U.S. Life Insurance and Annuity Benefits Paid to Nonresident Aliens Subject to U.S. Withholding. In a development that was not warmly received by the American Council of Life Insurers, the Internal Revenue Service (IRS) ruled payments and withdrawals from life insurance and annuity contracts issued by U.S. insurance companies out of a foreign branch constitute U.S. source income generally subject to a 30 percent withholding requirement. The ruling also applies to residents of Puerto Rico who purchase a U.S. insurance policy from a Puerto Rican branch of a U.S. company. The 30 percent withholding rate is applied to amounts received by a nonresident alien individual from U.S. sources. In the context of this ruling, the withholding requirement applies to annuity payments and cash withdrawals that would normally include income amounts under U.S. tax law. Withholding would not apply, however, to death benefits from life insurance that are normally excluded from gross income in the United States. In a comment issued by the American Council of Life Insurers, counsel to the organization noted the ruling will make it more difficult for U.S. insurers doing business through foreign branches. Withholding requirements may be affected by tax treaties; so non-U.S. citizens who might be affected by this ruling should consult cross-border tax counsel on how the ruling might affect their U.S. insurance policies. (Rev. Rul. 2004-75)

Vacation Pay Plan Trust Is Not an ERISA Welfare Plan. Denny’s Inc. set up a vacation plan trust as a pass-through funding arrangement to pay employees’ vacation pay. The trust handled about $8 million annually, but generally carried a $250,000 minimum balance, with biweekly vacation payments flowing into and out of the trust (usually within two days). The trust issued vacation pay checks on the same schedule as regular wages and included normal payroll information and deductions. Under a Department of Labor (DOL) ruling, the trust arrangement used by Denny’s would have established a welfare plan under the Employee Retirement Income Security Act (ERISA) if the trust were a bona fide separate fund established to finance the underlying benefit. In this case, because the trust acted essentially as a pass-through vehicle for the payment of ordinary vacation wages, an ERISA welfare plan was not created. (DOL Advisory Opinion 2004-08A)

Golden Parachute Guidance. Revenue Ruling 2004-87 provides guidance on the application of the golden parachute rules for companies in bankruptcy. Internal Revenue Code (IRC) § 280G denies an employer a deduction for certain excess payments to an employee that are contingent on a change of control of the corporation (“excess golden parachute payments”), and IRC § 4999 imposes a 20 percent excise tax on the recipient of an excess golden parachute payment. Under the ruling, when a creditor acquires 20 percent or more of a debtor corporation’s stock within a 12-month period, the debtor will be presumed to have had a change in control. The debtor may rebut this presumption by showing the creditor will not act to control the debtor’s management policies. Also, where a debtor corporation’s stock has been de-listed pursuant to the bankruptcy, the corporation is eligible to try to satisfy an exception to the golden parachute rules applicable to companies whose stock is not readily tradable.

“Deemed IRA” Rules Clarified. The IRS has issued proposed and final regulations for “deemed individual retirement accounts (IRAs).” IRC § 408(q) permits an employer to allow employees to keep IRA assets in the employer’s qualified retirement plan as separate IRA accounts under the plan. Both the IRA assets and plan assets may be held under the same trust. The guidance provides the qualified plan and a deemed IRA under the plan will be considered separate entities, and each entity will be subject to the tax rules generally applicable to that entity. These rules are effective for deemed IRAs established after July 31, 2003. The IRS also issued temporary regulations that allow a governmental unit to serve as a trustee of deemed IRAs that are part of the governmental unit’s plan. (69 FR 43,735)

Trust Company Exempt From ERISA Bonding Rules. As a general rule, all ERISA plan fiduciaries who handle plan assets are required to be bonded. The coverage, a relatively inexpensive dishonesty bond, is obtained through an insurance broker. Institutional fiduciaries such as banks and other financial institutions are normally exempt. The DOL ruled a non-depository trust company is exempt from the ERISA bonding requirement. In this case, the exempt trust company did not hold bank deposits covered under the Federal Reserve System, but operated as a subsidiary of a bank regulated under federal banking law. Note that satisfaction of the ERISA bonding rule is covered on Form 5500 and that the required coverage is different from optional, and more expensive, fiduciary liability coverage. (DOL Advisory Opinion 2004-07A)

Cases

It Doesn’t Always Pay to Be Promoted. The good news for Evelyn Petrus was that her employer, Lucent Technologies, Inc., promoted her to CFO of its Small Business Division. The bad news was that after the promotion, Lucent sold the division to an unrelated entity. At that time, Petrus was two years shy of becoming fully vested in her pension benefit under the Lucent retirement plan. Petrus brought suit alleging Lucent intended to interfere with her pension rights by promoting her. In affirming a lower court, the U.S. Court of Appeals for the Sixth Circuit held Petrus failed to show sufficient evidence that the promotion and subsequent sale were motivated by Lucent’s desire to avoid pension liabilities. The evidence showed Petrus was promoted because of her professional qualifications. (Petrus v. Lucent Technologies, Inc., 6th Cir. 2004 unpublished)

He Couldn’t Fix the Company, but Still Gets $5 Million. Outboard Marine Corp. (OMC) learned the hard way that a sale of assets in bankruptcy is still a sale of assets. OMC employed Robert Fix as CEO of the company. Fix’s employment agreement required OMC to pay Fix $5 million less the “exercise value of the Fix Options” upon a change in control of the company. Change in control was defined to include a sale of substantially all of the assets of the company. OMC filed for bankruptcy on December 22, 2000. Just prior to the bankruptcy filing, the board of directors of OMC approved the sale of the assets of OMC. Fix completed the sale of the assets on February 5, 2001, and the sale was approved on February 9. A week later, OMC fired Fix. Although OMC tried to argue that Fix’s employment agreement was ambiguous and the definition of change in control did not contemplate a sale in bankruptcy, the U.S. Court of Appeals for the Seventh Circuit held the contract was clear and unambiguous. The federal appellate court stated OMC, if it had desired, could have explicitly excluded a sale of assets in bankruptcy from the definition of change in control. (Fix v. Quantum Industrial Partners LDC, 7th Cir. 2004)

Global Crossing Settlement. The DOL announced a settlement of the Global Crossing litigation arising from losses in the Global Crossing Retirement Savings Plan (the Plan) of tens of millions of dollars in employee IRC § 401(k) accounts. Under the arrangement, the Plan will recover $79 million, including $25 million placed in escrow by the former CEO under an earlier arrangement with the DOL. The balance of the settlement comes from insurance policies covering the Plan’s former fiduciaries. The settlement must still be approved by the court.

“Lifetime” Medical Benefits Eliminated—Whose Life is it Anyway? In yet another retiree medical benefits case, the U.S. Court of Appeals for the Seventh Circuit ruled in a unanimous 34-page opinion that CNA Financial Corp. could eliminate a “lifetime” retiree medical arrangement it established under a voluntary early retirement program. Once again, the court looked carefully at the language used by the employer in setting up the program and found the reservation of rights by the employer to amend, revoke or suspend the retiree coverage was adequate to allow the employer to eliminate the benefit. The extended opinion covers the documents and oral representations used in setting up the program and the various theories used by the plaintiffs to assert their claim that the employer could not legally change the retiree medical benefit. Unlike retirement benefits that are “vested” under federal law, the court found that CNA had successfully retained the right to change the medical coverage. The opinion provides a good legal background for the distinction between “vested” ERISA retirement benefits and “lifetime” welfare benefits, as described by the court, and a bitter lesson in “lifetime medical benefits” for CNA retirees. (Vallone v. CNA Financial Corp., 7th Cir. 2004)

Time Runs Out on Multiemployer Plan Seeking Withdrawal Liability Payments. A multiemployer plan asserted withdrawal liability against a withdrawing employer in 1991 after a New Jersey trucking company ceased its plan contributions. The company had been sold in 1988 to a Canadian firm by an individual who owned the business as a sole proprietor. The plan obtained a 1995 judgment against the Canadian-owned firm but had not collected on the judgment. In 1998 the plan sued the sole proprietor who had sold the company in 1988 under a theory that might have succeeded had the suit been timely filed. ERISA has a 6-year statute of limitations to bring suit for withdrawal liability payments, in this case measured from the 1991 date when the plan made its original demand for payment. The plan argued its 1995 judgment could be enforced any time within a New Jersey 20-year statute of limitations for actions to enforce judgments. The 1995 judgment, however, was not against the individual from whom the plan now sought payment. In a split decision, the U.S. Court of Apppeals for the Third Circuit ruled the lawsuit commenced in 1998 to collect the withdrawal liability from the sole proprietor who sold in 1988 was not timely, and ruled against the plan. (Board of Trustees of Trucking Employees of North Jersey Welfare Fund Inc.—Pension Fund v. Kero Leasing Corp., 3rd 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.