Employee Benefits Developments - February 2021

Hodgson Russ LLP

The Employee Benefits Practice is pleased to present the Employee Benefits Developments Newsletter for the month of February 2021.

Temporary FSA Relief Clarified and Expanded by IRS Guidance

IRS Issues Final Regulations on the Excise Tax Imposed on Executive Compensation Arrangements of Tax-Exempt Organizations

District Court Denies Motion to Compel Arbitration Over Breach of Fiduciary Duties Claims

New Missing Participant Guidance from the DOL

Temporary FSA Relief Clarified and Expanded by IRS Guidance

The IRS issued Notice 2021-15, providing additional guidance on the temporary relief offered under the Consolidated Appropriations Act (CAA). Consistent with the CAA, this Notice allows plan sponsors to amend their cafeteria plans to allow participants greater flexibility regarding the use of health and dependent care flexible spending accounts. This temporary relief includes allowing health and dependent care FSAs unlimited carryovers, grace period extensions, and prospective election changes. Here is a link to our CAA client alert.

This new IRS guidance provides clarity on the administration of this relief, including:

  • Interaction of post-termination Health FSA relief and COBRA. Plan sponsors that adopt the relief allowing terminated employees to spend down the remaining balances in their health FSAs must still offer the qualified beneficiaries the option of electing COBRA. Employees foregoing COBRA may spend down their remaining Health FSA balances without paying a premium. Whereas employees electing to continue coverage under COBRA must pay a premium, but will have coverage up to their full FSA election amount.
  • Interaction of Carryover and Extended Grace Period Relief. Employers may adopt either the carryover relief or the extended grace period relief, but not both for the same plan. In most cases, the flexibility provided by the carryover and grace period relief is the same. That is, they both allow all unused benefits remaining for plan years ending in 2020 and 2021 to be made available incurred in the immediately subsequent plan year. However, because these two forms of relief interact differently with the post-termination health FSA relief, employers must be clear as to whether the carryover or extended grace period relief is being adopted.
  • Dependent Care Tax Reporting. On IRS Form W-2, employers must report amounts contributed to a dependent care assistance program in Box 10. Employers are not required to adjust the amount reported in Box 10 to take into account amounts that remain available during a grace period.
  • Expanded Relief. The IRS Notice also expands the available relief by allowing plan sponsors to make mid-year election changes with respect to employer-sponsored health coverage. This expanded relief is consistent with relief offered last year in IRS Notice 2020-29. Specifically, employees may be permitted to:
  1. make a new election on a prospective basis, if the employee initially declined to elect employer-sponsored health coverage;
  2. revoke an existing election and make a new election to enroll in different health coverage sponsored by the same employer on a prospective basis; and
  3. revoke an existing election on a prospective basis, provided that the employee attests in writing that the employee is enrolled, or immediately will enroll, in other health coverage not sponsored by the employer.
  • Plan Amendment. Consistent with the CAA, this IRS guidance notes that plan amendments for employers adopting any of these optional relief provisions must be adopted no later than the last day of the first calendar year beginning after the end of the plan year in which the amendment is effective, and the plan must be operated consistent with those provisions during the relevant period.

IRS Issues Final Regulations on the Excise Tax Imposed on Executive Compensation Arrangements of Tax-Exempt Organizations

On January 19, 2021, the Treasury Department and Internal Revenue Service issued final regulations under Code Section 4960 (“Final Regulations”), which impose a 21% excise tax on applicable tax-exempt organizations (“ATEO”) that pay remuneration to covered employees in excess of $1 million or provide excess parachute payments.

The Final Regulations do not depart significantly from the proposed regulations issued in June, 2020, or the interim guidance published in Notice 2019-9 (see our article here).

Rejection of Grandfathering Existing Agreements

The Section 4960 excise tax applies to compensation that is paid or vests during tax years commencing after December 31, 2017. Unlike Section 162(m), Congress did not provide an express grandfathering provision. Therefore, the Treasury and IRS concluded that it would not be appropriate to include a grandfather rule to protect executive agreements that were in effect before the Tax Cuts and Jobs Act became law.

Applicable Tax-Exempt Organizations

The Final Regulations leave in place the definition of ATEO as including any organization that:

  • is exempt from taxation under Section 501(a),
  • is a farmers’ cooperative organization as described in Section 521(b)(1),
  • has income that is excluded under Section 115(1), or
  • is a political organization described in Section 527(e)(1).

Under the Final Regulations, Section 4960 does not apply to a governmental entity that claims exemption from federal income tax, unless it happens to also be tax-exempt under Section 501(a). However, governmental entities may be related organizations to ATEOs, and thereby be subject to the excise tax.

In addition, the Final Regulations clarify that remuneration paid to a covered employee of an ATEO by a related foreign organization as described in Section 4948(b) may be taken into account under Section 4960, but the foreign organization itself is not liable for payment of the excise tax.

The Final Regulations indicate that future guidance will be forthcoming regarding the treatment of federal instrumentalities.

Related Organizations – 50% Test

The Final Regulations confirm that related organizations will be determined under the 50% standard relevant to Form 990 filings, rather than the 80% control rules of Code Section 414. Depending on the type of entity, control may mean 50% ownership of stock, a profits interest, or a beneficial interest. In the case of an entity without such interests, control exists if 50% of the trustees or directors are representatives of the entity, or the entity has the power to remove 50% of the directors or trustees. Finally, a related organization includes an entity that is supported or a supporting organization of the ATEO (as defined in Code Section 509(f)(3) and (a)(3)), or that establishes, maintains, or contributes to an ATEO that is a voluntary employees’ beneficiary association.

Covered Employees – Once In Always In

Section 4960 defines “covered employees” as the top five highest paid employees of the ATEO for any tax year beginning after December 31, 2016. All “common law” employees of the ATEO are taken into account, but non-employees such as directors and independent contractors are not included. There is no compensation threshold in order to be covered - the top five highest-paid employees are covered even if none has compensation of $1 million.

The Final Regulations maintain the rule that once an employee is a covered employee the person will remain a covered employee of the organization for all subsequent taxable years. Each ATEO and each related organization must maintain its own list of covered employees.

Exceptions to Covered Employee Status

Commenters expressed concern that employees performing limited, temporary or volunteer services to an ATEO might trigger the excise tax. In response, the Final Regulations clarify and expand on three exceptions:

Non-exempt Funds Exception – An employee is disregarded for purposes of determining an ATEO’s five highest paid employees for a taxable year if s/he was not paid or granted a legally binding right to non-vested remuneration by the ATEO or any related organization, and if his/her time performing service for the ATEO and any related organization over the applicable year and the preceding year do not exceed 50% of his/her total time performing services for the related group. The Final Regulations have expanded this measurement period to two years, and have allowed the determination of the ATEO’s level of control over another organization to be determined without regard to the “downward attribution” rules.

Limited Hours Exception - An employee is disregarded for purposes of determining an ATEO’s five highest paid employees for a taxable year if s/he was not paid or granted a legally binding right to non-vested remuneration by the ATEO or any related organization, and if his/her time (measured in hours or days) spent performing services for the ATEO during an applicable year is less than 10% of the time spent performing services for the entire related group. A safe harbor also exists, whereby an individual is disregarded if s/he does not work more than 100 hours for the ATEO and any related organization during an applicable year, thereby automatically satisfying the less than 10% of hours rule.

Limited Service Exception – The Final Regulations also address situations where the individual provides services to more than one related ATEO. In such cases, an employee is disregarded if the ATEO paid less than 10% of the employee’s total remuneration from the related group, and a related ATEO paid at least 10% of the employee’s total remuneration from the related group.


Remuneration to covered employees includes wages under Section 3401(a) and any amounts required to be included in gross income under Section 457(f). Under Section 457(f), remuneration is included in the calculation of the $1 million excess compensation when such amounts are no longer subject to a substantial risk of forfeiture. The Final Regulations point out that 457(f) requires amounts to be taking into account unless such compensation is conditioned upon the performance of substantial future services. Presently, the Proposed Regulations under 457(f) can be relied upon in making the determination of whether amounts are subject to a substantial risk of forfeiture.

Remuneration does not include the portion of any remuneration paid to a licensed medical professional for the performance of medical services. The Final Regulations are consistent with prior guidance in allowing ATEOs to make a reasonable, good faith allocation of remuneration for medical services and non-medical services provided by an employee. Such an allocation may be based on the terms of a written employment agreement, an analysis of patient, billing or time records, or an estimate of comparable services provided by similarly situated employees.

Applicable Year and Tax Reporting

The Final Regulations leave in place the rule that the “applicable year” is the calendar year ending with or within the ATEO’s tax year. For example, if an ATEO uses the calendar year as its taxable year, the ATEO’s applicable year for 2021 is the period from January 1, 2021 through December 31, 2021. However, for an ATEO using a fiscal year that runs from July 1, 2020 through June 30, 2021, the applicable year will be the 2020 calendar year.

The reporting on Form 4720 and payment of any excise taxes are due on the 15th day of the 5th month after the end of the ATEO’s tax year (May 15 for a calendar year employer), subject to applicable extensions.

Excess Parachute Payments

Payments to a covered employee triggered by an involuntary separation from service can also trigger the Section 4960 excise tax. If the covered employee’s parachute payments equals or exceeds three times the base amount, then the payments result in an “excess parachute payment” – the amount of the payment in excess of the employee’s base amount – that is subject to the tax. The base amount is the average of the employee’s annual compensation over the five most recent taxable years or the portion of the five-year period during which the employee was an employee of the ATEO or a related organization.

For purposes of excess parachute payments, remuneration is not limited to severance payments, but includes obligations to pay fringe benefits, continued health insurance, life insurance and the present value of any deferred compensation triggered by accelerated vesting. The Final Regulations contain an anti-abuse rule that may result in a payment being treated as contingent upon involuntary separation if, for example, the ATEO increases salary or accelerates the vesting of a bonus, or deferred compensation around the time of a separation.

The Final Regulations become effective December 31, 2021.

Department of Treasury, Internal Revenue Service, 26 CFR Parts 1 and 53 [TD 9938], Tax on Excess Tax-Exempt Organization Executive Compensation, Final Regulations, 86 Fed. Reg. 6196 (January 19, 2021).

District Court Denies Motion to Compel Arbitration Over Breach of Fiduciary Duties Claims

Despite the strong federal policy in favor of arbitration, the U.S. District Court for the Southern District of Ohio recently denied a motion to compel arbitration concerning an alleged injury to a defined contribution retirement plan and its participants. In this case, two plaintiffs brought an action pursuant to § 409 and § 502(a)(2) of the Employee Retirement Income Security Act of 1974 (“ERISA”) individually and on behalf of other similarly situated plan participants against Cintas Corporation for breaching its fiduciary duties of loyalty and prudence by mismanaging and failing to investigate and select better cost options for the plan. In response to this lawsuit, Cintas filed a motion to compel arbitration based on the employment agreements signed by the two plaintiffs.

In considering Cintas’ motion, the District Court identified four central issues: “(1) it must determine whether the parties agreed to arbitration; (2) it must determine the scope of the arbitration agreement; (3) if federal statutory claims are asserted, it must consider whether Congress intended those claims to be nonarbitrable; and (4) if the court concludes that some, but not all, of the claims in the action are subject to arbitration, it must determine whether to stay the remainder of the proceedings pending arbitration.” It was the second issue, the scope of the arbitration agreement, that doomed Cintas’ motion.

First and foremost, the District Court found that the plaintiffs’ claims were on behalf of the plan. As mentioned above, the plaintiffs brought this action pursuant to ERISA § 409 and § 502(a)(2). This is important because the Supreme Court has read these sections together to “authorize the Secretary of Labor as well as plan participants, beneficiaries, and fiduciaries, to bring actions on behalf of a plan to recover for violations of the obligations defined in § 409(a).” LaRue v. DeWolff, Boberg & Assocs., Inc., 552 U.S. 248, 253 (2008) (emphasis added). Moreover, the plaintiffs sought relief that would benefit the plan as a whole rather than their individual accounts. Thus, the District Court found that the claims were on behalf of the plan and not for individual relief.

Consequently, because the claims were on behalf of the plan, the question became whether the plan was a party to the arbitration agreement between the plaintiffs and Cintas. The answer was no. Here, the arbitration agreement stated that “the rights and claims of Employee” will be subject to arbitration. However, this provision was limited to the employees and does not extend to nonentities such as the plan. This is in contrast to another dispute where an agreement provided that “[a]ny claim, dispute or breach arising out of or in any way related to the Plan shall be settled by binding arbitration” and the court compelled arbitration. Dorman v. Charles Schwab Corp., 934 F.3d 1107 (9th Cir. 2019). As a result, the District Court denied the motion to compel arbitration because the claims were on behalf of the plan and claims by the plan were not subject to the arbitration agreement between Cintas and the plaintiffs.

This case highlights the importance of drafting when it comes to arbitration agreements. If a plan sponsor wants to arbitrate disputes brought on behalf of a plan, then it is in their best interest to make sure the plan agreement is written clearly to convey that desire. Although federal courts favor arbitration, they cannot compel it when the contract does not. Hawkins v. Cintas Corps., No. 1:19-CV-1062, 2021 WL 274341 (S.D. Ohio Jan. 27, 2021).

New Missing Participant Guidance from the DOL

In January, the U.S. Department of Labor (DOL) published a three-part package of sub-regulatory guidance addressing the topic of missing plan participants. Administering retirement plan distributions with respect to missing participants and uncashed checks has been a vexing challenge for plan administrators, particularly because missing participants draws the attention of government investigators and examiners, and because there has been a dearth of comprehensive guidance on the topic from either the DOL or the Internal Revenue Service (IRS). However, government investigators and examiners have learned through their routine audit and investigatory reviews of retirement plans that plan sponsors and service providers do not always have sufficient practices and procedures for tracking participants when they leave employment, communicating with participants about their eligibility for benefits, locating participants who are missing, and dealing with participants who are unresponsive.

DOL and IRS guidance that has been available on this topic has trickled out in bits and pieces over a period of years, despite regular calls from plan sponsors, service providers and ERISA practitioners for comprehensive guidance. The guidance published by the DOL in January is the latest installment of missing participant guidance promulgated by the DOL. While the guidance is not legally binding and might not be as comprehensive as many were hoping for, it does offer some helpful insights on what practices and procedures plan administrators and service providers should be considering to prudently manage the challenge of distributions for missing and nonresponsive participants.

There are three components to the DOL’s most recent sub-regulatory guidance on the subject of missing plan participants:

A publication entitled “Missing Participants – Best Practices for Pension Plans”

The Best Practices publication issued by the DOL’s Employee Benefits Security Administration (EBSA) includes a list of certain circumstances that can be indicative of a potential problem with missing or nonresponsive participants:

  • More than a small number of missing or nonresponsive participants.
  • More than a small number of terminated vested participants who have reached normal retirement age but have not started receiving their pension benefits.
  • Missing, inaccurate, or incomplete contact information, census data, or both (e.g., incorrect or out-of-date mail, email, and other contact information, partial social security numbers, missing birthdates, missing spousal information, or placeholder entries).
  • Absence of sound policies and procedures for handling mail returned marked “return to sender,” “wrong address,” “addressee unknown,” or otherwise, and undeliverable email.
  • Absence of sound policies and procedures for handling uncashed checks (as reflected, for example, by the absence of an accounting journal or similar record of uncashed checks, a substantial number of stale uncashed distribution checks, or failure to reclaim stale uncashed check funds in distribution accounts).

The Best Practices publication goes on to provide an extensive list of helpful practices EBSA believes have proven effective at minimizing and mitigating the problem of missing or nonresponsive participants. The practices apply equally to both defined benefit and defined contribution retirement plans. And because plan fiduciaries ultimately have fiduciary obligations under ERISA to missing participants, the Best Practices publication also stresses that those fiduciary obligations fully apply even if a plan conditionally forfeits the benefits of a missing participant, as is permitted under the Treasury Regulations – the plan fiduciaries have an obligation to keep accurate records and take appropriate steps to ensure that the participants and their beneficiaries are paid their full benefits when due.

This article does not list all the practices listed in the Best Practices publication, but they fall under four broad headings:

  • Maintaining accurate census information for the plan’s participant population. Eight specific practices are listed that focus on procedures for periodically contacting participants and beneficiaries for the purposes of maintaining and updating census and contact information.
  • Implementing effective communication strategies. Six specific practices are listed that focus on having a sound set of communications to help participants and beneficiaries understand when they are eligible to start plan benefit payments and the importance of confirming and updating their contact information.
  • Missing participant searches. Ten different strategies for locating missing participants are listed (checking related plan and employer records, checking with designated plan beneficiaries and the individual’s emergency contacts, using free online search engines, using a commercial locator service, etc.).
  • Documenting procedures and actions. Three specific practices are listed for plans to document their missing participant policies and procedures, to document action steps to implement those policies and procedures, and to coordinate those documentation efforts with third party record keepers.

The Best Practices publication acknowledges that not every one of the listed best practices is necessarily appropriate for every plan. Plan fiduciaries are expected to prudently consider which practices will yield the best results in a cost effective manner for their plan’s particular participant population.

The Best Practices publication is available here.

Compliance Assistance Release 2021-01

The Release is an internal memorandum that has been made public and outlines the general investigative approach that guides all of EBSA’s Regional Offices that are conducting Terminated Vested Participants Project (TVPP) audits; it is also intended to facilitate voluntary compliance efforts by plan fiduciaries. TVPP audits of defined benefit plans have been an ongoing EBSA initiative. EBSA reports that the TVPP audits have been instrumental in helping missing and nonresponsive participants recover billions of dollars in pension plan benefits.

TVPP audits are intended to ensure that defined benefit pension plans:

  • Maintain adequate census and other records necessary to identify and locate participants and beneficiaries due benefits under the plan, to determine the amount of those plan benefits, and to determine when participants and their beneficiaries are eligible to commence benefits;
  • Have appropriate procedures for advising terminated vested participants (TVPs) of their eligibility to apply for benefits as they near normal retirement age, as well as the date they must start required minimum distributions (RMDs);
  • Implement appropriate search procedures for TVPs and their beneficiaries for whom they have incorrect or incomplete information.

The Release provides a fairly detailed overview of a TVPP audit process, including:

  • The classes of records and documents to be requested to help analyze potential problems a pension plan might have with recordkeeping or administration of benefits for TVPs and their beneficiaries.
  • The errors an EBSA investigator is looking for to determine whether there are systemic issues in the plan’s administration of TVP benefits, including:
    • Systemic errors in plan recordkeeping and administration that create a risk of loss associated with TVPs or their beneficiaries failing to timely enter pay status;
    • Inadequate procedures for identifying and locating missing TVPs and their beneficiaries;
    • Inadequate procedures for contacting TVPs nearing normal retirement age to inform them of their right to commence payment of their benefits;
    • Inadequate procedures for contacting TVPs and the beneficiaries of deceased TVPs who are not in pay status at or near the required beginning date for commencing minimum required distributions;
    • Inadequate procedures for addressing uncashed distribution checks.

The investigator will review the plan census and other records for “red flags” that signal missing participants or incomplete participant data, including obvious data placeholders for missing or incomplete data, returned mail records, more than a small number of terminated vested participants who are eligible to claim benefits and have not done so. Other practices that can suggest a plan’s procedures for dealing with TVPs are insufficient include, for example, continuing delivery of required communications to a known “bad address” without taking steps to verify the correct address, or using benefit notices to TVPs/beneficiaries that do not clearly explain in plain English the recipient’s right to pension benefits or the consequences of not commencing benefits.

  • EBSA’s approach to closing cases where EBSA finds systemic errors in plan records that have hindered TVPs, spouses or other eligible beneficiaries from claiming benefits. Investigators are being advised to promptly inform the responsible fiduciaries of the agency’s findings and invite them to discuss how they can remedy the identified problems. EBSA’s stated aim is to help the plan find as many adversely affected participants and beneficiaries as possible and help the plan fashion an appropriate remedy for each affected individual. EBSA also will ask the plan to take appropriate corrective actions regarding their policies and practices regarding missing participants. In many cases, if the responsible plan fiduciaries provide appropriate remedies for affected individuals and correct any flaws in their recordkeeping, communication, search and other relevant policies, EBSA will recite those corrective steps, without citing the individual plan fiduciaries for specific violations of ERISA when closing out a case.

The published Release offers valuable insight into the standards EBSA will apply as part of a TVPP audit and can further assist defined benefit plans in shaping their practices and procedures for administering TVP benefits.

The Release is available here.

Field Assistance Bulletin 2021-01

The Pension Benefit Guaranty Corporation’s (PBGC) Missing Participants Program (the Program) was originally established by the PBGC to hold the benefits of missing participants under terminating defined benefit pension plans. In 2017, the Program was expanded to also encompass terminating defined contribution plans. The expanded Program represents one of two options terminating defined contribution plans fiduciaries have for addressing distributions missing or nonresponsive participants. The other option is a pre-existing fiduciary safe harbor under DOL regulations that permits a terminating defined contribution plan to transfer the benefits of missing participants to an IRA, certain bank accounts, or to a state unclaimed property fund, subject to satisfying certain notice requirements and meeting other conditions. But the fiduciary safe harbor has not been updated yet to cover transfers by terminating defined contribution plans to the PBGC under the Defined Contribution Missing Participants Program.

Field Assistance Bulletin 2021-01 (the FAB) announces a temporary enforcement policy for terminating defined contribution plans’ (e.g., 401(k) plans) use of the PBGC’s Defined Contribution Missing Participants Program. Until further guidance is made available, the DOL will not pursue violations of ERISA fiduciary standards against the responsible plan fiduciaries of terminating defined contribution plans in connection with the transfer of a missing or nonresponsive participant’s or beneficiary’s account balance to the PBGC Program rather than to an IRA, certain bank accounts, or to a state unclaimed property fund, as specified in the DOL fiduciary safe harbor, as long as the transfer to the Program meets certain conditions including the following:

  • The responsible fiduciary still must act in accordance with a good faith, reasonable interpretation of ERISA’s fiduciary standards.
  • The temporary enforcement policy does not relieve the responsible plan fiduciary from its obligation to diligently search for participants and beneficiaries prior to the transfer of their account balances to the PBGC Program, or its obligation to maintain plan and employer records.
  • The responsible plan fiduciary must otherwise comply with the requirements of the fiduciary safe harbor, except that the content of the notice to participants and beneficiaries must be modified to reflect the transfer to the PBGC. Notices to participants and beneficiaries must state clearly that their account balances are being transferred to the “Pension Benefit Guaranty Corporation’s Defined Contribution Missing Participants Program,” and include the PBGC’s website address and customer contact number.
  • The responsible plan fiduciary may pay the applicable PBGC fee from the transferred account, unless the plan terms prohibit such payment.
  • The DOL encourages plan fiduciaries who do not elect to transfer account balances to the PBGC to participate in the PBGC Defined Contribution Missing Participants Program by voluntarily electing to notify the PBGC about the disposition of the account balances of all or some missing participants.

Note that the FAB also is applicable to qualified termination administrators (QTA) of abandoned defined contribution plans.

The FAB is available here.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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