict with the formal plan document. In 1998, Fairview Health Services (Fairview) sent a packet of information to plan participants that contained a memo and an attached summary of benefits. The memo incorrectly stated that if a participant became disabled, disability benefits would be available until the participant reached age 67. Nothing in the summary contradicted this incorrect statement. However, the plan document stated that disability benefits would only be provided until age 65.

In 1999, plan participant Daniel Greeley started receiving long-term disability benefits. At this time, he noticed the discrepancy between the 1998 memo and the terms of the plan. Greeley sent a letter to Fairview requesting assurances that his benefits would continue until he reached age 67. Fairview failed to respond to Greeley’s letter. When Fairview terminated Greeley’s benefits upon reaching age 65, he sued.

As a threshold issue, the federal district court determined the 1998 memo and attached summary, although incomplete, contained enough information to constitute an SPD. Information included in the memo and summary included the name and type of the plan, the plan year, description of the eligibility requirements for coverage, and how the plan is funded. Furthermore, the 1998 memo and summary was the only information sent to participants regarding their benefits.

In granting summary judgment in favor of Greeley, the court stated he was prejudiced by the memo’s description of benefits “because the individual employee is powerless to affect the drafting and less equipped to absorb the financial hardship of the employer’s errors.” This case teaches the lesson once again that employers must be careful when drafting summary plan descriptions because a benefit mistakenly promised in a participant communication can sometimes be enforceable. (Greeley v. Fairview Health Services, D. Minn., 2006)

Lack of SPD costs employer
Affirming the importance of providing insurance plan participants with SPDs, the U.S. District Court for the Western District of Virginia ruled the husband of a deceased life insurance plan participant must receive plan benefits from the employer in spite of his spouse’s failure to complete the forms necessary to preserve her coverage under the insurance policy.

Upon her disability retirement, Martha Haynes contacted the human resources office of her employer, K-VA-T Food Stores, Inc., to determine the appropriate course of action to maintain her group life insurance coverage. Allegedly acting upon information provided by human resources employees, Haynes mailed a waiver of premium form to the insurer, Unum Life Insurance Company of America (UNUM). Under the policy, UNUM maintained the waiver of premium form did not apply to Haynes, and that her insurance coverage could only have been continued if she had elected to convert the coverage to an individual policy. Following her death, the plan denied her husband’s claim for benefits, citing Haynes’s failure to complete the appropriate conversion form within 31 days of her retirement. Her husband argued that K-VA-T breached its fiduciary duties as plan administrator when it did not provide his wife with an SPD as required by ERISA. Using its authority under ERISA § 502(c) to “order such other relief as it deems proper,” the court ordered the employer to pay the death benefit that was not payable under the terms of the insurance policy. Once again, we are reminded of the importance of welfare plan SPDs. (Haynes v. K-VA-T Food Stores, Inc., W.D. Va., 2006)

Website visit not sufficient to change beneficiary
A participant’s visit to a plan Web site, ostensibly with the intention of naming his children as beneficiaries of his 401(k) account, was not enough to change the participant’s prior written beneficiary designation. In 1998, Roy Robinson designated his sister as the sole beneficiary of his 401(k) plan account by filing a written beneficiary designation with the plan. Some time after 1998, Robinson’s employer created and maintained a plan Web site for participants. Robinson allegedly visited the plan’s Web site in 2003 to designate his children as his named beneficiaries. According to his children, no beneficiary was listed on the Web site. In addition, the Web site contained a statement that “beneficiary elections previously made on paper will no longer be valid” and that elections made on the Web site “will take precedence over all other previous beneficiary elections.” Another page of the Web site provided that if a participant has not named a beneficiary and is not married, the account will be paid to the participant’s children. Robinson made no designation on the Web site and filed no written revocation of his prior beneficiary designation.

Following Robinson’s death, the plan paid the 401(k) funds to Robinson’s sister in accordance with his written designation. The children brought suit, arguing that Robinson believed the language on the Web site meant that his written designation of his sister as beneficiary was no longer valid and that his children would therefore be his beneficiaries without his intervention. The U.S. District Court for the District of South Carolina disagreed, finding the plan administrator did not abuse its discretion when it denied the children’s claim, because the plan terms required a participant to revoke a prior designation by filing a written designation with the plan. The federal district court found Robinson’s visit to the Web site was not sufficient to discern an intent on his part to change his beneficiary and that he was not in substantial compliance with the plan’s revocation requirement simply because he visited the Web site. This case illustrates the principle that participants should be reminded periodically to update their beneficiary designations by making affirmative designations in accordance with the plan terms. (Robinson v. MeadWestvaco Corp. Savings and Employee Stock Ownership Plan for Salaried and Non-Bargaining Hourly Employees, Dist. S.C., 2006)