IRS Publishes Final Minimum Distribution Rules. On June 14, the Internal Revenue Service (IRS) published final regulations regarding required minimum distributions from defined benefit plans and from annuity products purchased with account balances from other qualified plans, individual retirement plans, and Internal Revenue Code (IRC) § 403(b) contracts. The final regulations retain the basic rules of the prior temporary and proposed regulations published on April 17, 2002, but also change a number of provisions. For example, the final regulations allow for greater flexibility in the payment of annuities. Certain increases are permitted, including adjustments to reflect increases in the cost of living, increases in benefits due to a plan amendment, or increases in payments on the beneficiary’s death or the employee’s divorce.

The regulations also include a change made in response to concerns raised under the temporary regulations that, for employees who die late in a calendar year, it is nearly impossible to set up separate accounts by the end of the year of death so that the separate accounts may be used to determine minimum distributions for the year after death. Under the revised regulations, if separate accounts, determined as of an employee’s date of death, are established by the end of the calendar year following the year of death, the separate accounts can be used to determine the required minimum distributions for the year following the year of death. The separate account rules also provide that post-death investment experience must be shared on a pro-rata basis until the date the separate accounts are actually established.

The regulations generally apply for purposes of determining required minimum distributions for calendar years beginning after 2002, but the regulations include transitional relief under which distributions from a defined benefit plan or annuity contract for calendar years 2003, 2004, and 2005 will be considered compliant as long as the payments are based on a reasonable and good-faith interpretation of the requirements of the minimum distribution rules. (T.D. 9130, 69 Fed. Reg. 33,288 (June 15, 2004))

Treasury/IRS Withdraw Much-Debated Cash Balance Plan Rules. On June 15, the Treasury Department and the IRS withdrew regulations published in December 2002 that were intended to provide guidance on when and how cash balance plans and cash balance conversions would violate age discrimination rules applicable to qualified retirement plans. (On a related note, see Cash Balance Conversion Does Not Discriminate Based on Age elsewhere in this issue of Employee Benefits Developments.) The regulations were withdrawn to give Congress an opportunity to review and consider a legislative proposal included in the administration’s 2005 budget. The legislative proposal would require a five-year “hold harmless” period following a cash balance conversion, would prohibit benefit “wearaways,” and would provide guidance on when cash balance formulas would be deemed to comply with age discrimination requirements. (IRS Announcement 2004-57)

The New HSA Forms Are Here! The New HSA Forms Are Here! On June 25, the IRS released draft versions of Forms 5305-B (“Health Savings Trust Account”) and 5305-C (“Health Savings Custodial Account”). Once finalized, these model forms may be used by financial institutions and others to establish health savings accounts (HSAs) for individuals. Notably, both forms place significant responsibility on the account holder for determining whether he or she:

is covered under a high-deductible health plan;
has exceeded the maximum dollar limit for HSA contributions; and
is seeking distributions for qualified medical expenses.

The forms are subject to a 30-day public comment period and may be viewed on the IRS website at www.irs.gov/pub/irs-dft/.

DOL Corrects Final COBRA Notice Regulations. In Employee Benefits Developments for the period May 17 through May 28, we reported the Department of Labor (DOL) had released final notice regulations under COBRA (that is, the Consolidated Omnibus Budget Reconciliation Act of 1986), effective for plan years beginning after November 25, 2004. The DOL now has offered corrections to the final regulations, including a change that affects the model COBRA election notice, a discussion of which may be found in the June 23 issue of the Federal Register, located on-line at: www.access.gpo.gov/su_docs/fedreg/frcont04.html.

HSAs to Be Available in States Without HDHPs… for Now. You must be covered by a high-deductible health plan (HDHP) (at least $1,000 single/$2,000 family) to open and contribute to a health savings account (HSA). But what if you live in a state that requires health plans to provide certain benefits without regard to a deductible or with a deductible below the HSA minimum deductible threshold? On June 18, the IRS published Notice 2004-43 granting temporary relief for individuals living in states where HDHPs are not available. For months before 2006, a health plan that would otherwise be an HDHP, except it complies with state laws (in effect on January 1, 2004) requiring the provision of certain benefits without regard to a deductible or with a deductible below the HSA minimum deductible threshold, will be treated as an HDHP and will not prevent an individual from making HSA contributions.

Canada Confirms Continuation of Foreign Tax Credit Against FICA Taxes. Judging by a recent ruling of its taxing authority, Canada apparently has forgiven the United States for Tampa Bay’s victory over Calgary in the Stanley Cup Finals. Canada’s Income Tax Act provides for a foreign tax credit for non-business income taxes paid to foreign jurisdictions, and the Canada Revenue Agency (CRA) previously had ruled U.S. social security taxes qualified for the credit, as did German and French social security contributions. In the June 23 Income Tax Technical News No. 31, the CRA, in somewhat of an about face, ruled its prior position was “not supportable in law” and held social security taxes will no longer be accepted as non-business income taxes for purposes of the credit. But, while characterizing technical interpretations regarding the tax treatment of French and German social security contributions as “obsolete and unreliable,” the CRA confirmed it will continue to allow a foreign tax credit for payments under FICA (that is, the Federal Insurance Contributions Act), as expressly required by the Canada-U.S. tax convention. Income Tax Technical News No. 31 can be found on the CRA’s Web site, www.cra.gc.ca.

Cases

Plan Participants May Not Seek Relief in State Courts for HMO Misdeeds. Normally, we don’t report on judicial decisions that address purely legal issues because … well, they’re just so darn legalistic. But a recent U.S. Supreme Court case is too important for even us to ignore because it’s caused quite a stir beyond the ivory tower of the lawyers’ bar. The case concerned the legal doctrine of preemption—specifically, preemption under the Employee Retirement Income Security Act, lovingly known to us all as ERISA. When Congress enacted ERISA some 30 years ago, it established a limited number of remedies of which wronged benefit plan participants could avail themselves. In fact, so smitten were the Congresspersons with the fine statute they had authored, they wished to ensure ERISA remedies were virtually the only remedies available to wronged participants. Since questions arising under ERISA would be matters of federal, not state, law, those questions would fall squarely within the exclusive jurisdiction of the federal courts, thereby ensuring consistency in the law’s application. In other words, a participant’s right to recovery would be the same whether she lived in San Diego, Seattle, Savannah or Springfield.

In the intervening years since ERISA’s enactment, however, many a plaintiff has learned the hard way that the available statutory remedies often fall short of making that plaintiff whole. To circumvent these deficiencies, clever attorneys have attempted to cloak claims for benefits as requests for relief under state law. But the federal courts have been too smart for such trickery and routinely rule ERISA’s comprehensive scheme for enforcement preempts—that is, takes precedence over—any remedy available under state law.

Enter Juan Davila and Ruby Calad, both participants in their respective employers’ ERISA-regulated health plans. A doctor prescribed Vioxx for Davila’s arthritis pain, but Aetna Health Inc. (Aetna), the health maintenance plan (HMO) administrator of Davila’s health plan, refused to pay. Davila began taking Naprosyn, and as a result, allegedly suffered a severe reaction that required extensive treatment and hospitalization. Meanwhile, Calad underwent surgery, and though her doctor recommended an extended hospital stay, CIGNA Healthcare of Texas, Inc. (CIGNA), the administrator of Calad’s health plan, thought otherwise and denied coverage for anything beyond a routine stay. No sooner discharged, Calad suffered post-surgery complications that required hospitalization. Davila sued Aetna, and Calad sued CIGNA, both in Texas state court, each alleging a refusal to cover the requested services violated a duty under Texas law “to exercise ordinary care when making health care treatment decisions” and that the refusals “proximately caused” each plaintiff’s injuries. Aetna and CIGNA, contending the state law claims were preempted by ERISA, removed the cases from state court to federal court, knowing full well the limited remedies favored their interests. While the federal district court agreed with the removal, the U.S. Court of Appeals for the Fifth Circuit did not, and threatened to return the matter to Texas state court. The stage was set for one final appeal.

On June 21, a unanimous Supreme Court sided with Aetna and CIGNA, ruling the plaintiffs’ state law claims were completely preempted by ERISA and thus should be heard in federal court. The end result? HMOs cannot be sued under state law for discretionary decisions regarding eligibility for group health plan benefits, and plaintiffs who seek redress are left to the federal courts and ERISA’s limited menu of remedies. Acknowledging the correctness of the Court’s ruling, Justice Ruth Bader Ginsburg, in a concurring opinion, nevertheless noted a “series of the Court’s decisions has yielded a host of situations in which persons adversely affected by ERISA-proscribed wrongdoing cannot gain make-whole relief.” As a result, she challenged Congress to “revisit what is an unjust and increasingly tangled ERISA regime.” Stay tuned to see whether Congress accepts Ginsburg’s challenge. (Aetna Health Inc. v. Davila, U.S. Sup. Ct. 2004)

ERISA Anti-Alienation Shield Not Available After Distribution Is Made. David Hoult abused his daughter, Jennifer, throughout her childhood, and a jury awarded her $500,000. Almost 11 years later, David still had not paid the judgment in full. To make certain David paid what he owed, a court ordered him to deposit all his income in a designated bank, including his ERISA pension benefits, from which he would be able to withdraw $2,900 for living expenses. David made a motion to have his ERISA pension benefits excluded from the court order on the grounds ERISA’s anti-alienation provision prohibits the court from ordering the deposit of his pension benefit in the designated account. The court denied the motion and David appealed. The U.S. Court of Appeals for the First Circuit upheld the lower court’s order, holding ERISA’s anti-alienation provisions do not apply where funds already have been disbursed to the plan participant. The federal appellate court’s holding in this case is consistent with the position of four out of five other federal appellate courts that previously considered this issue, including the Second Circuit, covering New York. (Hoult v. Hoult, 1st Cir. 2004)

Cash Balance Conversion Does Not Discriminate Based on Age. The controversy continues to rage over whether cash balance plan conversions violate ERISA’s age discrimination prohibitions. A defined benefit plan violates ERISA where, due to the attainment of any age, an employee’s benefit accrual ceases or the rate is reduced. Accrued benefits, for these purposes, are calculated in terms of an annual benefit commencing at age 65, and when applying this definition to a cash balance plan, an employee’s hypothetical account balance must be translated into the equivalent age-65 annuity those sums could purchase. Discrimination exists, so the argument goes, because money contributed for a younger employee is necessarily worth more (when expressed as an annuity starting at age 65) than the same amount of money contributed for an older employee. Hence, a case can be made that all cash balance plans inherently discriminate on the basis of age due to their design. In a recent case, the U.S. District Court for Maryland refused to accept this argument, holding that to calculate accrued benefits under a cash balance plan in terms of an age-65 annuity is inappropriate and leads to illogical results. Under the “more sensible approach,” benefit accruals should be measured by focusing on “the rate at which amounts are allocated and the changes over time in an individual’s account balance, as the ERISA provisions for traditional defined contribution plans would direct.” (Tootle v. ARINC, Inc., D. Md. 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.