Current developments in employee benefits.

• Author: Walker, Deborah
• Position: Part 1

This two-part article provides an overview of recent developments in employee benefits, including qualified and nonqualified retirement plans, welfare benefits and executive compensation. Part I focuses on current developments related to welfare benefits and compensation and addresses certain regulatory developments contained in the Small Business Job Protection Act Of 1996.

This two-part article provides an overview of recent developments in employee benefits, including qualified and nonqualified retirement plans, welfare benefits and executive compensation. Part I, below, focuses on current developments related to welfare benefits and compensation (excluding changes made by the Taxpayer Relief Act of 1997). While this article does not discuss specific provisions of the Small Business job Protection Act of 1996 (SBJPA), it does address certain regulatory developments contained in the SBJPA. Part II, to be published in December, will cover qualified and nonqualified retirement plans.

Intermediate Sanctions

The IRS recently issued temporary regulations(1) under Sec. 6071 on reporting the excess benefits tax (i, e., intermediate sanctions) that now applies to disqualified persons significantly benefiting from transactions with Sec 501(c)(3) and (4) exempt organizations. In most cases, the tax will apply to employee who receive excess compensation from the organization.

Background

The Taxpayer Bill of Rights 2 (TBOR2), enacted in 1996, added a series of excise taxes ("intermediate sanctions") under Sec. 4958; they allow the IRS to penalize a "disqualified person" rather than evoke the organization's exempt status. The excise taxes apply when such a person (defined by Sec. 4958(f)(1) as an individual who is in a position to exercise substantial authority over an organization's affairs, regardless of his official title, and certain related persons) enters into an "excess benefit transaction" with a Sec. 501(c)(3) or (4) exempt organization. In this type of transaction, the disqualified person engages in a non-fair market value (FMV) transaction with the organization or receives unreasonable compensation or payment based on the organization's income in a transaction that violates the private inurement rules.

The tax is similar to the Sec. 4975 prohibited transactions tax; the disqualified person must report the benefit on a special form and pay the excise tax. An organization manager who knowingly participates in an excess benefit transaction is also subject to the tax.

Excise Tax Rates

Under Sec. 4958(a)(1), a disqualified person must pay a 25% excise tax of the excess of the value of the consideration over the benefit received. If the excess benefit transaction is not corrected within the tax period, the tax is 200% of the excess benefit, under Sec. 4958(b). "Correction" is defined by Sec. 4958(f)(6) as undoing the excess benefit to the extent possible and taking any additional measures necessary to restore the organization to the financial position it would have had if the disqualified person had dealt with it under the highest fiduciary standards.

An organization manager who knowingly participates in 7an excess benefit transaction is subject to a 10% tax on the excess benefit amount (not to exceed $10,000 for any given transaction), under Sec. 4958(a)(2).

Rebuttable Presumption

The TBOR2 House Committee Report(2) incorporates a rebuttable presumption of reasonableness for a compensation arrangement approved by an independent board or committee that (1) was composed entirely of individuals unrelated to A not subject to the control of the disqualified person, (2) relied on independent, comparable data in approving the transaction and (3) adequately documented its determination. If these steps are met, penalty excise taxes could be imposed only if the IRS develops sufficient contrary evidence to rebut the probative value of the evidence put forth by the parties to the transaction.

Reporting

Temp. Regs. Sec. 53.6071-1T provides that the Sec. 4958 tax is reported on Form 4720, Return of Certain Excise Taxes on Charities and Other Persons Under Chapters 41 and 42 of the Internal Revenue Code; it must be filed by the disqualified person or organization manager by the fifteenth day of the fifth month following the close of the person's tax year. Thus, a person who received an excess benefit in 1997 must file Form 4720 by May 15, 1998.

COBRA Continuation Coverage

Does the Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA) required that COBRA continuation coverage (CCC) be offered to a qualified beneficiary covered by a spouse's health insurance at the time of a qualifying event? Recent decisions indicate that the courts are in favor of denying CCC in such cases unless a significant gap exists between said coverage and coverage under the spouse's health plan. Geissal v. Moore Medical Corp.(3) provides that CCC need not be offered to an otherwise qualified beneficiary if that individual is covered by a spouse's insurance plan at the time of the qualifying event, and no significant gap exists between CCC and coverage under the spouse's plan.

Courts' Current Stance

Employee Retirement Income Security Act of 1974 Section 1162(2)(D)(i)(4) provides that CCC can be terminated when a beneficiary is first covered by another health plan. The Fifth, Seventh and Eleventh Circuits have taken the position that the employer does not have to offer CCC if there are no substantial gaps in coverage under the spouse's plan.(5) The Tenth Circuit has ruled that the employer must offer COBRA coverage, regardless of the quality of the preexisting coverage.(6)

Given the split in authorities and the uniform requirement that CCC be available if gaps exist between it and the spouse's coverage, the prudent business decision would be to offer a qualified beneficiary CCC, regardless of coverage existing prior to the qualifying event. However, more authorities support denial of such coverage when no substantial gaps in coverage exist. The IRS is considering this issue and may eventually provide guidance in its final COBRA regulations.

Family High-Deductible Health Plans

The IRS has confirmed that a family health insurance policy with a $3,000 deductible that begins paying benefits after a family member incurs $1,500 of expenses is not a high deductible policy that will enable the taxpayer to establish a medical savings account (MSA) under Sec. 220. However, Rev. Rul. 97-207 offers relief under Sec. 7805(b), by not disqualifying plans with such policies acquired and effective before Nov. 1, 1997.

Rev. Rul. 97-20 defines a high-deductible plan under Sec. 220(c)(2)(A) that would permit a taxpayer to establish an MSA. High-deductible family plans require an annual deductible of at least $3,000, not exceeding $4,500, with a maximum out-of-pocket cost of $5,500; for individual coverage, an annual deductible of at least $1,500, not exceeding $2,250, with a maximum annual out-of-pocket cost of

Sec. 220 permits eligible individuals (self-employed persons and those who work for employers having no more than 50 employees) with health coverage under high-deductible health insurance policies to set up tax-deductible MSAs. Each year, under Sec. 220(b), the taxpayer may contribute up to 65% of the deductible for individual coverage; 75% of the deductible for family coverage. MSA amounts plus any earnings thereon are nontaxable if used to pay deductible medical expenses, regardless of the 7.5% threshold. Amounts in MSAs need not be used in the year in which they are contributed, but can accumulate year after year.

Long-Term Care Coverage

The IRS has issued interim guidance on qualified long-term care services and qualified long-term care insurance contracts under Secs. 213, 7702B and 4980C. Notice 97-318 includes guidance and safe harbors on the definition of 11 chronically ill individual"; an interim safe harbor allowing insurance companies to interpret certain key provisions in post-1996 qualified long-term care insurance contracts using pre-1997 standards; and guidance on grandfathered pre-1997 contracts. The guidance is effective pending the publication of proposed regulations or other rules.

Background

The Health Insurance Portability and Accountability Act of 1996 amended the Code to provide that qualified long-term care insurance contracts will be treated as accident and health insurance contracts, and amounts received under such contracts will be treated as received for personal injuries and sickness and as reimbursement for medical expenses. Thus, amounts received under such contracts generally will be...