Final 409A Regulations Issued

At long last, final regulations governing nonqualified deferred compensation under Code § 409A were issued on April 10, 2007. With an effective date of January 1, 2008, the final regulations require documentary compliance for all deferred compensation plans and arrangements by the end of 2007. Until then, plans must continue to be operated in good faith compliance with the IRC § 409A.

Totaling almost 400 pages, the final regulations contain significant changes from the proposed regulations issued in September 2005. The Employee Benefits Group is preparing highlights of changes, to be issued shortly.

New Rules on Distributions for Missing Nonspouse Beneficiaries

The Pension Protection Act of 2006 (PPA) modified the Internal Revenue Code (Code) to allow a distribution of a deceased plan participant’s benefit from eligible retirement plans to be directly transferred on a tax-deferred basis to an individual retirement account (IRA) established on behalf of the participant’s designated nonspouse beneficiary. That PPA change prompted the U.S. Department of Labor (DOL) to modify existing DOL regulations that provide terminated and abandoned plans a fiduciary safe harbor for making distributions on behalf of missing participants or beneficiaries.

In February, the DOL published an interim final rule requiring an individual account plan (e.g., 401(k) plan) benefit owed to a missing nonspouse beneficiary by a terminated or abandoned plan to be directly transferred into an IRA established for the missing nonspouse beneficiary. Under the DOL’s interim final rule, a direct transfer of a missing nonspouse beneficiary’s benefit to an IRA that fully complies with Code requirements is a condition of relief under the fiduciary safe harbor.

This interim final rule, which is applicable to distributions made on or after March 19, 2007, will affect fiduciaries, plan service providers, and participants and beneficiaries of individual account pension plans.

IRS Issues Guidance on Transfers from FSAs and HRAs to Health Savings Accounts

The Tax Relief and Health Care Act of 2006 (Act), enacted in December of last year, authorizes one-time transfers from health flexible spending accounts (FSAs) and health reimbursement accounts (HRAs) to health savings accounts (HSAs). The Act refers to these transfers as “qualified HSA distributions.” A qualified HSA distribution allows unused amounts in an FSA or HRA to be transferred to a tax-favored HSA of the employee.

The transfer option is available only to employees who were participants in an FSA or HRA as of September 21, 2006. Only one transfer per FSA/HRA is permitted for an individual, and it must be made on or before January 1, 2012.

In Notice 2007-22, the IRS describes the requirements for making year-end transfers from FSAs and HRAs. This guidance is especially important to employers who sponsor both general purpose FSAs or HRAs and also maintain a high deductible health plan (HDHP), a necessary requirement for the individual to qualify for an HSA.

Under the notice, only FSAs that have a grace period feature may make a qualified HSA distribution.

The notice provides that a year-end transfer from an HRA or grace period FSA must meet the following requirements:
• The FSA/HRA plan document must be amended by the last day of the plan year to authorize the transfer;
• The employee must make an election by the last day of the plan year of the FSA/HRA;
• The amount transferred may not exceed the employee’s FSA/HRA balance as of 9/21/2006 or, if less, the employee’s FSA/HRA cash balance as of the last day of the plan year;
• The FSA/HRA must make no reimbursements after the last day of the plan year, including reimbursement of claims submitted before the last day of the year;
• The employee must be HSA-eligible (i.e., the transfer occurs in a month in which the employee was enrolled in an HDHP as of the first day of the month); and
• The employer must make the transfer directly to the HSA within two and a half months following the end of the plan year of the FSA/HRA.

Employers maintaining HSAs and/or general purpose grace period FSAs and HDHPs would be well-advised to carefully consider this notice because failure to comply with the complex requirements will have adverse consequences.

Crime Doesn’t Pay — ERISA Is No Protection From MVRA

Last April, we reported on a Ninth Circuit case where a divided three-judge panel ruled that the federal government could garnish a criminal defendant’s pension benefits under the federal Mandatory Victim’s Restitution Act of 1996 (MVRA). In February, the full panel of judges in the Ninth Circuit took up the case and ruled once more in favor of the federal government’s ability, through MVRA, to reach the defendant’s pension benefits.

This case is significant because the Employee Retirement Income Security Act (ERISA) contains an anti-alienation provision that generally prohibits ERISA plans from paying participant benefits to creditors. Supreme Court rulings have held that, except when Congress expressly chooses to act, the possible exceptions to ERISA’s anti-alienation provision are limited to qualified domestic relations orders and recoveries from theft from the benefit plan itself.

MVRA allows a court to order a defendant convicted of certain offenses to make restitution to the victim of the offense. In this decision, the Ninth Circuit ruled that Congress intends MVRA to allow victims of crimes to seize pension benefits from a criminal defendant’s pension account. However, the court limited the ability to reach a criminal defendant’s pension benefits to instances where “the terms of the plan allow the defendant to demand a lump sum payment at the present time.” By holding that the MVRA takes precedence over ERISA’s anti-alienation provision, the Ninth Circuit has broadened the exception to ERISA’s pension benefit protection.

Take Care With Severance Pay Documents

Two recent cases decided in the federal appeals courts point out the importance of language in severance pay plans. The outcomes of both cases hinged on the interpretation of provisions in the plan documents.

In the first case, the United States Court of Appeals for the Sixth Circuit reviewed the procedural aspects of a severance plan to determine whether the plan included a stated deadline for executing a release of claims by the employee that was a prerequisite to the payment of benefits. The FirstEnergy Solutions severance pay plan contained two alternative methods for obtaining severance benefits — either by obtaining them automatically or by filing a claim for them.

This case involved the plan’s automatic eligibility provisions. Although the plan required a participant to execute a release agreement to receive benefits, it did not explicitly state a deadline for providing the release. The court ruled in favor of the employees, concluding that without clearer requirements in the plan, a denial based on a failure to provide a timely release was not a “reasoned explanation” for the denial of the claim. (Godleski v. FirstEnergy Corp., 6th Cir. 2007)

In the second case, the United Television, Inc. special severance plan provided for severance benefits in the event of a termination of employment following a change in control where an employee experienced a reduction in “salary or bonus opportunity,” as determined by a plan committee in its discretion. The employee in this case terminated employment following a change in control and claimed severance benefits because the bonus and commission structure was changed by the new employer to increase commission rates but to decrease the fixed salary. The former employee claimed that the reduction in fixed salary and the fact that she received slightly reduced overall pay following the change in control made her eligible for severance pay.

While a divided court disagreed on the meaning of the word “or” in the severance policy, the majority of the court found the plan’s interpretation to be reasonable and upheld the plan’s denial of benefits. If the language in the plan had been more carefully drafted, the plan might have avoided a trip to the federal appeals court to uphold its decision. (Smith v. United Television, Inc. Special Severance Plan, 8th Cir. 2007)

No Domestic Partner Benefits for Michigan Public Employees

Reversing a lower court decision, the Michigan Court of Appeals recently ruled that a 2004 state constitutional amendment banning same-sex marriage in Michigan bars public employers from providing benefits to domestic partners of employees. The amendment provides that “the union of one man and one woman in marriage shall be the only agreement recognized as a marriage or similar union for any purpose.”

At the time the amendment was adopted, several public employers had policies or agreements in place that extended health care benefits to same-sex domestic partners of employees. National Pride at Work Inc., together with a number of public employees, sought a declaratory judgment that the amendment does not prohibit public employers from providing health benefits for employees’ same-sex partners.

The trial court sided with the plaintiffs, holding that employers who voluntarily provide domestic partner health care benefits to an employer-defined group of people are not “recognizing a marriage or similar union.” Determining that the health care benefits could not be construed as benefits of marriage, which are prohibited by the amendment, the lower court held that the benefits could be provided to same-sex partners.

Focusing on the marriage amendment’s “plain language” prohibiting public employers from recognizing same-sex unions “for any purpose,” the appeals court disagreed. The appeals court found that a public employer that requires proof of the existence of a formal domestic partnership agreement to establish eligibility for benefits recognizes the validity of a same-sex union for the purpose of providing the same benefits to a same-sex couple that would be provided to a married couple.

Dismissing the plaintiffs’ equal protection arguments, the court also found that the marriage amendment does not preclude the extension of employment benefits to unmarried partners of either sex on a basis unrelated to recognition of their agreed-upon relationship. As a result, the amendment was found to be “narrowly tailored to further the legitimate governmental interest in protecting and strengthening the institution of marriage.” The decision to uphold a ban on same-sex benefits is expected to be appealed. (National Pride at Work, Inc. v. Governor of Michigan and City of Kalamazoo, Mich., Ct. App. 2006)

This newsletter is a periodic publication of Hodgson Russ LLP. Its contents are intended for general informational purposes only and should not be construed as legal advice or legal opinion on any specific facts or circumstances. Information contained in the newsletter may be inappropriate to your particular facts or situation. Please consult an attorney for specific advice applicable to your situation. Hodgson Russ is not responsible for inadvertent errors in this publication.