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It is common in a private company sale transaction to have an escrow in place that holds a portion of the sale proceeds to cover the seller’s post-closing indemnification liability. It also common to have an earn-out component, through which payment of a portion of the sale proceeds may be tied to the business’s achieving specified future performance metrics. However, unforeseen complexities may result when compensatory payments to employees of the business, such as the cash-out of stock options or the payment of sale bonuses, are subject to an escrow or earn-out.

For example, if there is an escrow in place for 10% of the sale proceeds and stock options are being cashed out for a payment at closing, 10% of the payment attributable to the cashed-out stock options may be held back in escrow. This commonly used structure ensures that the optionholders are subject to the same indemnification escrow as other shareholders. However, because most escrows are fully funded arrangements, careful consideration must be given to any compensatory amounts that are subject to the escrow.

One of the most popular pension derisking strategies for the last few years—which shows no sign of slowing down in 2015—has been offering lump-sum windows (LSWs) to terminated vested participants. (As discussed in an earlier blog post, after the issuance of IRS Notice 2015-49, lump-sum offers to retirees in pay status are no longer permissible, but the vast majority of LSWs have not been extended to retirees in any event.) LSWs offer plan sponsors the opportunity to reduce their pension plan liabilities and headcount, and the associated Pension Benefit Guaranty Corporation (PBGC) premiums and administrative expenses without the premium required to settle liabilities through an annuity purchase (and, in some cases, at a discount to the related balance-sheet liabilities). The knowledge that new updated mortality tables will be required in determining lump-sum amounts (and will increase those amounts by 5–8%) as early as 2016 (although, more likely, in 2017) has added some wind to the lump-sum sails this year.

But, as LSWs have proliferated, so have concerns among the various federal agencies that regulate pension plans. As noted, the IRS has served notice that lump-sum offers can no longer be made to retirees in pay status. The US Department of Labor's ERISA Advisory Council held hearings in 2013 on derisking, including LSWs, and issued a report that raises a number of concerns, including whether participants understood the risks that they were assuming by taking a lump-sum distribution and whether current disclosure requirements were sufficient. Additionally, the PBGC has recently begun requiring pension plans sponsors to provide reporting to PBGC regarding derisking activities, including LSWs.

As the business world migrates toward a paperless environment, it has been steadily pulling retirement plan administration in its wake. One area of focus for paperless administration in recent years has been 401(k) plan hardship withdrawals. Some third-party administrators (TPAs) have devised and marketed systems for e-certified hardship withdrawals, which effectively transfer the burden to participants to verify the existence of a qualifying hardship and maintain any records needed to support such verification.

These programs typically require a participant to electronically confirm

  • the nature of the hardship;
  • the person experiencing the hardship and his or her relationship to the participant;
  • the existence of specified documents required to support and substantiate the request;
  • the unavailability of other specified resources to meet the hardship; and
  • the amount of the hardship, which must equal or exceed the amount of the request.

The participant has to electronically certify the truth and accuracy of his or her statements and commit to retaining the required support documentation for a specified period of time.

Please join us in congratulating Matthew (Matt) Hawes and Michael Richman, our employee benefits and executive compensation practice colleagues who were invited to join the Morgan Lewis partnership today.

Matt has a broad-based practice that includes drafting and designing qualified retirement plans, health and welfare arrangements, deferred compensation plans, and employee agreements, as well as advising on regulatory compliance with the Internal Revenue Code, ERISA, and other applicable laws and regulations. Matt also provides advice on benefits and executive compensation issues that arise in mergers and acquisitions. Matt is resident in our Pittsburgh office. To review Matt’s biography, please click here.

Michael counsels clients on the fiduciary responsibility rules under ERISA, including the prohibited transaction rules, and he advises plan sponsors on investment matters for defined benefit and defined contribution plans. He also counsels banks, investment adviser firms, and broker-dealer firms on ERISA compliance for ERISA plan separately-managed accounts, collective investment funds, private funds, and other arrangements, as well as advises IRA custodians on permissible IRA investments and investment restrictions. Michael is resident in our Washington, DC office. To review Michael’s biography, please click here.

For more information about today’s partnership announcement, please see the firm’s press release.

For the second time in five years, Congress has doubled (and in some instances, tripled) both the minimum penalties and the per-employer aggregate penalty caps for erroneous (or unfiled) information returns (on Forms W-2 or 1099 and 1098). Unusually, this provision was contained not in a normal tax bill, but instead as one of the revenue raisers included in the Trade Preference Extension Act of 2015 (P.L. 114-27, section 806). The new penalties have an effectively retroactive application, because they will apply to information returns filed for all payments in 2015.

The new information reporting penalties (imposed under each of Code sections 6721 and 6722) are effective “with respect to returns and statements required to be filed after December 31, 2015,” and are increased as shown below:

Type of Penalty Prior Amount New Amount
Erroneous or Nonfiled W-2/1099/1098 (without “intentional disregard” of filing requirements) $100 per form,
$1.5M per filer
$250 per form,
$3M per filer
Lowered Penalty for Corrections by March 2 $30 per Form,
$250K per filer
$50 per form,
$500K per filer
Lowered Penalty for Corrections by August 1 $60 per form,
$500K per filer
$100 per form,
$1.5M per filer
“Intentional Disregard” of Filing Requirements $250 per form (or 10% of amount, if greater) $500 per form (or 10% of amount, if greater)
Lower Aggregate Caps for Small Payer-Filers (with no “intentional disregard”) (applicable to employers/payers with average gross receipts of under $5M during the three years before the reporting year) $500K per filer, lowered to $75K if corrected by March 2, or $200K if corrected by August 1 $1M per filer, lowered to $175K if corrected by March 1, or $500K if corrected by August 1

Notably, due to the inconsistent structure of the amount of the increase, this increased aggregate maximum penalty (applicable except in cases of intentional disregard) will apply to entities that file 12,000 forms (i.e., $3 million/$250), whereas the prior-law maximum penalty applied to entities that filed 15,000 returns ($1.5 million/$100). There is no aggregate cap in cases of intentional disregard.

Companies have increasingly used independent contractors for valid economic, business, and legal reasons to supplement their employee workforce. But the Department of Labor’s (DOL’s) recently issued Administrator’s Interpretation now attempts to expand coverage of the Fair Labor Standards Act (FLSA) and to dramatically alter the test for determining if an individual is an employee or an independent contractor. According to the DOL’s new interpretation of the “economic realities” test, “most workers are employees under the FLSA’s broad definitions.”

Citing “numerous complaints from workers alleging misclassification” and the history of “successful enforcement actions against employers who misclassify workers,” the DOL has reexamined each of the “economic realities” factors with the premise that the FLSA’s coverage should apply to the broadest extent possible. The Administrator’s Interpretation also attempts to legislate the weight afforded to each factor in a way that favors employee status, while inconsistently recognizing that “no single factor is determinative” and each factor “should be considered in totality” to determine whether a worker is an employee or an independent contractor.

For example, the DOL broadly interprets (in favor of employee status) the factor examining whether a worker performs functions integral to an employer’s business and then describes that factor as “compelling” in the independent contractor analysis. Conversely, the Administrator’s Interpretation affords minimal weight to the “control” factor and somehow concludes that neither working offsite (or at home) nor controlling one’s own hours, nor having little supervision, is “indicative of independent contractor status.” The DOL’s one-sided interpretation, however, ignores decades of legal precedent and relegates to “insignificance” concepts and factors that have long helped define the independent contractor relationship, such as whether a worker controls his or her own hours, has little or no supervision, and decides what tools and equipment to buy.

The IRS announced on July 21 that, generally effective for 2017 and future years, it will no longer accept determination letter (DL) requests under the current staggered five-year remedial amendment cycles for individually designed qualified plans.(Announcement 2015-19, issued July 21, 2015). Although the five-year cycle filing process instituted by the IRS in 2007 pursuant to Rev. Proc. 2007-44 seemed to be working reasonably well for plan sponsors, the IRS has determined that in order to “more efficiently direct its limited resources,” IRS involvement in the DL process must be materially reduced. Under the approach envisioned in the announcement, DL requests would be acted on by the IRS only for new plans and plan terminations.

This IRS policy change, although significant, is not unexpected, because IRS representatives had recently discussed fairly frequently at conferences what the IRS views as a resource shortage issue regarding plan reviewers’ availability and skill-sets. The approach taken in the announcement leaves plan sponsors in uncertain territory going forward, with the likely outcome being (a) greater reliance on law firm or other professional firm opinions or (b) a shift to prototype, volume submitter, or other “pre-approved” plan documents.

The US Supreme Court’s recent decision recognizing a constitutionally protected right for same-sex couples to marry, Obergefell et al. v. Hodges, was an important step forward for lesbian, gay, bisexual, and transgender (LGBT) rights, but it did not address other types of potential discrimination against LGBT individuals. Specifically, in the absence of a federal law that expressly protects employees from discrimination based on sexual orientation, and in the absence in many places in the United States of any similar state laws or municipal ordinances, employees who marry their same-sex partners arguably can still be subjected to workplace discrimination without remedy, thus burdening their newly protected right to marry. A proposed federal law that would bar sexual orientation discrimination in the workplace, the Employee Non-Discrimination Act (ENDA), is languishing in Congress, and its passage is uncertain.

As many expected it would, the Obama administration has stepped into this regulatory vacuum. On July 15, in Complainant v. Anthony Foxx, Secretary, Department of Transportation (Federal Aviation Administration), the Equal Employment Opportunity Commission (EEOC) reversed a prior decision based on timeliness, and determined that an air traffic controller’s allegations of discrimination based on sexual orientation against his employer, the Federal Aviation Administration, stated a valid claim of discrimination based on sex under Title VII of the Civil Rights Act of 1964, as amended. This decision builds on a prior decision from 2012 in which the EEOC determined that transgender employees were protected from discrimination under Title VII. In Foxx, the EEOC analyzed Title VII and relevant case law and concluded that discrimination against an employee based on the gender of his or her spouse or partner is discrimination based on sex, which is prohibited by Title VII: “[W]e conclude that sexual orientation is inherently a ‘sex-based consideration,’ and an allegation of discrimination based on sexual orientation is necessarily an allegation of sex discrimination under Title VII. A complainant alleging that an agency took his or her sexual orientation into account in an employment action necessarily alleges that the agency took his or her sex into account.”

Good housekeeping is an essential part of good plan governance. If a plan sponsor’s documents and governance structure were in a metaphorical closet, a closer peek inside might reveal that what plan sponsors are (or are not) doing could be putting their companies at risk.

The standards of fiduciary conduct for retirement and welfare plans are generally set forth in the Employee Retirement Income Security Act of 1974, as amended (ERISA). ERISA distinguishes between a plan’s fiduciary functions, which are subject to ERISA, and settlor functions, which are not. Fiduciary functions include exercising discretionary authority with respect to a plan’s management or administration, whereas settlor functions relate to a plan’s design, amendment, and termination. Although a person is allowed to wear “two hats” with respect to a plan (serving in both a settlor and fiduciary capacity), ERISA requires that these overlapping roles be kept separate and distinct.

On July 9, the Internal Revenue Service (IRS) issued Notice 2015-49, which prohibits sponsors of qualified defined benefit pension plans from adopting lump sum windows for retirees in pay status.

As part of pension plan “de-risking” efforts initiated in recent years, some plan sponsors have implemented lump sum windows programs that provided retirees in pay status with the opportunity to receive the present value of their remaining monthly benefit payments in a single, lump sum payment. Practitioners had concerns about whether such programs were permissible and satisfied the required minimum distribution rules set forth in Internal Revenue Code section 401(a)(9) (which limits changes in the form and timing of periodic retirement benefits after payment has started), but the Internal Revenue Service issued a series of private letter rulings (highlighted by rulings issued to Ford and GM in 2012) indicating that the programs were permissible if implemented correctly. These IRS rulings drew heavy criticism in some quarters, with some policymakers expressing concerns about allowing retirees in pay status to accelerate a stream of monthly retirement benefits payments into a single lump sum payment. In mid-2014, with no explanation, the IRS abruptly stopped issuing private letter rulings on these issues and even returned some ruling applications that had been submitted but not yet reviewed.

The IRS broke its silence on these issues with the issuance of IRS Notice 2015-49 that prospectively bars lump sum window programs for retirees in pay status. However, the IRS indicated that certain lump sum window programs for retirees implemented, authorized, and/or communicated before July 9, 2015 will continue to be permitted.

For more information about IRS Notice 2015-49, see our LawFlash on this topic.