On April 11, 2019, the Howard Jarvis Taxpayer’s Association (HJTA) filed its amended complaint challenging the propriety of California’s new CalSavers retirement program after a federal district court dismissed its first complaint on March 29, 2019.  See CalSavers Saved from ERISA Preemption By District Court.  Like the first complaint, the amended complaint attacks the statutory program in two ways.  First, it argues that the program is preempted by ERISA and therefore should be declared void.  Second, under California state law, the complaint asks the court to enjoin the implementation of CalSavers as a waste of taxpayer funds.

The amended complaint emphasizes that since the 2016 Department of Labor safe harbor for savings  arrangements established by states for nongovernmental employees was repealed by Congress that there is no exception from ERISA preemption.  Additionally, since under the CalSavers statute, the state is not liable for any loss of the payroll deduction contributions, the purposes of ERISA are thwarted by the program.

The complaint further alleges that since the CalSavers program has already spent over $1.5 million and has requested to borrow $20,000,000 more to further implement the program, the state is wasting taxpayer money when all California employees already have access and opportunity to save for retirement through private IRAs.  CalSavers has until May 25, 2019 to file its answer to the amended complaint.

To learn more about the CalSavers program and lawsuit, attend the Capitol Forum on Pensions on June 5, 2019, at Arden Hills resort in Sacramento which will have a session called “CalSavers is Here…Are You Ready?” featuring a panel of myself, Aaron Karr, from Ameriprise Financial, and a representative from CalSavers.  Details of the conference can be found at this link CFOP.

On March 29, 2019, the United States District Court for the Eastern District of California dismissed the lawsuit filed by the Howard Jarvis Taxpayers Association (HJTA) maintaining that CalSavers, California’s mandated auto-enrollment payroll deduction IRA retirement savings program, is preempted by ERISA.   The court found that HJTA had standing to bring the suit and that the case was ripe for decision and would not dismiss on those grounds.

It also found that CalSavers could not rely on a 1975 Department of Labor Safe Harbor to argue ERISA did not preempt CalSavers.  The Safe Harbor rules that programs whereby employers remit payroll deduction contributions to employee IRAs for employees whose participation is completely voluntary did not establish plans subject to ERISA.  However, CalSavers could not use the Safe Harbor to argue that employee participation was completely voluntary for its program, requiring automatic enrollment with an employee’s ability to opt out, because “completely voluntary” was not defined in the safe harbor.   Still, the court found that ERISA did not preempt CalSavers on general preemption principles.

Under general principles of preemption the court found that because CalSavers only applies to employers who don’t have existing retirement plans, no ERISA plans are governed or interfered with by it. Therefore, ERISA’s primary purposes of ensuring employees receive promised benefits and protecting employers from the burden of meeting multiple regulatory requirements in managing plans are not implicated.  CalSavers does not require employers to promise any benefits to employees and remitting payroll deduction contributions to CalSavers is simply a ministerial act.  The court cited the Golden Gate Resturant Association, 546 F.3d 639 (9th Cir. 2008), case that upheld San Francisco’s ordinance requiring employers within the city to make minimum healthcare expenditures on behalf of their employees as not being preempted by ERISA because the ordinance did not require employers without ERISA plans to establish one, just to contribute to the city administered plan. The court concluded that finding that ERISA preempted CalSavers would be “out-of-step” with ERISA’s underlying purposes because CalSavers does not govern an ERISA plan’s administration nor interfere with uniform plan administration.

The court did grant HJTA 20 days to amend its complaint.  Unless HJTA files an amended complaint or otherwise appeals the case to the Ninth Circuit, CalSavers is here to stay.  Employers with 100 or more employees who don’t otherwise provide a retirement plan must register and automatically enroll employees by July 1, 2020 or face penalties.  The number of employees then drops to 50 in 2021, and 5 in 2022.

I don’t believe much in coincidence when it comes to politics.  It is clear that the President and current administration believe that the Mueller Report exonerates the President from any wrongdoing with respect to the Russian interference in the 2016 election or the subsequent investigation.  Others disagree with respect to the obstruction of justice issue and congressional investigations continue.

It is interesting though that just a day after the Attorney General issued his summary of the Mueller report, the Justice Department changed its position regarding the federal case involving the constitutionality of the Affordable Care Act (ACA) on appeal before the United States Court of Appeals for the Fifth Circuit, Texas v. United States, No. 19-10011.  In December of last year, a federal judge of a U.S. District Court in Texas found the entire Affordable Care Act to be unconstitutional because Congress virtually repealed the individual mandate by decreasing the tax on individuals for not having health insurance, to zero.  Texas v. United States, 352 F.Supp.3d 665 (N.D. TX 2018).  The case was appealed to the Fifth Circuit and originally the U.S. Justice Department argued that if the individual mandate was no longer constitutional than the protections against pre-existing conditions of the Act were also unconstitutional.  On Monday, March 25, the Justice Department lawyers informed the Fifth Circuit that it now agrees entirely with the lower court decision that the entire Act is unconstitutional and will file a brief arguing the lower decision should be upheld in its entirety.

Coincidence? Or is the Administration emboldened by its perceived victory?  Senator Brian Schatz (D-Hawaii) seems to believe it’s the latter as he tweeted, “The Barr summary clearly demonstrates Republicans are trying to take your healthcare away.”

In any case, the new Justice Department position means the fight over the ACA and healthcare in general, rages on.  Regardless of the Fifth Circuit’s decision, it is likely to be appealed to the U.S. Supreme Court.  Of course, we know that President Trump was successful in getting his last nominee for Supreme Court Justice approved.  Therefore, the administration may like their chances to end the ACA at the high court.

In the meantime, on March 26, House Democrats introduced the Protecting Preexisting Conditions and Making Health Care More Affordable Care Act of 2019, a bill to preserve and strengthen the ACA by, among other things, protecting coverage for pre-existing conditions, expanding the availability of subsidies and increasing premium tax credits.  Other Democrats, and Independent Senator Bernie Sanders, are pushing for “Medicare for all” legislation but that is not included in the bill introduced on March 26. Democrats see protecting the ACA as a big part of the mid-term elections that gave them control of the House.  It is also likely to be a big part of the 2020 election.

As a result of the 2017 Tax Act, the costs of providing qualified parking to employees as a tax-free fringe benefit is not deductible by for-profit employers and is subject to a 21% tax for tax exempt organization employers.  Interim guidance provided by the Internal Revenue Service in Notice 2018-99 in December sets forth a four step process in determining how much of the cost of providing parking is nondeductible or taxable, respectively.  Where the parking is owned or leased by the employer, step 1 provides that the percentage of the total cost of parking that represents spaces that are reserved exclusively for employees are nondeductible by for-profit employers or taxable to exempt organization employers up to the $260 per month per employee excluded from their income.  Parking may be exclusively reserved for employees by a variety of methods, including signage or limiting access.

However, the Notice also contains an important election until March 31 of this year for an employer to change the characterization of some or all employee parking spots from reserved exclusively for employees to not so reserved and to treat those spots as not reserved retroactively to January 1, 2018.  This could save significant taxes for the 2018 tax year, but time is running out.

To change the characterization, the employer would have to change the method that made the parking reserved exclusively for employees such as signage or limited access.  Once the parking spaces are re-characterized, the remaining steps must be made to determine how much of the parking costs are nondeductible or taxable, respectively.  This includes determining how many spaces are reserved or primarily used (more than 50% of the time) for the general public, which are deductible by for-profit employers and not taxable to exempt employers.  If no spaces are reserved for employees or the general public, an allocation based on the typical use of the parking on a normal day between employee use and general public use must be determined.  Re-characterization could save taxes but like most things the numbers must be run.  This should be done before the meter expires at the end of this month.

Code section 4960 is not reaching one of the major sources of tax that it was intended to, well compensated coaches and athletic directors at public colleges and universities.

The 2017 Tax Act enacted section 4960 to the Internal Revenue Code, a new provision imposing a 21% tax on “applicable tax exempt organizations”, including 501(c)(3) charitable organizations, that pay any of their top five paid employees more than $1 million in annual compensation.  This tax was supposed to even the playing field with for profit public corporations that lost the ability to deduct compensation in excess of $1 million.  Additionally, applicable tax exempt organizations must pay the tax on excess parachute payments.  These are payments on account of termination of employment that exceed three times the average compensation paid to the employee for the past five years.

The types of applicable tax exempt organizations subject to the tax is quite broad.  It specifically includes all organizations exempt under Internal Revenue Code section 501(c) such as 501(c)(6) trade associations, 501(c)(5) labor organizations, and 501(c)(7) social clubs.  It also includes tax exempt farmers cooperatives under Code section 521, Political Action Committees under Code section 527 and any organization whose income is excluded from taxation under Code section 115(1) as the exercise of an essential government function accruing to a state or political subdivision of a state.

This is quite a large net designed to ensnare many tax exempt organizations and it was so intended.  However, when the IRS issued interim guidance on the tax in January under Notice 2019-09, it legitimized a major loophole in the statutory language that permits certain public colleges and universities to escape the tax.  This is a major development because the compensation of athletic coaches at public universities is one of the sources the tax was aimed at.

The issue surrounds the definition of an applicable tax exempt organization subject to the tax.  Public colleges and universities were not specifically named in the statute.  Many state colleges and universities have not been recognized by the IRS as tax exempt educational organizations under Code section 501(c)(3) because they never applied for such recognition from the IRS.  Others have applied and been so recognized to help with charitable giving efforts.  Also, many state schools are not separate entities from the state government and therefore, Code section 115(1) does not apply to them.  Instead, they consider themselves an integral part of the state government and exempt from taxation under the “implied statutory immunity” doctrine.  That doctrine basically says that if the federal government wants to tax states or political subdivisions it must specifically do so or implied immunity will prevent it.  An example of specific Congressional action was specifically including public colleges and universities as organizations subject to the unrelated business income tax when it was enacted in the 1950’s.  However, as mentioned, public colleges and universities are not specifically named in Code section 4960.

Thus, many public universities such as the University of Alabama that pays its football coach, Nick Saban, over $8 million annually, arguably escape the tax as the law is written. However, according to the General Explanation of the 2017 Tax Act prepared by the Congressional Joint Committee on Taxation (Committee), the statute was intended to apply to all public colleges and universities but the committee acknowledged that a legislative technical correction may be needed to reach this intention.  In its approach to section 4960 in Notice 2019-9, the IRS admitted that the statutory language does not reach public colleges and universities exempt under implied statutory immunity.  In fact, the Notice advises that such institutions that have received a determination letter from the IRS recognizing them as exempt under Code section 501(c)(3) may relinquish this status to avoid being subject to the tax.

Prior to the issuance of the Notice, legal scholars debated whether the IRS could still impose the tax on colleges and universities exempt under implied statutory immunity.  Some argued that regardless of whether an institution applies for recognition as exempt under Code section 501(c)(3) from the IRS, they are exempt under that section as an educational institution because the law grants them exemption not the IRS.  Therefore, the tax applies.  Others argued that all such schools fall under Code section 115(1).  The interpretation of the statute by the IRS in the Notice ends any such debate and makes it clear that legislation is needed to close the loophole.

Thus, the current status of the law is that Code section 4960 is not reaching one of the major sources of tax that it was intended to, well compensated coaches and athletic directors at public colleges and universities.  According to a 2016 study by ESPN the highest paid state employee was a college football or men’s basketball coach in 39 of the 50 states.  Therefore, without a legislative change this tax is likely to fall well short of the Committee’s estimate of raising $1.8 billion over 10 years.  Additionally, this loophole is unfair to private colleges and universities who pay coaches over $1 million such as Stanford, Northwestern, and Notre Dame, who cannot avoid the tax like their public counterparts.

Unfortunately, the prospect of legislation to close this loophole getting through a divided Congress and being signed by President Trump doesn’t look very promising.



Whether a plan permits hardship distributions is up to the employer when designing the plan.

Last November, the IRS issued proposed regulations incorporating several legislative changes regarding the ability of a 401(k) or 403(b) plan to make distributions to participants to relieve a hardship caused by an immediate and heavy financial need.  Of course, whether a plan permits hardship distributions is up to the employer when designing the plan.  Likewise, these changes give employers discretion in many areas to design their plan as to what, if any, hardship distributions will be allowed. These changes are described below.

Expansion of Safe Harbor Events.  A plan can provide that an immediate and heavy financial need is determined under a facts and circumstances test or it can choose from among a list of safe harbor events that are deemed to meet the immediate and heavy financial need test.  The proposed regulations address the expansion of the safe harbor events by adding three new events that qualify as of January 1, 2018.

  1. Primary Beneficiary. The qualifying medical, educational, and funeral expenses of the participant’s primary beneficiary under the plan has now been added to the safe harbor events to conform to a Pension Protection Act of 2006 change in the law.  Previously such expenses were only included for the participant, spouses, children, and dependents.
  1. Casualty Deduction Limit Eliminated. Safe harbor events include expenses to repair damage to a participant’s principal residence that qualify as a casualty loss deduction under Internal Revenue Code Section 165.  However, the 2017 Tax Act amended Section 165 to provide the deduction may only be taken if the participant’s home is in a federally declared disaster area.  The proposed regulations clarify that this federally declared disaster restriction does not apply for purposes of the safe harbor.
  1. Federal Disasters. Added to the safe harbor list is expenses and loss of income resulting from a federally declared disaster when the participant lives or works in the disaster area.

Expansion of Sources of Distribution.  Previously, hardship distributions could only be made from an employee’s elective deferrals under the plan and not even earnings on those deferrals.  The proposed regulations permit hardship distributions to be made from earnings, QNECs, and QMACs of 401(k) plans beginning in 2019.  However, for 403(b) plans, the restriction earnings remains and hardship distributions may only be made from QNECs and QMACs if they are held in custodial accounts. It should be noted that whether to allow distributions from these sources is discretionary, not required.  Therefore, employers need to decide as a matter of plan design whether to permit them.

Relief Provisions.  The proposed regulations also contain a number of relief provisions aimed at making the consequences of taking a hardship distribution less severe.

  1. Elimination of Six-Month Suspension. The proposed regulations eliminate the required suspension of the employee’s elective deferrals for six months following a hardship distribution. The suspension is prohibited for hardship distributions on or after January 1, 2020.  For 2019, the employer may choose to remove the suspension and may do so retroactively for employers currently under the suspension period.
  1. Elimination of Loan Requirement. Previously to be eligible for a hardship distribution the employee must have first taken all available loans under the plan to try to relieve the financial need.  This requirement may be eliminated beginning in the 2019 plan year. This too is not a required change but permissive.
  1. Substantiation. Beginning in 2020, when applying for a hardship distribution, the employee will have to represent that he or she has insufficient cash or liquid assets to satisfy the immediate and heavy financial need.  Plan administrators may rely on such representation.

Plan Amendments.  The IRS has requested comments on the proposed regulations within 60 days of their publication.  They may change the proposed regulations before finalizing them.  Plan documents will have to be amended to make any of the changes, however, the proposed regulations do not address when they will need to be made.  The preamble only addresses individually designed plan by stating they must be amended after the changes appear on the IRS list of amendments.

Many employers use preapproved plans and the sponsor of these plans may adopt default provisions but allow adopting employers to opt out of the default to design their own changes.  Employers need to decide whether they will make any optional changes and what needs to be done to implement required changes.  Hardship distribution forms and procedures will likely need changing as well as the summary plan description.

The IRS issued Notice 2018-97 (Notice) on December 7, 2018, providing some much needed guidance on interpreting Internal Revenue Code (Code) section 83(i) for qualified equity grants. Section 83(i) was added to the Code as part of the 2017 Tax Cuts and Jobs Act effective at the beginning of this year and permits employees granted stock options or Restricted Stock Units (RSUs) under a “qualified equity grant” to elect to defer the income tax resulting from the receipt of stock from the exercise of an option or the settling of the RSU for up to five years. See New Section 83(i) Provides a New Tool for Allowing Employees to Participate in the Sale of their Private Corporation-Employer, and A More Detailed Look at Section 83(i) Plans. The Notice was issued as a result of stakeholders requesting guidance from the IRS on certain aspects of section 83(i). The Notice provides guidance on calculating the number of employees receiving grants in the year to determine if the 80% test is met; the employer’s obligation to withhold income tax on the deferred income; and how an employer can opt out of a grant being subject to section 83(i) if its provisions are otherwise met.

Annual 80% Test. Section 83(i) provides that if qualified stock is transferred to a qualified employee who makes an 83(i) election, then the income tax on such transfer can be deferred up to five years. Qualified stock is defined as stock received by a qualified employee from the exercise of a stock option or the settlement of an RSU that was granted when the corporation was an eligible corporation. An eligible corporation is one that issues grants of stock options or grants of RSUs to at least 80% of its qualified employees (80% Test).

The Notice clarifies that the 80% Test only counts grants made during the calendar year and does not count grants made in prior years on a cumulative basis. In applying the 80% Test, employers must take into account the total number of non-excluded full time employees employed during the calendar year. This means the 80% Test is only met if the grants are made to at least 80% of the highest number of such employees during the year.

Income Tax Withholding. The Notice also reiterates how the employer is responsible for income tax withholding when the deferred income becomes taxable as wages to the employee. Income tax is to be withheld at the maximum rate which is currently 37%. The employer must make a reasonable estimate of the value of the stock at that time. However, withholding can be a problem if the employee who made the election no longer works for the employer. To remedy this, the Notice provides that the 83(i) election must provide that the employee agrees that stock subject to an 83(i) election must be held in escrow until: 1) the corporation has recovered the income tax withholding amount form the employee; or 2) between the date of income inclusion and March 31 of the following year, the employer retains an amount of stock with a fair market value equal to the amount of income tax withholding.

Opting Out. As soon as section 83(i) became law, the question arose as to whether any qualified employee participating in a stock option plan or RSU plan of an employer could make a valid 83(i) election if the grant met the requirements of section 83(i). The Notice somewhat clarifies this by providing an employer can avoid a plan being subject to section 83(i) by simply declining to offer the required escrow arrangement described above. Further, the terms of the stock option or RSU may provide that no 83(i) election will be available with respect to stock received upon exercise or settlement.

Conclusion. The Treasury Department intends that the guidance under the Notice will be incorporated into regulations in the future and the Notice guidance will be effective as of December 7, 2018, the date of the Notice. Any other future guidance will apply prospectively. The Treasury Department and IRS are requesting comments through February 5, 2019.

While the clarifications under the Notice are helpful, they do add additional complexity to the administration of plans eligible for the 83(i) election. Employers have to count all eligible employees throughout the year of grant to determine whether the stock issued as a result of that grant qualifies for the election. Additionally, 83(i) elections now must contain the required escrow arrangement language. This may require existing election forms to be rewritten. Employers considering adopting a stock option or RSU plan might decide not to offer the 83(i) deferral due to such complexity. Still for start-up companies or smaller employers who want to give a significant number of employees “skin in the game”, a section 83(i) eligible plan could be quite useful.

Plans Must Be Amended for New Disability Claims Procedures

The U.S. Department of Labor’s final disability claims procedures became effective for disability claims filed after April 1, 2018.  See No Fooling: New Disability Claims Procedures are Effective April 1, 2018. Any qualified or nonqualified retirement or deferred compensation plan governed by ERISA (including top hat plans that only cover a select group of management or highly compensated employees) that conditions a benefit on a determination of disability by the plan administrator must include the new procedures. 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.  Plan documents generally must be amended by the end of the plan year that includes April 1, 2018.  For calendar year plans that means by December 31, 2018!

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.