EMPLOYEE BENEFITS Recent Developments January 19, 2007 Curtis L. Harrington & Harrington (562) 594 -9784 curt@patentax. com http: //www. patentax. com §
Disclaimer: Educational Only § This Power Point Presentation is Educational Only and no part of this presentation can be considered as federal or state tax advice, opinion, or position and is not intended or written to be used, and may not be used, for the purpose of (i) avoiding tax-related penalties under the internal revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein, nor (iii) constituting guidance on any tax or intellectual property matter. 2
Pension Protection Act, (PPA) (2006) Defined Contribution Grading: 3 to 7 year vesting is replaced by graded 2 to 6 year vesting Defined Contribution Cliff Vesting 5 years instead of 3 Qualified Optional Survivor Annuity – which is some percentage of the joint annuity which would have otherwise been elected. 3
PPA-2006 Enhanced PLAN Reporting § certification that the adjusted funding target attainment percentage of the plan is not less than 100 percent § certification relating to requests extending amortization periods § within the 90 th day of each plan year, the plan actuary must certify to the Secretary of the Treasury and to the plan sponsor whether or not the plan is in endangered or in critical status (failure to certify can result in an ERISA penalty of $1, 100 per day) § Funding Improvements: After the adoption of a funding improvement plan, it may not be amended to increase benefits unless the plan actuary certifies that the benefit increase is consistent with the funding improvement plan § the construction of a separate mortality table upon request of the 4 plan sponsor by the actuary based on a plans own experience
CASE LAW DEVELOPMENTS Short Review of Pre-emption Suspension of Benefits Enforcement of Subrogation Rights Fiduciary Responsibility Standing Under ERISA Discretion in Carrying out Settlor Function Anti-Alienation under ERISA Various Cases of second half of 2006 Illustrating problems 5
Review of Pre-emption § ERISA’s Preemption Clause preempts state law which “relates” to employee benefit plans". (A very loose standard) § ERISA’s “Saving Clause” omits from preemption those state laws which are directly related to insurance. § The dividing line between these two characterizations is a rich battleground 6
Pension vs. Health & Safety § Recall that ERISA governs both plans which are “pension like” and which are “health and safety-like” § Pension-Like provisions in which rights arer vested are held to an inviolate standard. § Health-Like plans can be changed at the whim of the employer every day or every week. There is generally no vested right here 7
Pre-emption wall § In addition, pre-emption, regardless of whether the plan provision is pension-like or not, builds a wall in which legal action is severely restricted: § against the plan by beneficiaries § against the plan by the states § by the plan against others 8
SUSPENSION OF BENEFITS 9
Heinz v. Central Laborers’ Pension Fund 303 F. 3 d 802 (7 th Cir. Sept. 13, 2002), aff’d, 124 S. Ct. 2230 (June 7, 2004) § Anti-Cutback Rule § General rule established under Heinz: conditions imposed after a benefit has accrued make the “accrued benefit less valuable” whether or not an actual benefit suspension occurs 10
Swede v. Rochester Carpenters Pension Fund Cir. Ct. App. Oct 20, 2006, Case Number: 06 -0112 § Court instruction to IRS not to revisit the tax-exempt status in past years of plans that were amended in reliance on” other rules and procedures, cannot be used by a Defendant to resist applying the Heinz holding between the non-permitted plan amendment and the date of the Heinz holding. 11
Revenue Procedure 2005 -23 General Rule: A plan which adopts a “reforming amendment” and complies operationally with that amendment may obtain relief from the retroactive application of Heinz prior to its June 7, 2004 issuance § Reforming Amendment must contain the following provisions: § The original (more restrictive) amendment may not apply to benefits that have already accrued § Payment of retroactive benefits to an affected plan participant must include any appropriate interest or actuarial increase for benefits that have accrued as of the applicable amendment date § The applicable amendment date is the later of the original amendment’s effective date, or the date of its adoption 12
Revenue Procedure 2005 -76 Plan must provide for the payment of retroactive benefits, and must be in operational compliance with the reforming amendment no later than January 1, 2007 Under the Swede case rationale, any conforming amendments and actions should place the employee in at least as good a position as it would have been if no cutback had occurred. 13
SUBROGATION RIGHTS Insurance Accident Plans typically include a provision which gives them a claim to any monies recovered from the accident victim from others (typically the person who caused the accident) The insurance plan typically enforces its rights against its own insured who obtain the double coverage. Without a subrogation provision, the accident victim would get a double recovery (which may be permitted in the victim’s jurisdiction. 14
History Great-West Life & Annuity Ins. Co. v. Knudson (2002) 534 US 204 (Jan. 8, 2002): § ERISA Section 502 does not provide a plan with method of enforcing the plan’s subrogation provisions against participants or beneficiaries § Where participant obtained personal injury recovery against third party tortfeasor, Plan was not able to obtain reimbursement § Comment: : it may be beneficial to consider the use of an insurance company contractor and to compute the value of subrogation ability against the increased cost of using a contractor 15
Sereboff v. Mid Atlantic Medical Services, Inc. (2006, S. Ct. ) 2006 WL 310754 § The Supreme Court unanimously affirmed the Fourth Circuit’s decision that a group health plan’s claim against a plan beneficiary’s third-party recovery fund for the reimbursement of advanced payment of medical benefits was one for “other appropriate relief” allowed by ERISA § MAMSI’s action was brought to enforce the “Acts of Third Parties” provision, which thus qualified it as an equitable remedy § Comment: Here we see something other than subrogation, but the enforcement of a “trust like” duty on a third party fund. 16
FIDUCIARY RESPONSIBILITY Termination or Modification of Benefits 17
General Rule for Notice of Termination / Alteration of Benefits: Except for group health plans, ERISA contains no specific requirement for notifying welfare benefit plan participants and beneficiaries of the termination of their plan. Comment: Remember that ERISA has an inviolate standard for plans relating to pension & retirement, but for “health & welfare plans” the employee has a much higher vested ownership expectation threshold and without a specific requirement in ERISA, there is no such per se requirement. 18
Peralta v. Hispanic Business, Inc. , 419 F. 3 d 1064 (9 th Cir. Aug. 18, 2005) § Court held that the plan sponsor has a fiduciary duty to notify beneficiaries and participants promptly of the termination of coverage § Although the 210 day notice requirement under ERISA Section 104(b)(1) was satisfied; the court found that the plan fiduciary had an even more basic duty to provide timely notice of a plan termination under ERISA Section 404(a)(1) § However, ERISA does not provide the plaintiff with a remedy Comment: again, the omission inures to the benefit of the plan by a holding that a fiduciary duty was breached. Note that this is a Health-like plan and not a pension-like plan. Protections in healthlike plans are typically reached by fiduciary duty. 19
Fiduciary Duties Prudent Person Standard § Securities and Exchange Commission v. Capital Consultants, LLC, 397 F. 3 d 733 (9 th Cir. Feb. 2, 2005) § A receiver in charge of distributing assets from a litigation recovery, was not in violation of ERISA for enforcing an offset provision which required a 50 percent offset against recoveries from third parties, even though receiver was an ERISA fiduciary § ERISA’s fiduciary duty provisions do not prohibit such offsets and the receiver was not otherwise legally obligated under ERISA to favor ERISA plans over non. ERISA plans. A fiduciary is a “rights balancer” and not an unbridled advocate for the plan. 20
Standing Under ERISA Section 502(a)(2) § Massachusetts Mutual Life Insurance Co v. Doris Russell, 473 US 134 (1985, S. Ct. ): Actions for breach of fiduciary duty under ERISA Section 502(a)(2) must be brought in a representative capacity on behalf of the plan as a whole, and not for the benefit of individual participants § Barker v. American Mobil Power Corp, (1995, CA 9) 64 F. 3 d 1397: Remedies for alleged fiduciary breach must inure to the benefit of the plan (rather than individual participants), or to all plan participants § Comment: Again note the similarity to the corporate shareholder’s derivative actions. 21
Milofsky v. American Airlines, 2005, CA 5) 404 F. 3 d 338, vacd & remd (2006, CA 5) 2006 WL 488622 § 401(k) plan participants lacked standing to bring an ERISA Section 502(a)(2) breach of duty claim on behalf of the plan because they were seeking only individualized relief § Vacated and remanded on March 2, 2006, (Milofsky v. American Airlines, 2006 WL 488622, vacg & remg (2005, CA 5) 404 F. 3 d 338) § Comment: Again, the analogy to the approach for Section 502 standing is to that of shareholder derivative suits. 22
Exercising Discretion in Carrying Out Settlor Functions Beck v. PACE International Union, 2005 U. S. App. LEXIS 23190 (9 th : The sponsor of a single employer plan breached its fiduciary duties when, rather than investigating whether it should merge its pension plan with a multiemployer pension fund, the employer decided without much analysis to annuitize the plan so as to terminate it Cir. 2005) Comment: Similar to the “duty to bargain” even where a plant is closing, there is a “duty to try and save a pension plan in trouble” rather than terminating it (when it is sick). 23
Anti-Alienation under ERISA United States v. Novak, 9 th Circuit, No. 04 -55838 (March 23, 2006), the Ninth Circuit Court of Appeals held that the government could garnish vested pension benefits under a restitution order despite the anti-alienation provision of ERISA Comment: This case might be viewed as enabling federal invasion of pension plans, but the facts were so terrible that it is unclear as to how it will be viewed if the facts were not so severe. The employee garnished had a long history of continuing THEFT of his employer’s telephone board equipment ($millions) sold in interstate commerce, and the convicted employee was subject to federal restitution order of over $1 million (even though the pension was only about $147, 000). 24
Miscellaneous Recent Cases § Paul Bard V. Boston Shipping Association; International Longshoremen's Association Pension Plan (1 stt Cir. Ct. App. Dec 19, 2006) No. 06 -1810. The plan is liable where its employee was prejudiced by plan numerous regulatory violations (summary plan description not updated since 1988; The resoning for denial of benefits was withheld during a battery of appeals; Plan terms are disregarded because employee was so prejudiced) § COMMENT: Will the increase in reporting and notification provisions of under Pension Protection Act 2006 will put plans at further risk without an increased level of vigilance? YES 25
Miscellaneous Recent Cases § Richard Coleman et al, v. PBGC. (DC Columbia, Dec. 5, 2006) No. 055496. Agreement to remove improper terms from a plan is effective if the removed provision is honored, and proper memorialization of the proper change will not form the basis of a challenge under the “operational compliance requirement. ” of Treas. Reg. 1. 411(d)-4, Q&A 8(c). COMMENT: The Retirement Equity Act of 1984 (“REA”), Pub. L. No. 98 -397, 98 Stat. 1426 (26 U. S. C. and 29 U. S. C. ) prohibits discretionary benefit provisions in pension plans, and both employers and employees should rigorously test plan provisions to this standard. 26
Miscellaneous Recent Cases § Hutchison v. Fifth Third Bancorp (6 th Cir. Ct. App, Nov. 30, 2006) No: 05 -4389. Contractual sweetheart promises in an agreement between merging corporations to provide a company's pre-merger employee benefit (ESOP) plan (a third party? ) additional money availability to ESOP plan members was held to be pre-empted, even where plan participants benefitting under the offer were induced to vote their shares in favor of the merger. COMMENT: If the conditions and contract had been drawn between the Plan (trustees) and the merging company, this case might have had a different outcome. The plan was not a party to the agreement, and was not lied to. 27
Miscellaneous Recent Cases § Tocker v. Philip Morris Co. (2 nd Cir. Ct. App, Nov 22, 2006) No. : 04 -5904. Making an Exceptions to plan provisions even for the generous benefit of an employee can trigger extreme liability. Employee seemingly diagnosed with a terminal illness is granted an extraordinary retirement benefit, including a lump sum and long term disability simultaneously (not available to other employees under the plan). The employee brought suit for inclusion of the 10 -12 years of employment time corresponding to his long term disability period. It was held that the head of the plan may have breached his fiduciary duty by not informing the employee (whom no one expected to survive more than 2 years) of the effect on his retirement of the job termination in the “special package”. COMMENT: Any “special deal” in lieu of a “regular plan provision” should be examined with the same 28 scrutiny as you would apply to a new plan.
Miscellaneous Recent Cases § Northcutt v. General Motors Hourly-Rate Employees Pension Plan (7 th Cir. Ct. App, Nov 22, 2006, No: 05 -4484. Contractual self-help (setoffs) are available to enforce plan provisions for Social Security reimbursement. The use of the Social Security basic retirement & disability base in pension computations to reduce employer contributions for the amounts attributable to Social Security extends to contractual “self help” deductions, even where employees receive a lump-sum from the government and thereafter squander it. COMMENT: Although the Plan clearly wins under the broad public policy of “building onto” Social Security as a deductible base (a permitted disparity in plan discrimination testing), it would be helpful if Plans included this provision along with a waiver, especially at the time that lump sum payments are made. 29
Miscellaneous Recent Cases § Hooven v. Exxon Mobil Corp. (3 rd Cir. Ct. App. Oct 20, 2006) Case Number: 04 -3773. In a time consuming merger where things develop slowly, an omission in the Summary Plan Description are not fatal where continued employment with the merged companies, or the divested division (owned by purchasing company) continues throughout the period. COMMENT: Employees should watch the transformaiton of the plan like a hawk, as continuing to work after amendments will likely constitute waiver. In the alternative, the SPD is often considered a small matter unless it has a big effect, and here the SPD “omission” wasn’t big. 30
Miscellaneous Recent Cases § Miller v. Xerox Corp. Retirement Income Guarantee Plan (9 th Cir. Ct. App, Sep 13, 2006) No: 04 -55582. Use of “creative” phantom accounts to adjust the retirement of employees returning from retirement will be stricken. This was one of the problems with the Cooper v. IBM Personal Pension Plan 243 F Supp. 2 d 1010 (S. D. Ill. 2003) cash balance conversion case. Taking a deduction based upon prior lump sum retirement payment PLUS time accrual in the employment break period is forbidden. COMMENT: An actuary should be utilized to re-integrate a return to service, with a computed valuation and which is agreed upon and assented to by both the employee and the employer PRIOR to re-hire; real actuarial accounting will always be favored over phony phantom accounts. 31
CIRCULAR 230 Impact on Benefits Practitioners? § Circular 230 governs practice before the IRS of Attorneys, CPA’s and Enrolled Agents. § Section 10. 35 of Circular 230 (introduced in 2005) defines “Covered Opinions” as written advice by a Circular 230 practitioner relating to any transaction that the IRS considers to be a “tax avoidance” transaction published under 26 CFR 1. 6011 -4(b)(2). § Practice before the IRS goes beyond dealings which occur directly with the IRS 32
Why did the IRS focus on this Document? § Tax Opinions can be used to shield a taxpayer against the imposition of penalties. This mechanism is covered elsewhere in the Internal Revenue Code, and has traditionally been used to protect good faith taxpayers who choose a path of action based upon assurances by a tax practitioner as to the propriety or outcome of the action. § By placing a control in the document which governs the actions of tax practitioners, the IRS has chosen not to eliminate the benefit to taxpayers from obtaining a prophylactic opinion or advice, but instead to place the burden on the tax practitioner. 33
Covered Opinion Standards When giving covered opinions, practitioners must (among other things) § Use reasonable efforts to identify and ascertain the facts (Independent Efforts, rather than reliance on the client) § Not base the opinion on unreasonable facts § Relate the law to the facts § Not base the opinion on unreasonable assumptions § Provide his or her conclusion as to the likelihood that the taxpayer will prevail on the merits with respect to each significant federal tax issued considered in the opinion 34
Practical Effect § Turns every comment into a potential COVERED OPINION § Turns every small opinion tangential to a tax transaction which might be required to have a “COVERED OPINION” into a “COVERED OPINION” § Turns an INTENDED task to produce a “COVERED OPINION” into a MAJOR PROJECT having a cost and depth equivalent to a MAJOR RESEARCH PROJECT not unlike the size of a dictionary § Exponentially raises the cost to the client for providing an opinion from a few thousand dollars to the cost for producing a “MAJOR PROJECT” 35 § Most Practitioners have simply stopped preparing opinions
Minimum “Employment” Listed Transactions from IRS Website § 401(k) Accelerated Deductions § S Corporation ESOP Abuse of Delayed Effective Date for Section 409(p) § Collectively Bargained Welfare Benefit Funds under Section 419 A(f)(5) § Certain Trust Arrangements Seeking to Qualify for Exemption from Section 419 § Abusive Roth IRA Transactions § S Corporation ESOP Abuses: Certain Business Structures Held to Violate Code Section 409(p) § Deductions for Excess Life Insurance in a Section 412(i) or Other Defined Benefit Plan 36
Imposition of sanctions and monetary penalties § Sanctions for violations of Circular 230 include Suspension, disbarment in their representation of taxpayers before IRS and censure § Monetary penalties may also be imposed in addition to other disciplinary action and may equal the gross income derived from the conduct giving rise to the penalty 37
Covered Opinion Standards When giving covered opinions, practitioners must (among other things) § Use reasonable efforts to identify and ascertain the facts (Independent Efforts, rather than reliance on the client) § Not base the opinion on unreasonable facts § Relate the law to the facts § Not base the opinion on unreasonable assumptions § Provide his or her conclusion as to the likelihood that the taxpayer will prevail on the merits with respect to each significant federal tax issued considered in the opinion 38
Covered Opinion Effect § The issuance of an Opinion might violate the standard and subject you to discipline from the IRS Office of Discipline § A Tax Court, U. S. District Court or other court’s holding that the standards were not met could result in an ethical violation and disbarment. § A holding that the Standard was not met might also allow your efforts to be colored as being in collusion with the client to perpetrate a fraud on the government and subject the practitioner to liability as a co-conspirator in a fraudulent tax scheme. § Any covered opinion would have to be considered as a large information gathering and investigation project to insure that the standards are met and exceeded. 39
Effect on Retirement Plans § Enrolled Actuaries cannot rely as much upon client/employer provided data in computing benefits for plan participants. Additional Investigation will be required. § Combined effect of Circular 230 with the additional duties under PPA 2006 will place an even greater burden on Enrolled actuaries, especially as to the depth to which investigations relating to their expanded duties must be performed, including target attainment percentage and endangered or in critical status. 40
Effect on Plan Service Providers § Enrolled Actuaries, Tax Attorneys, and Accounts will be less able to rely upon the data provided from the client and will be statistically forced to have greater personal oversight and inspection of company records and books when signing documents relating either to PBGC Form 1 or Form 5500 and associated documents. Because boilerplate disclaimer language cannot be incorporated into the form signatures, the only choice is due diligence, resulting in a rise in client costs. § Previous isolated systems, wherein the client provided data to an accounting service who provided summaries to various practitioners in turn, will either be duplicated by practitioners doing the same job twice, or else will undergo a shift of services to the practitioners, at least in part. § The combination of the above will tend to favor more vertically integrated practitioners who can bring the data investigation and treatment function inhouse. 41
Employer/Supervisor Penalties § Moreover, a monetary penalty may also be assessed against an employer if the employer, firm or entity knew, or reasonably should have known, of the conduct. § Given the organizational nature of PLAN service firms, additional levels of supervisors will be needed, as well as increased internal controls to eliminate potential liability imposed by Circular 230. 42
What legal advice may be covered? Circular 230 covers written advice about: § “listed transactions” § any partnership or other entity, any investment plan or arrangement or any other plan or arrangement the principal purpose of which is the avoidance or evasion of any federal tax § any partnership or other entity, any investment plan or arrangement or any other plan or arrangement, a significant purpose of which is the avoidance or evasion of any federal tax, if such significant purpose advice is one of the following: § A “reliance” opinion § A “marketed” opinion § Condition of confidentiality, or § Contractual protections 43
“Tax Avoidance” Defined § “Tax avoidance” is not something that is wrong or unlawful § “[o]ne who avoids tax does not conceal or misrepresent. He shapes events to reduce or eliminate tax liability and, upon the happening of the events, makes a complete disclosure. ” Internal Revenue Manual 9. 1. 3. 3. 2. 1 (7/29/98) 44
Qualified Plan Issues Exception § “Covered Opinions” do not include advice that concerns the qualification of a qualified plan § Except for advice regarding a listed transaction or where the “principal purpose” of the plan or arrangement is the avoidance or evasion of taxation § “Concerns the qualification” must be interpreted very narrowly 45
Covered Advice Could Also Include: § § § Section 79 “early distribution” tax Sections 105 and 106 health benefits 402 distributions, rollovers, direct transfers 404 deductions 409 A nonqualified deferred compensation plans 412 minimum funding 403(b) plans 457 plans Stock options Mergers and acquisitions Golden parachutes Taxation to alternate payees 46
Pension Potential Gray Areas Include: § Qualified plan and trust documents § Merger and Acquisition Agreements § Cover letters transmitting documents § Situations where a plan turns out to be not qualified § SPD and SMM § 402(f) Notices § 204(h) Notices 47
Enrolled Actuaries Are Uncertain § The Enrolled Actuaries Society have been pressing the IRS for answers to specific questions about the new Circular 230 Rules because of the Continued uncertainty in its application: § Confirmation as to whether establishment or maintenance of a qualified retirement plan is a transaction, “the principal purpose of which is the avoidance or evasion of any tax imposed by the Internal Revenue Code (IRC). ” § Whether making calculations and measurements based on an understanding of the law is tantamount to giving an opinion of the law. 48
Enrolled Actuaries Are Uncertain (Contd) § Whether communicating, in writing, the results of actuarial computations — constitutes the rendering of a covered opinion. § The meaning, scope and breadth of the exception in Circular 230 enabling enrolled actuaries regarding the establishment of the qualification of a qualified plan. § Guidance on clarification of the provisions of Section 10. 33 outlining “best practices. ” (This would seem to point out a “financial engineering” conflict between the plan beneficiaries who seek maximum funding to maximally insure an abundant supply of retirement funds versus the plan sponsors who are seeking to satisfy minimum funding 49 in order to satisfy the rules and reduce costs. )
How Does This Affect Anyone Dealing with Tax? § Just about any letter sent to a client which is involved in Business Planning could be held to have a tax effect. (Recall that Attorney Client privilege is for “legal advice” rather than business advice and that “work product” deals with communications in anticipation of litigation 50
Potential Circular 230 Opinions § Just about any letter sent to a client with tax advice or planning with a tax effect? § A short e-mail with tax or business advice (either yours or another’s) which could affect the tax treatment? § Sent a client a memorandum with a small tax advice component? § Responded to a client’s simple question? 51
DISCLAIMER LEGENDS Popular way in which practitioners are avoiding Circular 230 requirements is to include a legend which states that the written advice is not to be used to avoid penalties Every accounting firm and almost every legal practice has added these legends to their written client communications 52
Here’s My Legend § Circular 230: Pursuant to the June 2005 US Treasury Department Regulations, I am now required to advise you that, unless otherwise expressly indicated, any federal tax advice contained in this communication, including attachments and enclosures, is not intended or written to be used, and may not be used, for the purpose of (i) avoiding tax-related penalties under the internal revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein. This communication may contain material protected under attorneyclient privilege and/or work product doctrine. If you are not the intended recipient, please contact the sender at curt@patentax. com or by telephone at (562) 594 -9784, and destroy the original transmission and its attachments without reading them or saving them to disk. Thank you. 53
Will the legend Solve the Problem? § NO, it will not cover comments on a listed transaction! § Because a legend won’t protect a communication which is directly contrary to the prohibited action, a legend only works if the advice is NOT regarding: § § § A listed transaction A principal purpose (tax avoidance) transaction A transaction with confidentiality A transaction with contractual protection And if the goal is to avoid a marketed opinion the legend must be much more detailed 54
Legend Requirements § Prominently disclosed § “Readily apparent” to the reader § Not a footnote § Separate section § Same size typeface as analysis of facts and law 55
WANT A COPY OF THIS POWER POINT? § Please visit: http: //www. patentax. com And click on “LIBRARY“ 56
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