IRS Provides Guidance on Retirement Plan Tax Shelters. The Internal Revenue Service (IRS) launched a new section on its website providing information on abusive schemes involving employee retirement plan tax shelters. The IRS stated in IR-2004-20 that the new guidance is intended to warn promoters and plan professionals about the consequences of participating in these schemes. The new section identifies listed transactions involving employee benefits plans and provides guidance on abusive life insurance policies, S corporation ESOP abuses, and abusive Roth IRA transactions. The section also provides a link to the IRS’s Corporate Abusive Tax Transactions webpage. Contact information for reporting suspected abusive transactions to the IRS is provided in this section. The section can be accessed at: http://www.irs.gov/retirement/article/0,,id=118821,00.html.

Treasury and IRS Guidance Target Abusive Life Insurance Policies. The Department of the Treasury (Treasury) and the IRS issued guidance February 13 to shut down abusive transactions involving specially designed life insurance policies in retirement plans, known as § 412(i) plans. These are retirement plans funded exclusively with insurance products that are free from the funding requirements applicable to defined benefit pension plans if certain requirements are met. An employer can claim tax deductions for contributions that are used by the plan to pay premiums on an insurance contract covering an employee. Three specific issues were targeted in the Treasury and IRS’s guidance items:

A set of proposed rules states any life insurance contract transferred from an employer or tax-qualified plan to an employee must be taxed at fair market value. Some firms have employed a springing cash value life insurance arrangement to permit the employers to claim tax deductions for amounts far in excess of the amount the employee recognizes for income tax purposes. The proposed rules would prevent taxpayers from using artificial devices to understate the value of the contract. Revenue Procedure 2004-16 (see item below) provides a temporary safe harbor for determining fair market value and is effective Feb. 13, 2004.
Revenue Ruling 2004-20 was issued in conjunction with the guidance and states an employer cannot buy excessive life insurance to claim large tax deductions.
Revenue Ruling 2004-21 also was issued in conjunction with the guidance and states a § 412(i) plan cannot use differences in life insurance contracts to discriminate in favor of highly-paid employees.

IRS Provides Guidance on Determining Fair Market Value of Distributed Life Insurance Contract. In connection with the promulgation of proposed regulations, the IRS issued Revenue Procedure 2004-16 regarding appropriate methods for valuing life insurance contracts distributed from qualified retirement plans. Previously, the IRS addressed the issue of so-called “springing cash value” life insurance policies for which the value of the policy was higher than the stated cash surrender value in the policy. The IRS held in those situations cash value was not an appropriate measure of the policy’s fair market value. The IRS indicated in those situations the policy reserves may be a more accurate indicator of fair market value. Since then, some insurance contracts have been developed that provide for large surrender charges or other charges not expected to be paid because they are expected to be eliminated or reversed in the future, either under the terms of the contract or under another contract for which the first contract is exchanged. The future elimination or reversal of these charges is not always reflected in the calculation of the contract’s reserves. Accordingly, the IRS indicates the use of reserves also may not be an appropriate indicator of fair market value.

Until final regulations are issued governing the valuation of life insurance policies, the IRS provides interim guidance that may be used to value a policy. Generally, the guidance provides the cash value of the policy, without reduction for surrender charges, may be treated as fair market value if the cash value is at least equal to the sum of premiums paid under the policy plus all adjustments and reflecting investment return and market value of segregated asset accounts minus a reasonable mortality charge and other reasonable charges but only if those charges are actually charged on or before the date of determination and are expected to be paid.

Department of Labor Provides Guidance on Fiduciary Duty. The Department of Labor’s Employee Benefits Security Administration (EBSA) issued a statement February 17 outlining the duties of employee benefit plan fiduciaries in response to alleged abuses involving mutual funds. The guidance highlights the obligations of fiduciaries to review their mutual fund and pooled investment fund investments with respect to reported and potential late trading and market timing abuses. The statement provides no clear answers to dealing with these issues but instructs fiduciaries to follow prudent plan procedures and to document their decisions. The guidance also provides examples of steps fiduciaries can take to deal with market timing concerns within their own plans without losing the protections of § 404(c) of the Employee Retirement Income Security Act. The EBSA guidance statement is available at http://www.dol.gov/ebsa/newsroom/sp021704.html.

Medicare Entitlement Not Second Qualifying Event for COBRA Purposes. Generally, the Consolidated Omnibus Budget Reconciliation Act provides for an 18-month continuation coverage. One exception to this rule is that a 36-month coverage period applies if the qualifying event is the covered employee becoming entitled to Medicare benefits. In Revenue Ruling 2004-22, the IRS examined the situation where an employee loses coverage due to termination of employment. The employee and his spouse were entitled to an 18-month maximum coverage period. Within that 18-month period, the former employee became entitled to Medicare benefits. The IRS determined the former employee’s spouse was not entitled to a 36-month coverage period. The IRS reviewed the underlying health plan of the employer. The underlying group health plan, complying with the Medicare Secondary Payor provisions of the Social Security Act, provided an active employee who became entitled to Medicare benefits would continue coverage under the regular health plan. The IRS determined because of this provision, the employee’s entitlement to Medicare did not result in the loss of coverage and, therefore, no expanded coverage period would be provided.

Cases

Non-Adoption of Plan Amendment Is Not Considered A Breach of Fiduciary Duty. The Court of Appeals for the Sixth Circuit ruled February 10 an employer did not breach its fiduciary duty when it decided not to adopt a proposed pension plan amendment and opted instead to adopt a retroactive amendment that did not provide as many benefits as the unadopted amendment. The federal appellate court held the employer acted as a plan settlor when it declined to adopt the first proposed amendment. The court stated the employer’s decision to amend the plan was a plan settlor function because it “concerns the design of the plan itself and does not implicate its fiduciary duty.” (Gromala v. Royal & SunAlliance,
6th Cir. 2004.)

Administrator’s Failure to Provide Benefit Caps Information Not a Breach of Fiduciary Duty. The United States District Court for the Southern District of New York held the failure to provide information to a plan participant about monthly benefit caps for a long term disability benefit plan (LTD) was not considered a fiduciary breach of duty by the plan administrator. At the time the plaintiff began employment, he was given an enrollment package that contained a booklet about the flexible benefit plan. The booklet did not contain information about the monthly benefit caps. The booklet made references to a separate fact sheet that included a description of the monthly benefit caps. The plan’s SPD, fact sheet, and a later version of the booklet all contained information about the monthly benefit cap. The plaintiff argued the plan administrator and the third-party benefits administrator breached their fiduciary duties by making certain misrepresentations with respect to the LTD benefits. The court held the plan administrator acted reasonably because later versions of the flexible benefit plan brochure, the SPD, and fact sheets all contained information about the monthly benefit caps and because the plan administrator put in place procedures designed to provide these documents to all eligible employees. (Denniston v. Taylor, S.D.N.Y. 2004.)

When is an Accident Not an Accident? A Tale of Two Circuits. Martin Schanus had a blood alcohol level of 0.19% when he crashed his motorcycle and died. Hartford Life and Accident Insurance Co. refused to pay an additional benefit for “accidental death” arguing that Schanus’s voluntary intoxication and driving was considered a “self-inflicted injury” and not an “accident” under the life insurance plan. Because the term “accident” was not defined in the plan, Hartford relied on the definition of “accident” in Black’s Law Dictionary to mean “happening by chance, or unexpectedly; taking place not according to the usual course of things; casual; fortuitous” and determined death is an expected outcome of drunken driving. The United States Court of Appeals for the Eighth Circuit disagreed and ruled the insured participant must have both a subjective intent and an objective expectation of not being injured and that death caused by crashing a motorcycle while intoxicated is considered an accident under the plan. The court held, subjectively speaking, Schanus expected to come home safely. Objectively speaking, a reasonable person in the shoes of Schanus would not have viewed the crash and subsequent death as an event “highly likely to occur.” (King v. Hartford Life and Accident Insurance Co., 8th Cir. 2004.)

Randall Lee Duvall, a participant in an accident and dismemberment plan, had a blood alcohol level of 0.212% when he died from injuries sustained in a single-car collision. Hartford Insurance Company did not pay benefits to Duvall’s beneficiary, determining the participant’s death did not result from an accident and therefore was not considered an “injury” under the plan. The United States Court of Appeals for the Fourth Circuit agreed, holding a plan participant’s death from driving while intoxicated was not an “accident.” The federal appellate court relied on one of its prior rulings to hold a “death that occurs as a result of driving while intoxicated, although perhaps unintentional, is not an ‘accident’ because that result is reasonably foreseeable.” (Poeppel v. Hartford Insurance Co., 4th Cir. 2004.)

This newsletter is a periodic publication of Hodgson Russ LLP and should not be construed as legal advice or legal opinion on any specific facts or circumstances. The contents are intended for general informational purposes only, and you are urged to consult your own lawyer concerning your own situation and any specific legal questions you may have.