New Proposed Rules on Eliminating Optional Benefit Forms. New Internal Revenue Service (IRS) proposed regulations would allow plan sponsors of qualified defined benefit and money purchase plans to eliminate certain optional forms of benefit to simplify plan administration. The Internal Revenue Code of 1986 has an “anti-cutback” rule that prohibits the reduction or elimination of optional forms of benefit by plan amendment, with limited exceptions. The proposed regulations would expand the exceptions to the anti-cutback rule by allowing a plan to eliminate an optional form of benefit if the optional form were redundant with respect to another form available under the plan. The redundancy test is met if the retained optional form of benefit is in the same family of benefit forms as the option being eliminated and a participant’s rights under the retained option are not subject to materially greater restrictions than those applied to the eliminated option. The regulations also would allow a plan to eliminate optional forms of benefit if the plan satisfies certain criteria, including offering a designated set of “core options” to participants and providing that the eliminated options would remain available to participants with annuity starting dates less than four years after the effective date of the elimination. These new rules would apply to plan amendments adopted on or after the date the proposed regulations are finalized. (IRS Prop. Reg. §§ 1.411(d)-3, 54.4980F-1)

IRS Provides New HSA Guidance. The IRS issued guidance on health savings accounts (HSAs) regarding preventive care and prescription drug coverage. Tax-favored HSAs can be established for eligible individuals who are covered by a high-deductible health plan (HDHP) and not covered by any other type of health plan. Eligible individuals may make contributions to HSAs, subject to statutory limits. Employers also may contribute on behalf of eligible individuals. For 2004, an HDHP is a health plan with an annual deductible of at least $1,000 for individual coverage ($2,000 for family coverage). However, an HDHP may have a preventive care deductible that is zero or below the minimum annual deductible. The IRS has provided guidance on what constitutes preventive care. In Notice 2004-23, the IRS provides a safe harbor list of specific services, including periodic health evaluations, routine prenatal and well-child care, child and adult immunizations, tobacco cessation programs, and obesity weight loss programs, that constitute preventive care benefits. (IRS Notice 2004-23)

Relating to prescription drug coverage, the IRS guidance states prescription drug coverage can be provided only when it is subject to the same deductible that applies to the HDHP. In Revenue Ruling 2004-38, the IRS held individuals with non-HDHP prescription drug coverage are not eligible for HSAs. The ruling, however, provides transitional relief from this restriction until January 1, 2006. (Rev. Rul. 2004-38, Rev. Proc. 2004-22)

Lastly, the IRS established a transitional rule relating to medical expenses that may be paid or reimbursed on a tax-free basis from an HSA. In general, to qualify for payment or reimbursement, a medical expense must be incurred after the date the HSA is established. Because there has been a lack of trustees or custodians willing to open HSAs, the IRS recognized it may be difficult for individuals to establish HSAs when they are first eligible to do so. Consequently, an HSA established before April 15, 2005 may pay or reimburse on a tax-free basis qualifying medical expenses incurred on or after the later of January 1, 2004 or the first day of the month the individual is eligible. (IRS Notice 2004-25)

IRS Cracking Down on Frivolous Options Claims. In Notice 2004-28, the IRS warned taxpayers against making frivolous claims to avoid income tax or alternative minimum tax on the exercise of stock options. Apparently, some consultants are encouraging taxpayers to use several unsupported arguments in claiming tax refunds on option income. The IRS intends to challenge these positions and will not rule out imposing civil and criminal penalties in appropriate cases. Examples of arguments the IRS considers frivolous include: 1) options should have been taxed at the grant date rather than the exercise date, 2) the fair market value of stock purchased under an option is reduced by any employer restriction that prohibits the employee from selling the stock for a specified time, and 3) options should be viewed as the economic equivalent of the underlying stock and thus not subject to tax of the spread on exercise. (IRS Notice 2004-28)

FASB Formally Proposes Requirement to Expense Stock Compensation. On March 31, the Financial Accounting Standards Board (FASB) formally proposed a requirement to count the value of employee stock compensation as a cost against earnings. Employee stock-based compensation would be recorded at its fair market value, measured at the compensation’s date-of-grant. After a 90-day period for public comment, FASB plans to issue a final accounting standard for stock compensation in the fourth quarter of 2004. The rule would become effective for calendar-year public companies in January 2005. FASB believes this new rule will help provide for more transparent, comparable financial statements that properly reflect economic activities and performance. The proposal can be found at www.fasb.org.

Cases

Supreme Court Declines Review of Same Sex Benefits Mandate. The U.S. Supreme Court declined to review the constitutionality of a San Francisco ordinance requiring contractors providing services to the city of San Francisco to provide domestic partner benefits to their employees. S.D. Myers, an Ohio company that was denied a contract with the city because it refused to provide the benefits, brought the petition for review. In rejecting the review, the Court let stand a decision by the federal Court of Appeals for the Ninth Circuit that San Francisco could use its contract power to impose its social policy in favor of domestic partners. (S.D. Myers v. San Francisco, US Sup. Ct. 2004)

No “Bad Boy” Clause, No Forfeiture. An employer that fired its chief operating officer for allegedly sexually harassing employees still had to pay the executive retirement benefits pursuant to the employer’s top hat plan. When Gerald Fields became COO of Thompson Printing in 1990, he signed a contract with Thompson providing for certain compensation, medical benefits and retirement benefits under a plan for certain highly-compensated management employees. The contract provided that if Thompson terminated Fields prior to the end of the contract, all benefits would continue in accordance with the contract. Three years prior to the end of the contract’s term, three female employees alleged Fields had sexually harassed them. Two days later, Fields was fired. Fields sued Thompson for failure to pay his retirement benefits pursuant to the contract and the plan. In affirming the federal district court’s decision, the Court of Appeals for the Third Circuit held Fields was entitled to the benefits under the plain language of the contract’s nonforfeiture clause. The federal appellate court noted the contract did not carve-out any exceptions, such as discharge for cause, to the nonforfeiture provision. The court also rejected the employer’s argument that the contract contained an implied covenant of good faith that Fields breached. (Fields v. Thompson Printing, 3rd Cir. 2004)

When is a Benefits Program Under Serious Consideration? Here is a new addition to the growing list of cases holding that once a benefit program is under “serious consideration,” an employer cannot mislead employees about the program. In this case, Chevron adopted a benefits program to provide enhanced severance benefits to participants in its retirement plan who were involuntarily terminated during a specified period. The general manager of Chevron’s Richmond, Virginia location decided at first not to use the program at the Richmond facility. He posted a statement to that effect on the company’s internal website. A few months later, however, the general manager decided to use the program, at first for certain employees and then for all employees at the Richmond facility. In affirming in part and reversing in part a federal district court decision, the Court of Appeals for the Ninth Circuit determined the program was under serious consideration from the time of a meeting at which the Richmond general manager agreed to consider the program for management-level employees. After that point, the federal appellate court determined Chevron should have informed retiring employees of the program. Thus, those employees who retired after the meeting were entitled to the enhanced benefits because Chevron breached its fiduciary duties under the Employee Retirement Income Security Act of 1974 by not telling them about the benefits before they retired. (Matthews v. Chevron Corp., 9th 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.