Cross-Border Employees: IRS Proposes New Rules for Determining Source of Compensation. On August 6, the Internal Revenue Service (IRS) withdrew previously proposed regulations and published a new set of proposed regulations for determining the source of income for work performed partly within and partly without the United States. The new proposed regulations reflect the IRS’s belief that a time basis generally is the most appropriate method for determining the source of an individual employee’s compensation. With respect to compensation in the form of fringe benefits (e.g., housing, education, local transportation, tax reimbursement, hazardous or hardship duty pay, and moving expense reimbursement), the new proposed regulations generally provide for sourcing on a geographical basis (e.g., at the employee’s principal place of work). For compensation for work performed by persons other than individuals and by individuals who are not employees, the new proposed regulations retain the facts and circumstances basis as the general rule for determining the source of compensation. (69 Fed. Reg. 47816)

Governmental Deferred Compensation Plans: IRS Model Amendments Published. The IRS published model amendments that may be used by a state or local government employer to amend or draft its eligible Internal Revenue Code (IRC) § 457(b) deferred compensation plan to reflect changes made to IRC § 457 by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the Taxpayer Relief Act of 1997 (TRA ‘97), and the Small Business Job Protection Act of 1996 (SBJPA). The changes addressed in the model include increases in elective deferral limits, repeal of the rules coordinating the IRC § 457 plan limits with contributions to certain other types of plans, catch-up contributions for individuals age 50 or over, extension of qualified domestic relations order rules to IRC § 457 plans, rollovers to and from various types of eligible retirement plans, IRC § 403(b) contracts and individual retirement arrangements (IRAs), and transfers to purchase permissive service credits under governmental defined benefit plans. An eligible IRC § 457(b) governmental plan will be treated as having adopted timely amendments to reflect the requirements of EGTRRA if

the related Model Amendment, or any other amendment that satisfies that requirement, is adopted no later than December 31, 2005;
the amendment is effective as of a date not later than the latest date permitted under IRC § 457(b); and
the operation of the plan since that date is not inconsistent with the amendment.

(Rev. Proc. 2004-56)

IRS to Enforce Compensation Rules for Tax-Exempt Organizations. The IRS announced a new enforcement effort to identify and halt abuses by tax-exempt organizations that pay excessive compensation and benefits to their officers and other insiders, to increase awareness of tax issues as organizations set compensation in the future, and to learn more about the practices tax-exempt organizations are following as they set compensation and report it to the IRS and the public on their annual Form 990 returns. The IRS is expecting to contact nearly 2,000 charities and foundations to seek more information about their compensation practices and procedures. The IRS began this enforcement project at the end of July and says it will continue into 2005. (IR-2004-106)

IRS Finalizes Regulations Addressing Nonstatutory Stock Option Tax Shelters. If a nonstatutory stock option is granted to an employee or service provider in connection with the performance of services, and the option’s fair market value can’t be determined, the grantee doesn't realize taxable income until the option is exercised. There is an exception, however, where the option is sold at arm’s length before exercise. In Employee Benefits Developments (June 30, 2003–July 11, 2003), we reported that the IRS had launched a concerted attack against tax shelters designed to defer income and employment taxes on the transfer of nonstatutory stock options between related parties (e.g., family members). At that time, the IRS issued proposed regulations, among other guidance, that foreclosed the treatment of these types of transfers as taxable events. On August 9, the IRS finalized these regulations without change. (69 Fed. Reg. 48,392)

CMS Releases New Q&As Regarding HIPAA Security. Just when you thought it was safe to forget everything you ever knew about HIPAA (i.e., the Health Insurance Portability and Accountability Act of 1996), the Centers for Medicare & Medicaid Services (CMS) has posted a series of new questions and answers on its website pertaining to the HIPAA security rule. The security rule, for all you non-HIPAA fanatics, sets forth standards for the electronic transmission and retention of protected health information (PHI). Most covered entities must comply with the rule by April 21, 2005, though small health plans are permitted an extra year to demonstrate compliance. Among other topics, the new Q&As address the transmission of PHI via e-mail as well as access to PHI by those employees who telecommute or have home-based offices. (http://questions.cms.hhs.gov)

Cases

Covered Minor Dependent Not Required to Receive Separate COBRA Notice. Gary Starr, individually and on behalf of his daughter, brought a lawsuit against his former employer, Metro Systems, Inc. (Metro), in which he alleged Metro violated the Consolidated Omnibus Budget Reconciliation Act of 1986 (COBRA) notice requirements by failing to provide his daughter with adequate notice of her continuation of coverage rights under COBRA after Metro terminated Starr. Metro mailed to Starr’s last known address a COBRA notice that described the right of Starr and his daughter to elect COBRA coverage. Starr asserts that neither he nor his daughter received the notice. Consequently, they never made any election to continue their benefits under the plan. Metro terminated coverage under the plan in June 2000. In August 2000, the daughter’s appendix ruptured. She had surgery and later experienced complications associated with her ruptured appendix. The medical expenses associated with the appendectomy and complications totaled $116,188. Starr asked the court for summary judgment for a number of reasons, including Metro’s failure to deliver a separate COBRA notice to his daughter as well as Starr’s assertion that the COBRA notice was never received at his residence. Starr’s summary judgment motion was denied. In response to Starr’s separate notice argument, the U.S. District Court for Minnesota noted that no section of COBRA addresses the issue of whether a minor child living with a covered employee is entitled to a separate COBRA notice following an employee’s termination and that whether a COBRA notice is sufficient is a question of fact that involves determining whether the notice was sufficient to allow the qualified beneficiary to make an informed decision whether to elect coverage. Accordingly, the federal district court concluded under the facts of this case that there is no COBRA requirement entitling Starr’s daughter (a minor child living in the same household as her father) to a separate COBRA notice. With respect to Starr’s claim that he never received the COBRA notice at his residence, the court noted Starr was unable to contradict Metro’s testimony that it had properly mailed the COBRA notice. The court stated the law presumes a letter properly addressed, stamped and mailed was received by the person to whom it was addressed, and ruled a reasonable fact-finder could conclude that Starr received the COBRA notice. (Starr v. Metro Systems Inc., D. Minn. 2004)

Deference Given to Determination Despite SPD’s Failure to Name Administrator. An issue that routinely arises in ERISA litigation over a benefit claim determination concerns the court’s so-called standard of review. Plaintiffs typically push for a de novo standard, which permits the court to “ignore” the claims administrator’s decision and consider the facts of the claim itself as if for the first time. On the other hand, defendants prefer the arbitrary and capricious standard, which requires the court to afford great deference to the claims administrator’s decision, unless the administrator has acted in a particularly egregious manner. A plan sponsor can ensure that the more deferential standard will apply if it expressly reserves to the claims administrator discretionary authority in the plan document, though care must be taken to ensure that the summary plan description is consistent with the plan document in this respect. Such was the issue in a recent decision by the U.S. District Court for the Southern District of New York. Mark Winkler worked for The Jack Morton Company. Following his last day of work (i.e., October 10, 2001), Winkler filed a claim for long-term disability benefits under the company’s welfare benefit plan, but Metropolitan Life Insurance Company (MetLife), the plan’s claims administrator, denied it, finding Winkler was not “totally disabled.” After exhausting the plan’s administrative remedies, Winkler sued MetLife and contended MetLife’s determination was subject to de novo review, noting the summary plan description’s section on discretionary authority did not expressly mention MetLife by name. The federal district court, however, balked at Winkler’s contention, and in citing a prior court ruling on the same issue, noted, “The plan need not spell out in intricate detail who has the discretion, other than to specify that those charged with implementing it will have such discretion.” (Winkler v. Metropolitan Life Insurance Company, SDNY 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.