The U.S. Department of Labor’s final disability claims procedures become effective for disability claims filed after April 1, 2018. The purpose of the new procedures is to ensure full and fair claims review procedures for any determination of disability in line with protections for certain group health plans under the Affordable Care Act. This means any employee benefit plan governed by ERISA that conditions a benefit upon a determination that a person is disabled must be amended to adopt these new procedures. The procedures do not only apply to long and short-term disability plans but any qualified or nonqualified retirement or deferred compensation plan governed by ERISA that conditions a benefit on a determination of disability. Likewise, group health plans often extend coverage beyond age 26 for disabled children of insureds.

If a plan conditions a benefit on disability as determined by another plan administrator or program, then the plan need not be amended provided the plan making the determination is amended. For example, nonqualified deferred compensation plans often provide that if the claimant has been determined to be disabled by the Social Security Administration, they will be considered disabled for purposes of the plan. However, if the plan provides that the plan administrator can otherwise determine that the claimant is disabled and entitled to benefits, the plan must adopt the claims procedure. Likewise, if a plan provides for a disability benefit if the employee is determined to be disabled but incorporates by reference the procedures of another plan, such as a long term disability plan, then only the incorporated procedures need to be amended.

Plan documents generally must be amended by the end of the plan year that includes April 1, 2018. However, the procedures must be followed for any claims on or after April 1, 2018.

Employers should take steps to review all plans that might condition a benefit on a determination of disability ASAP, and implement a strategy for compliance. Health plans, qualified retirement plans, nonqualified supplemental retirement or deferred compensation plans, severance plans or any other plan that provides for a benefit upon disability should be reviewed.

In January, the IRS announced changes to the fees required for filing under the Voluntary Correction Program (VCP) of the Employee Plans Compliance Resolution System (EPCRS).  The VCP program allows employers to voluntarily bring errors in plan documentation or operation to the attention of the IRS, and propose a correction method, and receive a compliance statement from the IRS stating if the corrections are made within 150 days, then the IRS will not disqualify the plan because of the error.

Filing a VCP submission with the IRS requires the payment of a user fee to the IRS to consider the filing.  In the past, the user fees have been based on the number of participants in the plan.  Prior to the change, the user fee was as low as $500 for a plan with 20 or fewer participants with a high of $15,000 for a plan with over 10,000 participants.  The breakdown of all the former user fees is in the chart below:

 

Participants

Fee

20 or less

21 to 50

51 to 100

101 to 1,000

1,001 to 10,000

More than 10,000

$500

$750

$1,500

$5,000

$10,000

$15,000

 

 

Additionally, there were special lower user fees for failing to adopt interim amendments, errors involving participant loans, and minimum distribution requirement failures.

In January of this year, the IRS announced that for submissions filed after 2017 the user fees would be based on the net plan assets in the plan, under the following schedule:

 

Assets

User Fee

$0 to $500,000

Over $500,000 to $10,000,000

Over $10,000,000

$1,500

$3,000

$3,500

 

 

While touted as a lowering of the user fees by many reports, because the highest fee now paid is $3,500 rather than $15,000, for most plans the user fees are likely to increase.  A small plan with under 100 participants now has to pay $1,500 as a minimum.  Under the old schedule, such a plan would only pay $500 if it had 20 or fewer participants, or $750 from 21 to 50 participants.  Plans with over $500,000 in assets and more than 100 participants will benefit the most under the new schedule as their user fee drops to $3,000 from $5,000, or more.  And the user fee remains $3,000 until a plan has over $10 million in net assets, at which time it only increases $500.

It is unfortunate that the increase in user fees for smaller plans may have a chilling effect on those plans seeking compliance statements under the VCP.  Smaller plans are most likely to experience an error that needs to be corrected under VCP.  However, the increased cost might cause the plan sponsor to self-correct the plan and “bear the risk.”  I almost always recommend against this approach because without receiving a compliance statement from the IRS, the plan sponsor has no reliance that the IRS will agree with the self-correction. If the IRS doesn’t agree, it will threaten to disqualify the plan and seek a higher employer penalty under the audit closing agreement program of EPCRS based on the amount of tax the government would receive if it disqualified the plan from denied employer deductions, employee income, and the plan’s investments becoming taxable.

Employers often tell me how they want to provide their employees who have helped them build their business an opportunity to benefit from a future sale of the business.  In the past, I have then discussed with them the pros and cons of such techniques as restricted stock, phantom stock, and stock appreciation rights, including the application of ERISA, tax law including Internal Revenue Code Section 409A, securities law, and shareholder rights under corporate law.  Afterward, the employer often decides that they don’t want all employees becoming actual shareholders in the company with the statutory rights that go with it, and opt for a phantom arrangement that provides for them to receive cash only as if they were a shareholder or due to a change in control.

Now, thanks to tax reform under the Tax Cuts & Jobs Act, there is a tool that can help with the tax burden of employees receiving compensatory stock by giving them up to five (5) years to pay the tax on the receipt of the stock.  If a qualified employee receives qualified stock from a qualified corporation as a result of exercising a non-statutory stock option (NSO) or settling a Restricted Stock Unit (RSU), the qualified employee can file an “83(i) election” to defer the tax for five (5) years unless a disqualifying event occurs in the interim.

An NSO is any stock option granted by a qualified employer that is not an incentive stock option (or statutory stock option) or provided under an Employee Stock Purchase Plan that qualifies for special tax treatment under Code Section 422.  An RSU is the right to receive stock in the future.

Generally, without an 83(i) election, employees are subject to income tax on the difference between the fair market value of the stock on the date of exercise of the option less the exercise price, if any.  Likewise, employees are subject to income tax from receiving stock on the settling of an RSU on the fair market value of the stock on settlement less any amount the employee paid for the RSU.  A Section 83(i) election allows the qualified employee to defer the tax for five (5) years.

Qualified Employee – A qualified employee is a U.S. based employee that regularly works more than thirty (30) hours per week that is not:  already an owner of at least 1% of the stock of the corporation; an employee that is or has ever been the CEO or CFO; a spouse, child, grandchild or parent of a 1% owner, CEO or CFO; or among the four (4) highest paid officers of the corporation.

Qualified Stock – Qualified stock is stock in the employer corporation received by a qualified employee in connection with the exercise of an NSO or settlement of an RSU in exchange for services to the employer during a year when the employer was an eligible corporation.

Eligible Corporation – An eligible corporation is one that during the calendar year in which the NSO or RSU was granted:  No stock of the corporation is readily tradeable on an established securities market during any preceding calendar year and the corporation has a written plan under which at least 80% of all U.S. based full-time qualified employees are granted NSOs or RSUs with the same rights and privileges to receive more than a de minimis amount of qualified stock.

Upon receipt of the stock, the qualified employee has thirty (30) days to make the 83(i) election by filing it with the IRS and giving a copy to the employer.  If made, the tax that would have been incurred will not be taxed until five (5) years from the year it would have been taxable without the election unless one of the following intervening events occurs earlier:

  1. The first date stock of the employer becomes publicly traded;
  2. The date the employee ceases to be a qualified employee;
  3. The date the qualified stock becomes transferable including to the employer;
  4. The date the employee revokes the 83(i) election.

The intent of Section 83(i) is to help with the “phantom income” problem that employees of private corporations have when being compensated with stock.  Without the Section 83(i) election, the employee is taxed on the exercise of an NSO on the difference between the fair market value of stock on exercise and the exercise price.  The income is considered wages subject to income tax withholding and employment taxes.  Likewise, upon receiving stock from the settling of the RSU the employee is taxed on the fair market value of the stock on the date of settlement.  Both situations cause phantom income because while the employee has taxable income, he/she has not received any cash to pay the additional tax or withholding which must come from other income.  Additionally, unlike employees of public corporations, the employee of a private corporation cannot just sell some of the stock received on the open market to get cash to pay the tax.

A Qualified Equity Grant Plan under Section 83(i) could be just the tool for a small private corporation that expects to be acquired in the next couple of years, to allow its full-time employees to share in the acquisition transaction.  For example, the qualified corporation could grant RSUs to all full-time employees in Year 1, with a fair market value of $2.00/share to be settled in Year 2.  In Year 2, the employees could make the 83(i) election deferring tax for five (5) years. However, in Year 4, all the employer’s stock is acquired by a buyer (including the employees’ stock which is transferrable upon a sale) for $5.00/share.  The employees now have money to pay the tax on the ordinary income of $2.00/share from receipt of the stock, plus the capital gain on the $3.00/share of appreciation based on the purchase of their stock by the buyer.  Thus, the employees have participated in the sale at capital gain rates and have cash to pay the tax on what would have been phantom income in year 2, if not for the Section 83(i) election.

If you think you may be interested in establishing a Qualified Equity Grant Plan or other compensatory equity or bonus plan, please contact me.