While most courts agree that coming to work regularly is an essential job function, many courts also have found that leave for a specified period of time is a reasonable accommodation if it does not cause an undue hardship.
Earlier in April, Franczek Radelet attorney Jeff Nowak co-presented with Chai Feldblum, a commissioner with the U.S. Equal Employment Opportunity Commission, on the subject of "Leave as a Reasonable Accommodation under the Americans with Disabilities Act" at an employment law conference in Washington, D.C.
EEOC established guidance from the “very beginning" that leave could be one form of reasonable accommodation, without rigid limits, Feldblum said.
Leave is "always" a reasonable accommodation, she said, because it is plausible and is subject only to the employer's undue hardship defense.
So what exactly is an "undue hardship" and how does an employer prove it?
Undue hardship can be defined as significant losses in productivity because work is completed by: (1) less effective, temporary workers; (2) last-minute substitutes; or (3) overtired, overburdened employees working overtime who may be slower and more susceptible to error, said Nowak.
According to the Mercer 2010 survey on the Total Financial Impact of Employee
Absences, indications of undue hardship include:
lower quality and less accountability for quality;
less responsive customer service and increased customer dissatisfaction;
increased burden on management staff required to find replacement workers, or readjust workflow or readjust priorities in light of absent employees;
increased stress on overburdened co-workers; and
Feldblum, however, emphasized that "lower morale alone" is not an explanation of undue hardship.
An undue hardship is based on several factors, including:
nature and cost of the accommodation needed;
overall financial resources;
company size (number of employees);
type and location of facilities;
effect on expenses and resources of facility;
type of operation of the employer; and
impact of the accommodation on operations.
Employers, Feldblum said, need to identify how the requested leave actually impacts their business and operations.
From a timing standpoint, when it comes to leave, employers generally conduct the undue hardship analysis only after the employee has exhausted FMLA leave and is requesting additional leave as an accommodation, Nowak said.
Feldblum noted, however, that employers have the flexibility as early as "day one" of an employee's FMLA leave to assess whether the absence constitutes an undue hardship.
Since EEOC's Guidance does not precisely address the timing of when an employer should assess undue hardship, Feldblum's comments should help clarify the issue for employers, Nowak wrote in his FMLA Insights blog post.
EEOC has been working on issuing guidance on leave as a reasonable accommodation for several years. When asked by Nowak at DMEC whether new guidance was forthcoming, Feldblum said that it was up to EEOC Chair Jacqueline Berrien to determine when to "move" that guidance.
The Guidance also states that an employer may not apply a “no-fault” leave policy, under which employees are automatically terminated after they have been on leave for a certain period of time, to an employee with a disability who needs leave beyond the set period.
The employer instead "must modify its "no-fault" leave policy to provide the employee with the additional leave, unless it can show that: (1) there is another effective accommodation that would enable the person to perform the essential functions of his/her position, or (2) granting additional leave would cause an undue hardship. Modifying workplace policies, including leave policies, is a form of reasonable accommodation."
EEOC's position has put the burden on employers to determine whether and how much additional leave is needed, without any clear guidance on when enough is enough, Jackson Lewis attorney Michael Soltis said.
Employers must engage in the ADA interactive process after FMLA leave is exhausted to determine if extended leave is a reasonable accommodation and necessary in the individual circumstance.
While ADA protects an extended period of absence, most courts have said that a requested indefinite period of leave is not reasonable under ADA.
To help handle accommodation requests, employers should review job descriptions and reexamine “essential functions” so that they better understand how employees spend their time — and how it may be possible for them to return to being productive.
The IRS recently explained various tax code implications that come into play when offering domestic partners coverage under a health reimbursement arrangement that is funded through a voluntary employees’ beneficiary association. Private Letter Ruling 201415011 reiterated the long-standing principle that health coverage for domestic partners who are not dependents for tax code purposes does not get tax-favored treatment. But it explained that providing such benefits would not affect the VEBA’s tax-exempt status, because the coverage in this situation would be de minimis. It also noted that HRA payments or reimbursements for non-dependent domestic partners would not be considered included in gross income if the fair market value of that partner’s HRA was included in the participant’s gross income.
The VEBA trust requesting the IRS ruling is tax-exempt and has an HRA that provides “Qualified Health Care Benefits” as defined by Code Section 213(d). Such health benefits are excludable from participants’ gross income under Code Sections 105 and 106.
The trust extends coverage to participants’ dependents, defined in the plan document as participants’ spouses, dependents or children under age 27 (based on Code Section 152). The trust is responsible for enrolling participants and administering all benefits. The trust also provides HRA benefits to domestic partners who qualify as dependents under Code Section 152, but wants to change its plan terms to provide such benefits to non-dependent domestic partners. In doing so, the trust noted that the total amount of all impermissible benefits (for tax code purposes) provided in any plan year — to include benefits for non-dependent domestic partners and associated taxes — would not exceed 3 percent of total benefits. The trust calls this a “de minimis amount.”
The trust sought rulings on eight issues related to this change:
Issue 1: If the trust extended HRA benefits to dependent domestic partners, would it jeopardize its tax-exempt status under Code Section 501(c)(9)?
Issue 2: Would this tax-exempt status be jeopardized if de minimis benefits were extended to non-dependent domestic partners?
Issue 3: Are benefits extended to dependent domestic partners excludible from the participant’s gross income and not considered wages for employment tax purposes?
Issue 4: Is the FMV of the HRA benefits extended to non-dependent domestic partners includible as income and considered as wages subject to FICA, FUTA and income tax for the plan participant?
Issue 5: Would the participant’s and non-dependent domestic partner’s gross income include the partner’s HRA reimbursements or payments to the extent the FMV of the partner’s HRA coverage is included in the gross income of the participant?
Issue 6: Is the trust considered the employer under Code Section 3401(d)(1), and, due to the HRA coverage for the non-dependent domestic partner, is therefore responsible for: (1) withholding income tax and employee FICA tax; and (2) paying employer FICA and FUTA tax?
Issue 7: Regarding payment of income tax, are wages paid by the employer separate from wages of the common law employer?
Issue 8: Would the trust be allowed to treat annual HRA benefit coverage as wages for income tax purposes, FICA and FUTA, as stated under Announcement 85-113?
IRS Rulings Related to Tax-exempt Status
Section 152(a) defines dependents as those who receive over half of their support for a taxable year is received from the taxpayer, and who, for the taxable year shares a home with the taxpayer. This may include natural children, stepchildren, other family members or individuals who are part of the taxpayer’s household.
Treasury Regulation 1.501(c)(9)-3(a) states that the purpose of a VEBA is to provide life, sick, accident or other benefits to participants and their dependents under Code Section 152(a). Furthermore, a VEBA is not deemed a tax-exempt organization if it “systematically and knowingly” provides benefits to those non-participants or non-dependents, unless these benefits are of a de minimis amount.
IRS first ruled that the trust would not jeopardize its tax-exempt status in extending benefits to dependent domestic partners, because they fit within the definition of dependent under Section 152(a).
Based upon the trust’s assertion that the benefits provided to non-dependent domestic partners would be de minimis (not exceeding 3 percent of the total benefits provided in a plan year), the IRS stated that providing such benefits would not jeopardize the trust’s tax-exempt status.
Rulings Related to Gross Income
Generally, gross income is defined as compensation for services, which includes fringe benefits and similar items. (Code Section 61(a)(1) and Treasury Reg. 1.61-21(a)(3)) It does not include employer contributions to an accident or health plan that compensate employees for medical expenses (see for example, Code Sections 104(a)(3), 105(b) and 106, and Treasury Reg 1.106-1).
Employees must include in their total gross income the fair market value, or the amount that the individual would have to pay outright, for fringe benefits. (Treasury Reg. 1.61-21(b)(2)) The FMV of health coverage would be includible in an employee’s gross income.
Based upon the statutory and regulatory language, IRS ruled that HRA coverage provided to dependent domestic partners would not be included in the participant’s gross income.
IRS also ruled that HRA payments or reimbursements for non-dependent domestic partners would not be considered included in gross income if the FMV of that partner’s HRA was included in the participant’s gross income.
Ruling Related to Income Tax, FICA and FUTA
Employees and employers are subject to FICA taxes under Code Sections 3101 and 3111, which tax a percent of wages earned. Wages for this purpose does not include amounts paid under a plan for employee or covered dependent’s medical expenses. Health benefits provided to persons other than the employee or dependents are not excluded from FICA or FUTA wages.
Accordingly, IRS ruled that the FMV of the HRA coverage paid to non-dependent domestic partners is considered wages for FICA, FUTA and income tax withholding purposes. The gross-up amount also must be included in a plan participant’s gross income in covering a non-dependent domestic partner, and should be reported as wages for FICA, FUTA purposes, and should be reported on the participant’s W-2.
Regarding who is responsible for withholding income taxes, Code Section 3401(d)(1) defines an employer as “the person having control of the payment of … wages.” Because the trust is responsible for the administration and payment of plan benefits, IRS ruled it has legal control of the payment of the wages (that is, the FMV of the coverage provided). Therefore, the trust must withhold income and employee FICA taxes, and is responsible for paying employer FICA and FUTA taxes.
Also, plan benefit payments are considered supplemental wages and are separate from common-law employer wages for purposes of determining the amount of income tax to withhold. Finally, Announcement 85-113 gives guidelines for the treatment of taxable noncash fringe benefits paid on a regular basis that is no less than annually. IRS ruled that the trust may treat HRA benefits as provided annually for employment tax withholding, FICA and FUTA purposes.
Although this ruling is specific to the trust involved in this case, and should not be used as precedent, it is helpful in reviewing the possible treatment of non-dependent domestic partners s, and the impact of their participation in an employer’s health plan.
For more information on HRA design, see ¶291 of the Flex Plan Handbook.
An insurance analyst who waived her claims against her employer when she signed a severance agreement was not entitled to protections under the Family and Medical Leave Act, the 11th U.S. Circuit Court of Appeals affirmed in Paylor v. Hartford Fire Insurance Co., 2014 WL 1363544 (11th Cir. April 8, 2014).
The case examined the “prospective rights” under FMLA that allow an employee to invoke FMLA protections at some unspecified time in the future. (See 29 C.F.R. §825.220(d).)
Facts of the Case
Blanche Paylor, a long-term disability analyst with Hartford, requested FMLA leave to take care of her ailing mother in early September 2009. Hartford responded with a packet of administrative forms for Paylor to complete as part of her FMLA request.
On Sept. 11, 2009, Paylor’s direct supervisor criticized the quality of her work in a performance review that included a job termination warning and an explanation of what she would need to do to keep her job.
Five days later, Paylor’s supervisors initiated a meeting and gave Paylor a choice: (1) accept a one-time offer of 13 weeks of severance benefits in exchange for signing a severance agreement, under which she waived any FMLA claims; or (2) agree to a performance-improvement plan that required her to meet various benchmarks or face termination.
Paylor signed the severance agreement on Sept. 17, and said in court that she signed it because her stress level had become unmanageable. Between her mother’s deteriorating health and the pressures she experienced at work, she said, she “just wanted out.”
Paylor later sued Hartford, alleging that it interfered with her FMLA rights and retaliated against her for exercising those rights. Hartford asserted that Paylor waived all FMLA claims when she signed the severance agreement.
Paylor argued that because she had an outstanding request for FMLA leave when she signed the agreement, she had “prospective” FMLA rights that the agreement could not lawfully abrogate.
The U.S. District Court for the Middle District of Florida sided with Hartford, writing “although the 11th Circuit Court of Appeals has not directly addressed the legality of a release of FMLA claims based on past employer conduct, the [District] Court is confident that such a release would be held enforceable” under 29 C.F.R. §825.220(d).
Appeals Court Weighs in
The 11th Circuit agreed with the district court’s reasoning that Paylor’s FMLA rights were not “prospective” because the company conduct she claimed to be unlawful — that is, presenting her with the choice of a PIP or severance agreement — all happened before she signed the severance agreement.
It is well-settled within the amended 2009 FMLA regulations, “that an employee may not waive prospective rights under the FMLA, but an employee can release FMLA claims that concern past employer behavior,” the appeals court wrote.
Prospective waiver is “[a] waiver of something that has not yet occurred, such as a contractual waiver of future claims for discrimination upon settlement of a lawsuit,” the court said, citing Black's Law Dictionary 1718 (9th ed. 2009) (emphasis added).
The court found Paylor's circumstances to be different because the signed severance agreement did not ask her to assent to a general exception to FMLA, but rather to a release of the specific claims she might have based on past interference or retaliation.
“Section 825.220(d) makes clear that the FMLA's private right of action attaches to the employer's conduct — i.e., to the alleged act of interference or retaliation — and not to some free-floating set of ‘unexercised’ FMLA rights,” the court found.
“If by ‘prospective rights’ the DOL regulation really meant ‘unexercised’ rights, the FMLA would make it unlawful to fire any eligible employee … with an outstanding request for FMLA leave. That is not the law,” the court concluded.
Employee rights under FMLA are not absolute. For example, an employer is not liable for interference if it can show that it refused to restore an employee to his position of employment for a reason unrelated to his FMLA leave.
However, to use the Paylor court’s example, FMLA does not permit an employer to offer all new employees a one-time cash payment in exchange for a waiver of any future FMLA claims. That waiver would be “prospective,” and therefore invalid under FMLA, because it would allow employers to negotiate a freestanding exception to the law with individual employees.
When Paylor signed the severance agreement, it wiped out any backward-looking claims she might have had against her employer. In signing the agreement and accepting her severance benefits, she settled claims “based on past employer conduct.” (See §825.220(d).)
A federal judge approved a $15 million settlement last week between Wells Fargo and its mortgage consultants, despite objects from two plaintiffs who said the agreement releases too many claims and “sells out” the class they represent. A federal judge in Illinois has ordered the former CEO of a defunct company to pay $12 million to his former managers, finding that they were improperly classified as exempt employees. And in Texas, an employer has turned the tables on the U.S. Department of Labor, winning a $565,527 judgment against the agency after it conducted an investigation and improperly concluded that the employer owed its workers more than $6 million. Finally, Major League Baseball successfully defended a lawsuit last week from an All-Star Week volunteer who alleged that he was actually an employee entitled to minimum wage pay.
Despite objections from two plaintiffs, a federal judge has approved a $15 million settlement for Wells Fargo mortgage consultants who alleged they were denied overtime, in violation of the Fair Labor Standards Act.
The settlement resolves multidistrict litigation that also included claims from employees who worked for Wachovia, which is now a Wells Fargo subsidiary. The settlement resolves two of the six suits involved (In re: Wells Fargo Wage and Hour Employment Practices Litigation, No. 4:11-md-02266 (S.D. Texas, March 25, 2014)).
The deal was approved despite claims from two lead plaintiffs in one of the other suits that the deal was “over broad” and would adversely affect class members living in Washington state. They accused the multidistrict lead counsel of over-reaching and “negotiating a self-serving deal that sells out” the members of their suit. They asked the court to reject the settlement offer and order that the release provisions be modified to involve only the first two suits.
Wells Fargo responded, saying that the settlement does not cover the objecting plaintiffs and that their rights will not be affected by it. The judge said the settlement was fair and reasonable and approved it April 8.
CEO Ordered to Pay Managers $12M in Back Overtime
The CEO of a defunct company has been ordered to pay $12,207,880 to about 150 managers who were denied overtime pay, in violation of the FLSA.
The managers worked for THR & Associates, Inc., and were classified as exempt from the law’s minimum wage and overtime requirements. However, their pay was docked for partial or full days that they did not work, rendering them nonexempt, hourly employees under the FLSA, according to the compliant.
The U.S. District Court for the Central District of Illinois ordered Jeffrey Parsons to pay the back overtime and another $120,930 in attorney’s fees. Parsons initially had bankruptcy protection but the court determined that he had committed fraud in filing for bankruptcy and reinstated him as a defendant in the case. (Lee v. THR & Associates, Inc., 3:12-cv-03078-RM-TSH (C.D. Ill., March 11, 2014))
DOL Must Pay $565K to Cover Employer’s Attorney’s Fees
DOL must pay an employer $565,527 after a federal court determined that it erred in concluding that an employer misclassified its workers as independent contractors and demanding it settle for $6 million.
The agency conducted an investigation into the employment practices of Gate Guard Services, L.P., and determined that it had misclassified its workers who log traffic entering and exiting oil fields. The workers live in personal recreational vehicles on site and log in traffic as needed. They are paid flat day rates and are permitted to engage in personal activities throughout the day and night.
When DOL investigated the company’s practices, it concluded that the guards were employees who were entitled to minimum wage and overtime pay for 24 hours per day for as long as they were stationed at an oil field. It determined that the employer owed the guards $6,192,752 in back pay.
The company sued, asking the U.S. District Court for Southern District of Texas to review the agency’s decision. The court granted summary judgment for the employer last year and last week granted its request for attorney's fees. (Gate Guard Service, L.P. v. Perez, No. 6:10-cv-00091 (S.D. Texas, April 9, 2014))
MLB’s All-Star Week Volunteers Not Entitled to Back Pay
Individuals who volunteered for MLB’s All-Star Week FanFest were not employees and are not entitled to back pay, the U.S. District Court for the Southern District of New York has ruled.
John Chen, a volunteer, alleged in a lawsuit that he and the other workers were due minimum wage for the week they worked for MLB.
MLB argued that even if Chen was an “employee,” he still was not entitled to minimum wages because he worked for an “amusement or recreational establishment” that is exempt from the FLSA’s minimum wage requirement (29 U.S.C. §213(a)(3)). The court agreed, dismissing Chen’s FLSA claims. (Chen v. Major League Baseball, et al., No. 1:13-cv-05494-JGK (S.D.N.Y., March 31, 2014))
White House Office of Management and Budget Director Sylvia Matthews Burwell was nominated to take over as Secretary of the U.S. Department of Health and Human Services in the wake of the resignation of Kathleen Sebelius on April 11. Promoting a budget expert to this position was seen as a good choice for interpreting metrics relating to success or failure of the law. Health care reform could lower the cost of workers’ compensation and liability coverage, while possibly raising medical malpractice premiums, a research study found. Nearly 7.5 million people signed up for health coverage on state and federal exchanges, the government announced, as open enrollment on the exchanges ended definitively on April 15. The RAND Corp. released findings that the share of the population that is uninsured dropped from 20.5 percent before health care reform, to 15.8 percent since the law’s enactment. And pharmacy benefit manager Express Scripts released data showing more use of specialty drugs by people who bought coverage on public exchanges, as opposed to commercial health plans.
OMB Director Nominated as Replacement After Sebelius Resigns HHS Secretary Post
President Obama nominated OMB Director Sylvia Matthews Burwell as the new HHS Secretary on April 11, the day that Kathleen Sebelius resigned from that post.
Commentators said her experience as budget chief will come in handy as questions arise about the solvency of the program; for example, whether: it increases or slows the growth of premiums; a new round of cancelled policies might occur in the next year; new subsidies under the program will be a drag on the federal budget; and the program will hinder job growth or hurt employers’ ability to compete. She will have to be confirmed by the U.S. Senate.
Likewise, reports predicted that Burwell’s confirmation hearings are likely to be more about the health care law than about the nominee. Republicans will likely use the Burwell hearings to spotlight problems with the health care law, including canceled policies, higher premiums and the administration’s unilateral delays of some provisions, including the employer mandate, which was delayed twice.
Sebelius entered a firestorm of GOP criticism after implementing the health care reform law, to and trying to defend the program after its embarrassing website rollout in late 2013.
Accepting her resignation, President Obama said in spite of the difficulties, Sebelius had successfully improved the health care situation in the United States. Obama gave Sebelius credit for keeping the growth in health care costs under control, for helping to promote digital health records and for combatting Medicare fraud and abuse.
One of Sebelius’ last acts as HHS Secretary was to announce that 7.5 million people had enrolled for coverage through federal and state health insurance exchanges. Sebelius provided the new figures in testimony before the Senate Finance Committee about the agency's 2015 budget request. Commentators said large insurers, heavily invested in high enrollment they would benefit from, must have welcomed the news.
Senate Finance Committee Ranking Member Orrin Hatch, R-Utah, said that Sebelius had one of the toughest jobs in Washington because she had to implement a law that is "flawed and continues to fall short." Sebelius “did the best she could during the tumultuous and volatile rollout of the law,” Hatch said in a statement.
RAND: ACA Could Reduce Cost of Some Insurance Lines due to Substitution Effect
The Affordable Care Act will have contrasting effects on lines of insurance other than health, such as auto, workers’ compensation and medical malpractice, the RAND Corp. found in a new study. The amount of claims formerly assigned to auto and worker’s compensation insurers might decrease as health insurance treats more problems and more people have health insurance who lacked it before.
Patients might use liability insurance less often for treatment of health problems that health insurance would otherwise treat. The same goes for workers’ compensation, but the trend to watch involves whether increased utilization fostered by the ACA drives up the cost of medical treatment. On the other hand, insured individuals will have more contacts with physicians, and receive more procedures, so the number of medical malpractice claims could increase, driving up the cost of malpractice insurance, RAND researchers found.
The overall impacts are likely to be small (that is, a few percentage points) in the short run and likely to vary across states. Other impacts include: new payment models and health care organizational structures; more subrogation against liability awards; and more preventive care and possibly better health across the population, RAND concluded.
Another RAND study estimated that 9.3 million people gained insurance as a result of the law. Most of this increase, the researchers found, came from new Medicaid beneficiaries and enrollment in employer plans. Although a total of 3.9 million people enrolled in marketplace plans, only 1.4 million of these individuals were previously uninsured. Of the 40.7 million who were uninsured in 2013, 14.5 million gained coverage, but 5.2 million of the insured lost coverage, for a net gain in coverage of approximately 9.3 million. The share of the population that is uninsured dropped from 20.5 percent before the law to 15.8 percent now that the first year of the program’s open enrollment has ended.
Express Scripts: ACA Expands Utilization of Specialty Drugs
Pharmacy benefit manager Express Scripts released data showing increased use of specialty medication by people who purchased insurance plans on public exchanges (contrasted with regular health plan usage) through February 2014.
The phenomenon is easy to explain: the first enrollees were people who were sicker than the general public and flocked to get subsidized prices on expensive drugs: including drugs that fight the AIDS virus, specialty drugs to treat multiple sclerosis or rheumatoid arthritis. Contraceptives were prescribed less for people on exchange plans. Key findings from the report stated:
More than six in every 1,000 prescriptions in the exchange plans were for a medication to treat HIV. This proportion is nearly four times higher than commercial health plan rates.
The proportion of pain medication was 35 percent higher in exchange plans.
The proportion of anti-seizure medications was 27 percent higher in exchange plans.
The proportion of antidepressants was 14 percent higher in exchange plans.
And the proportion of contraceptives was 31 percent lower in exchange plans.
These data, however, did not represent a loss to the insurance industry: Patients in exchange plans had 35 percent higher cost-sharing than commercial plans, so insurance plans paid less per member for medications in those plans than for members in regular commercial plans, the report stated. So the trend was not necessarily bad for insurer profits.
Stanford Hospital & Clinics and two of its business associates have agreed to pay $4.125 million to settle a class-action lawsuit that arose from a 2011 data breach. The settlement, tentatively approved March 20 by a California state court, resolves the civil claims of nearly 20,000 SHC patients.
The incident involved an electronic file with protected health information on these emergency room patients, created by a billing contractor, that wound up on a student homework help website. This spreadsheet, which included names, diagnosis codes and other data, spent nearly a year on this website before being discovered and removed.
“I commend Stanford for stepping up on this,” said plaintiffs’ attorney Brian Kabateck of the settlement. “I hope this is a wake-up call to a lot of medical institutions.” Most of the settlement amount was paid by the business associates, Multi-specialty Collection Services and Corcino & Associates. It includes more than $100 to compensate each class member, and $500,000 to the California HealthCare Foundation for a program to educate business associates on privacy and security compliance.
One key factor in the plaintiffs’ favor was California’s Confidentiality of Medical Information Act which, unlike HIPAA, not only provides a private right to sue but also specifies a certain amount plaintiffs can collect for violations — even if they cannot show they were harmed. These damages can add up rapidly in a class action.
“It’s bizarre to me that so many large institutions are being ensnared in these problems when they’re so easy to take care of,” Kabateck said. “We need to do a better job of protecting patients’ private information in 2014.”
The compromised file included names, medical record numbers, hospital account numbers, admission/discharge dates, ICD diagnosis codes and billing charges. SHC had the spreadsheet taken down from the “Student of Fortune” website immediately after discovering it in August 2011.
As is customary, SHC and its co-defendants did not admit liability in the settlement. SHC could not be reached for comment, but in past statements has emphasized its rapid response on discovering the breach, including notifying all affected patients and offering free identity protection services.
SHC’s settlement comes on the heels of health insurer AvMed’s $3 million settlement of a data breach class action in federal court. That lawsuit arose from the 2009 theft of laptops with PHI on more than 1 million AvMed customers.
A wave of state minimum wage increases and proposed bills is reshaping efforts to raise the federal minimum wage.
Dozens of states have taken up minimum wage bills over the last year, with five states — Connecticut, Delaware, Maryland, Minnesota and West Virginia — passing measures in the last few months.
According to the National Council of State Legislatures, 38 states have considered minimum wage bills during the 2014 session (as of April 8) and 34 states are considering increases to state minimum wages. At the beginning of 2014, 21 states and Washington D.C. had minimum wages higher than the federal rate of $7.25 per hour. A total of 19 states had wages the same as the federal minimum as of Jan. 1, 2014, and four had rates below the federal rate.
On the federal stage President Obama, his proxies and Democratic members of Congress continue to push for the federal minimum wage to increase from $7.25 to $10.10, but increasingly the states are getting more done on the local level. Republican legislators have blocked Democrats efforts to bring a higher federal minimum wage up for debate or any kind of vote, citing an adverse impact on the business community.
Obama has publically called Republicans to task for blocking his party’s efforts while simultaneously signing a series of executive orders, largely aimed at federal contractors, that address workers’ wages. He has used each state action to increase minimum wages to bring attention to his domestic economic agenda, which includes a high profile push for a higher federal minimum wage and an effort to change the U.S. Department of Labor’s overtime regulations.
In a statement released after the most recent announcement from Minnesota, Obama said, “Minnesota joins a growing coalition of states, cities, counties and businesses that have taken action to do the right thing for their workers and their citizens.”
Critics of higher minimum wages have charged the administration and Congressional Democrats with playing politics in an election year.
The Connecticut state legislature voted to raise its minimum wage incrementally to $10.10 by 2017 in March; Maryland will raise its rate to $10.10 incrementally by 2018; and Minnesota goes from one of the lowest minimum wages to one of the highest with a vote to raise its rate to $9.50 by 2016. The Minnesota governor is expected to sign that states’ law into effect on April 14. All three states will move into the group of states with the highest minimum wages when the new rates are effective. Delaware’s minimum wage will increase to $8.25 by 2015; and West Virginia will increase its rate to $8.75 by 2016. See box for more details.
Recent State Increases
Connecticut: Connecticut’s minimum wage will increase in stages on the way to $10.10. The state’s minimum wage will increase to $9.15 on Jan. 1, 2015; to $9.60 on Jan. 1, 2016; and to $10.10 on Jan. 1, 2017.
Delaware: Delaware will increase its minimum wage from $7.25 to $7.75 on June 1, 2014; and then again to $8.25 on June 1, 2015.
Maryland: Maryland’s minimum wage will increase in 50 cent increments, beginning on July 1, 2015 when it will rise from the current rate of $7.25 to $8.25. The rate will increase to $8.75 on July 1, 2016, to $9.25 on July 1, 2016 and finally to $10.10 on July 1, 2018.
Minnesota: Minnesota’s legislature improved an incremental minimum wage increase to $9.50 over three years for employers with gross sales over $500,000. The minimum wage rate for large employers will increase to $8.00 on Aug. 1, 2014; $9.00 on Aug. 1, 2015; and $9.50 on Aug. 1, 2016. The wage for small employers (those with sales of less than $500,000) that are exempt from certain federal labor laws will increase to $6.50 on Aug. 1, 2014; $7.25 on Aug. 1 2015; and $7.75 on Aug. 1, 2016. Beginning in 2018 the Minnesota minimum wage will be indexed to inflation, with a 2.5 percent cap.
West Virginia: West Virginia will increase its state rate to $8.00 on Jan. 1, 2015; and then again on Jan. 1, 2016, to $8.75.
Several other states, including Hawaii, Arkansas, Nebraska and Illinois have debated or are currently debating raising state minimum wages. And several cities also have debated or voted to increase local wages. Seattle and San Francisco lead the race for the highest minimum wage, both are looking at a local wage possible as high as $15 per hour.
Washington and Oregon currently have the highest state minimum wages, at $9.32 and $9.10 respectively. California’s state rate will increase to $9.00 on July 1, 2014, with another increase to $10 slated for Jan. 1, 2016. New York also has incremental increases to its minimum wage scheduled. The wage there will go from $8.00 to $8.75 on Dec. 31, 2014, and then to $9.00 on Dec. 31, 2015.
Plan sponsors and administrators received some positive news in recent IRS clarifications on in-plan Roth rollover procedures, and related federal agency guidance. Now they will be able to confirm more easily valid rollovers from other qualified plans with less paperwork and need to contact the distributing plan. This is also positive for participants, who will be able to move retirement accounts from several kinds of qualified plans to a new employer to keep their savings momentum going more seamlessly. This column takes a deeper look at the recent rollover guidance, and examines procedures to help plan administrators ensure receipt of valid rollover contributions.
The IRS in early April issued Revenue Ruling 2014-9, “Rollovers to Qualified Plans,” in which the agency clarified the circumstances under which a qualified retirement plan administrator may reasonably conclude that a potential rollover contribution is valid under U.S. Treasury regulations. (This IRS guidance follows U.S. Department of Labor and SEC guidance that ensure rollover investment activity is occurring within Financial Industry Regulatory Authority guidelines.)
As a general rule, taking a lump-sum distribution from a qualified retirement plan is a taxable event. If the participant elects to receive the distribution in cash, a mandatory withholding of 20 percent of the distribution amount applies. However, the participant may avoid immediate taxation by taking the distribution in the form of a direct rollover for deposit into a traditional individual retirement account or another qualified retirement plan, if the plan permits.
While the rollover process has been around a long time, some plans were reluctant to accept rollover contributions from new participants because of the uncertainty about the source of the money. Questions would arise on whether the source of a potential rollover into the plan was money resulting from annual IRA contributions (which are after-tax), former 401(k) plan contributions (generally pretax) or a combination of both.
More recently, the retirement plan community’s view has become more favorable toward plan-to-plan rollovers, with the Pension Protection Act of 2006 and subsequent IRS guidance. Under PPA and through further agency guidance, rollovers have been positioned as a solution to prevent the “leakage” from retirement savings that often comes with an employment change. The types of retirement plans considered eligible for inclusion in rollovers were expanded, income and related limits for Roth rollovers were eliminated and provisions were enacted that protected a plan’s qualified status if an invalid rollover contribution was accepted.
Accepting Rollover Contributions
Accordingly, many plans were amended to allow participants to make rollover contributions from their prior employer’s 401(k) plan, which resulted in more of these coming into 401(k) plans. This plan feature was attractive both to newly hired employees with a 401(k) account from a prior employer, and longstanding employees looking to consolidate their retirement savings. Under the amended plan, they too could roll over their accounts from a prior employer’s plan to their new employer’s plan.
Past IRS guidance offered some protection for plan sponsors of receiving plans by outlining conditions under which rollover contributions may be accepted. As such, Regulation Section 1.401(a)(31)-1, Q&A-14(b)(2) provided that if a plan accepts an invalid rollover contribution, the contribution will be treated as if it were a valid rollover contribution if two conditions are met:
When accepting the amount from the employee as a rollover contribution, the plan administrator for the receiving plan must reasonably conclude that the contribution is a valid rollover contribution.
If the plan administrator for the receiving plan later determines that the contribution was an invalid rollover contribution, the plan administrator must distribute the amount of the invalid rollover contribution, plus any earnings attributable to it to the employee in a reasonable time after such determination.
A more recent requirement used an entry on Form 5500 annual reports from retirement plans to help plan administrators trying to assess rollovers into their plans. The 2012 instructions for Form 5500 contained a list of plan-characteristic codes to be used by a plan administrator in completing the annual report.
The new Rev. Rul. 2014-19 points practitioners to Code 3C, which indicates that a plan is not intended to be qualified under Code Section 401, 403 or 408, and demonstrates how this information may be used to make a reasonable conclusion about the qualified status of a potential rollover contribution. Specifically, Line 8A on Form 5500 and Line 9A on the Form 5500 Short Form may show information about the distributing plan. When Code 3C is entered, a plan administrator has indicated that the plan is not intended to be qualified under Code Section 401, 403 or 408. So when this code is absent, the receiving plan administrator may reasonably conclude that a potential rollover from such plan is a valid one.
Implementing Administrative Procedures
Now, plan administrators should implement procedures that demonstrate reasonable effort was made to determine the validity of any potential rollover contributions. These procedures may place the onus on the participants, prior plan administrators or receiving plan administrator, or some combination thereof. A few examples of reasonable steps include:
Self-certification by the participant that the amount of the rollover contribution is being withdrawn from a 401(k) plan intended to be qualified under Code Section 401(a).
Distributing-plan certification by the administrator of the previous employer’s 401(k) plan — a written statement that the plan is intended to be qualified under Code Section 401(a).
Receiving-plan verification by reviewing the entries on the distributing plan’s most recent Form 5500, the receiving plan may reasonably determine whether the distributing plan is intended to be a qualified plan.
Determination letter provided by the participant — this is a copy of the IRS determination letter for the distributing plan that states that the plan is qualified under Code Section 401(a).
The ability to roll over plan assets from one employer to the next is very beneficial for participants, and has been shown to reduce cash-outs that deplete retirement savings.
Rollovers coupled with immediate, or 30-day, eligibility may also have a few unintended, yet beneficial consequences. For example, the plan terms may allow a participant to roll over an outstanding plan loan, and may allow a new participant to take a plan loan, which would come primarily from amounts in his or her rollover source under the plan. Rollovers in these three scenarios help participants avoid having to pay tax on a rollover distribution, on an outstanding loan amount or on the new plan loan amount that might otherwise have been taken as a distribution.
For plan sponsors and administrators, these changes also should save time, reduce paperwork and give peace of mind about their own plans’ qualified status as they encourage greater retirement savings.
Finding out More
For more information about eligible rollover distributions, see ¶267 in the 401(k) Handbook.
Arris Reddick Murphy is an attorney with experience in the employee benefits and executive compensation practice area, and she is senior counsel with FedEx Corp.’s Tax & Employee Benefits Law group. Before joining FedEx, she held the position of associate with the law firm of Potter Anderson & Corroon, LLP, and worked in-house with The Vanguard Group and the City of Philadelphia as counsel to its Board of Pensions and Retirement.The views expressed in this column are strictly Ms. Murphy’s, and are not those of FedEx Corp.,any of its operating companies or affiliates. She is contributing editor of The 401(k) Handbook.
Financial advisers on TV and in reputable financial publications consistently encourage people who participate in an employer-sponsored retirement plan to contribute as much as possible. In many cases, retirement plan platforms offer online tools to assist plan participants in projecting how much they need to save to achieve high income-replacement levels when they get to retirement age.
The simple explanation for the unexpected refunds is that IRS wants to ensure that the contributions deposited in the accounts of non-highly compensated employees are proportional to contributions made for HCEs. Counterintuitive as it may seem to the surprised HCEs, the nondiscrimination rules apply to the elective 401(k) deferrals that they contribute out of their own salary (ADP test) as well as to the match contributions they receive from the employer (ACP test).
As the NHCEs contribute more into the plan, the HCEs are, in turn, allowed to contribute more into the plan, up to the legislative maximum limits.
Discrimination Test Refunds
The plan distributes the excess contributions to HCEs, to lower their average percentage contribution until the test is passed. The distributions are made first to HCEs who deferred the highest dollar amounts, not the highest percentage, and they must include earnings.
If distributed within 2½ months of the end of the plan year, there is no tax penalty to the employer. If returned after 2½ months, the employer is subject to a 10-percent excise tax. HCEs report the distribution as taxable income in the year in which the excess is distributed. The recipients of the excess contributions receive a Form 1099-R to facilitate their tax reporting.
It is important to note that 403(b) plans for nonprofit entities are not subject to the ADP test, but they are subject to the ACP test, which is the same as the ADP test described above, but computed using the employer match contributions. Excess match contributions are called excess aggregate contributions and they are refunds to the HCEs. They are processed in the same way as excess deferral contributions, except that excess match contributions that are not fully vested are reallocated to other participants or forfeited to an unallocated suspense account to reduce future contributions.
Plans can base the ADP and ACP percentages for NHCEs on either the current- or the prior-year contributions. The election whether to use current- or prior-year data is contained in the plan document. A plan can change from prior-year testing to current-year testing during any plan year, but once current-year testing is elected, the employer cannot change back to prior-year testing except under limited circumstances.
Other HCE Refunds
Refunds of excess contributions are not the only alternative available to employers whose plans have failed the ADP and/or ACP tests. Other options include additional vested contributions to the NHCEs and, prospectively, the plan’s third-party administrators and/or ERISA counsel can assist the plan sponsor in reviewing alternative plan designs that achieve the employer’s objectives in a more cost-effective manner.
In many cases, the HCEs receiving the refunds are not in a position to influence the corrective method selected by the employers. In cases when refunds of excess contributions are processed, plan officials have to be prepared to explain why contributing as much as possible is encouraged by the media, but the maximum limits allowable can be lower than expected if the plan does not pass the non-discrimination tests.
Finding out More
For an overview and more information on nondiscrimination testing rules, see ¶301 of the 401(k) Handbook.
Maria T. Hurd, CPA, is a shareholder and director of benefit plan audit services at Belfint Lyons & Shuman, P.A., the largest provider of retirement plan audits in Delaware, servicing a national client base. She is the treasurer of the American Institute of Pension Professionals and Administrators’ Benefits Council of Greater Philadelphia, belongs to the International Foundation of Employee Benefit Plans and speaks frequently on a variety of retirement plan audit topics.
Although not unexpected, the Supreme Court’s holding that severance payments are taxable under the Federal Insurance Contributions Act will be disappointing to some employers; however, others will breathe a sigh of relief. Most certainly, the federal government has the most to gain, because it now will not have to pay more than $1 billion of FICA tax refunds. Whether you, as an employer, consider yourself a winner or loser as a result of this ruling depends on the type of supplemental unemployment compensation benefits plan you have.
On March 25, the U.S. Supreme Court held that severance payments are taxable under FICA when made to employees whose employment is involuntarily terminated. The Court reasoned that FICA’s definition of wages encompasses severance payments and that the severance at issue in this case, which was not linked to the receipt of state unemployment benefits, was not exempt from FICA tax. United States v. Quality Stores, Inc., No. 12-1408 (S. Ct., March 25, 2014).
In the midst of entering into bankruptcy, Quality Stores, Inc., a specialty retailer, closed several plants or operations and discharged thousands of employees. The company paid the discharged employees severance payments pursuant to two termination plans based on seniority, job grade, and management level (among other factors). Quality Stores reported the severance payments as wages on W–2 tax forms, paid its share of FICA taxes, and withheld the employees’ share of FICA taxes. The company later asked its former employees to allow it to file FICA tax refund claims for them. As a result, the company filed a refund claim in the amount of $1,000,125 in FICA taxes, which the IRS neither allowed nor denied.
Quality Stores then initiated a proceeding seeking a refund of the amount in the bankruptcy court, which granted summary judgment in the company’s favor. On appeal, both the federal district court and the 6th U.S. Circuit Court of Appeals ruled in favor of Quality Stores. The 6th Circuit held that the severance payments were not subject to FICA taxes because they qualified as supplemental unemployment compensation benefits, or SUBs, as defined by tax Code Section 3402(o)(2)(A) — thereby creating a circuit split on the issue. The Supreme Court agreed to hear the case to decide whether severance payments made to employees whose employment is involuntarily terminated are taxable under FICA.
As an initial matter, Justice Anthony Kennedy, writing for a unanimous court (with Justice Elena Kagan recused from the case), noted that FICA’s definition of wages includes the severance payments that Quality Stores made to its employees. Under both FICA’s definition of “wages” (as “all remuneration for employment”) and the plain meaning of the terms, severance payments are wages.
Kennedy, in analyzing the statutory text, noted that the fact that FICA exempts some termination-related payments from the definition of wages shows that the severance payments at issue were purposely not exempted. For example, the Court noted that section 3121(a)(13)(A) exempts severance payments made because of retirement for disability from taxable wages. Moreover, FICA includes “a lengthy list of specific exemptions from the definition of wages.” “The specificity of these exemptions,” the Court found, “reinforces the broad nature of FICA’s definition of wages.”
The Court also took into account FICA’s statutory history noting that Congress amended the statute in 1939 to create an exception from “wages” for dismissal payments that employers are not required to make. However, in 1950, Congress repealed that exception, and according to the Court, “since that time, FICA has contained no exception for severance payments.”
Definition of “Wages” for Income Tax Withholding Purposes
The Court then addressed the question of whether Code Section 3402(o), which relates to income-tax withholding, limits the meaning of “wages” for FICA purposes. Quality Stores argued that because Section 3402(o) treats SUBs as wages for purposes of income tax withholding, the definition of wages for income tax withholding does not cover severance. Quality Stores argued further, if the definition of wages for income tax withholding purposes does not cover severance, then severance is not covered by FICA’s similar definition of wages. Quality Stores’ argument and the 6th Circuit’s decision was incorrect, Kennedy ruled, in using Section 3402(o) to conclude that severance payments are not included in the definition of wages for the purposes of income tax withholding and thus, are also not included in the definition of wages for FICA taxation purposes.
Kennedy again relied on statutory interpretation to find that the Code chapter on income tax withholding has a broad definition of “wages,” which, like FICA, specifically exempts some payments from its definition, but not severance pay. He also reasoned that the regulatory background of Section 3402(o) shows that it was enacted to solve a problem with employee withholdings — namely the prospect that involuntarily discharged employees who received SUBs would owe large payments in taxes at the end of the year as a result of the IRS’ administrative exemption of those payments from withholding. Congress enacted Ssection 3402(o), the Court found, to provide that “all severance payments — both SUBs as well as severance payments that the IRS considered wages — shall be ‘treated as if’ they were wages for purposes of income-tax withholding.” Because Section 3402(o) covers more than just severance payments that were excluded from income-tax withholding, the 6th Circuit’s and Quality Stores’ interpretation of the section “as standing for some broad definitional purpose” failed. Thus, the Court concluded that Section 3402(o) “does not narrow the term ‘wages’ under FICA to exempt all severance payments” from FICA tax.
Before concluding, the Court also noted that the severance payments at issue in the case were not linked to the receipt of state unemployment benefits. As a result, the Court expressly declined to consider whether the IRS’ current administrative position that severance payments tied to the receipt of state unemployment benefits are exempt from FICA taxation is consistent with its holding in this case.
Based on these considerations, the Court reversed the 6th Circuit decision and held that the severance payments at issue in this case — which had been made to employees who were discharged against their will, varied based on job grade and seniority, and had not been linked to the receipt of state unemployment benefits — constituted FICA taxable wages.
Although not unexpected, the Supreme Court’s holding that severance paid to involuntarily discharged employees is subject to FICA will be disappointing to the many employers that filed FICA-tax refunds following workforce reductions in response to changes in the economy over the last several years. It will also be disappointing to their discharged employees, who either participated in those refund claims or filed their own, and to future financially strapped employers and discharged employees.
On the other hand, the government will not be faced with paying out the more than $1 billion of FICA tax refunds relating to this issue. In addition, employers in all industries across the United States that implemented a SUB plan linking severance pay to the receipt of state unemployment benefits, in accordance with the IRS’ administrative rulings issued over the last half-century, are going to be relieved that the Supreme Court’s decision left the IRS’ rulings intact. Under the IRS’ current ruling position, which the IRS could change, severance paid pursuant to a SUB plan to involuntarily discharged employees that is linked to the receipt of unemployment benefits and that is not paid in a lump sum is FICA exempt.
About the Authors
Vicki M. Nielsen is of counsel in the employee benefits and executive compensation practice of the Washington, D.C. office of Ogletree Deakins. She has worked extensively in the areas of executive compensation arrangements, equity compensation and benefits provided to employees and independent contractors outside of qualified retirement plans. Ms. Nielsen advises clients regarding fringe benefit plans, severance plans, supplemental unemployment compensation benefit plans (SUBpay), worker classification, employment taxes and related reporting and withholding requirements and tax minimization strategies. She is a contributing editor to the Employer’s Guide to Fringe Benefit Rules.
Hera S. Arsen, J.D., Ph.D. is managing editor of firm publications in the Torrance, California office of Ogletree Deakins.
The market for individual retirement accounts is growing dramatically, partly as a result of plan participants in employer-sponsored retirement plans rolling over funds into an IRA upon leaving employment. But there are investment factors that participants should evaluate before choosing an IRA rollover. This column suggests best practices for plan administrators hoping to arm participants with useful information about rollovers.
IRAs have grown significantly and now amount to $5.4 trillion, compared with $5.1 trillion in defined contribution plans and $9 trillion held in other retirement plans, according to the Investment Company Institute.
In recognition of the increasing importance of IRA rollovers from employer-sponsored defined contribution retirement accounts, the U.S. Securities and Exchange Commission in late December 2013 issued Financial Industry Regulatory Authority Notice 13-45, which gives guidance on brokers’ responsibilities concerning IRA rollovers.
It followed Notice 13-23, which dealt with the possibility of misleading investors when a firm’s marketing materials claim that its IRA is “free” or has “no fee,” when investment and related fees do apply.
Notice 13-45 offers guidance on the activities involved in assisting a participant with an IRA rollover, and is intended to provide money management firms with policies and procedures designed to achieve compliance with FINRA rules.
After leaving an employer, a participant has options for how to handle any accumulated retirement plan assets. He or she can:
A participant who asks to take a 401(k) plan distribution must receive from the plan he’s departing an IRS 402(f) Special Tax Notice, which outlines applicable taxes for such a distribution. At present, the SEC’s focus is on broker-dealers and any securities recommendations they make to participants seeking guidance on rolling over 401(k) retirement plan assets to an IRA. However, it is also critical that broker-dealers be familiar with applicable taxes, in cases where the participant requests a partial rollover.
Best Practice: Plan administrators want to ensure that a participant receives the special notice before taking a withdrawal so that he fully understands the tax consequences of each plan distribution option.
Similarly, there are several factors to consider when deciding whether to leave assets deferred in an employer-sponsored plan or to roll over plan assets to an IRA. The SEC encourages financial professionals to discuss these factors with a participant before making a rollover recommendation.
Investment options may be limited to designated investment options under a plan, while the IRA offers much broader investment alternatives, including brokerage services.
Fees and expenses may differ, with institutional versus retail pricing for investment expenses. The employer plan has administrative and service fees, and the IRA investor will likely be subject to custodial fees.
Services, though similar, will vary, with education, investment advice and retirement planning being offered to plan participants, while the IRA offers brokerage, income and distribution services.
Permissible withdrawals in the plan include loans, hardships and penalty-free withdrawals after termination of employment with the sponsoring employer and attainment of age 55. Penalty-free withdrawals from the IRA may occur after age 59½.
Required minimum distributions have to be taken from both types of plans by age 70½. Generally, if the plan participant is actively employed with the sponsoring employer, he may delay distribution until the latter of age 70½ or termination of employment.
Asset protection in the plan regarding bankruptcy and lawsuits is broad. State law varies on protection of IRA assets in lawsuits.
Company stock paid to the participant in-kind is subject to tax at the ordinary income rate on the cost-basis amount, and a future sale results in tax on the appreciation at the long-term capital gains rate, which is usually more favorable. On the other hand, if the stock is rolled over to an IRA, when later sold the cost basis and appreciation will be taxed as ordinary income.
Best Practice: Plan administrators will want to incorporate the factors from FINRA Notice 13-45 into any retirement education materials and retirement planning seminars that are offered to plan participants.
Cross-selling Plan Participants
Many plan sponsors include limitations in their service provider agreements related to marketing directed toward plan participants. The plan administrator may fear potential fiduciary liability for a perceived endorsement of a particular service provider’s investments and services, especially after the participant terminates employment.
At the same time, the service provider will seek to develop a relationship with plan participants that will continue beyond retirement. This difference in objective may test existing plan sponsor-provider relations.
For example, a spokesman for Charles Schwab recently commented on the company’s frustration with plan sponsor clients that use Schwab’s recordkeeping services, yet disallow marketing efforts designed to attract rollover assets from their 401(k) plan participants.
Best Practice: Plan sponsors will want to check service-provider agreements and make sure they understand the terms related to marketing products and services to plan participants. (See related column on p. 5.) In addition, plan sponsors should inquire about incentive programs for their service providers’ employees that may influence their interactions with participants.
When a service provider is marketing additional services to plan participants, there is also the risk of a potential conflict of interest. As service providers seek to extend existing relationships, FINRA’s goal in its new notice is to ensure that broker-dealers review their investment services to ensure that conflicts of interest do not impair the judgment of their associates.
A financial adviser, who may receive compensation based on the number of IRAs opened, has a financial incentive to encourage a departing plan participant to roll plan assets into an IRA. Similarly, a retirement specialist who conducts education seminars for retiring participants may be rewarded for converting class attendees into IRA investors.
Monitoring Service Providers
In order to advise plan participants on the advantages and disadvantages of IRA rollovers, it is necessary for financial advisers to have a certain level of plan knowledge. For example, they should know the types of investments available under the plan, applicable fees and withdrawal options available to plan participants and applicable taxes on various plan distributions.
It is important that financial professionals consider the participant’s investment profile, age, financial needs, investment objectives, risk tolerance and other information that affects investment decisions. And it is equally critical that plan participants be armed by the plan sponsor with investment and distribution information needed to make an informed decision.
Best Practice: As it relates to financial services, plan sponsors will want to include a clause in the service provider agreement that requires suitability and fair dealing.
Last, FINRA also intends for investment firms to establish and maintain practices that promote suitability and fair dealing. Namely, the practices should entail confirming that rollover decisions are reasonable and investments are suitable in light of the investor’s objectives, time horizon and liquidity needs.
When the service provider’s financial professional provides education as well as IRA rollover services to participants, the plan administrator should actively monitor such offerings.
Model Rollover Notices
For sample rollover/withholding notices for participants, see ¶716 in the Handbook.
Arris Reddick Murphy is an attorney with experience in the employee benefits and executive compensation practice area, and she is senior counsel with FedEx Corp.’s Tax & Employee Benefits Law group. Before joining FedEx, she held the position of associate with the law firm of Potter Anderson & Corroon, LLP, and worked in-house with The Vanguard Group and the City of Philadelphia as counsel to its Board of Pensions and Retirement.The views expressed in this column are strictly Ms. Murphy’s, and are not those of FedEx Corp.,any of its operating companies or affiliates. She is contributing editor of The 401(k) Handbook.
As all plan administrators know, COBRA coverage must made available for up to the maximum COBRA coverage period. But coverage can terminate early under certain conditions, as provided under COBRA’s other coverage cut-off rule. This rule has been a source of a great deal of controversy in plan administration and in litigated court cases. It also been modified through several different legislative and IRS regulatory actions. Most recently, though, health care reform has indirectly had a significant impact on the rule’s operation. This column explains how and provides five tips that plan administrators should consider for their COBRA programs moving forward.
Early Termination of COBRA Coverage
Generally, the COBRA coverage period is up to 18 months if the qualifying event is a reduction in hours or a termination (other than for reasons of gross misconduct) of employment (plus another 11 months in cases of certain qualifying disabilities) or 36 months for other qualifying events. That maximum period may be terminated earlier, however, if (among other reasons) a qualified beneficiary first becomes covered under another group health plan after the date on which COBRA coverage was elected.
By contrast, if a qualified beneficiary first becomes covered under another group health plan on or before the date on which COBRA coverage was elected, the other coverage cannot be a basis for terminating the COBRA coverage. In other words, a qualified beneficiary’s right to COBRA coverage turns on the timing of when he or she obtains other group health plan coverage as compared to the date of the actual COBRA election.
the qualified beneficiary actually must be covered, not just eligible for coverage, under the other group health plan;
the other group health plan must be maintained by another employer (or another employee organization), other than the one maintaining the plan providing COBRA coverage; and
the other group health plan cannot contain any exclusion or limitation with respect to any pre-existing condition of the qualified beneficiary (other than an exclusion or limitation that does not apply to, or is satisfied by, the qualified beneficiary by reason of the provisions in HIPAA.
The ACA Provision that Affects the Other Coverage Rule
The Affordable Care Act has indirectly affected the other coverage cut-off rule due to the elimination of pre-existing condition clauses in group health plans.
Beginning Sept. 23, 2010, group health plans were no longer allowed to exclude from coverage those eligible individuals under age 19 based on their pre-existing conditions. For other eligible individuals age 19 and older, the elimination of pre-existing condition exclusions is effective for plan years (or insured policy years) beginning on or after Jan. 1, 2014. Thus, calendar year group health plans can no longer exclude coverage for pre-existing conditions.
This new ACA rule applies to grandfathered group health plans in the same way as non-grandfathered health plans. The rule also applies in the same way to collectively bargained and non-collectively bargained plans.
The only exception to the health care reform prohibition is that grandfathered health plans in the individual insurance market still may apply pre-existing condition exclusions.
DOL Model Notices Were Changed Due to ACA Rule
ACA’s new rule has a very important impact on COBRA administration of the other coverage cut-off rule. Before the ACA, other group coverage only would terminate COBRA coverage if that coverage did not contain a pre-existing condition exclusion affecting the qualified beneficiary. Once the ACA rule applies, no other group health coverage could impose such a limitation. Therefore, all other group health coverage could potentially terminate a qualified beneficiary’s COBRA coverage as long as that qualified beneficiary first becomes covered by that other coverage after making a COBRA election.
Anticipating this new ACA rule, the U.S. Department of Labor modified its model COBRA election notice in a couple of respects: (1) it added a new parenthetical explanation about the ACA rule; (2) it deleted a discussion comparing the benefit of electing COBRA as opposed to other plan coverage that had pre-existing condition clauses; and (3) it eliminated language on how not electing or exhausting COBRA coverage could affect coverage rights in the individual market.
The New Parenthetical Explanation
Before the ACA rule, the model notice referred to COBRA coverage being terminated under the other coverage cut-off rule if:
A qualified beneficiary becomes covered, after electing continuation coverage, under another group health plan that does not impose any pre-existing condition exclusion for a pre-existing condition of the qualified beneficiary.
Now, that reference includes a new parenthetical explanation reading:
(note: there are limitations on plans’ imposing a preexisting condition exclusion and such exclusions will become prohibited beginning in 2014 under the Affordable Care Act).
This new parenthetical explanation can be somewhat confusing for qualified beneficiaries because of the ambiguity of the 2014 date reference. Technically, the ACA rules are applicable for plan years or policy years beginning in 2014, which can vary by plan. To avoid that confusion, some employers have simply eliminated the reference to pre-existing condition exclusions altogether. In those cases, the notice would read that COBRA coverage would be terminated if “a qualified beneficiary becomes covered, after electing continuation coverage, under another group health plan.”
Discussion Deleted on COBRA Versus Other Plans
The DOL deleted a discussion concerning the benefits of electing COBRA coverage vis-à-vis pre-existing condition clauses in other plans. That is, under pre-ACA rules (since HIPAA), an individual can lose the right to avoid having pre-existing condition exclusions applied by other group health plans if the individual has more than a 63-day gap in health coverage. Electing COBRA coverage helped eliminate that gap. However, now that pre-existing condition exclusions are less common (and will be eliminated entirely once the 2014 plan years apply), this discussion is unnecessary.
For those plan administrators that feel it is still necessary, however (at least until all 2013 plan years end), the discussion could be added back. The DOL has provided a redlined version of its notice so plan administrators and employers may see the deleted text.
COBRA Language on Individual Market Eliminated
Finally, DOL also eliminated language explaining that failure to elect and exhaust COBRA coverage could cause someone to lose the guaranteed right to purchase individual health insurance policies without the imposition of a pre-existing condition exclusion. Although this is generally true of non-grandfathered individual policies, it still might be relevant for grandfathered policies. Nevertheless, DOL has deleted the language. Some plan administrators have decided to keep a modified explanation in their COBRA notices for grandfathered policies.
Time to Review How to Apply the Other Coverage Rule
Given these changes to the pre-existing condition clauses, plan administrators should review how they will apply the other coverage cut-off rule. Here are a few tips:
Remember that the rule specifically refers to other group coverage. Therefore, a person covered under an individual health insurance policy or other non-group coverage still can maintain COBRA coverage, regardless of when that individual or non-group coverage is obtained.
The rule is optional. A group health plan is not required to terminate COBRA coverage before the maximum period due to a qualified beneficiary’s obtaining other group health coverage. If the plan coverage continued and a qualified beneficiary wanted to pay for double coverage, the plans’ coordination-of-benefits rules would apply and, generally (but not always), the COBRA coverage would be secondary.
Once the cut-off rule applies, a plan needs to determine whether it will cause an immediate loss of COBRA coverage or a termination of coverage at the end of a month. COBRA does not mandate a rule in this case. Often plans are administered on a monthly basis and not a daily basis; so it can make sense to terminate coverage at the end of a month in which a qualified beneficiary first becomes, after the COBRA election, covered by other coverage.
Have a procedure in place to find out whether a qualified beneficiary has other coverage. Many group health plans require as part of any benefit claim that covered individuals identify any other coverage available. In the case of COBRA coverage, extra steps are often taken. For example, some plans will provide premium coupons for the payment of COBRA premiums. On each coupon, the plans will have a statement to the effect that the qualified beneficiary’s coverage is conditioned on not having other coverage in place. If that other coverage exists, the qualified beneficiary is required to notify the plan administrator. This type of provision can help emphasize to qualified beneficiaries the need to keep the plan administrator informed of any change in coverage status.
Plan administrators should make sure to review all their documentation. This includes COBRA notices, benefits booklets, summary plan descriptions, plan documents and training materials. All these documents should be amended to be up to date with the latest COBRA rules and the interplay with health care reform.
With the health insurance marketplace under health care reform now functioning, what does that do to COBRA? How do these two methods for obtaining health insurance interact?
The marketplace (aka health insurance exchange) is a creation of the Affordable Care Act. It opened for enrollment beginning Oct. 1, 2013, with coverage first beginning Jan. 1, 2014. Generally, the marketplace will offer an open enrollment period each year from Oct. 15 through Dec. 7. During this first year of operation there was an extended marketplace open enrollment period, which was from Oct. 1, 2013, through March 31, 2014.
The marketplace offers an alternative to, not a replacement for, COBRA. Employers must continue to offer continuation coverage to individuals with a qualifying event. The COBRA premium continues to be calculated the same way, the total cost for COBRA coverage plus an additional 2-percent administrative cost. The cost of a marketplace plan varies widely, based on geography, plan type, coverage levels and eligibility for premium tax credits.
The marketplace offers individuals alternative options, and it could even mean cheaper costs. However, that is not certain. Another difference between COBRA and the marketplace is that stand-alone dental, vision and prescription drug coverage is not required to be offered in the marketplace. Additional coverage not available in the marketplace but available through COBRA include flexible benefits such as health reimbursement accounts and health flexible spending accounts.
Marketplace coverage could be beneficial for some individuals, particularly those who might qualify for premium tax credits that could reduce the cost of marketplace coverage compared to COBRA premiums. Premium tax credits are for individuals making up to 400 percent of the federal poverty level in annual income. This cap is based on a sliding scale, capping the premium from 2 percent to 9.5 percent of an individual’s annual income. Individuals within their COBRA election period may need to consider all options carefully.
An ill-timed election may cause an individual to be stuck paying for COBRA coverage until the marketplace open enrollment period or COBRA coverage expires. There is still a gray area regarding whether that individual would be eligible for a premium tax credit to help pay for the marketplace coverage if it is picked up during the annual open enrollment period while COBRA coverage is still available.
An individual who waits until COBRA expires can go onto a marketplace plan due to a special enrollment period. This is similar to the HIPAA special enrollment rules for an employer-sponsored group health plan, which allows the individual to purchase marketplace coverage due to the following reasons:
Losing other minimum essential coverage.
Gaining a dependent (or becoming a dependent) through marriage, birth, adoption or place for adoption.
Newly gaining status as a citizen, national or lawfully present individual.
Unintentionally or inadvertently failing to enroll due to an error on the part of the marketplace.
Demonstrating to the marketplace that the plan in which the individual is enrolled substantially violated a material provision of its contract in relation to the enrollee (this would permit an individual to change marketplace plans).
Being determined newly eligible (or experiencing a change in eligibility) for subsidized coverage (regardless of whether the individual is already enrolled in marketplace coverage).
Changing residence such that the individual gains access to new marketplace options.
Being a Native American Indian, who may enroll in a QHP or change from one to another one time per month.
Demonstrating that the individual meets other exceptional circumstances as the marketplace may provide.
The marketplace determines that the lack of coverage or premium tax credits was due to misconduct by a non-marketplace entity.
Health reform regulations make it clear that the loss of minimum essential coverage excludes any loss of coverage because of a failure to pay premiums on a timely basis. This includes failure to pay COBRA premiums on a timely basis. Also, loss of minimum essential coverage excludes certain situations allowing for rescission of coverage.
To aid individuals with being aware of their options, the U.S. Department of Labor issued a model exchange notice that employers are required to send to all employees. This notice is intended to inform employees of health coverage options and provide information regarding the existence of the marketplace. It also serves to ensure that employees understand the trade-off when they give up employer-provided coverage and instead choose marketplace coverage. The notice also contains certain information about the employer’s health plan. Additionally, DOL issued a revised COBRA election notice, which includes information to COBRA qualified beneficiaries that alternate coverage options are available in the marketplace.
Beyond sending the model notice, the ACA does not require employers to assist employees in determining coverage options upon the occurrence of a qualifying event. However, employers and COBRA administrators may face questions from qualified beneficiaries and may want to be prepared with some standard responses regarding the marketplace. Individuals can be directed to find more information and resources at www.healthcare.gov.
While COBRA coverage may come at a higher cost, it may appeal to some individuals because they can maintain access to a particular network of providers. Some may have their deductible used up on the employer’s plan for the year and not want to switch to a new plan with a new deductible.
No matter what the reasons, the bottom line is former employees will need to compare their COBRA coverage to the marketplace options. It’s important that plan and COBRA administrators keep these issues in mind and anticipate questions from individuals evaluating COBRA coverage or marketplace coverage.
Juli Hanshaw has more than 16 years of experience with COBRA and works directly for the president of Infinisource, Inc., which provides workforce management, COBRA, flexible benefit and other administrative services to more than 63,000 employers nationwide.
The April 2013 decision in US Airways v. McCutchen affirmed employer-sponsored health plans’ ability to fully recover all amounts they spent on health care from a plan member’s tort settlement recoveries.
While that was a tremendous affirmation, it raises the related question of whether complete recovery under reimbursement and subrogation provisions could “kill the goose laying the golden eggs.” Might health plans be shooting themselves in the foot by insisting on the whole loaf when under traditional notions of equity they might be better off strategically being content with less than 100 percent?
Have We Gone Too Far?
Plan and insurer recoveries remain controversial. Even when the plan is well within its rights to eliminate an individual’s fund, the resulting bad press has on occasion led a plan to reverse its decision, as was the case in Wal-Mart v. Shank in 2007. And another question is whether the full assertion of a plan’s right to recovery will have a chilling effect on plan participants pursuing tort settlements to begin with.
In McCutchen, the U.S. Supreme Court confirmed that health plans that correctly reserve subrogation and reimbursement rights in plan documents are clearly not subject to the bevy of equitable defenses plaintiffs’ attorneys have long sought to impose, such as common-fund and made-whole doctrines.
Has the development of the law in subrogation for ERISA self-funded plans developed to the point where it is not in a plan’s best interests to approach these matters with a hard line of no compromises? As many of us in the industry have heard from almost every plaintiff counsel we have ever encountered, “I would not have taken this case and my client (the plan participant) would not have pursued this matter if we had really understood what the plan documents actually said and had believed that the reimbursement provisions would have been enforceable.”
Lawyers for health plans should be applauded for the efforts they have made to confirm the law in the areas of subrogation and reimbursement. Subrogation benefits all plan participants by reducing overall plan costs to make the plan more affordable for the plan sponsor, to support the expansion of plan benefits, to ensure monies are available to pay for other plan beneficiaries and to provide for the overall financial continuation of the plan. This is unlike the insured world where individual insurance companies now have fewer and fewer tools to fight the onslaught of claim dumping by property and casualty and other insurers. In the insured world, unfair claim shifting laws allow specific-risk insurers such as auto, medical malpractice and workers’ compensation insurers to shift their risk to the much larger pools of general-loss carriers such as insured health plans, because of specific lobbying by legislators to appease the public.
The area of subrogation/reimbursement by self-funded ERISA plans is progressing moving forward as it should. Plans must seek to recover from all possible sources to maintain their cost efficiency and to support their sponsor employer’s bottom line. The cost of health benefits to employers is widely acknowledged to be a huge stumbling block to an employer’s economic growth. The development of the law in this area to allow employers to recover from other insurers and responsible third parties is a key element for efficiently-run health plans.
Plaintiffs’ counsel will often dismiss subrogation/reimbursement claims as “found money’ and argue that without the plaintiff’s counsel’s effort, the plans would never have recovered anything. In my opinion they are simply incorrect. There is no magic to a personal injury or medical malpractice case that competent subrogation counsel could not pursue effectively — like any other case it needs causation, liability and damages. While the plan may not always have a sympathetic claim of a lifetime of pain and suffering, now that there are no limits on medical benefit requirements, health plans need to use all resources available to continue their financial viability. Health plans need to aggressively pursue subrogation and reimbursement claims and forget the notion that plaintiffs’ counsel is out there to help them or to get them their money back. Plaintiffs’ counsel have but one client, the plan participant, and they are duty-bound to do everything they can to put the maximum amount of money in their clients’ pockets, and not the plan’s.
Therefore, payment of attorney’s fees under common-fund doctrines should be avoided where ever possible by available plan language.
Plans Owe Nothing to Plan Member’s Counsel
Do not believe the plaintiff’s long-used mantra that but for their involvement the plan would have recovered nothing. Most plan language is clear that participants must advise the plan of potential third parties and other available insurances. Plan participants gladly accept prompt payment of health benefits provided by the plan, and they agree, as part of the bargain, to return to the plan monies from responsible third parties and available insurers.
Plan members’ lawyers are not doing us any favors when they tell the plan, on behalf of their clients, of a third-party case or of other available insurance such as bodily injury limits, or uninsured and underinsured motorist coverage. They are merely complying with the terms of the plan that their client is covered under. Therefore, plans should treat subrogation and reimbursement claims like property/casualty claims and pursue such claims whenever possible without the aid of plaintiffs’ counsel.
Who ever heard of a fire insurance company using the plaintiff’s personal injury counsel to pursue its property damage claims against a negligent contractor or builder by using the attorney of a person who happened to be injured by the same fire? And then paying them a 40-percent fee on their structure loss claim? Health plans should demand cooperation from their plan members for whom they have paid benefits and should pursue third party and other insurance claims on their own and avoid any common fund or attorney’s fee issues. The argument that cases would not be pursued without the help of beneficent plaintiff counsel is just not true. Plan participants have an obligation to assist the plan by notifying them of responsible third parties and assisting the plan whenever possible with its efforts to recover its funds.
Of course we have all come across the insurance tragedy cases where there is a severely injured person and the defendant driver of the other vehicle has woefully underinsured coverage. And we’re familiar with the common law logic that applies to insurance companies: that they are better suited to bear the risk. Well, that logic should not apply to self-funded health plans that comply with the terms of their plans and promptly pay health benefits.
It’s those cases where legislators should have pushed for greater automobile minimum coverage limits to protect their constituents (including the general-liability benefit plans) rather than attempting to limit the plan’s recovery efforts against limited funds when the plan has potentially unlimited financial exposure.
In sum, the legal advances and trends in health plan subrogation and reimbursement are welcome, hard fought and long overdue. Employer plan recovery monies should not be arbitrarily given to plaintiff attorneys or plan participants under any pretense of equity when they can be recovered for the greater benefit of all plan members and the plan sponsor. It is the obligation of the plan sponsor to ensure that the health plan benefits to all members, not just those who seem sympathetic.
For more information on subrogation and reimbursement since McCutchen, see Section 633 of the Coordination of Benefits Handbook.
Michael J. Laffey, principal of Laffey & Associates, P.C., and Other Party Liability Inc., focuses exclusively on assisting insurers and third-party administrators identify and pursue subrogation claims. He has represented indemnity health plans, HMOs, PPOs, various self-insured companies and TPAs and has litigated numerous ERISA and Medicaid TPL cases. He is a member and frequent lecturer for the National Association of Subrogation Professionals, the National Other Party Liability Group and the National Healthcare Anti-fraud Association. Mr. Laffey is contributing editor of Thompson’s Coordination of Benefits Handbook.