Final Regulations on Incentive Stock Options. The Internal Revenue Service (IRS) issued final regulations regarding incentive stock options (ISOs) that generally follow proposed regulations issued in 2003. However, some modifications were made in the rules relating to shareholder approval of ISO plans, and substitution, assumption and modification of ISOs in connection with corporate transactions. The final regulations replace regulations proposed in 2003 and in 1984. The final regulations are effective August 3, 2004, but there are some special transition rules that may allow reliance on the earlier proposed regulations through the end of 2005. (TD 9144)

More Health Savings Account Guidance from the IRS. Earlier this year, the IRS issued Notice 2004-2 that provided basic guidance on health savings accounts (HSAs) in a question-and-answer format. Recently-issued IRS Notice 2004-50 provides more HSA guidance in the form of 88 new questions and answers. Notice 2004-50 states that employers may provide wellness, disease management, and employee assistance programs without disqualifying employees from making HSA contributions; that employers, HSA custodians and trustees may not place any restrictions on the employee’s use of HSA contributions, including employer contributions; and that catch-up contributions may be made on behalf of individuals age 55 or older who are not enrolled in Medicare. The notice was published in the August 16 Internal Revenue Bulletin (2004 IRB 33).

Cases

Denial of Claim is Claims Denial. Thomas Maniscalco was a participant in the TAC Americas Comprehensive Healthcare Plan. Mr. Maniscalco’s daughter was receiving 24-hour private duty nursing care due to a serious medical condition. The plan switched to self-funding and Mr. Maniscalco requested confirmation that 24-hour nursing care would continue to be provided. In response, Mr. Maniscalco received an e-mail from a case manager stating that most of the 24-hour care was determined to be custodial in nature and that payment would be provided only for four hours of nursing care. The e-mail also informed Mr. Maniscalco of his rights to appeal the determination. Mr. Maniscalco appealed the determination to the plan administrator. The administrator also issued an adverse determination on appeal. Not unexpectedly, Mr. Maniscalco brought suit against the plan. TAC responded that Mr. Maniscalco did not pursue all of the administrative claims available to him because the e-mail did not constitute a claims denial. The U.S. District Court for the Southern District of New York rejected TAC’s claim, finding the form of communication, an e-mail, was not determinative of whether the denial was in writing, and that information on appeals rights was provided. The federal district court further found the fact that an appeal was taken clearly shows Mr. Maniscalco pursued all administrative remedies. (Maniscalco v. TAC Americas Healthcare Plan, SDNY 2004)

Phantom Account Offset Did Not Deprive Rehired Employees of Benefits. Approximately 100 retired and current Xerox Corporation (Xerox) employees (the plaintiffs) claimed the Xerox Corporation Retirement Income Guarantee Plan and its administrators (the defendants) wrongfully calculated the amount of their benefits under the plan. The plaintiffs are all former employees of Xerox who left the company and requested lump-sum distributions from the plan, but were later rehired by Xerox and began accruing benefits under the plan again. The plaintiffs contended the plan administrator improperly offset the plaintiffs’ prior lump-sum distributions against the retirement benefits accrued after they were rehired. The plaintiffs alleged their plan benefits should be governed by the plan’s 1989 restatement, or in the alternative, the plan’s earlier 1993 and 1996 restatements, and further alleged these plan provisions did not call for the use of the phantom account offset. The plaintiffs also alleged the plan was improperly amended in 1998 when the phantom account offset provisions were first expressly stated, because the plan administrator and the plan did not provide notice of the amendments to the plaintiffs pursuant to § 204(h) of the Employee Retirement Income Security Act (ERISA). ERISA § 204(h) requires a written notice in the event of significant reduction in the rate of future benefit accrual. The defendants argued the plan had always provided for an offset for prior distributions and the 1998 plan amendment simply clarified how the phantom account offset was calculated. They also contended the amendments had no effect on the plaintiffs’ future benefit accrual. The U.S. District Court for the Western District of New York held the plan had been consistently interpreted by the plan administrator as providing for a phantom account offset for prior distributions. The federal district court also held the amendments do not reduce accrued benefits, or the rate of benefit accrual, rejecting the plaintiffs’ claim the plan provisions were improperly amended under ERISA § 204(h). (Frommert v. Conkright, WDNY 2004)

Not All Plans Are ERISA Plans. Mark Adams and John Muldoon were two of the founders of Intralinks, a secured digital work space for execution of financial and commercial transactions. Adams and Muldoon received options to buy shares of Intralinks. In 2000, Intralinks attempted to go public, but the IPO did not proceed. Shortly thereafter, Adams and Muldoon entered into exit agreements with Intralinks, which provided for vesting their stock options even though they would no longer be employees. Subsequent to their departure, Intralinks engaged in a new private financing and increased the number of outstanding Intralinks shares. The valuation of the shares now reflected a price of $0.54 per share, down from the prior valuation of $8.50 per share. One of several claims made by Adams and Muldoon was that the dilution in the value of their options violated ERISA. The U.S. District Court for the Southern District of New York rejected the ERISA claim finding the stock option plan is a bonus plan and not an employee pension benefit plan under ERISA. A bonus plan could be an ERISA plan if it systematically defers payment of benefits to the termination of employment or beyond. However, like most option plans, the term of the plan was limited in years and the terms of each option extended for 10 years from date of grant and were subject to termination when employment ends. (Adams v. Intralinks Inc., SDNY 2004)

New York, New York. If It’s Granted There, We Will Tax You Anywhere. Randall Stuckless, an employee of Microsoft Corporation, was granted options under the Microsoft stock option plan while residing and working in New York. Mr. Stuckless later moved to Washington State and, from September 1, 1996 through July 4, 1998, was not a New York State resident. During that period, he exercised the options. For federal tax purposes, Mr. Stuckless included the income recognized on the exercise of the option. Mr. Stuckless did not report the income from the exercise of the options as New York taxable income. In a decision issued by an administrative law judge for the New York Division of Tax Appeals, it was determined the options were includable in New York source income because the granted options related to the performance of services within New York State. The amount to be included in New York income would be determined based on the days from date of grant to date of exercise during which Mr. Stuckless worked inside and outside of New York State. (In re Stuckless, NYDTA 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.