In passing the Bipartisan Budget Act of 2018 (the “Act”), Congress loosened the reins on hardship withdrawals from 401(k) and 403(b) plans. The Act eases limitations on amounts eligible for hardship withdrawal, eliminates the six-month suspension requirement on elective deferrals after making a hardship withdrawal, and removes the requirement that a participant obtain all available loans before obtaining a hardship withdrawal. Starting in 2019, employees will find it much easier to make hardship withdrawals from their employer-sponsored retirement plans should an employer choose to implement these voluntary changes.
Prior to the Act, participants in a 401(k) or 403(b) plan could only make a hardship withdrawal from elective deferral contribution amounts. Hardship distributions from employer matches, non-elective contributions, or earnings on elective deferrals were prohibited. However, under the new rule, Congress has removed this prohibition and expanded on the amounts eligible for hardship withdrawal. The Act allows employees to take a hardship distribution from elective deferral earnings and employer contributions.
The Act also eliminates the six-month suspension of contributions after a hardship withdrawal. In other words, employees no longer have to wait six-months before making further contributions to their retirement plan and are able receive employer matching contributions immediately after taking a hardship distribution. Removing the prohibition on contributions during this six-month period provides administrative simplicity for employers and helps employees continue to save for retirement.
Finally, Congress used the Act to eliminate the rule requiring participants to take all available loans, even loans available under other qualified plans, before taking a hardship distribution. Although the requirement that participants take all other available distributions before obtaining a hardship withdrawal still remains intact, the removal of the participant loan requirement makes it easier for employees to take a hardship withdrawal and helps them avoid loan repayments.
As employers consider implementing these new changes, they should ensure they continue to educate participants on the importance of saving for retirement. While the ease on hardship withdrawal restrictions may prove beneficial for some employees, others could end up significantly limiting their retirement savings (especially considering the 10% penalty tax applied to hardship withdrawal amounts). Employers should also consider the administrative simplicity that comes with removing the six-month suspension on contributions following a hardship withdrawal and expanding the types of contributions that are eligible for hardship distribution. If you are considering making any of these changes to your company’s retirement plans or have any questions on the new law, please contact our employee benefits group.
The Top 10 Tax Reform Impacts On Employee Benefit Plans, Executive Compensation, And Fringe Benefits
On December 20, 2017, Congress passed the Tax Cuts and Jobs Act (the “Act”), which some consider to be the most sweeping tax reform in 30 years. While the main focus of tax reform is to reduce tax rates for corporations and individuals, the law also impacts employee benefit plans and fringe benefits offered to employees. This client alert summarizes key provisions of tax reform and its impact on employee benefit plans.
- Elimination of the ACA’s Individual Mandate. Despite initial disagreement on the issue, the House and Senate agreed to eliminate the shared responsibility payment for individuals failing to maintain minimum essential health care coverage. The Act reduces the penalty for failure to obtain health coverage to $0, effectively eliminating the provision. The individual mandate will remain in effect for the years 2017 and 2018; the penalty will be reduced to $0 starting in 2019.
- Employer Tax Credit for Paid Family and Medical Leave. The Act adds a new tax credit for employers offering paid family and medical leave to employees. This provision comes on the heels of many states either implementing or considering the implementation of paid family leave. New York and Rhode Island both recently enacted paid leave laws. In order to be eligible for the credit of 12.5% of wages paid during leave, employers must have a written paid leave program that pays qualified employees at least 50% of their wages and must provide employees at least two weeks of annual paid family and medical leave. The employer credit will increase to as much as 25% of wages if the employer provides 100% continuing wages up to the 12-week maximum. The tax credit will go into effect for wages paid in 2018 and 2019.
- Elimination and Modification of Certain Fringe Benefits. The Act makes many changes to fringe benefits offered by employers to employees.
- Qualified Transportation Fringe Benefits. The new law eliminates the deduction for qualified transportation fringe benefits and transportation, payments, or reimbursements in connection with travel to and from work, except as necessary for an employee’s safety, which is not defined: and, an 8-year exception for qualified bicycle commuting. Additionally, tax-exempt entities must treat nondeductible qualified transportation fringe benefits or parking facilities as unrelated business taxable income (UBTI).
- Moving Expenses. The Act eliminates the moving expense deduction for employees’ qualified moving expense reimbursements. Starting in 2018 and lasting for eight years, employees must include reimbursed qualified moving expenses in income.
- Employer-Provided Meals. Starting in 2018 until 2026, employers will be limited to a 50% deduction for meal expenses provided on or near business premises. Employers are subject to the 50% limitation on deductions for food or beverages if the expenses are excludible from employees’ income as de minimis fringe benefit and for the convenience of the employer.
- Entertainment Expenses. Employers will lose their deduction for expenses related to entertainment, amusement, or recreation under the Act. Effective in 2018, employers can no longer take a deduction for 50% of entertainment expenses related to the employer’s business.
- Employee Achievement Awards. An employer deduction for the cost of an employee achievement award for length of service, safety award, and awards given during meaningful presentations must be pursuant to a qualified plan award, which does not favor highly compensated employees and the average cost of which per recipient cannot be more than $400 in a year. Such awards may be tangible personal property such as pins, jewelry or other items from a catalog.
- Onsite Gyms. The new law repeals the employer deduction for onsite gyms and characterizes amounts used to pay for on-premises athletic facilities as UBTI.
- Modification of Limitation on Deductible Employee Remuneration. Public employers should start reviewing their compensation arrangements in light of the new law. Section 162 of the Internal Revenue Code prohibits publicly traded companies from deducting more than $1 million per year in compensation paid to or accrued for senior executive officers. However, under pre-Act law, exceptions applied for: (a) commissions; (b) performance-based remuneration; (c) payments to a tax-qualified retirement plan; and (d) amounts that are excludable from the executive’s gross income. In an effort to reform executive compensation, the Act eliminates the exemption for commissions and performance-based pay under Internal Revenue Code Section 162. The Act also modifies the definition of “covered employee” for purposes of Section 162, expanding the definition to include the principal executive officer, the principal financial officer, and the three other highest paid officers. If an individual is a covered employee at any time on or after January 1, 2017, the individual remains a covered employee for all future years. Under a transition rule, the changes do not apply to any remuneration subject to a written binding contract in effect on November 2, 2017 and which was not modified in any material respect after that date.
- Extended Rollover Period for Plan Loan Offset Amounts. Prior to the Act, participants in a qualified plan were given 60 days to repay an outstanding plan loan that became due upon the participant’s termination of employment. However, tax reform extends the 60-day rollover deadline until the due date of the participant’s tax return for the year in which the amount is treated as distributed from the participant’s account. In other words, participants have a longer time period in which they can contribute to an IRA or another qualified employer plan in an amount equal to the plan loan offset amount. The contribution will be treated as a rollover offsetting the outstanding plan loan upon separation from employment. Employees whose plans terminate, or who separate from employment while they have outstanding plan loans, will have an extension for contributing the loan balance to an IRA or eligible retirement plan to prevent the loan from being taxed as a distribution.
- Medical Expense Deduction. Although the House originally wanted to repeal the medical expense deduction, the Act instead implements a temporary reduction of the medical expense deduction floor to 7.5% during 2017 and 2018. Starting in 2019, the deduction floor will return to its previous floor (10%). This means the threshold for employees to claim an itemized deduction for unreimbursed medical expenses will be reduced to 7.5% of adjusted gross income for the years 2017 and 2018.
- Recharacterization of Roth IRA Contributions. The Act repeals the rule allowing for the recharacterization of Roth IRA contributions as traditional IRA contributions to unwind a Roth conversion. As a result, beginning in 2018, recharacterization cannot be used to unwind a Roth conversion.
- More Flexibility for 529 Savings Accounts. Under pre-Act law, funds in a Code Section 529 college savings account could only be used for qualified higher education expenses and nonqualified withdrawals were subject to a 10% additional tax. The new Act expands the use of 529 accounts to allow withdrawals for elementary or secondary schools. This provision will allow individuals to withdraw up to $10,000 per year for tuition at an elementary or secondary public, private, or religious school. The Act also provides the ability to rollover a 529 plan to an ABLE account (a tax-advantaged savings account for individuals with disabilities and their families) if the rollover is made within 60 days of the distribution.
- Disaster Relief Through Eligible Retirement Plans. After the call for relief due to an uptick in natural disasters, the Act allows 401(k) plans and other eligible retirement plans to make “qualified 2016 disaster distributions” of up to $100,000 per individual prior to January 1, 2018, to victims of federally-declared major disasters occurring in 2016. The distributions will not be subject to the 10% excise tax on early distributions and can be included in income ratably over three years. All or part of the distributions can be repaid to a qualifying plan if the repayment occurs during the three-year period.
- New Measure of Inflation. Tax bracket amounts, standard deduction amounts, personal exemptions, and various other tax figures are annually adjusted to reflect inflation. Rather than using the Consumer Price Index for All Urban Consumers or “CPI-U” in order to make inflation adjustments to certain amounts, including benefit-related amounts, the new Act provides that inflation adjustments will be made using the Chained Consumer Price Index for All Urban Consumers or “C-CPI-U”. This index usually increases at a lower rate, resulting in smaller annual increases to certain benefit limits, such as HSA and FSA contributions.
If you have questions or concerns regarding the impact of tax reform on your benefit programs, please do not hesitate to contact one of our employee benefits attorneys for assistance.
The recent Equifax and Yahoo security breaches impacted an astounding number of people, serving as a fire alarm to individuals and businesses regarding cybersecurity. Due to the fact 401(k) plans are the primary savings vehicle for Americans, immediate attention should be directed towards the protection of 401(k) plan assets from cyber risk. This article focuses on considerations and measures 401(k) plan sponsors and fiduciaries can take to protect plan participants and, in so doing, fulfill their fiduciary obligations with respect to guarding against cyberattacks on their 401(k) programs. This article is written in the context of 401(k) plans. However, this discussion is applicable to most benefit plans.
A Fiduciary Matter
Plan fiduciaries, including plan sponsors and fiduciary committees, have the broad duty under the Employee Retirement Income Security Act (“ERISA”) to act solely in the interest of plan participants and beneficiaries “with care, skill, prudence and diligence…” This standard requires plan fiduciaries to take all actions to serve plan participants and beneficiaries and monitor service providers. Recently, there has been much substantial guidance and discussion regarding the monitoring of plan fees and expenses. Although the Department of Labor (the “DOL”) has not officially issued guidance on the actions fiduciaries should take in the present climate, the recent news of massive cybersecurity breaches should lead fiduciaries to focus on cybersecurity with the same zeal applied to monitoring plan fees and expenses. By addressing cybersecurity risks, fiduciaries limit their exposure and, more importantly, they will protect the plan participants and beneficiaries whom they serve.
In recent years, firms and vendors that work with retirement plans have offered and encouraged plan sponsors and their fiduciary committees to attend fiduciary training. Fiduciary education should include a section on cybersecurity and measures that should be taken to reduce cyber threats to 401(k) plans.
Advisory Council Guidance
In 2016, the ERISA Advisory Council (the “Council”) held hearings and investigated the cybersecurity threat. The Council articulated actions that should be taken to protect against the cybersecurity threat and, in early 2017, issued a report entitled “Cybersecurity Considerations for Benefit Plans” (the “Report”). The published study serves as recommendations to the DOL. The DOL has not issued guidance directly addressing cybersecurity. Until the DOL issues guidance, the Report provides meaningful guidance to plan sponsors and fiduciaries.
Among the recommendations offered by the Report is the establishment and operation of a security risk management strategy. The nature of the strategy depends largely on the business and the employee benefit plans involved. Universal elements of the strategy include establishing who is responsible for the design and implementation of the strategy, ongoing monitoring to guard against hackers and monitoring activity that includes testing, training those with access to plan data, hiring practices (including background checks), limiting user access to certain payroll or HR personnel and the establishment and execution of data retention and encryption policies and practices.
A very critical element of the cybersecurity risk management strategy is the selection and monitoring of third party service providers. Third party service providers, such as 401(k) plan record-keepers, will have access to sensitive participant data. This information includes names and the associated addresses, social security numbers, beneficiary information and bank information of plan participants. Moreover, 401(k) plans, with liquid assets, may be readily accessed by cyber criminals. Due to the fact plan sponsors do not control their hiring process and internal controls, extra care must be taken in the selection and monitoring of such providers.
The Report offers a list of questions plan sponsors should pose to their benefit plan providers which include:
- Does the service provider have a comprehensive and understandable cybersecurity program?
- What are the elements of the service provider’s cybersecurity program?
- How will the plan(s) data be maintained and protected?
- Will the data be encrypted at rest, in transit and on devices, and is the encryption automated (rather than manual)?
- Will the service provider assume liability for breaches?
- Will the service provider stipulate to permitted uses and restrictions on data use?
- What are the service provider’s protocols for notifying plan management in the case of a breach and are the protocols satisfactory?
- Will the service provider agree to regular reports and monitoring and what will they include?
- Does the service provider regularly submit to voluntary external reviews of their controls (such as Service Organization Control or SOC reports or a similar report or certification)?
- What is the level and type of insurance coverage that is available?
- What is the level of financial and fraud coverage that protects participants from financial damage?
- If the service provider subcontracts to others, will the service provider insist on protections (as noted above) in its agreement with the subcontractor?
- What controls does the service provider have in place over physical assets that store sensitive data, including when such assets are retired or replaced (servers, hard drives, mobile devices, etc.)?
- What are the service provider’s hiring and training practices (for example, background checks and screening practices and cyber training of personnel)?
Service Provider Agreements
Several of the questions that plan sponsors should pose to their service providers can be addressed in the service agreement between the plan sponsor and the service provider. Service agreements should include a section specifically addressing cybersecurity specifically. The provisions, at a minimum, should require the third party provider to maintain adequate controls to protect sensitive data, including data breach notice requirements to the affected participant and the plan sponsor, and provide for external audits or reviews. Since several state laws require notice to affected individuals in the event of a breach, the service agreement should clearly define who (plan sponsor or service provider) has the duty to act in accordance with state law in the event of a breach.
In addition, service agreements should include provisions for the acceptance of liability on the part of the service provider after a data security breach and an indemnification provision in the event of a third party claim from a plan participant or other party. The agreement should further require the service provider to maintain cyber insurance at a level commensurate to the size and demographics of the plan.
At this time, plan sponsors should review existing service agreements. If the agreement lacks or has an insufficient cybersecurity provision, a revised agreement or agreement rider should be put in place.
In addition to the above steps fiduciaries can take to protect against cyber-attacks, cybersecurity should be incorporated into participant education. Just as a purse or wallet should not be left visible in a locked car, participants should take preemptive measures to protect their benefits. Participants can limit and even eliminate cyber risk before it occurs if they are aware of the threat and advised as follows:
- Regularly check their accounts for unauthorized activity.
- Protect their passwords and login information. If passwords need to be written and/or stored, they need to be in a locked file or otherwise secured. Participants should change their passwords regularly.
- Stolen laptops are a source of data breaches. Laptops should be protected with encryption.
- Participants should be instructed to read plan issued materials and not discount correspondence as “junk mail.”
Participant plan education should include materials addressing cybersecurity and, for live presentations, a discussion of best practices for cybersecurity.
Surrounded by the real and present threat of a cyber-breach, plan sponsors and fiduciary committees need to acknowledge the threat to employee benefits plans for which they are responsible. In keeping with the recommendations of the ERISA Advisory Council, plan fiduciaries should discuss, design and implement a “risk management strategy.” The strategy must be tailored to the business, the company’s benefit plans and the participant demographic. The critical elements of the strategy should include:
- Vendor Monitoring. Ask the critical questions outlined above of third-party service providers at the request for proposal stage as well as on an ongoing basis.
- Insurance. Verify not only cyber insurance coverage by third party service providers, but review the plan sponsor’s own fiduciary liability umbrella policy, and cybersecurity insurance coverage.
- Service Agreements. Negotiate, review and, to the extent necessary, update vendor contracts.
- Education. Educate participants on the importance of self-protection and vigilance.
By following these steps, plan sponsors and fiduciaries can fulfill their fiduciary obligations and, in so doing, protect the hard earned benefits of plan participants and their beneficiaries.
As 2017 comes to a close, many small employers are struggling to find affordable group health plans on the insurance market. Given the substantial impact increased premiums have on individuals and small employers, many small employers have sought out alternative mechanisms for providing health insurance to their employees. Qualified Small Employer Health Reimbursement Arrangements (“QSEHRAs”) might be their best option for providing tax-free reimbursements of medical expenses.
Under the Affordable Care Act’s (“ACA’s”) Market Reform rules, stand-alone Health Reimbursement Arrangements (“HRAs”) and employer payment plans used to reimburse employees for medical care expenses violate the ACA and are subject to Internal Revenue Code Section 4980D excise tax. The IRS quickly became aware of the negative impact this rule had on small employers and decided to create QSEHRAs, which became available to qualified small employers on January 1, 2017. QSEHRAs, unlike HRAs, are not subject to health care reform requirements for group health plans. At first, many areas of uncertainty surrounded the formation and implementation of QSEHRAs. However, the IRS released Notice 2017-67 in mid-October, which contains detailed guidance on the requirements for providing a QSEHRA to employees.
A QSEHRA must meet the following four basic requirements: (1) the QSEHRA must be funded solely by an eligible employer, and no salary reduction contributions may be made under the arrangement; (2) after an eligible employee provides proof of coverage, the QSEHRA must provide for the payment or reimbursement of medical expenses incurred by the employee or the employee’s family members; (3) the amount of payments and reimbursements for any year cannot exceed the statutory limits ($4,950 for self-only coverage and $10,050 for family coverage in 2017; $5,050 for self-only coverage and $10,250 for family coverage in 2018); and (4) the QSEHRA must generally be provided on the same terms to all eligible employees of the employer.
In order to qualify for a QSEHRA as a small employer, a company cannot be an Applicable Large Employer under the ACA (i.e., must have less than 50 full-time equivalent employees in the prior calendar year) and cannot offer a group health plan to any of its employees. If an employer’s workforce increases to 50 or more full-time equivalent employees during a calendar year, that employer will become an Applicable Large Employer before the first day of the following calendar year. Offering a group health plan to former employees or retirees will not disqualify the employer. However, if an employer endorses a particular policy, form, or issuer of health insurance, it will constitute a group health plan and disqualify the employer.
Any eligible employee or family member can participate in the QSEHRA. Reimbursements for medical care are tax-free to the employee if the employee has minimum essential coverage (MEC) for the month in which the medical care is provided. Medical care, as defined in Internal Revenue Code Section 213(d), includes health insurance premiums, but excludes out-of-pocket expenses already reimbursed from another source and premiums paid by the employee on a pre-tax basis, for coverage under a group health plan of another employer. However, the QSEHRA can reimburse an employee for premiums paid after-tax under a group health plan provided by a spouse’s employer. An initial submission of proof of MEC must be provided to the employer, in addition to proof of MEC with each new request for reimbursement for the same plan year. An attestation by an employee will constitute proof of coverage if it states that the employee and family members have MEC, provides the date coverage began, and includes the name of the provider.
A QSEHRA must be provided on the same terms to all eligible employees on a “uniform and consistent basis,” but may exclude the following employees: (1) employees that have not completed 90 days of service; (2) employees that are under age 25; (3) part-time or seasonal employees; (4) employees covered by a collective bargaining agreement if health benefits were the subject of good faith bargaining; and (5) nonresident aliens with no earned income from the employer or sources within the U.S. Former employees, retirees, and non-employee owners must be excluded from the QSEHRA. Furthermore, a 2% shareholder-employee of an S corporation does not constitute an employee for purposes of QSEHRAs.
IRS Notice 2017-67 provides many detailed rules on eligibility, nondiscrimination notice and reporting requirements, integration with other laws, and more. Complying with these rules is considerably important since failure to comply with the QSERHA requirements will result in a noncompliant group health plan and trigger ACA penalties. If you are a small employer and are interested in setting up a QSEHRA, please contact one of our employee benefits attorneys for more information on the legal requirements and implementation process.
According to the IRS, payments made to participants under certain fixed indemnity insurance policies must be included in the employees’ gross wages, unless the premiums are paid on an after-tax basis. Fixed indemnity health plans are plans that pay covered individuals a specified amount of cash for the occurrence of certain health-related events such as hospital visits or the diagnosis of a particular condition or disease (e.g., cancer). The benefit amounts paid to participants in the plan are not related to the amount of medical expenses actually incurred by the employee.
Earlier this year, the IRS released a Chief Council Advice Memorandum, CCA 201703013. The IRS concluded that “an employer may not exclude from an employee’s gross income payments under an employer-provided fixed indemnity health plan if the value of the coverage was excluded from the employee’s gross income and wages” or “if the premiums for the fixed indemnity health plan were originally made by salary reduction through a Section 125 cafeteria plan.” If the premiums are paid with after-tax dollars, the plan benefit payments are excluded from the employee’s gross income. Employer payments and employee premiums paid under a cafeteria plan towards fixed indemnity health plan coverage are not included in the employee’s compensation income at the time the amounts were paid since they are made through salary reduction under a cafeteria plan. Therefore, according to this memorandum, benefit payments associated with that coverage constitute taxable income.
The problem with fixed indemnity health plans for the IRS is the fact that cash payments are made to employees without regard to the actual amount of expenses incurred by the employee for medical care. Section 106(a) of the Internal Revenue Code (the “Code”) excludes from income premiums for accident or health insurance coverage that are paid by an employer. Section 105(b) of the Code allows employees to exclude amounts received through employer-provided accident or health insurance, if those payments are made as reimbursement for medical care related to personal injuries or sickness. However, the IRS reasons that since amounts received under employer-sponsored fixed indemnity health plans do not take into account the actual medical costs incurred, the reimbursements are not reimbursements for personal injury or sickness, and therefore must be included in gross income.
The IRS guidance also specifically discusses cafeteria plans. The IRS notes that under Section 125 of the Code, the employee has the option to receive cash instead of a salary reduction applied to purchase accident or health coverage. If the employee elects a pre-tax salary reduction for accident coverage instead of cash, that amount is excluded from gross income as employer-provided accident or health coverage under Section 106. However, if the employee elects a salary reduction for premiums toward a fixed indemnity health plan, the amounts payable as benefits to the employee under the plan will be includible in gross income since the cash reimbursement amount is provided to the employee without regard to the amount of medical expenses otherwise incurred.
In light of this guidance, employers offering fixed indemnity plans should carefully evaluate how premiums for that coverage is paid and the impact of that decision on future benefit payments. According to the IRS, when employees pay premiums for a fixed indemnity health plan through a pre-tax salary reduction under a Section 125 cafeteria plan, benefit payments under the policy will be treated as taxable income. If you are uncertain about the tax implications of your fixed indemnity benefits or have questions about this IRS guidance, please contact a member of the McGrath North employee benefits practice group.
Equifax, one of the three major consumer credit reporting agencies, was the victim of a criminal cyber-attack this summer that potentially impacted 145.5 million people in the United States. Hackers gained access to company data that contains highly sensitive information, including social security numbers, driver’s license numbers, addresses, birth dates, credit card information, and more. Although there have been other cyber-security breaches in recent years, this attack is particularly concerning for many consumers due to the ultra-sensitive nature of the information. Additionally, the information that Equifax maintains in their databases is much more extensive than the information that was exposed in previous publicized security breaches.
For those that assume they are not impacted by the breach because they have never personally used Equifax, think again. Any individual that has requested a credit report or uses credit could potentially be affected. Equifax handles the data of 820 million consumers and works with more than 91 million companies around the world. Although Equifax has promised to notify those potentially affected by e-mail, Equifax suggests visiting the Equifax website to check for a potential impact. Equifax is also offering the opportunity for consumers to enroll in one year of free credit monitoring and identity theft protection offered through TrustedID (an Equifax product). For those consumers that receive an affirmative potential impact result, enrolling in one year of free credit monitoring is one way to monitor whether a thief is attempting to use your social security number for credit purposes. Enrolling in TrustedID does not take away consumers’ rights to take legal action against Equifax. Consumers must make an independent decision as to whether they should follow Equifax’s advice.
Some consumers may have considered freezing their credit. While this is a viable option for preventing thieves from opening any lines of credit under their stolen social security numbers, consumers considering this option should also consider the difficulties associated with trying to re-open and re-freeze their credit. Other options consumers have for protecting themselves after the Equifax breach include resetting passwords, setting fraud alerts with credit reporting agencies, and vigilantly monitoring bank and credit card statements.
Making a few adjustments, the IRS has released the 2018 cost-of-living adjustments applicable to the dollar limits and thresholds for retirement plans and health and welfare benefit plans. Plan sponsors should update their systems and formulas to include the limits that have been adjusted.
To view the chart, click here.
Recent Modifications To Puerto Rico’s Tax Code And The Impact It May Have On Your Qualified Retirement Plan
Governor Ricardo Roselló of Puerto Rico enacted certain revisions to the Puerto Rico tax code (the “PR Code”) in February 2017. He did so with the goal of retaining and attracting workers to Puerto Rico by improving the benefits for its professional workforce. The Governor also hoped to alleviate difficulties associated with the establishment and administration of retirement plans. As a result, tax-qualified retirement plans covering Puerto Rico employees are subject to new requirements. Although the PR Code generally tracks the U.S. Internal Revenue Code, the new rules under Act No. 9-2017 (the “Act”) establish differences between the two codes. These differences affect various aspects of qualified retirement plans, including contributions, highly compensated employees, and cash or deferred arrangements. The Act took immediate effect in February, but the Puerto Rico Treasury Department (the “Hacienda”) is still in the process of addressing the application of the various changes and the implementation of the Act. Despite the lack of guidance, employers sponsoring Puerto Rico retirement plans or dual-qualified retirement plans should pay attention to these rules because the requisite amendments will most likely require new determination letters from the Hacienda.
Material Changes to the PR Code
On February 8, 2017, the Governor of Puerto Rico enacted Act. No. 9-2017 modifying retirement plan qualifications under the PR Code. The following changes were made and apply to all retirement plans (regardless of the employer), including Puerto Rico-only plans and dual qualified plans.
- Highly Compensated Employees (“HCEs”): USD $150,000 Threshold and No Automatic Treatment for Corporate Officers.
Prior to the Act, the U.S. and Puerto Rico used the same monetary threshold for defining HCEs. However, under the new rules, the threshold has been increased from USD $120,000 to $150,000. Unlike the U.S. tax code, which subjects its HCE threshold to cost-of-living adjustments, the Act establishes the PR Code’s HCE threshold as a fixed number. Additionally, corporate officers may no longer receive automatic treatment as HCEs under the PR Code. Rather, corporate officers will only be classified as HCEs if their salary surpasses the new USD $150,000 threshold.
- Annual Contribution Limits: Limited to the lesser of 25% of net income or USD $75,000.
The new annual contribution limit on per-participant contributions to defined contribution plans under the Act is the lesser of 25% of “net income” or USD $75,000. This is a departure from the previous statutory limit, the lesser of 100% of compensation or USD $54,000, which is the current rule under the U.S. tax code. The maximum contribution under the Act does not allow cost-of-living adjustments and does not apply to rollover contributions. This new limit also comes with ambiguities, including how the Hacienda will define “net income” and whether the annual, per-participant limit on compensation under a plan will apply under the Act. Currently, both the U.S. and Puerto Rico tax codes contain provisions limiting the amount of compensation that may be used to determine benefits under the qualified retirement plan. If this annual USD $270,000 compensation limit continues to apply in both countries, contributions under the new rule cannot exceed US $67,500.
- Increase in the Aggregate Limit on Tax-Deductible Employer Contributions.
Currently, tax deductible contributions to defined contribution plans cannot exceed 25% of the aggregate compensation of all plan participants. However, under the Act, this aggregate limit is increased to the extent that the tax-deductible contributions do not exceed the aforementioned individual annual contribution limits.
- Plans with a Cash or Deferred Arrangement (“CODA”) Could Qualify for Exemption From the Average Deferral Percentage Test.
For the most part, retirement plans must comply with Puerto Rico’s laws governing coverage and participation requirements, as well as non-discrimination provisions. However, the Act provides an exemption from the Average Deferral Percentage Test for certain CODA plans. The new safe harbor rule applies to: (1) plans containing a CODA that have fewer than 100 participants; (2) whose business generates less than $10 million in annual gross income, and (3) where the employer provides a benefit of no less than 3% of compensation to all eligible employees. The definition of “business” and “gross income” are not specifically defined in the Act and require further guidance by the Hacienda.
Looking Forward: Assessing the Impact on Your Plan
Differences in the Puerto Rico and U.S. tax codes can cause confusion for employers that hire Puerto Rican employees or sponsor dual-qualified retirement plans. For example, an employer with a dual qualified retirement plan will have to comply with the new PR Code definition of HCEs, which conflicts with the HCE definition in the U.S. tax code. Furthermore, there are various ambiguities within the Act which could elicit different interpretations of the new rules. Therefore, although the Act took immediate effect, it may be prudent for employers to wait for further guidance from the Hacienda on how best to implement certain new rules (such as the safe harbor provision for plans containing a CODA). The Act does not make clear when the retirement plans must be in compliance with all of the new rules, and have yet to define many key terms for purposes of implementation.
Importantly, the amendments necessary for compliance with the new law most likely will be classified as qualification amendments, which would necessitate updated determination letters from the Hacienda. It would be wise for employers sponsoring Puerto Rico plans or dual qualified plans to begin updating their plans and policies to the extent possible under the unambiguous provisions of the Act. Furthermore, employers should continue to monitor developments regarding the new Act by looking for newly released guidance on the aforementioned, unresolved ambiguities since mid-year changes might be necessary.
This summer, New York joined the small group of U.S. states that offers paid family leave to employees. New York’s Workers’ Compensation Board adopted final regulations implementing paid family leave, the Paid Family Leave Benefits Law (“NY PFL law”), which goes into effect on January 1, 2018. The New York law has been dubbed one of the most comprehensive paid family leave programs in the nation. The NY PFL applies to all employers with employees working in New York for 30 or more days in a calendar year. The New York law is a benefit for people who work in New York; it does not matter where the employer is headquartered or where the employee lives.
The new law covers both full-time employees that have worked at least 20 hours per week for at least 26 consecutive weeks and part-time employees that have worked at least 175 days within a 52 consecutive-week period. Once an employee has met one of the two aforementioned eligibility requirements, paid leave will be granted in the following situations:
• To provide physical or psychological care and support to a family member due to a family member’s serious health condition;
• To bond with a newborn child during the first year of the child’s life or, if an adopted or foster care child, for the first year after the placement of a child with the employee; or
• For any qualified reason as provided for under the federal Family and Medical Leave Act (“FMLA”) arising from the employee’s spouse, domestic partner, child, or parent being active military duty, or being notified of an impending call or order to active military duty.
Employees on leave will receive up to 50% of the state’s average weekly wage for up to eight weeks in 2018 and this amount will gradually increase during the coming years, reaching 67% of the state average weekly wage for up to twelve weeks by 2021. The program is mandatory for private employers with one or more employees while public employers may opt into the program.
New York’s law is significantly more generous than the FMLA, which does not require paid leave and only applies to employers with 50 or more employees within a 750-mile radius of the worksite at which the employee is employed. Another key difference is that while FMLA requires employees to first use accrued Paid Time Off (“PTO”), an employer under the NY PFL law cannot require employees to use PTO before paid family leave unless that employee is eligible for both FMLA and NY paid family leave. Other benefits under the NY PFL law include continued health benefits during leave as if the employee continued to work, and reinstatement to the same or comparable prior position of employment without reduction in accrued benefits.
The NY PFL law does contain some restrictions on when employees can utilize paid family leave. For example, employees who are eligible for disability benefits and paid family leave benefits may only receive a combined amount of 26 weeks of disability and paid family leave benefits in a 52-consecutive calendar week period, and may not collect benefits for short term disability and paid family leave concurrently. The regulations also list various situations in which paid family leave benefits may not be available to the employee, such as when the employee is collecting sick pay or PTO from the employer, receiving total disability payments pursuant to workers’ compensation, or working part of the day with pay for the employer or any other employer.
Funding for paid family leave will come from employee contributions of up to $1.65/week for 2018. While it is unclear whether the short-term disability insurance carriers required to provide paid family leave benefits will be able to charge an amount in excess of the employee contributions, the intent behind the law is to ensure that the employee contributions are sufficient to fund all paid family leave costs. Employers who either currently self-insure for short-term disability benefits or who provide paid family leave to public employees not represented by employee organizations are given the option to self-insure for paid family leave, but must do so before September 30, 2017. However, self-insurance comes with a risk of bearing paid family leave costs not covered by employee contributions.
In addition to the heightened benefits, the NY PFL law adds notice requirements that may not be ignored. Employers must provide written notice to employees regarding their rights under the NY PFL law, including how to file a claim for leave. Employers must also post a prescribed notice regarding the NY PFL. Employees are also subject to notice requirements, as the law mandates 30 days’ advance notice of intent to take paid family leave.
Looking forward, employers should determine whether to obtain separate coverage for these benefits. Employers that insure short-term disability benefits should contact their insurance carriers to determine when payroll deductions for paid family leave should go into effect. Private employers that self-insure short term disability must determine whether they will elect to self-insure paid family leave, and must do so no later than September 30, 2017. The NY PFL law is much broader than FMLA, meaning that more employees can take leave than before and various leave policies will overlap in a new and complicated manner. Employers should review and update their employee handbooks, notices, plan documents, summary plan descriptions, and leave forms to ensure compliance with the new law.
Good news! We have received formal IRS approval of our new 403(b) prototype plan document. Previously, 403(b) plans had not been reviewed or approved by the IRS. Now our 403(b) prototype plan is approved for tax-exempt organizations. The new 403(b) prototype plan is in addition to our 401(k) and profit sharing prototype plan documents. We are currently awaiting IRS approval of a defined benefit pension prototype plan document. We provide prototype plans as a convenience to our clients and to assure them that the plan is always updated. Employers can change recordkeepers without changing the plan document which sometimes causes mistakes. We are very excited to be able to restate 403(b) plans on our prototype plan with advance assurance from the IRS. Please let us know if you have any questions or interest in utilizing our prototype plans.