The Employee Benefits practice is pleased to present the Benefits Developments Newsletter for the month of October 2018. Click through the links below for more information on each specific development or case.
IRS Issues New Model 402(f) Safe Harbor Notice
Plan administrators of plans qualified under Internal Revenue Code (Code) Section 401(a) (401(k) plans, profit sharing plans, defined benefit pension plans, etc.) must provide a prescribed tax notice (sometimes referred to as the “special tax notice”) described in Code Section 402(f) to any recipient of an eligible rollover distribution. A similar requirement is applicable to other retirement plans, including Code Section 403(b) plans and governmental Code Section 457(b) plans. The special tax notice must be provided within a reasonable period of time before making an eligible rollover distribution.
To help plan administrators comply with the 402(f) special tax notice requirement, the IRS, for several years, has been periodically publishing safe harbor notices that plan administrators may use to satisfy the notice requirement. From time to time, the IRS will update and republish the safe harbor notices when there are significant rule changes that need to be incorporated into the 402(f) notice.
A plan administrator may customize a safe harbor explanation by omitting any information that does not apply to the plan. A plan administrator also may satisfy the 402(f) notice requirement by providing an explanation that is different from a safe harbor notice. Any explanation must contain the information required by Code Section 402(f) and must be written in a manner designed to be easily understood.
In September, the IRS issued Notice 2018-74 in which it published two updated safe harbor 402(f) notices – one notice reflects the rules relating to distributions not from a designated Roth account, and the other is for a distributions from a designated Roth account. The two updated safe harbor explanations modify previously published safe harbor special tax notices to reflect certain legislative changes and guidance issued after December 8, 2014, including:
The extended rollover deadline for qualified plan loan offset amounts under Tax Cuts and Jobs Act of 2017 (TCJA);
The exception to the 10% additional tax under Code Section 72(t) for phased retirement distributions to certain federal retirees under MAP-21;
The expanded exception to the 10% additional tax under Code Section 72(t) for certain qualified public safety employees who participate in a governmental retirement plan and have reached age 50; and
The self-certification procedures for claiming eligibility for a waiver of the 60-day deadline for making rollovers.
The safe harbor explanations also include other modifications –
Clarifying that the 10% additional tax under Code Section 72(t) for early distributions applies only to amounts includable in income;
Explaining how the rollover rules apply to governmental Code Section 457(b) plans that include designated Roth accounts;
Clarifying that the Code Section 72(t) exception for qualified public safety employees does not apply to payments from IRAs; and
Recognizing the possibility that taxpayers affected by federally declared disasters and other events may have an extended deadline for making rollovers.
A plan administrator is not necessarily required to replace an existing safe harbor notice with the new safe harbor notices. Instead, a plan administrator may update a pre-existing safe harbor notice using amendments described in detail in new Notice 2018-74.
Notice 2018-74 does not specify an effective date or deadline by which a plan administrator must either begin using the new safe harbor 402(f) notices or amend a plan’s existing 402(f) notice, but plan administrators will want to take steps to ensure the 402(f) notices they use, or that are being used by a third party administrator, are up to date.
New York’s Highest Court Strikes Down the Executive Order 38 “Soft Cap” on Executive Compensation
On October 18, 2018, the New York State Court of Appeals issued a decision striking down Department of Health (“DOH”) regulations under Executive Order 38 that limited compensation paid to executives of Medicaid-funded entities when paid from non-state sources. The cap on executive compensation derived from state funds and state-authorized payments remains in place.
Executive Order 38 (“EO 38”) and its accompanying regulations limit executive compensation and administrative expenses for covered providers who receive state funds or state authorized payments that exceed $500,000, and account for 30% or more of the entity’s annual revenues.
Respecting executive compensation, the EO 38 regulations established a “hard cap” prohibiting covered providers from using state funds to provide annual compensation greater than $199,000 to a covered executive. The regulations also imposed a “soft cap” prohibiting a covered executive from receiving more than $199,000 annually — regardless of the source of the funds — unless certain exceptions apply. “Executive compensation” is broadly defined to include any form of compensation reportable on Form W-2 or 1099, including salary, bonuses, company vehicles, housing, entertainment, travel, etc. The definition also includes nontaxable retirement and welfare benefits to the extent they are not “substantially equal” to employee benefits provided to other employees.
Two groups of petitioners, whose members include Medicaid-funded nursing homes, home care entities and health care plans, challenged the EO 38 regulations on the basis that DOH exceeded its authority under the separation of powers doctrine, and acted in an arbitrary and capricious manner. In consolidated proceedings, the state trial court invalidated the “soft cap,” finding that the DOH had “engaged in legislative activity” beyond its regulatory powers, but upheld the “hard cap” as an appropriate regulation within DOH’s authority. The Appellate Division concurred.
The New York Court of Appeals analyzed the EO 38 regulations under the four factor test in Boreali v. Axelrod to determine whether DOH had overstepped the “’the difficult-to-define line between administrative rule-making and legislative policy-making.’” The Court concluded that DOH properly exercised its powers to ensure the appropriate use of state health care funds when it imposed the “hard cap” on executive compensation from public funding sources. In contrast, the Court struck down the “soft cap” as an inappropriate “value judgment” by DOH that executive compensation from all sources, including private funds, should be limited as a matter of public policy.
The decision leaves covered providers with an unclear path forward to pay executives compensation in excess of $199,000 solely with privately-sourced funds. Waivers on the executive compensation limit remain available under the existing regulations. However, it may be possible for covered providers to use strategies such as the segregation of accounts, or other methods to demonstrate executive compensation is privately-sourced, and compliant with the “hard cap” limit on compensation paid from state-sourced funds. Entities without privately-sourced funding must continue to comply with the executive compensation cap, and all covered providers must satisfy annual reporting and disclosure obligations. In the Matter of LeadingAge New York, Inc., et al. v. Shah, 2018 N.Y. Slip Op. 06965, 2018 WL 5046104 (October 18, 2018).
Proposed Rules Permit Integration of HRAs and Individual Health Insurance
The Departments of Labor, Treasury, and Health and Human Services jointly issued proposed regulations that would expand the use of health reimbursement arrangements (“HRAs”), in part by allowing employees to use HRAs to purchase individual health insurance policies.
The proposed effective date for these regulations, when finalized, would be January 1, 2020. HRAs are a type of account based group health plan that are exclusively funded with employer dollars, and may be used by employees to pay for certain eligible medical expenses. Although HRAs have been around for many years, under the Patient Protection and Affordable Care Act (“ACA”) the use of HRAs were somewhat curtailed. This is due to the ACA requirement for group health plans (including HRAs) to comply with certain rules, such as providing first dollar coverage to preventive care services and a prohibition on annual dollar limits. These types of rules are generally incompatible with account based plans that cease proving coverage once the account balance has been exhausted. To work around these issues, sub-regulatory guidance had been issued to permit HRAs so long as they were integrated with other group health plans that fully complied with the ACA rules.
However, under this existing guidance, HRAs were expressly not permitted to integrate with individual health coverage. These new proposed regulations would significantly expand the use of HRAs by allowing individuals to purchase individual health insurance policies, or allow employers to reimburse individual policies that the employees purchase on their own. Under these new proposed rules, to be reimbursed for individual coverage through an HRA, the participant would need to show proof that he or she purchased individual health coverage (that was not an excepted benefit). In addition to allowing employees to purchase individual health insurance with HRA funds, these proposed regulations set forth conditions under which certain HRAs would be considered limited excepted benefits. This alternative HRA design would be subject to an annual reimbursement cap of $1,800 and would only permit the reimbursement of certain types of benefits, such as standalone dental insurance or COBRA coverage. Employers offering excepted benefit HRAs would be required to offer them in conjunction with standard group health benefits. In contrast, employers offering HRAs that would be compatible with individual health policies could not also provide employees with an option for standard group coverage.
The regulations also propose rules regarding premium tax credit eligibility for HRAs integrated with individual coverage, clarify that the individual coverage purchase with the HRA funds is not covered by ERISA, and a provide special enrollment period in the individual market for individuals who gain access to an HRA integrated with individual coverage. Employers wishing to provide benefits through an HRA have had to navigate the challenges of these ever changing rules. Likely, additional guidance will be issued between now and when these proposed regulations are scheduled to become effective. Stay tuned.
Electronic Voluntary Correction Program Submissions Required After March 31, 2019
The Internal Revenue Service (“IRS”) recently updated its Employee Plans Compliance Resolution System (“EPCRS”), with the updates to be effective as of January 1, 2019. EPCRS allows sponsors of tax-favored retirement plans to correct plan failures that affect a plan’s tax-favored status. One component of EPCRS is the voluntary correction program (“VCP”), which may generally be used for all types of plan failures.
The most significant change to EPCRS is that, beginning April 1, 2019, all VCP submissions must be filed electronically using the www.pay.gov website. For the period from January 1, 2019 until March 31, 2019, plan sponsors may continue to file paper VCP submissions or may elect to use the www.pay.gov website.