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Employee Benefits

Employee Benefits Developments 8/25 to 9/5 2003

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HOT TOPIC

Over-the-Counter Drugs Reimbursable by Health FSAs and HRAs. On September 3 the Internal Revenue Service (IRS) issued Revenue Ruling 2003-102, changing its informal position on the ability to reimburse over-the-counter drugs from health care flexible spending accounts (FSAs) and health reimbursement arrangements (HRAs). Previously, the IRS had indicated over-the-counter medications were not reimbursable under FSAs or HRAs because these plans could reimburse only prescribed drugs that are deductible expenses within the meaning of Internal Revenue Code (Code) § 213(b). In the Revenue Ruling, the IRS indicated permissible reimbursements under FSAs and HRAs should be determined under the definition of medical care under Code § 213(d). This definition is much broader than Code § 213(b), used to determine which items are deductible on an individual’s tax return.

The significance of this change is illustrated by the press release issued by the Treasury Department (Treasury) and the IRS in connection with the ruling. Treasury and the IRS indicated the ruling was issued in response to the availability of many drug treatments in over-the-counter form. By expanding reimbursement of over-the-counter medications to these arrangements, more individuals will be able to finance these purchases in a tax-beneficial manner.

Employers will need to address many questions about these arrangements:

• Do you want to offer this arrangement? Employers will need to determine if they wish their health FSAs and HRAs to reimburse these over-the-counter medications. The increase in the number of drugs available for reimbursement could increase plan administrative costs and employer costs for direct reimbursements.
  
  
• What do your plan documents say? Employers will need to review their plan documents and related employee communications to determine how their plans currently provide for reimbursement of over-the-counter medications. Many plans already refer to Code § 213(d), which now would provide for reimbursement of over-the counter drugs. However, employee communication materials, reflecting the IRS’s former position, very well may indicate only prescription drugs would be reimbursable. The Revenue Ruling has no specific effective date, indicating this new IRS position applies to prior periods. 
  
  
• What operational issues will you face? If an employer chooses to allow reimbursement of over-the-counter drugs, difficult issues arise. The Revenue Ruling indicates over-the-counter drugs taken for maintaining general health (such as daily vitamins) or for cosmetic purposes do not constitute medical care and would not be properly reimbursable. It may be difficult to distinguish over-the-counter items used to maintain general health (not reimbursable) from those used to treat a specific medical condition (reimbursable). Additionally, verification of expenses for over-the-counter medications may not be as simple as for prescription drugs. Prescription drugs usually have a receipt clearly showing the drug expense and the patient name. Over-the-counter drug receipts may not indicate the item description or for whose benefit the item was purchased. Processing these types of claims is likely to increase plan administrative burdens.

CASES

Department of Labor States Position on Appointing Fiduciaries. On August 20 the Department of Labor (DOL) issued its amicus brief to In re: Williams Company ERISA Litigation. In this “friend-of-the-court” brief, the DOL agreed with the plaintiff’s allegations that a claim arises under ERISA and asked the federal district court of the Northern District of Oklahoma to reconsider its prior decision dismissing the members of the board of directors from the suit. The plaintiffs alleged members of the Williams Company board of directors breached their fiduciary duties under ERISA by failing to monitor committee members charged with investment duties under certain ERISA plans sponsored by the Williams Company. Under the plan documents, the board of directors had the authority to appoint, retain and remove members of the committee. The DOL contended these “appointing fiduciaries” have on-going duties under ERISA to monitor the performance of the investment fiduciaries and to take appropriate action if the investment fiduciaries’ conduct falls short in meeting their responsibilities to the plan or its participants and beneficiaries. According to the DOL’s position, appointing fiduciaries are required to have procedures in place so they may review and evaluate on an on-going basis whether the investment fiduciaries are doing an adequate job. 

Withdrawal Liability Imposed on “Transfer” of Work. The 7th Circuit Court of Appeals, in what it states is a case of first impression, has attempted to define when a withdrawal occurs—for multiemployer plan purposes—because of transfers of work to another location. It is unclear whether this decision will help determine the meaning of “transfer” under the multiemployer withdrawal liability rules. However, we expect multiemployer plans to argue that a withdrawal has occurred in more situations where the work of union employees is reduced. Here’s a summary of the complex facts in this federal appellate case: Nestlé had a transportation network composed of independent common carriers, owner-operator drivers, and employee drivers. Some of Nestlé’s employee drivers were represented by various local unions. Nestlé, as of a result of its loss of a shipping contract in a region, closed two of its shipping terminals. Before closure, Nestlé used independent contractor drivers and union drivers to cover certain routes served by those terminals, depending on which driver could perform a particular task most efficiently. After closure of the terminals, Nestlé continued from time to time to use the independent contractor drivers on certain routes previously served by those terminals. Nestlé argued it did not transfer the work from union drivers in this case, but rather its business was reduced significantly and even the independent contractor carriers handle significantly less business. The court upheld the prior lower court and arbitrator decision that Nestlé’s actions constituted a transfer. The court found that, prior to closure, union drivers, from time to time, were the most efficient drivers to handle a particular shipment. The fact that union drivers were no longer used for any shipments on these routes meant some work had been “transferred” from unionized drivers to independent contractor drivers. (Nestlé Holdings Inc. et al v. Central States, Southeast and Southwest Areas Pension Fund, 2003 U.S. App. LEXIS 18396 (7th Cir. Sept. 5, 2003).)

IRS/DOL RULINGS, ETC.

Employer’s Recovery of Assets From Terminating Plan Excluded From UBTI But Not From 50% Excise Tax. A private letter ruling held a reversion of surplus assets from a terminating defined benefit plan to the tax-exempt employer maintaining the plan was excludable from the employer's unrelated business taxable income (UBTI) because of the tax benefit rule. However, the reversion was subject to the 50% excise tax on employer reversions. Employer M qualified for exemption from federal income tax as a social club under Code § 501(c)(7). Employer M decided to terminate its defined benefit plan when the plan’s assets were estimated to be $6.1 million and the plan’s liabilities $4.3 million. Employer M received a reversion of the $1.8 million surplus assets. According to the IRS, the issue of whether the reversion was income to Employer M and taxed as UBTI involved an analysis of whether the reversion was income under the tax benefit rule. Under Code § 111(a), gross income does not include income attributable to the recovery of an amount deducted in any prior tax year to the extent that the amount did not reduce the amount of tax. Employer M, as a social club, paid unrelated business income tax on its investment income but never received a tax benefit from its pension contributions to Plan X. The IRS concluded Employer M did not have UBTI from the recovery of the surplus of assets from Plan X following Plan X’s termination. However, the IRS concluded Employer M was subject to the 50% excise tax under Code § 4980 because Employer M had been subject to the tax on UBTI, which in turn meant Plan X had not been maintained by an employer that was at all times exempt from tax. (Priv. Ltr. Rul. 200334043 (May 28, 2003).)

Payment to Retirement Plan Following Stock Collapse Qualifies as Restorative. In this private letter ruling, the IRS ruled a fiduciary’s proposed payment to a defined contribution plan, intended to reimburse participants for losses they suffered when their employer’s stock became worthless, constitutes a restorative payment and not a plan contribution. The facts involve a bankrupt company whose present and former directors, officers, and employees are under investigation by the DOL and are named in many lawsuits alleging violations of federal securities laws and ERISA. The ruling cites the principles of Revenue Ruling 2002-45, which provides payments to a plan may qualify as restorative payments if they are made to restore some or all of the plan’s losses due to an action (or a failure to act) that created a reasonable risk of liability for breach of fiduciary duty. The IRS ruled the proposed allocation will ensure affected participants recover a portion of their account balances and constitutes a restorative payment. Accordingly, the payment (1) will not be treated as a plan contribution and is not subject to the excise tax under Code § 4972, (2) will not be subject to the nondiscrimination requirements of Code § 401(a)(4) or the limits on annual additions under Code § 415, and (3) will not result in taxable income to the plan’s participants or beneficiaries when contributed to the plan. (Priv. Ltr. Rul. 200334041 (May 28, 2003).)

PBGC Storm Relief. The Pension Benefit Guaranty Corporation (PBGC) is waiving certain penalties and deadlines to persons affected by storms, tornadoes, flooding, Hurricane Claudette, and high winds and rains occurring in Indiana, Ohio, Tennessee, and Texas in July 2003. Relief is available for deadlines involving premium payments, plan terminations, participant notices, reportable event notices, annual employer reporting, requests for reconsideration of appeals, and multiemployer plans. (PBGC Technical Updates 03-12, 03-13, 03-14, 03-15 (Aug. 20, 2003).)