IRS Publishes Final Hardship Withdrawal Regulations

The Pension Protection Act of 2006 (PPA), the Tax Cuts and Jobs Act of 2017 (TCJA), and the Bipartisan Budget Act of 2018 (the Budget Act) included statutory changes affecting the hardship withdrawal rules for 401(k) plans. As we reported in our November 2018 Employee Benefits Newsletter, the IRS published proposed regulations that addressed changes made to the hardship withdrawal rules. After receiving relatively few comments on the proposed regulations, the IRS has now published the final version of those hardship withdrawal regulations.

In publishing the final regulations, the Department of the Treasury states that the “final regulations are substantially similar to the proposed regulations,” and confirmed “plans that complied with the proposed regulations will satisfy the final regulations.” Nonetheless, there are minor clarifications made by the final regulations that are noteworthy:

• Under both the proposed and final regulations, the employee must represent (in writing or by an electronic medium) that he or she has insufficient cash or other liquid assets to satisfy the financial need. A plan administrator may rely on that representation unless the plan administrator has actual knowledge to the contrary. The requirement to obtain this representation generally applies to any distribution that is made on or after January 1, 2020. The final regulations, however, clarify that an acceptable form of electronic medium for receiving the representation includes an employee’s verbal representation that is obtained via telephone if it is recorded.
• Both the proposed and final regulations included language that prohibits a plan from including a provision under which an employee’s elective contributions would be suspended as a condition of obtaining a hardship distribution. The final regulations, however, now limit the prohibition on suspensions of employee elective contributions to qualified retirement plans, section 403(b) plans, and eligible deferred compensation plans described in Code Section 457(b) maintained by governmental entities. Accordingly, a plan subject to Code Section 409A (i.e., a nonqualified deferred compensation plan) may retain its elective contribution suspension provisions (or, to the extent consistent with Code Section 409A, the plan may be amended to remove them).

Many of the hardship rule changes that were otherwise addressed in the proposed regulations are now finalized by the final hardship regulations and remain optional (expanded sources for hardship distributions; eliminating the “deemed necessary” standard under which an employee first must take available plan loans prior to obtaining a hardship distribution; adding the “primary beneficiary under the plan” as an individual for whom qualifying medical, educational, and funeral expenses may be incurred; adding a new type of safe harbor expense for expenses and losses (including loss of income) incurred by the employee on account of a federally-declared disaster; etc.). The final regulations provide that the hardship distribution rule changes generally may apply to distributions made on or after January 1, 2020 (rather than, as in the proposed regulations, to distributions made in plan years beginning after December 31, 2018).

However, the hardship distribution rule changes, at the option of the plan sponsor, may be applied to earlier distributions made in plan years beginning after December 31, 2018. And the prohibition on suspending an employee’s elective contributions and employee contributions as a condition of obtaining a hardship distribution may be applied as of the first day of the first plan year beginning after December 31, 2018, even if the distribution was made in the prior plan year. In addition, the revised list of safe harbor expenses may be applied to distributions made on or after a date that is as early as January 1, 2018.

The required changes (i.e., the required employee representation, and prohibiting suspensions of elective deferrals as a condition for obtaining a hardship distribution) must in any event take effect January 1, 2020, and plans that offer hardship withdrawals must begin to comply with those required rule changes at that time even if the deadline for amending the plan is somewhat later. If a plan sponsor chooses to apply the hardship distribution rule changes to distributions made before January 1, 2020, the new rules requiring an employee representation and prohibiting a suspension of contributions may be disregarded with respect to those earlier hardship distributions.

Plans that offer hardship distributions will need to be amended to reflect both the required hardship rule changes as well as any optional rule changes plans choose to implement. For an individually designed plan that is not a governmental plan, the deadline for amending the plan to reflect a change in qualification requirements is the end of the second calendar year that begins after the issuance of the annual Required Amendments List (RAL) that includes the change. Assuming the final hardship regulations are included in the 2019 RAL, the amendment deadline for such individually designed plans is expected to be December 31, 2021. For an employer using a pre-approved plan, the amendment deadline will be the interim amendment deadline for making required changes, which might make the amendment deadline somewhat earlier (e.g., due by the tax-filing deadline (plus extensions) for 2020). The amendment deadlines for pre-approved and individually designed section 403(b) plans is March 31, 2020, but the Treasury Department and IRS are still considering a possible later amendment deadline for the amendments relating to the final regulations.

Federal Agencies Defer Rule Requiring Crediting Drug Coupons towards Health Plan Cost Sharing

Under new guidance issued on August 26, 2019, the three federal agencies charged with implementing the Affordable Care Act have announced they will not enforce a rule requiring the crediting of drug manufacturer coupons towards health plan annual out-of-pocket maximums in situations where no generic equivalent is available.

Previously, the Department of Health and Human Services published the Notice of Benefit and Payment Parameters for 2020 (“NBPP”). The NBPP included a rule permitting health plans to exclude the value of drug manufacturers’ coupons from the calculation of annual cost sharing limits when a medically appropriate generic equivalent is available. Per the preambles to the NBPP, the converse was also true, that health plans must credit drug discounts towards annual out-of-pocket maximums when no generic equivalent is available.

This NBPP guidance on the application of drug coupons towards health plan cost sharing limits has now been put on hold due to a potential conflict with existing IRS guidance on the topic. In 2004, the IRS issued guidance (Notice 2004-50, Q&A-9) stating that drug discounts would not disqualify an individual from being HSA-eligible provided that the Plan disregarded the drug discount in determining whether the annual deductible was satisfied.

Thus, the IRS would require the value of the discount to be ignored in determining whether the annual HDHP deductible was satisfied. In contrast, the HHS notice would require that the drug discount be applied to determine if the annual out-of-pocket maximum was met in situations where no generic is available.

To address this potentially conflicting guidance and to allow the three agencies to issue new guidance about the effect of drug manufacturer discounts on plan cost sharing limitations, the agencies have issued temporary non-enforcement relief. Until the NBPP for 2021 is effective or other guidance is issued, health plans may continue to exclude the value of drug coupons from the calculation of annual cost sharing limits, including in situations where no generic equivalent is available.

PLR Allows Health FSA Reimbursement of Genetic Testing

The Internal Revenue Service issued a Private Letter Ruling (PLR) stating that certain genetic testing services and related reports constitute medical care and may be reimbursed as an eligible medical expense under a health flexible spending account (Health FSA). With the recent rise of genetic testing services, individuals are able to obtain information on their ancestry and in some cases information on health predisposition and wellness reports, based on their DNA samples. The PLR makes it clear that ancestry portion of these services are not considered eligible medical expenses. Therefore taxpayers must allocate the cost of the DNA collection kit between the ancestry service and the health service using a percentage (cost of the health service / total cost of ancestry plus health service). The taxpayer may use a reasonable method to value and allocate the cost of the health services between services that are medical care (e.g., lab tests) and non-medical services (e.g., reports that provide general information). As with all PLRs, the IRS ruling is directed only to the taxpayer requesting it. However, as a result of this guidance, administrators of Health FSAs and Health Reimbursement Accounts may find that they will be asked to adjudicate these types of claims. PLR -132576-18

Third Circuit Addresses Partial Withdrawal Liability Situation

Caesar’s Entertainment Corporation operated four casinos in Atlantic City, New Jersey. Each casino was covered by a collective bargaining agreement for engineering work that required contributions to IUOE Local 68 Pension Fund. In 2014, Caesar’s closed its Showboat Casino in Atlantic City. It continued to operate the other three casinos and continued to contribute to the Fund for the engineering work that was performed at those locations. The closure of the Showboat Casino operation reduced Caesar’s contributions to the Fund by 17%. Thus, the cessation of operations at the Showboat Casino did not trigger a partial withdrawal because total contributions made by Caesar’s to the Fund remained well above the 70% decline threshold for a partial withdrawal.

The Pension Fund sought to impose withdrawal liability under a different partial withdrawal rule. Under this other so called “bargaining out” provision, an employer would have a partial withdrawal if it ceases to have an obligation to contribute to a plan under one or more but fewer than all collective bargaining agreements and it continues to perform work in the jurisdiction of the type for which contributions were previously required. The Fund argued that the shutdown of the Showboat operation resulted in a cessation of the obligation to contribute under one collective bargaining agreement and that Caesar’s continued to perform work in the jurisdiction as Caesar’s performed engineering work at the other three casino locations. The Fund won this argument at the arbitration level. The district court overturned the arbitrator’s decision and the Third Circuit Court of Appeals now agreed that a partial withdrawal had not occurred.

The Third Circuit found that for a partial withdrawal to occur it was necessary for work to continue to be performed within the jurisdiction and that the work did not result in contributions to the Fund. Here, because the work at the other casinos continued and contributions to the Fund were made, there was no partial withdrawal. The Court found that a mere closing of one location and shifting the work to other locations with continuing contributions to the Fund would not result in a withdrawal liability. The Court also pointed to guidance in an opinion letter issued by the PBGC that reached this same conclusion.

The employer in this case was successful in defeating the Fund’s claim of withdrawal liability. However, this case again demonstrates that multiemployer plans are increasingly aggressive in their attempts to impose withdrawal liability in many day-to-day situations. Caesars Entertainment Corp. v. Int’l Union of Op. Engineers Local 68 Pension Fund, 3d Cir., 2019

9th Circuit Enforces Plan Arbitration Provision

In a recent case, the 9^th Circuit Court of Appeals upheld a provision in the Schwab Retirement Savings and Investment Plan (the “Plan”) requiring that any dispute relating to the Plan be settled by binding arbitration. The arbitration provision also included a class action waiver.

The plaintiff in the case was a former participant in the Plan who filed a class action suit alleging that the Schwab defendants had breached their fiduciary duties under ERISA by including poorly performing Schwab-affiliated investment funds in the Plan’s investment lineup that generated fees for Schwab. In 2014, the Plan had been amended to add the arbitration provision, effective as January 1, 2015. Thus, in response to the plaintiff’s suit, the Schwab defendants moved to compel arbitration.

The district court refused to compel arbitration. On appeal, the 9^th Circuit reversed, reasoning that Supreme Court precedent had effectively overturned prior 9^th Circuit precedent that arbitrators were not qualified to hear ERISA arbitrations. The 9th Circuit further held that, because any fiduciary breach claim is brought on behalf of the Plan, and the Plan had agreed to arbitrate any claims as a result of the 2014 amendment, the plaintiff’s claim was covered by the arbitration provision.

The case leaves unanswered a number of critical questions, including how to reconcile an individual participant’s damages in an arbitration with the notion that a fiduciary breach claim is brought on behalf of the Plan as a whole. (Dorman v. The Charles Schwab Corporation, 9^th Cir. 2019).