For this purpose, the facts at issue in McCutchen are quite simple:
An ERISA plan participant suffered severe injuries in a car accident caused by a third party, and his employer, US Airways, paid nearly $67,000 toward his medical expenses through the company’s group health plan. By its terms, the plan entitled US Airways to reimbursement of amounts paid if the participant later recovered money from the third party. After filing suit, the participant was awarded $110,000 in damages attributable to his injuries – of which the participant retained $66,000 after deducting the lawyers’ 40% contingency fee and expenses. US Airways sought reimbursement of the full amount it had paid.
When the participant refused to reimburse the plan, US Airways filed suit in the U.S. District Court for the Western District of Pennsylvania against both the participant and his attorney seeking to enforce the reimbursement provision of the plan pursuant to ERISA Section 502(a)(3) which, on its face, authorizes civil actions by fiduciaries “to obtain…appropriate equitable relief…or…to enforce…the terms of the plan.”
The district court rejected the participant’s argument that the common fund doctrine should apply to require US Airways to contribute to the costs of recovery and, instead, granted summary judgment to US Airways holding that plan terms required reimbursement from “any monies recovered.” On appeal, the participant argued under a couple of different theories that it would be “inequitable” to reimburse US Airways in full when he had not been fully reimbursed for all his medical expenses. The Third Circuit agreed and reversed the lower court. In its decision, the Third Circuit held “Congress purposefully limited the relief available to fiduciaries under [ERISA] Section 502(a)(3) to appropriate equitable relief.” The appellate court found that it would be inequitable for US Airways to be fully reimbursed when the participant received less than full payment for his medical expenses.
The Supreme Court granted US Airways’ petition for certiorari and ultimately reversed the Third Circuit decision. In doing so, the high Court majority concluded that the participant could not rely on equitable defenses to trump the plan’s clear reimbursement provision. However, since the plan at issue was silent with respect to the allocation of attorneys’ fees, it was appropriate to apply the common fund doctrine The Court reinforced that US Airways could have provided in the plan that the common fund doctrine did not apply to the application of the reimbursement provision, but since it did not, “the common-fund doctrine provides the best indication of the parties’ intent.” The majority’s analysis indicates that the well-established application of the common fund doctrine in equity cases supports the conclusion that the parties must have intended for this default rule to govern “in the absence of a contrary agreement.”
A brief dissent (authored by Justice Scalia and joined by Chief Justice Roberts and Justices Thomas and Alito) disagreed with the majority’s use of the common fund doctrine, finding that this issue was not properly before the court. The dissenting opinion, however, agreed with the portion of the majority’s opinion concluding that equity cannot override unambiguous plan terms.
Suggested Steps for Employers
The holding of this case provides a good reminder that the reimbursement language in health plans should be dusted off and carefully reviewed. Most notably, the issue of whether a participant’s attorneys’ fees will reduce the reimbursement obligation should be specifically addressed, with express language indicating whether the common fund doctrine or any other equity doctrine may be applied to reduce the plan’s reimbursement right. Scrutiny should be placed on the reimbursement provision with other aspects of third party litigation in mind to ensure that the reimbursement the plan expects is what the plan ends up with.
Following its December 22, 2011, ruling we discussed previously that retired Kelsey-Hayes (“Company”) union members must arbitrate their claims for fully-paid lifetime retiree medical benefits, the Eastern District of Michigan handed a victory to different class of union retirees facing similar changes to their healthcare coverages. United Steelworkers of America v. Kelsey-Hayes Co.
Plaintiffs worked at the now closed automobile parts manufacturing plant in Jackson, Michigan. Under the collective bargaining agreements (“CBAs”) with the United Steel, Paper and Forestry, Rubber, Manufacturing, Energy, Allied Industrial and Service Workers International Union, the Company was required to establish healthcare coverage for retirees and their dependents and surviving spouses and to contribute the full premium for such coverages. Before and after the plant closing in 2006, the Company paid all retirees’ healthcare coverage costs. In September 2011, the Company announced plans to replace the retiree medical plan with individual health reimbursement accounts funded by the Company and to be used by retirees to purchase of individual healthcare policies. On January 1, 2012, the Company discontinued healthcare coverage for retirees age 65 and older and made a one-time contribution of $15,000 for each retiree and spouse for 2012 and provided for an additional $4,800 credit for 2013. Any future contributions would be at the discretion of the Company. Retirees filed suit alleging that the Company’s unilateral modification of their health benefits constituted a breach of the terms of the CBAs in violation of ERISA.
Citing a line of cases addressing the vesting of retiree benefits, including Int’l Union v. Yard Man, 716 F.2d 1476 (6th Cir. 1983), the court held that the CBAs’ promised “continuance” of the healthcare coverages employees had “at the time of retirement” and that such coverages “shall be continued thereafter” for retirees, their spouses and eligible dependents and that any changes could be made “by mutual agreement between the Company and the Union” was unambiguous language demonstrating the plaintiffs’ right to vested lifetime retirement healthcare coverage. In granting summary judgment for in favor of the plaintiffs, the court noted that it had previously held that identical CBA terms unambiguously promise vested, lifetime retiree healthcare benefits. The court further noted that an arbitrator recently considering virtually identical CBA terms found that those Kelsey-Hayes’ retirees had vested rights to medical plan coverages for their lifetime.
On Tuesday, the PPACA triumvirate of DOL, Treasury/IRS and HHS issued a new set of FAQs (number 14, for those still counting) covering changes to the Summary of Benefits and Coverage. The only changes (as emphasized in multiple places in the FAQs) are to add two disclosures:
- Whether the plan provides “minimum essential coverage” (or MEC)
- Whether the plan meets, or does not meet, the “minimum value” requirements.
MEC, simply put, is an employer-sponsored plan that complies with health care reform (whether or not its grandfathered). Minimum value (which is also relevant for play or pay purposes) generally means that the plan’s share of the total allowed costs of benefits provided under the plan or coverage is not less than 60 percent of such costs.
The agencies released templates in both Word and PDF showing how this is done (as well as blank revised SBCs in Word and PDF).
The good news is that the agencies did not add additional coverage examples or otherwise modify the SBC format, even though they had previously said that they would.
The agencies also extended much of the transition relief provided in prior guidance (see Q5). However, there is some question as to whether the transition relief afforded under Q10 of Number IX Set of FAQs, was extended. That FAQ provides, in relevant part, that for the first year only, a group health plan utilizing two or more insured products under a single health plan (as where the plan separately insures medical and prescription drugs) may issue separate partial SBCs for the different insured pieces of the plan. Additional clarification from the agencies would be helpful; however, we think the better interpretation is that this relief from the prior FAQ is extended.
The minimal SBC changes are welcome news for plan sponsors in dealing with this additional disclosure obligation. Plan sponsors should be sure to update their SBC templates for the new disclosures mentioned in the FAQs.
Update: The post below has been updated. After discussing this post with an alert reader, we have concluded that the correct reading of the regulations is reflected in Q8-10 below. The good news is: we don’t think there is a hole in the play or pay regulations! However, this reading of the rules results in John Boy (in our example) not getting coverage for more than two full years! Please see below.
In a prior post we discussed the general rules for hours counting and what it means to be full time under the play or pay/shared responsibility rules under ACA (a.k.a. health care reform). In this post, we address the special rules for new hires/new employees and how those rules overlap with the rules for ongoing employees. As before, we retain our Q&A format.
Q1: Who is considered a new employee?
Someone who has not been employed for at least one standard measurement period (SMP) is a new employee. (See our prior post for more detail on SMPs).
Q2: Do I have to count hours for all my new employees?
You don’t have to count hours for anyone if you just offer coverage to all your employees. However, assuming you don’t want to do that, then to the extent you choose to count hours, you can only count hours for new employees who are either (1) seasonal employees or (2) variable hour employees.
Q3: Who is a seasonal employee?
Right now, we don’t know. The definition is “reserved.” The IRS has said any reasonable, good faith interpretation may be used. However, it is not reasonable to treat an employee of an educational organization (e.g. teachers/professors) as “seasonal” even though they may not work a full 12-month year. (Note that “seasonal employee” is different than “seasonal worker,” which is the term that applies for determining if an employer is subject to the play or pay/shared responsibility tax.)
Q4: Who is a variable hour employee?
Not this kind of imp.
A variable hour employee is someone who, as of his/her start date, you cannot tell whether that employee is reasonably expected to work an average of at least 30 hours per week during the initial measurement period (IMP). This is a “facts and circumstances” determination, which basically means you have to take all relevant information into account and the IRS is unlikely to provide much, if any, guidance on what facts and circumstances are relevant. However, the IRS has said that, beginning in 2015, you cannot take into account the likelihood that the employee may terminate employment before the end of the IMP, so at least you know that.
Q5: How long can an IMP be?
It can be between 3 and 12 months, as selected by the employer.
Q6: When does an IMP start?
It can start any time between date of hire and the first of the month following date of hire. You could even pick two days in a month. For example, you could say that the IMP for all employees hired on the first through 15th will be the 15th and the IMP for all employees hired after that will begin on the last day of the month.
Q7: What if I determine that my new seasonal or variable hour employee worked more than 30 hours/week or 130 hours/month during the IMP?
Then you have to treat her as full time (i.e. offer coverage for her and her non-spouse dependents) during the following stability period. The stability period has to be at least six months long and cannot be shorter than your IMP. However, there are special rules for when the person moves from being a “new” employee to an “ongoing” employee” discussed below.
Q8: And if I determine that he didn’t?
Then you can treat him as not full-time/not have to offer him coverage during the stability period. In this case, the stability period is subject to a few rules:
(1) it cannot be more than 1 month longer than the IMP
(2) it cannot exceed the remainder of the SMP (plus any administrative period) in which the IMP ends.
So for example, say you have an SMP of October 15 to October 14 and an administrative period that runs through December 31. Say you’ve also chosen an 12-month IMP and a 12-month stability period following the IMP. John Boy is hired on October 31, 2013 and he’s a variable hour employee. You measure JB’s hours from October 31, 2013 to October 30, 2014 and determine that he was not full-time. Under rule (2) immediately above, John Boy’s stability period cannot exceed the remainder of the SMP (plus any administrative period) in which the IMP ends. Shall we read this to mean that the period in which the IMP ends includes the associated administrative period, or that it does not? October 30, 2014 falls in the administrative period following the 2013-2014 SMP, but it also falls within the 2014-2015 SMP that begins on October 15, 2014. While the regulations are a bit unclear, we think the better reading is that the period in which the IMP ends does not include the associated administrative period, and therefore, that John Boy’s initial stability period does not end December 31, 2014, but can last the full 12 months.
Q9: Do I get any kind of administrative period for new employees?
Yes, it can also be up to 90 days, but there are a couple of catches. First, you do not have to start your IMP on a date of hire (as noted above). But if you pick a later date (like first of the month following date of hire), any days between date of hire and that later date count against the 90-day period.
Perhaps more important, however, is that the combination of your IMP and the administrative period for new employees cannot extend beyond the last day of the first calendar month beginning on or after the first anniversary of date of hire. So in the example above with John Boy, the combined IMP and administrative period could not extend beyond November 30, 2014. This creates an incentive to hire employees early in the month but after the first of the month to provide as much time as possible for the administrative period. This is particularly true for employers who choose a date other than date of hire to start the IMP.
Q10: You mentioned some rules about new hires transitioning to ongoing employees. Can you talk about that some more?
Basically, once an employee has been employed for one full SMP, he or she is an ongoing employee. This means there could be significant overlap between the SMP and IMP and their respective stability periods. There are essentially 4 scenarios:
(1) Employee determined to be full-time during IMP and SMP – This is an easy one. The employee must be offered coverage for the stability period following the IMP and the stability period following the SMP. Going back to the John Boy example, assuming you took the maximum administrative period (through November 30), he would have to be offered coverage for the month of December 2014 and all of 2015.
(2) Employee determined to be full-time during the IMP, but not during the SMP – This employee has to be offered coverage for the entire stability period following the IMP. In the John Boy example, he would be offered coverage through November 30, 2015.
(3) Employee not full-time during IMP, but is full time during SMP – The employee does not have to be offered coverage until the stability period following the SMP. In the John Boy example, the initial stability period would go through November 30, 2015. At that point, JB has been through an SMP (October 15, 2014 – October 14, 2015), but his coverage (if elected) does not need to begin until January 1, 2016. Note that under our facts, John Boy is not offered coverage for more than two years from his date of hire (October 31, 2013)!
(4) Employee not full-time during either measurement period – This result is the one you think it is – no coverage during either period.
Q11: Can I have different IMPs and IMP stability periods, like I do for SMPs, for different categories of employees?
Yes, and they’re the same categories as we detailed in the prior post.
Q12: What if I determined that John Boy was full-time during the IMP and during the stability period he tells me he wants to go back to the prairie and only work part-time (because of the long commute)?
The same rules as we described in the prior post apply: he still must be considered full-time and eligible for coverage during the stability period.
Q13: Does the same rule apply if he is not full-time, but then I promote him to a full-time position during the IMP?
Here it’s a bit different. Under these rules, you have to treat John Boy as a full-time as of the earlier of:
(1) the first day of the fourth month following his promotion; or
(2) The first day of the first month after the end of the IMP and any administrative period.
However, other health reform rules currently require you to offer coverage within 90 days of when someone becomes full-time, which will likely be less than the first day of the fourth month following the promotion. Failure to comply with the 90-day rule could result in other penalties being assessed on the employer. It’s not yet clear how these rules interact, so the safest bet is to make the offer no later than 90 days following the promotion or the period described in (2), at least until the IRS clears up this confusion.
Q14: What if John Boy quits and then I rehire him? How do I count hours? What about leaves of absence? I still have so many questions left unanswered!
This is already getting kind of long, so we’ll address those in a future post.
Related Links
Technical Corrections to Proposed Regulations
IRS Q&A on Employer Shared Responsibility Penalties
Other Health Care Reform Posts
Disclaimer/IRS Circular 230 Notice
Yesterday, the Supreme Court granted a plan participant’s petition for a writ of certiorari in Heimeshoff v. Hartford Life & Acc. Ins. Co., No. 12-729, 2013 WL 1500233 (Apr. 15, 2013). The Court limited its review to a single question raised by the petitioner: “When should a statute of limitations accrue for judicial review of an ERISA disability adverse benefit determination?” The Supreme Court declined review of two other questions raised by the petition regarding the adequacy of notice provided to the participant: (1) “What notice regarding time limits for judicial review of an adverse benefit determination should an ERISA plan or its fiduciary give the claimant with a disability claim?”; and (2) “When an ERISA plan or its fiduciary fails to give proper notice of the time limits for filing a judicial action to review denial of disability benefits, what is the remedy?”
The Second Circuit in Heimeshoff had affirmed the district court’s judgment, holding that Connecticut law permitted the plan to shorten the applicable state limitations period (to a period not less than one year) and that the plan’s three-year limitations period could begin to run before the participant’s claim accrued, as prescribed by plan terms. Heimeshoff v. Hartford Life & Acc. Ins. Co., 496 Fed. Appx. 129, 130 (2d Cir. 2012). In this case, the plan provided that the limitations period ran from the time that proof of loss was due under the plan. Id.
In January, Bryan Cave issued a client alert detailing the Second Circuit opinion in Heimeshoff.
1. Cash payments calculated by reference to benefits provided under an ERISA plan do not “relate to” an ERISA plan for purposes of determining ERISA preemption issues.
2. Attempts to bring executive severance payments and benefits within the scope of ERISA raise a variety of tax and benefits issues that require careful consideration.
As noted in our blog entry on October 16, 2012, under the Sixth Circuit’s discussion in U.S. v. Quality Stores, severance payments made because of an employee’s involuntary separation resulting from a reduction-in-force or discontinuance of a plant or operation are not subject to FICA taxes. This holding is contrary to a prior decision of the Federal Circuit Court of Appeals and published IRS guidance. The government has until May 3 to appeal the case to the Supreme Court. Until a final decision in this case has been rendered, taxpayers that have made severance payments in 2009 should file a protective claim for a FICA tax refund no later than April 15, 2013. This protective claim will preserve the taxpayer’s right to a refund should the IRS not appeal the decision or should the decision be upheld on appeal.
Last month the SEC issued a no-action letter to a financial services firm that sheds light on the scope of the prohibition under Section 402 of the Sarbanes-Oxley Act of 2002 which makes it unlawful for an issuer to “extend or maintain credit, to arrange for the extension of credit, or to renew an extension of credit, in the form of a personal loan to or for any director or any executive officer . . . of that issuer.”
Historically, the SEC appears to have been reluctant to issue formal guidance respecting the parameters of the loan prohibition under Section 402. Common arrangements left in limbo by this lack of regulatory guidance extend to personal use of company credit cards, personal use of company cars, travel-related advances, and broker-assisted option exercises.
The SEC’s no-action letter was issued to RingsEnd Partners, a financial services firm. The letter addresses a program established to facilitate the payment of taxes associated with the grant of restricted stock awards. Under this program, recipients of restricted stock awards make a qualifying election to be taxed on those shares at the time of grant (a so-called 83(b) election) and then transfer those shares to a trust administered by an independent trustee who is directed to borrow funds from an independent bank through non-recourse loans sufficient in amount to pay the tax liability incurred as a result of the stock awards. Through this mechanism, recipients of these awards can retain ownership of all shares granted to them rather than sacrificing a number of those shares necessary to pay applicable tax obligations. To facilitate utilization of the program, however, an employer is involved in a variety of administrative actions necessary to maintain the program, including delivering the share awards to the trust, providing information to the lending institution and delivering prospectuses and registration statements covering the shares to the trustee. All administrative costs associated with administering the trust are borne by those recipients electing to participate in the trust.
The SEC concluded that employers whose employees where involved in this program would not by their administrative activities be deemed to be in violation of the prohibitions of Section 402. The conclusions reached by the SEC in this case would appear to be very instructive in reaching conclusions about the permissibility of other more common practices that would appear to involve arrangements that are no more administratively intensive, such as broker-assisted option exercises.
Section 162(a) of the Internal Revenue Code allows as a deduction all the ordinary and necessary expenses paid or incurred during the year in carrying on a trade or business, including “reasonable compensation for personal services actually rendered.”
The reasonableness of compensation is a question of fact. A taxpayer is entitled to a deduction for salaries or other compensation if the payments were reasonable in amount and are in fact payments purely for services.
Sometimes it is difficult to determine whether amounts are “reasonable,” especially when payments are made to a shareholder-employee or the shareholder’s relatives.
A ruling by the U.S. Tax Court on March 25, 2013, provides a helpful analysis of 10 factors considered by the Court in deciding that amounts deducted as compensation paid to a sole shareholder-employee, his officer-wife, employee-brother and employee-daughter were not reasonable. (K & K Veterinary Supply, Inc. v. Commissioner, T.C. No. 9442-11, T.C. Memo 2013-84, 3/25/2013).
Compensation Reasonableness Factors
The following is a brief summary of the 10 factors discussed by the Court:
- Employee Qualifications. An employee’s superior qualifications for his or her position with the business may justify high compensation.
- Nature, Extent and Scope of Employee’s Work. An employee’s position, duties performed, hours worked, and general importance to the company’s success may justify high compensation.
- Size and Complexity of the Business. The size and complexity of a taxpayer’s business may warrant high compensation. This assessment may include consideration of a company’s sales, net income, gross receipts, or capital value, as well as the number of clients, and the number of employees of the company; growth in these areas; and compliance with government regulations.
- General Economic Conditions. General economic conditions may affect a company’s performance. This factor may be relevant, for example, in connection with adverse economic conditions where the taxpayer may show that an employee’s skill was important to the growth of the company during lean years.
- Comparison of Salaries Paid With Gross and Net Income. Compensation as a percentage of a taxpayer’s gross or net income may be important in deciding whether compensation is reasonable.
- Prevailing Rates of Compensation. The Court considered prevailing rates of compensation paid to those in similar positions in comparable companies within the same industry as “a most significant” factor. Both the taxpayer and the Commissioner relied on expert reports and testimony to support this factor.
- Salary Policy of the Taxpayer as to All Employees. The amount of compensation paid to all employees may be a factor that supports a high level of compensation. Whether the company pays top dollar to all of its employees, including both shareholders and non-shareholder employees may be relevant in assessing the pay of shareholder-employees. Evidence of a reasonable, longstanding, consistently applied all-employee compensation plan may support that the compensation paid was reasonable.
- Compensation Paid in Previous Years. The amount of compensation paid in previous years may support a high amount of compensation for a tax year. This factor will likely only be relevant where the company is deducting compensation in one year for services rendered in prior years.
- Comparison of Salaries With Distributions and Retained Earnings. The reasonableness of compensation may take into account the absence of dividend payments by a profitable corporation. Because a corporation is not required to pay a dividend, the company’s return on equity may be a better measure of this factor.
- Debt Guaranty. The Court also considered whether an employee personally guaranteed the taxpayer employer’s debt.
The Court considered these various factors and noted that some factors favored the taxpayer, other factors favored the Commissioner, and other factors were either neutral or did not apply.
Expert Reports and Testimony
After giving “due weight” to each of the factors, the Court found the report of the Commissioner’s expert on prevailing rates of compensation, supported by individual company information and financial data, as “persuasive.” In contrast, the report of taxpayer’s expert provided “guidance of dubious value” because it failed to identify comparable companies by industry or size and the expert did not provide any financial analysis or relevant financial data.
Unreasonable Rent and No Equitable Recoupment
In addition to finding that amounts paid as compensation to the officers (shareholder-employee and his officer-wife) and certain employees (the shareholder’s brother and daughter) were not reasonable, the Court ruled on two related issues. The Court disallowed a deduction for certain amounts paid by K & K Veterinary Supply, Inc. as rental expenses to a related entity (an entity owned 100% by the shareholder-employee and his officer-wife). The taxpayer then unsuccessfully argued that the disallowed portions of the compensation and rent were dividends taxable at a lower rate – using the doctrine of equitable recoupment.
