There are many hoops to jump through to enjoy the benefits of Section 83(i), but under the right circumstances they may be worth it.

Last February I blogged about new Section 83(i) of the Internal Revenue Code that was added by the 2017 tax reform legislation and provides for up to a five-year deferral of the income tax consequences to an employee when exercising a Non-Statutory Stock Option or settling a Restricted Stock Unit in stock.  See New Section 83(i) Provides a New Tool for Allowing Employees to Participate in the Sale of their Private Corporation-Employer. That article was a brief overview of the new law. For a more detailed discussion click on my article published in the Summer issue of the Journal of Pension Benefits, titled Ay, Ay, Ay, How Do You Comply with Section 83(i) – To Obtain Tax Deferrals on Qualified Equity Grants.  As discussed in the article there are many hoops to jump through to enjoy the benefits of Section 83(i), but under the right circumstances they may be worth it.

On October 30, the California Secure Choice Retirement Saving Investment Board issued yet another notice withdrawing the October 12 proposed regulations.

Last week I reported that the California Secure Choice Retirement Saving Investment Board (Board) posted a Notice of Proposed Emergency Regulation Action twice, once on October 9 and again on October 12 because the October 9 proposed regulations were changed. See CalSavers Files Emergency Proposed Regulations Twice. On October 30, the Board issued yet another notice withdrawing the October 12 proposed regulations, because they were changed yet again, and issuing a new notice of filing proposed regulations with the Office of Administrative Law within five days.  The public comment period for these latest proposed regulations is expected to be November 7 through November 11.

What is frustrating about this process and making following developments difficult is that the notices do not describe what was changed nor does the content of the proposed regulations.  They are not redlined nor otherwise show the changes.  They are not even dated.  However, redlined versions can be found on the agenda for the November 6 meeting of the Board at https://www.treasurer.ca.gov/scib/meeting/index.asp.

On October 9, 2018, the California Secure Choice Retirement Savings Investment Board (Board) posted a Notice of Proposed Emergency Action to issue proposed regulations regarding CalSavers, the California mandated payroll deduction IRA program expected to become effective early next year.  However, on October 12, 2018, the Board filed another notice because it modified the proposed regulations in the October 9th notice.

These proposed regulations replaced those that were initially noticed on March 5, 2018 but then not proposed as the Board decided to wait until after summer.  See California Secure Choice/CalSavers Retirement Savings Program Proposed Regulations Delayed.

The new proposed regulations shed some important light on the details of the CalSavers program (Program).  They provide the last date for covered employers to register for the Program as June 30, 2020 for covered employers employing more than 100 employees; June 30, 2021 for those employing more than 50 employees; and June 30, 2022 for those employing five or more employees.  The proposed regulations also provide for the default options under the Program if a participant does not elect otherwise.  These include a participant contribution rate of 5% which will automatically escalate 1% per year until reaching 8%.  Participants can choose an alternative contribution rate but will still be subject to the automatic escalation unless they opt out of it as well under the proposed regulations.  The default account is a Roth IRA, meaning that after-tax dollars will go into the account.  This is troublesome as there are qualification requirements for being able to make a Roth IRA contribution under federal law. If the Roth IRA owner makes too much income based on his or her filing status, he or she won’t be eligible to make a Roth IRA contribution.

The first $1,000 in contributions will be invested in a capital preservation investment selected by the Board according to the proposed regulations.  Thereafter, contributions will be invested in a Target Date Fund based on the participant’s age.  The Target Date Funds each only cover four years at a time.  Participants can opt out of the default investment options but the proposed regulations do not state what the other investment options are.

Participants can make non-payroll deduction contributions to the account as well.  If they are made on a recurring basis, at least quarterly, they can be as low as $10.  If they are less frequent and non-recurring, each contribution must be at least $50.  Also, under the proposed regulations, individuals who are not required to be automatically enrolled by their employer may elect to contribute to the program outside of an employment relationship.  The recurring and non-recurring minimum contribution rules above apply to such individuals.

It is important to note that these are only proposed regulations at this point.  However, the period to make public comments on these proposed regulations ends October 24, 2018.

Also, the Board is going forward with the Program despite a lawsuit filed in May, demanding an injunction that the Program be stopped.  See Suit Claims CalSavers is Preempted by ERISA.  In July, the Board filed a motion to dismiss.  The parties filed replies and now we are awaiting a decision by the court.

The August 31st Executive Order may make open MEPs more feasible.

On August 31, 2018, President Trump signed an Executive Order directing the Labor Department to consider issuing regulations and guidance that would make it easier for businesses to join together in Association Retirement Plans also known as open multiple employer plans (MEPs).  It is believed that the Labor Department will act to remove the commonality requirement of existing regulations which requires that all employers participating in the MEP must share some commonality such as being members in the same industry trade group.  So called “open” MEPs don’t meet the commonality rule and each employer is currently treated as adopting its own individual plan rather than one single MEP.  This means each employer’s plan has its own administration and must file its own Form 5500.  In addition, the current regulations contain a “one bad apple rule” that says under a MEP, if a single employer fails to meet qualification requirements, the entire MEP is subject to disqualification affecting all employers.

Of course, we will have to see what the Labor Department does in its new guidance, however, a relaxation of these restrictions would encourage more MEPs to be created and adopted, allowing smaller employers to pool together to enjoy economies of scale in the administration of plans like plans of larger employers enjoy.  This should encourage small businesses to provide retirement plans for their employees and help with the low rate of retirement savings.  In my opinion, this would be a better way to encourage small employers to offer retirement plans than state mandated payroll deduction IRAs which may be preempted by ERISA (see Suit Claims CalSavers is Preempted by ERISA).

In a new private letter ruling (PLR 201833012) released August 17, 2018, the IRS approved amendments to a 401(k) plan that effectively permit the employer to treat an employee’s student loan repayments similar to elective contributions under the plan by making a nonelective employer contribution equal to the matching contribution the employer would have made, if instead of making the loan repayments, the employee made elective contributions of the same amount.  The plan at issue provided that if an employee made an elective pre-tax, Roth, or after-tax contribution of at least 2% of compensation during a pay period, the employer would provide a 5% matching contribution.  The employer proposed to amend the plan to provide for a student loan repayment (SLR) benefit whereby if an employee enrolled in the SLR program and paid back student loans in an amount that was at least 2% of compensation during the pay period, the employer would make a nonelective employer contribution of 5% of compensation regardless of whether the employee made elective deferrals under the plan.  However, any elective deferrals also made while participating in the SLR program would not be eligible for matching contributions.  The SLR nonelective contributions would be subject to the same vesting schedule as the matching contributions.

SLR program may help reduce student loan debt.

The employer asked the IRS to rule that the proposed amendment to the plan to add the SLR program nonelective contributions would not violate the prohibition against “contingent benefits” under the 401(k) regulations. Those regulations provide if a benefit is conditioned on an employee electing or not electing to make elective contributions to a 401(k) plan, the plan will not be considered a qualified cash or deferred arrangement under section 401(k) of the Internal Revenue Code.  The IRS ruled the SLR nonelective contributions are conditioned on the employee making student loan repayments, not elective contributions under the plan.  Therefore, the regulations would not be violated.

INSIGHT.

Key facts in the ruling were that the SLR program was subject to all applicable plan qualification requirements such as eligibility, coverage and nondiscrimination testing.  Nevertheless, this ruling authorizes a plan design to help employees who have significant student loan debt that might prevent them from otherwise participating in the employer’s 401(k) plan.  It effectively gives employees credit for student loan repayments as if they were elective contributions.  The ruling does not discuss what constitutes eligible student loan repayments.  For example, does a parent’s loan for his or her child’s college education qualify for either the parent as the employee-participant?  Nor does it address any loan repayment substantiation requirements.

It is also important to note that the employer already had a fairly generous plan formula (5% match on a 2% employee contribution).  Many employers only match employee contributions on a dollar for dollar basis and some provide no match at all.  Additionally, it seems that if the employer had a significant number of employees enroll in the SLR program and not make any elective contributions to the plan because that money was used to make the student loan repayments, the plan could have difficulty passing the ADP test.  Still under the right circumstances this new plan design could be a tremendous benefit for employers to attract recent graduates who are saddled with significant student loan debt.

The Federal Reserve reports that student loan debt in the U.S. reached 1.5 trillion dollars in the first quarter of 2018, which is more than double the credit card debt.  Additionally, the average student loan debt is over $37,000.  This SLR program plan design, as authorized by the ruling, is a welcome tool that may help fight this crisis.  While a private letter ruling is technically only binding on the taxpayer that requested it, they do provide the reasoning of the IRS and there is no reason to believe the IRS would take a different position with respect to a different taxpayer with similar facts.

Last month,  I reported on how California’s mandated payroll deduction IRA program known as CalSavers is being challenged in court as preempted by ERISA. CalSavers is California’s attempt to address the fact that many Americans do not have the opportunity to save for retirement at their workplace because their employer does not offer a retirement plan.  The California Treasurer’s Office reports that 7.5 million Californians work for employers who don’t offer a plan.  Other states such as Oregon and Illinois have also implemented a state mandated payroll deduction IRA program.

As mentioned last month, I have been critical of these programs because of the open issue of ERISA preemption.  I have also been critical because the limits on how much can be contributed to an IRA are so much lower than those of employer sponsored retirement plans.  An individual under age 50 can only contribute $5,500 annually to an IRA compared to $18,500 for a 401(k) plan.  A Savings Incentive Match Plan for Employees (SIMPLE) plan, available for employers with 100 or fewer employees, allows employees to save up to $12,500 annually.  Therefore, in speeches and presentations, I have encouraged retirement industry professionals to use the mandated IRA programs as incentive to persuade employers to adopt employer sponsored plans.

Now federal legislation has been introduced that, if passed, would also encourage small employers to adopt SIMPLE plans by increasing the limits on the amounts that can be contributed by employees.  The SIMPLE Plan Modernization Act, S. 3197 (Act) was introduced in the Senate July 13 by Senators Susan Collins (R-ME) and Mark Warner (D-VA).  The Act would raise the elective contribution limit for SIMPLE plans to $15,500 for employers with 25 or fewer employees.  The catch-up contribution limit for employees over age 50 would also increase from $3,000 to $4,500.  Additionally, employers with more than 25 employees but no more than 100, would have the option to provide these higher limits but it would cost them a corresponding increase to their mandatory employer contributions by one percentage point.  The purpose of this cost is to continue to encourage such employers to consider transitioning to a traditional 401(k) plan.

SIMPLE plans were first created under the Small Business Jobs Protection Act of 1996 as a cheaper, easier retirement savings plan for small businesses.  Through a SIMPLE plan, an employer contributes to the IRAs of participating employees.  The employer must generally provide an employer contribution of either: 1) a 1 for 1 matching contribution up to 3% of the employee’s compensation contributed; or 2) a nonelective employer contribution of 2% of compensation for all eligible employees.  Under the Act, these contribution amounts would increase to 4% and 3% respectively, for employers with between 26 and 100 employees who opt for the higher limits.

The Act is only a bill at this point and these days nobody can predict what will happen in Washington DC, but it does have bipartisan support.  Additionally, it is a sign that Congress is willing to consider action to improve retirement saving.  Federal legislation that encourages small businesses to adopt plans that permit employees to save for retirement at work, such as the Act, seems like a much simpler way to tackle the retirement savings crisis than leaving it to state laws that might be preempted by ERISA.

For the past year or so, I have been speaking and writing about the California Secure Choice Law authorizing the State’s mandatory payroll deduction IRA program named CalSavers (“Program”).  When implemented, the Program will require private employers who don’t otherwise offer employees a retirement plan to automatically enroll their employees and withhold and contribute to the Program a percentage of the employees’ pay to be invested in an individual retirement account for the employee.  Employees can elect to opt out but must be automatically enrolled first.  In particular, I have stressed that there is still an open issue as to whether the statute creating the Program is preempted by ERISA due to the way the statute was enacted and amended.  And, I have pointed out that it is likely going to require litigation to settle the matter.

On May 31, my prediction came true when the Howard Jarvis Taxpayer’s Association (“HJTA”) and two of its employees sued the Program and the Chair of its Board, State Treasurer, John Chiang, in Federal District Court.  As predicted, the suit maintains that the statute creating the Program is void as preempted by ERISA.  The suit also seeks to enjoin the State from spending any further money on the Program.

State Sailed Legislation Through Rough Water Without Safe Harbor

The issue of ERISA preemption exists because of the history of the Secure Choice Law as well as Federal regulatory developments between the Obama and Trump administrations.  The statute creating the Secure Choice Board was enacted in 2016 and the Program’s implementation was contingent upon the Board reporting to the Governor and State legislature that the U.S. Department of Labor (“DOL”) had issued a safe harbor regulation stating that state run mandated employer payroll deduction IRA plans were not subject to ERISA and that the Program met such safe harbor’s requirements.  In August of 2016, the DOL issued the safe harbor.  In November, Trump won the election and took office in 2017.  In May of 2017, Congress repealed the safe harbor regulation under the Congressional Review Act, providing it shall have no force or effect and Trump signed it.

Also in May of 2017, the Secure Choice Board received a legal opinion from a private law firm stating that even without the Obama administration’s 2016 safe harbor, the Program would not create one or more ERISA plans (see www.treasurer.ca.gov/scib/background.asp).  The legal opinion relied on interpretive guidance by the DOL from 1975 (“1975 Safe Harbor”), finding that a payroll deduction IRA plan is not an ERISA plan where:  1) there are no employer contributions to the plan; 2) the only employer involvement is publicizing the program without endorsing it; collecting employee contributions through payroll deductions and remitting them to the IRA sponsor; 3) employee participation is “completely voluntary”; and 4) the employer receives no compensation from the IRA sponsor.

The opinion summarizes how when the 2016 safe harbor was issued, the DOL stated it was necessary because the 1975 Safe Harbor would not cover a program using auto enrollment.  The DOL analyzed that if an employer voluntarily adopted auto enrollment, it may exercise undue influence over an employee’s decision to participate.  This would prevent the employee’s participation from being completely voluntary because it is not “employee initiated”.  Therefore, the employer has established an ERISA plan.  The opinion then states that where an employer is offering the Program because it is required by State law, the employer is not voluntarily acting to establish a plan, or coercing employees to participate.  Therefore, the employee’s participation through auto enrollment with an opt out should be considered “completely voluntary”.

The Program requires covered employers of a certain size to automatically enroll employees into CalSavers and contribute a percentage of the employees’ pay.  However, the employee may opt out of participation in the Program.  In the first year of implementation, covered employers are those with 100 or more employees.  In the second year, the number drops to 50 or more employees and in the third year it drops to 5 or more employees.  The Board will decide when the Program is ready to be implemented and is aiming for 2019.

If the HJTA lawsuit is successful it would be the end of the Program.  Of course, the Program could appeal the initial decision.  And given that other states, such as Oregon, have similar laws, the issue could eventually wind up before the U.S. Supreme Court to decide.  Of course, this will take time.

Currently, the anticipation of CalSavers becoming effective serves as a great opportunity for the California retirement plan industry to market the value of employers adopting other types of retirement plans that would exempt them from the mandate (such as 401k or SEP-IRA plans), and the flexibility of design they offer to meet an employer’s needs.

The California Supreme Court recently decided an important decision on the issue of when a worker is properly classified as an independent contractor or employee for purposes of California wage orders.  On April 30, the Court decided in Dynamex Operations West, Inc. v. Superior Court, that drivers for a delivery service were employees “for purposes of California wage orders, which impose obligations relating to the minimum wages, maximum hours, and a limited number of very basic working conditions (such as minimally required meal and rest breaks) of California employees.”

The Court held that when classifying workers for purposes of California wage orders, employers must start with the presumption that the worker is an employee and to classify a worker as an independent contractor the worker must pass a three-pronged ABC test.   Failing any prong means the worker is an employee.  The Court said to be classified as an independent contractor the employer must show: “(A) that the worker is free from the control and direction of the hiring entity in connection with the performance of the work, both under the contract for the performance of the work and in fact, (B) that the worker performs work that is outside the usual course of the hiring entity’s business, and (C) that the worker is customarily engaged in an independently established trade, occupation, or business, the worker should be considered an employee and the hiring business an employer under the suffer or permit to work standard in wage orders”.

Clearly this test leans toward employee status.  Prongs B and C are very difficult to meet for a business that substantially uses independent contractors.  For example, drivers for a delivery company, taxi company or private ride requesting company would generally fail these prongs.

Aaron Silva, a partner in Murphy Austin’s Labor & Employment practice group and host of the Murphy Austin HR LegalCast said of the decision, “Importantly, this new case is not a “universal” independent contractor test.  The Court even says it is possible for someone to be an independent contractor for purposes of one law, like workers’ compensation, but not another, like the wage orders.  Regardless, businesses need to be cautious when deciding whether to retain someone as an independent contractor rather than an employee, because the consequences can be severe.”

So what does this mean for employee benefits governed by ERISA?  First, the case says it is limited to wage orders.  Second, ERISA preempts state law.  Therefore, the Dynamex decision would not govern whether a worker is an employee as defined under ERISA.  In fact, the United States Supreme Court has said that one should apply the common law test of agency surrounding the right to control the manner and means by which the work is accomplished to determine if a worker is an employee for ERISA purposes.  Nationwide Mutual Insurance Co. v. Darden, 112 S. Ct. 1344 (1992).  The United States Court of Appeals for the Ninth Circuit, of which California is a part, adopted the common law test for ERISA from Darden in Burrey v. Pacific Gas & Electric, 159 F3d 388 (Ninth Cir. 1998).

Additionally, a worker that is re-classified for California wage order purposes as an employee most likely will not be retroactively eligible for ERISA covered benefits plans because the plan document likely has “Microsoft” language in its eligibility provisions.  This is language resulting from another Ninth Circuit case, Vizcaino v. Microsoft Corp., 120 F.3d 1006 (Ninth Cir. 1997).  In that case, the IRS, on audit, reclassified certain workers from independent contractor to employees based on the common law test and Microsoft agreed with the reclassification.  The workers then sued for retroactive benefits and the court held they were entitled to them.  Since the Microsoft case, most plans contain language stating that workers who agree they are independent contractors will not be retroactively eligible for plan benefits if a government agency determines they were misclassified and retroactively classifies them as employees.  This Microsoft language is in virtually all pre-approved retirement plans.  However, the language of the plan should always be checked, especially if it is an individually designed plan.  Additionally insured health plans that don’t have a “wrap” plan document, probably won’t have Microsoft language.

Thus, it is possible, especially in this gig economy, for a worker to be eligible for minimum wages, break periods, and overtime and not be eligible to participate in the employer’s 401(k) plan.  Therefore, employers should really consider all factors when deciding whether to attempt to classify workers as independent contractors.

Most employee benefits require a written plan document setting forth the terms of the plan.  ERISA requires that every employee benefit plan be established and maintained pursuant to a written instrument.  In addition, the Internal Revenue Code also requires many employee benefits be pursuant to a written plan.  For example, cafeteria plans must be in writing under Code Section 125; self-insured health plans must be written under Code Section 105(h); dependent care assistance plans are required to be in writing under Code Section 129; and Code Section 409A requires nonqualified deferred compensation plans to be operated and maintained pursuant to a compliant written document.

The terms of the benefits plan don’t necessarily have to be contained in a single document, more than one document taken together can make up the plan.  A common example of this is a pre-approved qualified prototype plan which usually consists of at least two documents, a basic plan document (BPD) and an Adoption Agreement.  The BPD contains all the qualification requirements and boilerplate language to be a qualified plan under the Internal Revenue Code.  The Adoption Agreement contains various options for the employer to choose regarding the design of the plan and is completed and signed by the employer indicating it has adopted the BPD as part of its plan.  The National Office of the Internal Revenue Service (IRS) approves the BPD and blank Adoption Agreement and issues an opinion letter to the pre-approved plan sponsor upon which adopting employers can rely.  Both these documents make up the “written plan document.”

It is important for an employer to keep its plan documents in a safe place where they can be easily retrieved for a number of reasons.  First, for a plan governed by ERISA, plan participants may request the plan document from the plan administrator and if it is not provided within 30 days, the plan administrator can be liable for a penalty of up to $110/day that it is late.  Second, the language of the actual plan document may need to be consulted to properly administer the plan, decide claims or settle disputes.  Finally, if your retirement plan is audited by the IRS, the agent is likely going to ask for every plan document since the plan was originally adopted.  That is, the IRS will want the employer to prove that the plan was always a qualified plan in form and was timely amended and restated for changes in the law.  It is also very important to be able to demonstrate that the plan documents or amendments were actually adopted by the employer.  To do so the employer should have signed copies of the plan documents and minutes, resolutions or consents evidencing the action of the appropriate body approving the documents on behalf of the employer.

I write this article because throughout my years of practice, I have had occasion to have to remind employers of the importance of maintaining plan documents.  Many times I have asked for retirement plan documents and was provided only an unsigned Adoption Agreement and have to ask for the BPD.  On occasion a client may then have to obtain the document from a third-party administrator (TPA) or other service provider.  Also, at times, clients simply cannot find a signed version of the plan document.  Once, I had a client inform me they had to retrieve their current document from storage.

Often employers mistakenly rely on their TPA or other service provider to maintain signed copies of their plan documents.  Many TPAs have a policy not to maintain signed copies of plan documents but inform clients that it is the responsibility of the adopting employer to safeguard documents.  Additionally, if the employer changes TPAs, the former TPA has no real incentive to help its former client find old documents.  Ultimately, legally, the responsibility falls on the employer even if it has contracted with a service provider to be responsible for maintaining the plan document.

The act of adopting plan documents or amendments should be well documented like any important employer action.  If the employer is a corporation, minutes or consents reflecting the action should be kept in the corporate book or filed where records of shareholder and directors meetings are kept.  Other types of entities such as limited liability companies and sole proprietorships should also keep them with their important records.  This is important because in an audit or investigation, if the employer cannot find a signed plan document, if it has a blank document and a signed resolution showing that it was approved, this might suffice.

I recommend that one or more persons be assigned the duty of maintaining the complete plan document for each written benefit plan of the employer.  This could be the Secretary of the corporate employer or a similar officer.  It could be the plan administrative committee that acts as plan administrator.  It could be an administrative fiduciary.  The point is that the employer should take action to ensure that someone is monitoring the plan documents.  Many service providers are now offering to store electronic versions of plan documents.  The agreements for such services should be reviewed to determine what responsibilities the provider has with respect to the plan documents.  For example, who is responsible for ensuring that the provider has the most current plan documents?  That they are signed?  Are they stored on multiple servers in the cloud to reduce the chance of them being lost or destroyed upon a server failure?  What happens if the provider loses documents?  Even in such an arrangement, someone from the employer should be designated to ensure that the most up to date documents are provided to the service provider for storage.

Ultimately, it is the employer’s responsibility to establish and maintain the written employee benefit plan document.  Therefore, employers should ensure that all of their employee benefit plans have up to date plan documents that have been properly adopted and are easily retrieved.

The California Secure Choice Retirement Savings Investment Board posted proposed emergency regulations to implement the Secure Choice mandatory payroll deduction IRA program on March 5, 2018, stating it intended to file them with the Office of Administrative Law after 5 days.  However, on March 22, 2018, the Board posted a notice that the rule making process for the proposed emergency regulations would not be initiated until late summer to give the Board time to consult with a yet to be hired third-party administrator for the program and to ensure the most effective coordination.

The program, which the Board has re-named CalSavers Retirement Savings Program (CalSavers), when implemented, will require California employers of a certain size who don’t maintain a tax-qualified retirement plan to automatically enroll employees into CalSavers, a state run, payroll deduction IRA program.  Employers are also required to deduct contributions from employees pay and contribute them to the program unless the employee opts out.  The Board hopes to have the program implemented beginning next year with it applying to employers with 100 or more employees.  In its second year it will apply to employers with 50 or more employees, and in its third year, employers with 5 or more employees.

For more details on CalSavers, come see me speak on “CalSavers:  If You Don’t Have a Retirement Plan, One Will Be Provided For You” at the Capital Forum on Pensions on May 16, 2018.  For more information, follow this link https://wpbcsacramento.org/event-2865770 .