September 1998 Vol. III, No.1

This past year has been busy indeed with respect to numerous legal changes brought about by recently enacted legislation and pronouncements by the Internal Revenue Service and the Department of Labor. For the benefit of our clients and business associates, this newsletter summarizes these important changes in the employee benefits area. The newsletter is not intended, and cannot be considered to constitute, specific legal advice, as each individual circumstance is unique. However, we are prepared to assist our clients and business associates in reviewing their employee benefit programs and in making any necessary or desirable revisions to take into account changes in the law. (This memorandum is provided for information purposes by Marcia S. Wagner, Esq. & Associates, P.C. to clients and others who may be interested in the subject matter. This material is not to be construed as legal advice or legal opinions on specific facts. Under the Rules of the Supreme Judicial Court of Massachusetts, this material may be considered advertising.)

Since our last newsletter (Vol. II, No. 2, November 1997), Attorney Marcia S. Wagner has been interviewed on public television, listed in the Nationwide Register's Who's Who in' Executives and Businesses, and quoted in Forbes magazine all regarding benefits issues. If you desire a tape of the television show, please let us know. Also, we welcome you to visit our new web site at (you are on the site)

In the event you desire legal advice or consultation or wish to discuss the appropriate timing of necessary plan amendments, please feel free to contact Attorney Marcia S. Wagner.



A. Hardship Distributions

B. Capital Gains Tax Rates

C. No Early Withdrawal Tax on IRS Levy

D. Mergers and Acquisitions - SIMPLE IRAs

E. Nonattorney Confidentiality Privilege

F. Surface Transportation Revenue Act of 1998


A. Introduction


C. General Correction Rules Under All Programs

D. Modifications of Current Programs

E. Effective Dates


A IRS Approves Negative or Automatic Elections Under 401 (k) Plans

B. Additional Guidance on 401 (k) Nondiscrimination Testing

C. Final Regulations Permit Qualified Plans to Eliminate Preretirement Distributions to Employees Over Age 70-1/2

D. Proposed Regulations Permit Revocable Trust as Plan Beneficiary

E. IRS Seeks Comments on Proposed Exceptions to Anti-Cutback Rules

F. IRS Provides More Guidance on Plan Loans

G. IRS Notice Provides Favorable Capital Gains Tax Rate for Distributions of Employer Stock


A. U.S. Supreme Court Rules That Former Employers May Take COBRA Even If They Have Other Coverage

B. IRS Issues COBRA Guidance

C. Proposed Regulations Expand Change In Election Rules For Cafeteria Plans

D. Proposed Rules on Claims Procedures and Summary Plan Description Requirements

E. Americans With Disabilities Act Bars Discrimination Based on HIV

F. Health Plan Fiduciaries Must Assess Quality of Service


A. Department of Labor Announces that Plan Administrators Have A Fiduciary Responsibility To Address The "Year-2000" Computer Problem

B. Microsoft Freelancers Were Employees Despite Transfer To Temp, Agencies

C. IRS Extends Worker Classification Settlement Program

D. IRS Issues Proposed Regulations On Exempt Organization "Excess Benefit Transactions"

E. Massachusetts Small Necessities Leave Law


The IRS Restructuring and Reform Act of 1998 ("IRRA '98"), which was signed into law by President Clinton on July 22, 1998, contains several provisions that affect employee benefits. Many of these are technical corrections to provisions contained in the Small Business Job Protection Act of 1996 ("SBJPA") and the Taxpayer Relief Act of 1997 ("TRA '97"). Employee communications and plan administrative procedures need to be revised where appropriate.

A. Hardship Distributions

TRA '97 exempts certain IRA distributions from the 10% early withdrawal tax distributions used to pay "qualified higher education expenses" or expenses incurred (up to $10,000) in connection with the first-time purchase of a home). However, it did not provide similar treatment for the same type of distributions from 401(k) or 403(b) plans. It was thus possible for participants in 401(k) or 403(b) plans to roll over tax-free hardship distributions from such plans to an IRA, and then withdraw the amounts from the IRA for qualified higher education or first-time home purchase expenses, thereby avoiding the 10% tax, which would have otherwise applied. Also, because the distributions were direct rollovers, they were not subject to the 20% withholding requirements.

A technical correction in IRRA '98 closes this loophole by providing that hardship distributions from 401(k) or 403(b) plans are no longer eligible rollover distributions. Therefore, they cannot be rolled over into an IRA and are not subject to the 20% withholding requirement. However, they are still subject to other pension withholding requirements and, if applicable, the 10% early withdrawal tax. This provision is effective for distributions made after December 31, 1998.

B. Capital Gains Tax Rates

TRA '97 lowered the long-term capital gains tax rate to 20% for assets held for more than 18 months (10% for taxpayers in the 15% tax bracket). In addition, TRA '97 provided that assets held for more than 12 months but less than 18 months would be taxed at the pre-TRA '97 rate of 28%. These rules applied to assets sold after May 6, 1997.

IRRA '98 reduced the holding period to qualify for long-term capital gains taxation at a 20% rate from more than 18 months to more than 12 months. The 28% capital gains tax rate is retained in limited situations (e.g., for collectibles). These provisions are effective for tax years ending after December 31, 1997.

Comment: These changes should have no immediate effect on the capital gains tax treatment of any net unrealized appreciation ("NUX') in employer stock distributed from qualified plans. As a result of IRS Notice 98-24, the 20%/10% tax rates apply to NUA in such distributions. See discussion in Section III.G. of this newsletter.

However, the changes will be beneficial with respect to appreciation in employer stock after it is distributed - if held for more than 12 months. Employers will want to communicate how these changes affect plans involving employer stock (e.g. stock purchase plans, stock option plans, etc.).

C. No Early Withdrawal Tax on IRS Levy

IRRA '98 provides that the 10% penalty tax on early withdrawals from qualified plans and IRAs (generally before age 59-1/2) will not apply if the distribution is due to an IRS levy on the qualified plan or IRA. This provision is effective for distributions due to an IRS levy after December 31, 1999.

D. Mergers and Acquisitions - SIMPLE IRAs

SBJPA created SIMPLE IRAs under which employers with fewer than 100 employees in the preceding year who do not maintain a qualified plan may provide a salary reduction arrangement for their employees. SBJPA also provided a two-calendar year grace period for maintaining a SIMPLE IRA in the event the 100-employee rule is exceeded.

IRRA '98 contains a technical correction if the 100 employee rule is exceeded because of a merger or acquisition. It creates a transition period extending to the last day of the second calendar year that begins after the merger or acquisition.

During this transition period, an employer will not be treated as violating a SIMPLE requirement as long as certain coverage rules are met (i.e., generally coverage may not be significantly changed during the transition period). In addition, the acquired employer would have to continue to qualify to maintain the SIMPLE IRA as if it had remained a separate employer. Therefore, presumably, the employees could not participate in any qualified plan of the acquiring company during the transition period.

These provisions are effective for tax years beginning in and after 1997.

E. Nonattorney Confidentiality Privilege

There is a privilege of confidentiality which protects certain communications, including written materials, between an attorney and client from disclosure in any type of legal proceeding.

IRRA '98 extends this confidentiality privilege to communications regarding tax advice between clients and nonattorneys who are "federally authorized tax practitioners" (e.g. CPAs, enrolled actuaries). Although this protection is not all encompassing, it should provide a more open communication process in dealing with the tax implications of various benefit strategies. This provision is effective for communications made on or after July 22, 1998.

F. Surface Transportation Revenue Act of 1998

President Clinton signed a separate tax bill into law - the Surface Transportation Revenue Act of 1998 - on June 9, 1998. One provision amended Code Section 132(f) to allow employees to make salary reduction elections to receive tax-free employer provided transportation benefits of up to $65 per month (increasing to $100 per month in 2002). TRA '97 already allows this treatment for qualified parking benefits.

Comment: These benefits will be very well received by employees and are low cost for employers since they are paid for through salary reduction. The administrative issues to consider in implementing these benefits are chiefly payroll and communication issues. For example, an employer must decide how often to allow and how to administer changes in elections. Also, employers implementing these programs may have to amend their other plans where appropriate to specify that the definition of compensation includes these salary reduction amounts.


A. Introduction

In December 1990, the IRS introduced its first qualified plan compliance program on a temporary basis, the Closing Agreement Program ("CAP"). Under this program, a plan sponsor facing disqualification could enter into an agreement with the IRS to correct an operational or form plan defect, pay a fee and avoid plan disqualification. Subsequently, the IRS made this program permanent and added other programs under which plan sponsors could voluntarily correct plan defects in order to avoid plan disqualification (e.g., Administrative Policy Regarding Sanctions ("APRS"), and the Voluntary Compliance Resolution ("VCR") program).

Over the years, these programs were expanded, modified and honed into such variations as Walk-in CAP and Administrative Policy Regarding Self Correction ("APRSC"). A program was also introduced for correction of defects under Section 403(b) plans, the Tax Sheltered Annuity Voluntary Correction ("TVC") program. Many of the modifications were inspired by recommendations from private sector groups, in which Marcia Wagner is heavily involved.

The IRS has now consolidated all of these programs (except TVQ into one program, the Employee Plans Compliance Resolution System ("EPCRS"). In Revenue Procedure 98-22, the IRS introduces this consolidated system and explains the changes made to the various correction programs under the system.


The purpose of EPCRS is to encourage plan sponsors to maintain their plan practices and procedures in accordance with the terms of their plans and IRS rules, and when defects are discovered, to encourage voluntary and timely correction. EPCRS allows sponsors to correct defects without fear of onerous sanctions or excessive fees being imposed. EPCRS outlines a consistent, consolidated scheme for correction of plan defects on which plan sponsors can rely.

One of the key objectives of EPCRS is to promote the establishment of administrative procedures that will assure ongoing compliance by plan sponsors. The IRS will generally require as part of the closing agreement proof that ongoing administrative procedures have been established.

The various IRS programs under EPCRS, as discussed below, allow for correction of form, operational and demographic defects. A "form defect" is one relating to the plan document, such as a plan document not timely amended to be in compliance with tax law changes. An "operational defect" results when the terms of the plan have not been followed. A "demographic failure" occurs when a change in the employee population results in a plan failing to meet IRS rules (e.g.., nondiscrimination). In some cases, EPCRS allows for correction of egregious defects.

The EPCRS incorporates the following IRS correction programs:

Administrative Policy Regarding Self-Correction ("APRSC"), which allows a plan sponsor of a qualified or Section 403(b) plan to self-correct an insignificant operational failure without fee, sanction or IRS involvement.

Voluntary Compliance Resolution ("VCW') program, which allows a plan sponsor to voluntarily correct an operational plan defect before IRS audit with payment of a fixed fee and IRS approval.

Standardized VCR Procedure ("SVP"), which allows correction of seven specified operational defects in a prescribed manner with payment of a minimal compliance fee.

Walk-In Closing Agreement Program ("Walk-In CAP"), which allows a plan sponsor to disclose and correct form, operational or demographic failures voluntarily before an IRS audit and pay a compliance correction fee.

Audit Closing Agreement Program ("Audit CAP"), which allows correction of form, operational or demographic defects after an IRS audit has commenced, with payment of a negotiated sanction.

Revenue Procedure 98-22 does not incorporate or modify the Tax Sheltered Annuity Voluntary Correction ("TVC") program, although it notes that TVC could be incorporated in the future. However, the revenue procedure does specify that certain Section 403(b) operational violations (other than those that would cause income inclusion for some employees) are eligible for correction under APRSC.

The EPCRS provides an element of consistency for all its component programs by including a list of uniform definitions. It also illustrates the interrelationship of the various programs. For example, for plans under current IRS examination, EPCRS provides that the VCR program and Walk-In CAP cannot be used. However, for plans under current IRS examination, under APRSC, insignificant violations may be corrected and even significant violations may be corrected if certain conditions are met (as discussed below). It should be noted that no program is available to correct problems relating to diversion or misuse of plan assets.

EPCRS revises the sanction and fee structure of the various programs, as noted below. It also reduces uncertainty by promising plan sponsors that if they meet the eligibility requirements under EPCRS, then they may rely on the availability of EPCRS in making corrections with respect to their plans.

C. General Correction Rules Under All Programs

The correction method should restore the plan to the position in which it would have been had the qualification failure not occurred. Although there may be more than one reasonable and appropriate correction method, the correction method should resemble, to the extent possible, methods already provided in the Internal Revenue Code, regulations, or other IRS guidance of general applicability. The correction method should keep assets in the plan, either by reallocating excess assets to other participants or by reducing future employer contributions. Thus, for example, nondiscrimination rule violations should be corrected by providing additional benefits for nonhighly compensated employees. The IRS has added a provision that allows special exceptions to full correction in certain situations, although the correction method must not have a significant adverse impact on participants and must not discriminate significantly in favor of highly compensated employees. These special exceptions: (i) allow reasonable estimates when precise calculations are not possible; (ii) eliminate the requirement of corrective distributions of $20 or less if the reasonable distribution costs would exceed the amount of the distribution; and (iii) excuse the failure to locate lost participants after use of the IRS or Social Security program for locating missing individuals.

D. Modifications of Current Programs

Revenue Procedure 98-22 makes the following modifications to the programs incorporated in the EPCRS:


Under the APRSC, a plan sponsor can correct insignificant operational failures without fee or sanction at any time. A plan sponsor can correct significant operational failures without payment of fee or sanction if the plan has a favorable determination letter and the correction is substantially completed by the end of the second plan year after the plan year of the failure.

Whether an operational failure is significant is determined under all the facts and circumstances, including: (i) the number of the operational failures; (ii) the percentage of plan assets and contributions involved; (iii) the number of years and participants involved; (iv) the timeliness of the correction; and (v) the reason for the failure.

In addition, the revenue procedure provides the opportunity under APRSC to complete the correction of a significant operational failure after the end of the correction period if the correction was substantially completed by the end of the correction period.

The revenue procedure reiterates that egregious failures may not be corrected under APRSC.

2. VCR

The VCR program, which involves the correction of operational failures raised by the plan sponsor in its submission to the IRS national office, has not been significantly modified. However, the revenue procedure makes the VCR program more user-friendly by reducing the specificity required in the calculations supporting a plan sponsor's proposed correction method and extending the time period for correcting defects to 150 days after IRS approval of the compliance method. Also, it modifies the circumstances under which closing agreements may be entered into with respect to excise taxes for failure to meet minimum distribution requirements under Internal Revenue Code Section 401(a)(9). Further, the revenue procedure provides a checklist for use by plan sponsors in preparing VCR requests.

3. SVP

The revenue procedure modifies the correction methods under the Standardized VCR Procedure. It also provides a checklist for making SVP requests.

4. Walk-In CAP

The revenue procedure makes the Walk-In CAP more palatable for plan sponsors by restructuring the sanction amounts. Importantly, the use of 40 percent of the maximum payment amount (tax due on plan disqualification) as a negotiation starting point is no longer required, other than for egregious failures. The revenue procedure provides fee charts for this program with six ranges of fees based on the size of the plan. The minimum fees are the VCR fees (which range from $500 to $ 10,000) and the maximum fees are specified dollar amounts (which range from $4,000 to $70,000). The expected amount of the fee (the presumptive amount) is one-half of the maximum.

The revenue procedure also provides a checklist for plan sponsors preparing Walk-In CAP requests.

5. Audit CAP

The revenue procedure restructures the sanctions under the Audit CAP to be commensurate with the type and extent of the violation. It also states that any corrections made before audit will be an important factor in reducing the potential sanction under Audit CAP. As noted above, insignificant violations, as well as certain significant violations, may still be corrected under APRSC after audit.

E. Effective Dates

Revenue Procedure 98-22 is generally effective for VCR, SVP and Walk-in CAP applications submitted on or after September 1, 1998. For Audit CAP, it is effective with respect to examinations commencing on or after September 1, 1998. Under APRSC, it is effective for failures that have not been fully corrected before January 1, 1999.

Comment: The EPCRS shows the IRS' willingness to listen to the employee benefits community and Congress and make its plan qualification programs more reasonable and user-friendly. It is also important to note that the IRS plans to further modify the system based on the experience and input of plan, sponsors.

Under EPCRS, the IRS has modified its qualified plan compliance programs and made them more usable. Plan sponsors should review their qualified plans for past and future compliance with IRS rules, and, if appropriate, consider one of the IRS correction mechanisms. We would be pleased to assist in this review and if defects are found, to help employers choose an appropriate option for correction under the EPCRS.


A. IRS Approves Negative or Automatic Elections Under 401(k) Plans

I . Background

Some employers have designed their 401(k) plans to include an automatic deferral election feature. Under this type of election feature, a newly eligible employee's compensation is automatically reduced by a fixed percentage and deposited into an account set up for the employee under a 401(k) plan - unless the employee elects otherwise. In most cases, this automatic election occurs unless the employee affirmatively elects to receive cash (i.e., full compensation) or change the amount of deferral before the end of the first pay period for which the deferral will be deposited.

The automatic deferral feature is beneficial for both employees and employers - it helps employees save while increasing the plan's participation rates. However, in the absence of any formal guidance, employers have been reluctant to adopt this feature. Now that the IRS has officially sanctioned the use of this type of election under the circumstances described in Revenue Ruling 98-30, employers can feel secure in adopting an automatic election feature.

2. IRS Revenue Ruling 98-30

IRS Revenue Ruling 98-30 outlines a situation in which an employer uses an automatic election feature for newly hired employees under its qualified cash or deferred arrangement (i.e., 401 (k) plan).

The 401(k) plan allows employees to participate immediately upon hire. Under the plan, if a newly hired employee does not make an election upon hire, or within a reasonable period ending before the compensation for the first pay period is made available, the employee's compensation is automatically reduced by 3% and this amount is contributed on the employee's behalf to the 401 (k) plan. Employees can elect to change their salary reduction contributions at any later time. However, these later elections are effective for payroll periods beginning in the month following the date the election is filed.

At the time of hire, employees are given an explanation of the automatic election feature and of their right to elect not to make any contributions or to alter the amount of contribution. In addition to this initial notification, employees are notified annually of their current contribution election and their right to change the amount of contribution.

It should be noted that after-tax contributions are not permitted under the plan, and therefore are not discussed in the ruling. Also, under the plan described in the ruling, the automatic salary reduction amounts are invested in the plan's balanced (i.e.., diversified equity and fixed income) investment fund.

B. Additional Guidance on 401(k) Nondiscrimination Testing

1. General Information

The IRS has issued additional guidance on nondiscrimination testing of 401(k) plans in Notice 98-1. Employers can now use prior year data to determine the actual deferral percentage ("ADP") and actual contribution percentage ("ACP") for the nonhighly compensated employees ("NHCEs") while still using current year data to determine the ADP and ACP for the highly compensated employees ("HCEs"). This should permit plan administrators to monitor more easily their plans throughout the plan year to make it more likely for the plans to pass the tests. Even if a plan does not pass the tests, such occurrences should happen in fewer plan years and require smaller refund amounts. Employers can also use current year data to determine the ADP and ACP for both groups of employees. In addition, nothing in the current IRS guidance prevents mixing methods using the current year testing method for the ADP while using the prior year testing method for the ACP, or vice versa). The IRS, however, expects employers to choose a method of testing and to retain it for some period of time, and the plan document must state which testing method is being used. In addition, a plan will not be treated as satisfying the ADP or ACP test if there are repeated changes in the testing method used which result in distorting the ADP or ACP test so that HCEs may have a higher ADP or ACP without a refund.

2. Use of QNECs and QMACs Under Prior Year Method

In order to be taken into account in determining the ADP or ACP under the prior year testing method, qualified nonelective contributions ("QNECs") or qualified matching contributions ("QMACs") must be allocated as of a date within the year being tested and actually be paid to the trust no later than the end of the twelve-month period following the year to which the QNEC or QMAC relates. For example, assume the testing year is 1998, and 1997 data is used to determine the ADP and ACP of the NHCEs and 1998 data is used to determine the ADP and ACP of the HCEs. For QNECs or QMACs allocated to the NHCEs for the 1997 plan year to count in determining the NHCEs' ADP or ACP, the QNECs or QNIACs must have been paid by the end of the 1998 plan year.

3. First Plan Year Testing Using Prior Year Method

If an employer chooses the prior year testing method for the first plan year that 401 (k) contributions are permitted, the employer can elect to use 3% or the current plan year ADP for the NHCEs. The same rule applies with regard to the ACP of the NHCEs in the first plan year that employer matching contributions are made.

An employer using the prior year testing method and choosing to use the current year ADP for NHCEs in the first plan year, can use that same ADP in the second plan year as the prior year ADP. Thus, such an employer can use the same ADP for NHCEs for the first two plan years.

4. Changes in Group of Eligible NHCEs

Generally, where the prior year testing method is used, any changes in the group of eligible NHCEs from the prior year to the testing year are ignored. The prior year ADP and ACP for the NHCEs is used even though some NHCEs may have first become eligible to participate in the testing year, may have terminated employment in the prior year or may have become HCEs in the testing year. Different and extraordinarily technical rules apply, however, if there is a plan coverage change during the testing year. A "plan coverage change" results from one of the following: the establishment or amendment of a plan; a plan merger, consolidation or spin-off; aggregating plans not previously aggregated or disaggregating plans previously aggregated; or a combination thereof.

5. Change in Testing Method

An employer may switch from the prior year testing method to the current year method at any time without having to notify the IRS. However, the IRS has limited the circumstances in which an employer may switch from the current year testing method to the prior year testing method to the following situations: (i) the plan has not been aggregated with one or more plans and has used the current year testing method for the previous five years; (ii) the plan has been aggregated with one or more plans and each plan used the current year testing method for the previous five years; (iii) after a transaction (e.g. acquisition or merger) resulting in the employer maintaining a plan using the current year testing method and a plan using the prior year testing method, the change from the current year testing method to the prior year testing method occurs within the time between the transaction effective date and the last day of the first plan year beginning after the date of the transaction; or (iv) the change occurs during the remedial amendment period for changes under the SBJPA, which is the last day of the first plan year beginning on or after January 1, 1999.

Employers should note that, commencing with testing years beginning after December 31, 1998, limitations on double-counting QNECs and QNIACs apply when switching from the current year testing method to the prior year testing method. Employers should also note that a plan using the current year testing method may not be aggregated for testing purposes with a plan using the prior year testing method.

6. Plan Provisions

A plan is required to specify which of the two testing methods it is using, and, therefore, must be amended if the employer changes the testing method. If the first plan year rule explained above applies, the plan must state whether the ADP and ACP for the NHCEs for the prior plan year is 3% or the current year's ADP and ACP. Amendments to testing method provisions must be adopted before the last day of the first plan year beginning on or after January 1, 1999, but plans must be operated in accordance with the above rules beginning with the 1997 plan year.

Comment: Periodic testing throughout the plan year using the prior year testing method provides plan administrators with the ability to take preemptive measures to reduce the maximum amount of 401(k) deferrals HCEs are permitted to make in order to prevent the plan from failing the ADP and ACP tests. Selecting the most effective methodology for performing the ADP and ACP tests has become very complicated with the introduction of the prior year method of testing.

C. Final Regulations Permit Qualified Plans to Eliminate Preretirement

Distributions to Employees Over Age 70-1/2

The IRS has issued final regulations permitting qualified retirement plans to eliminate preretirement distributions to employees over age 70-1/2. The regulations are an exception to the anti-cutback rules of Internal Revenue Code (the "Code") Section 411 (d)(6), and are designed to help employers implement a change to the required distribution rules enacted by the Small Business Job Protection Act of 1996 ("SBJPA").

I . Required Distribution Change

SBJPA liberalized the required minimum distribution beginning date rules for participants who are not 5% owners. Effective for years beginning after 1997, such participants no longer have to commence required minimum distributions by the April I of the year following the year they turn age 70-1/2 if they have not retired; instead, they can postpone distributions until the April 1 of the year following the year in which they retire.

2. Anti-Cutback Rule Problem

Qualified plans generally cannot be amended in a way that decreases a plan participant's accrued benefit. For this purpose, a plan amendment that eliminates an optional form of benefit is treated as reducing accrued benefits to the extent that the amendment applies to benefits accrued at the time it is adopted or becomes effective. However, the IRS may provide in regulations that this "anti-cutback" rule will not apply to an amendment that eliminates an optional form of benefit.

The right to commence benefit distributions in any form at a particular time is an optional form of benefit. However, in changing the required minimum distribution rule, the SBJPA did not make any exception to the anti-cutback rules. So, except to the extent authorized by regulations, a plan amendment that eliminates the right to begin preretirement distributions after age 70-V2 (or restricts the right by adding an additional condition) violates the anti-cutback provisions of Code Section 411 (d)(6) if it applies to benefits already accrued at the time it is adopted or becomes effective (whichever is later). Without a regulatory exception, a plan would either have to (i) give employees the option of commencing distributions at age 70-1/2 or deferring commencement until after retirement, or (ii) be amended to eliminate the right to preretirement distributions for future accruals only.

3. Regulations Provide Relief

Recognizing the potential complexity of administering plans (particularly defined benefit plans) that adopt either of the above two choices, final regulations provide relief from the anti-cutback rule for certain plan amendments that eliminate preretirement distributions commencing at age 70-1/2. The final regulations allow a plan to be amended to eliminate the preretirement distribution option, if: (i) the amendment applies only to benefits with respect to employees who attain age 70-1/2 after the later of December 31, 1998 or the adoption date of the amendment; (ii) the plan does not preclude an employee who retires after the calendar year in which the employee attains age 70-1/2 from receiving benefits in any of the same optional forms of benefits that would have been available had the employee retired in the calendar year in which the employee attained age 70-1/2; and (iii) the amendment is adopted no later than the last day for any remedial amendment period that applies to the plan for changes under the SBJPA (i.e., the end of the 1999 plan year).

According to the IRS, the reason for this limitation is that employees who were near age 70-V2 when the SBJPA was enacted may have expected to receive preretirement distributions in the near future, and therefore may have made plans that took these expected distributions into account.

4. Some Plans Need Not Act

Many employers do not need relief in order to implement the SBJPA required beginning date change. The regulations point out that a profit sharing plan that permits an employee to elect distributions after age 59-1/2 at any time and in any amount may be amended to implement the required beginning date change without violating Code Section 411 (d)(6). That is because the right to commence distributions at age 70-1/2 continues to be available under the plan even after the plan is amended to implement the SBJPA change in the required beginning date.

5. Effective Date

The final regulations apply to plan amendments adopted and effective after June 5,1998.

D. Proposed Regulations Permit Revocable Trust as Plan Beneficiary

The IRS recently issued proposed amendments to proposed regulations that were issued on July 27, 1987 under Code Section 401(a)(9) which make the use of revocable trusts easier in planning for distributions from qualified retirement plans and IRAs. The revocable trust is an important, flexible tool of modem estate planning. Often the principal wealth of working taxpayers consists of retirement plans, particularly 401(k) and profit sharing plans, and IRAs. The proposed amendments change the 1987 provisions which rendered use of the revocable trust for such assets impossible for a taxpayer age 70-1/2 or older, and difficult for others.

The 1987 proposed regulations provided that a trust could only be the designated beneficiary with the life expectancy of the trust beneficiary for purposes of calculating minimum distributions from the plan or IRA, if. (i) the trust was irrevocable, (ii) the trust was valid under local law, (iii) a copy of the trust instrument is delivered to the plan administrator, and (iv) the beneficiaries of the trust, who are beneficiaries with respect to the trust's interest in the employee benefits, are identifiable from the trust instrument.

The theory behind these requirements is that only an individual may be a beneficiary for purposes of making the minimum required distribution calculation under Code Section 401(a)(9). Generally, under Code Section 401(a)(9), a participant may elect a plan distribution schedule based on his or her own life expectancy plus the life expectancy of his or her beneficiary, which cannot be anyone other than an individual. Before 1997, the minimum required distribution period began at April 1 of the year following age 70-1/2 for everyone, but now that age applies only to 5% owners of the sponsoring employer with regard to qualified retirement plans and to the holders of IRAs. For all others, the period begins on April 1 of the year following the later of age 70-1/2 or the actual date of retirement. Estate planners often used revocable trusts as designated beneficiaries with the proviso that the trust become irrevocable at the participant's attainment of age 70-1/2.

The new amended proposed regulations still require that the trust be valid under local law and that the beneficiaries be identifiable, but now only require that the trust either be: (i) irrevocable, or (ii) by its terms become irrevocable on the death of the plan participant. The new amended proposed regulations provide that the participant may either provide a copy of the trust instrument to the plan administrator or, alternatively, provide: (i) a list of beneficiaries to the extent they are contingent, (ii) a description of the conditions on their entitlement, (iii) certification that the list is correct, (iv) an undertaking to make corrected certifications in the event of any amendments to the trust, and (v) an agreement to provide a copy of the trust to the plan administrator upon request. A final certification is required within nine months after the participant's death.

E. IRS Seeks Comments on Proposed Exceptions to Anti-Cutback Rules

1. Background

Internal Revenue Code Section 411 (d)(6) generally prohibits plan amendments that decrease a plan participant's accrued benefit. Specifically, the Code provides that a plan amendment that eliminates an optional form of benefit will be treated as reducing accrued benefits to the extent the amendment applies to benefits accrued up to the time of the amendment's adoption date or the effective date of the amendment, if later. Thus, a plan could lose its qualified status if an amendment effectively eliminates or reduces an early retirement benefit, a retirement-type subsidy, or an optional form of benefit.

However, Code Section 411 (d)(6) authorizes the IRS to provide exceptions to this anti-cutback provision.

The IRS is considering expanding the available relief from the Code Section 411 (d)(6) anti-cutback provisions for certain plan amendments that eliminate optional forms of benefit from defined contribution plans and has asked for comments in Notice 98-29 on whether additional Code Section 411 (d)(6) relief should be provided for either defined contribution or defined benefit plans.

It should be noted that Notice 98-29 provides that any regulatory relief from Code Section 411 (d)(6) would not permit the elimination of required forms of distribution joint and survivor annuity) from money purchase pension plans.

2. IRS Notice 98-29

In Notice 98-29, the IRS outlines four approaches in which the elimination of certain optional forms of benefit payments from a defined contribution plan would not be treated as a Code Section 41 l(d)(6) violation.

The first approach would permit a plan amendment eliminating alternative forms of payment if, after amendment, each affected participant could elect a lump sum distribution or at least one extended payment option. The extended payment option would have to be either a joint and survivor option or installment payments over joint life expectancies. In addition, if a plan did not permit either of these options, installments payable over the longest period permitted by the plan would be acceptable. This approach would be available only if the amendment does not apply to a participant whose benefit payments began before, or would begin within, 90 days of the amendment's option.

The second approach would allow amendments that eliminate optional forms of benefit that are infrequently selected by participants. This approach would require that the utilization of each option be substantiated.

The third approach would permit plan amendments that eliminate optional forms of benefit that apply to no more than a small portion of a participant's benefit. Notice 98-29 cites as an example the elimination of an optional form of benefit that applies only to benefits attributable to contributions made before a certain date if these contributions represent a small portion of an affected participant's benefit.

The fourth approach outlined in Notice 98-29 would permit plan amendments eliminating optional forms of benefit that do not become effective for some period of years.

3. Conclusion

Marcia S. Wagner, Esq. & Associates, P.C. plans to submit comments to the IRS supporting the expansion of relief from the Code Section 411(d)(6) anti-cutback provisions for both defined contribution and defined benefit plans.

F. IRS Provides More Guidance on Plan Loans

1. Background

Internal Revenue Code Section 72(p) provides that an amount received as a loan from a qualified employer plan by a plan participant or beneficiary is treated as a taxable distribution unless certain criteria are satisfied (e.g. generally, a 5-year repayment schedule).

In December 1995, the IRS issued proposed regulations providing guidance on the basic requirements and conditions that must be met to ensure that plan loans are not treated as actual or deemed distributions. Although the proposed regulations covered many issues (e.g. missed loan payments, grace periods), they did not address questions on the effect of a deemed distribution on the tax treatment of subsequent distributions to a participant or whether interest should continue to accrue on a defaulted loan. The latest IRS proposed regulations provide guidance on these issues.

2. Deemed Distributions

If a loan becomes a deemed distribution (i.e. under the terms of a plan, a participant fails to make timely repayments) and the loan note has not been distributed, interest must continue to accrue on the defaulted loan (i.e., the deemed distribution) but these interest accruals are not included in the participant's income. Also, neither the income that results from the deemed distribution nor the interest that continues to accrue increases the participant's after-tax basis in the plan. These rules apply for purposes of calculating the taxable and nontaxable portions of payments to the participant.

3. Cash Repayments

Any cash repayments made after the loan is deemed distributed would, for income tax purposes, increase a participant's tax basis in the same manner as if the repayments were after-tax contributions. However, cash repayments of the defaulted loan are not treated as after-tax contributions in applying the Section 415 maximum limits on annual additions nor are they taken into account in applying the Section 401(m) nondiscrimination test.

4. Subsequent Loans

According to the proposed regulations, a loan becomes a deemed distribution upon default if the loan is not repaid by offsetting the participant's account balance and the loan note under the plan is not distributed. Importantly, the deemed distribution is still considered to be an outstanding loan for purposes of determining the maximum amount of any subsequent loan that may be made to the affected participant.

5. Conclusion

We can help you review your plan loan provisions and, if necessary, bring the provisions into compliance with this latest guidance.

G. IRS Notice Provides Favorable Capital Gains Tax Rate for Distributions of Employer Stock

The IRS issued Notice 98-24, which describes the capital gains tax treatment of the net unrealized appreciation (i.e., the difference between the fair market value of the employer stock at the time of distribution and the plan's cost basis for such stock) in the employer stock distributed from qualified plans. In general, the new lower 20% capital gains tax rate (10% for taxpayers in the 15% tax bracket) will apply to the net unrealized appreciation in employer securities which are distributed from the plan and then sold after May 6, 1997. This lower rate will apply regardless of the period the stock was held by the plan.

In the case of a qualifying distribution which includes employer stock (e.g., lump sum), a recipient will not be taxed on the increase in the value of the employer stock while that stock was held by the plan (i.e.., net unrealized appreciation). In general, this appreciation will be treated as a long-term capital gain when the stock is sold.

Any further appreciation after the stock is distributed will result in either a longer short-term capital gain upon sale, depending on how long the stock is held by the recipient after he or she receives the stock from the plan.

Comment: The IRS' position allowing plan administrators to disregard the actual holding period of the individual securities held by the plan is extremely welcome because it eliminates the burden of tracking the different acquisition dates of the securities.


A. U.S. Supreme Court Rules That Former Employees May Take COBRA Even If They Have Other Coverage

A qualified beneficiary under the Consolidated Omnibus Budget Reconciliation Act of 1985 ("COBRA") is entitled to continue coverage under the former employer's health plan even if he or she already has coverage from another group health plan when electing COBRA, according to a recent U.S. Supreme Court ruling in Geissal v. Moore Medical Corp. The Court's decision is contrary to the proposed IRS regulations implementing COBRA and some federal court decisions. Plans that relied on those regulations and decisions may have COBRA forms and procedures that do not comply with the current understanding of the law.

COBRA permits a qualified beneficiary to elect to continue coverage under an employer's group health plan after a qualifying event (such as termination, reduction in hours, or death of a spouse) that would otherwise cause the coverage to terminate. However, COBRA eligibility stops if, after the COBRA election, the qualified beneficiary becomes covered under another group health plan (unless it excludes or limits coverage for a pre-existing condition of the individual) or Medicare. When a COBRA beneficiary has duplicate coverage (such as coverage under a spouse's employer sponsored plan), most commentators initially assumed that the purpose of COBRA - to protect against an abrupt loss of health coverage - did not apply. As a result, the COBRA regulation proposed by the IRS took the position that a plan does not have to provide COBRA if the qualified beneficiary has other coverage at the time of the COBRA election.

Since then, lawsuits have brought to light the fact that sometimes a person who has other coverage still needs COBRA because the other plan does not cover the person's particular health problems. The Supreme Court noted that COBRA states that health continuation coverage can be terminated when the beneficiary "first becomes, after the date of the election," covered by another plan or by Medicare. In Mr. Geissal's case, he had been covered by the health plan sponsored by his wife's employer before he was fired, and still had that coverage at the time he elected COBRA. Since he did not "first" become covered "after" electing COBRA, the Supreme Court held that the other coverage did not disqualify him from COBRA.

Operational Impact

As a result of the Supreme Court's decision, plans can no longer rely on the proposed regulations or other court decisions to deny COBRA benefits to people who have other coverage.

The Supreme Court's decision is effective immediately, so plan sponsors must review current and future applications for COBRA continuation coverage with these rules in mind:

Qualified beneficiaries with coverage under another health plan, or Medicare, at the time of their COBRA election must be offered COBRA continuation coverage.

A qualified beneficiary who first gets other coverage after having elected COBRA may be able to keep the COBRA coverage anyway, if the other plan has a limit or exclusion that expressly applies to a pre-existing condition of that individual.

If a qualified beneficiary has both COBRA and other coverage, standard coordination of benefits rules typically provide that the plan that covers the qualified beneficiary as an employee is primary to the plan that covers him or her as a former employee, but that either plan would be primary to one that covers the person as a spouse or dependent. So, for example, Mr. Geissal's COBRA coverage, to which he was entitled as a former employee, would be primary to the coverage he had through his wife's employer.

Consequently, plan sponsors should review plan documents, summary plan descriptions ("SPI)s"), and COBRA forms and procedures to assure that they accurately reflect the current rules.

Comment: We would be happy to apprise sponsors of the impact of the Geissal decision and make any needed changes to plan policies, procedures and communications.


B. IRS Issues COBRA Guidance

I . Introduction

Several changes to the health coverage continuation rules have been made by various laws enacted in the past several years. For example, the Omnibus Budget Reconciliation Act of 1989 ("OBRA '89") extended the continuation period for certain disabled beneficiaries from 12 months to 29 months, and the Health Insurance Portability and Accountability Act of 1996 ("HIPAA") extended the period during which a beneficiary could become disabled and claim the extended period. Now, the IRS has issued proposed regulations which provide guidance on this and other changes made by these laws.

2. IRS Regulations

The IRS has issued proposed regulations primarily to provide guidance on the most recent changes made to COBRA by HIPAA. However, they also address changes made to COBRA by the Technical and Miscellaneous Revenue Act of 1988 ("TAMRA") and OBRA '89.

3. Extended Period for Disabled Beneficiaries

COBRA generally requires a health coverage continuation period of 18 months for qualifying events resulting from termination of employment or a reduction in hours. OBRA '89 allowed this period to be extended to 29 months in the case of a qualified beneficiary who was disabled at the time of the qualifying event. HIPAA amended COBRA to allow this extension for a qualified beneficiary who became disabled as determined under the Social Security Act during the first 60 days of COBRA coverage. It also clarified that nondisabled beneficiaries entitled to continuation coverage because of the same qualifying event were also entitled to the 29-month period.

The proposed regulations make several clarifications with regard to the operation of these rules. They establish the following three conditions for entitlement to the extended period:

a termination-of-employment qualifying event occurs;

the qualified beneficiary resulting from the qualifying event is disabled (as determined under the Social Security Act) during the first 60 days of COBRA continuation coverage; and

the qualified beneficiary resulting from the qualifying event notifies the plan administrator of the determination of Social Security disability within 60 days after the date the determination is issued and before the end of the initial 18 month period.

4. Measurement of 60-Day and 29-Month Periods

The regulations specify that the 60-day period is generally measured from the date of the qualifying event. However, if the loss of coverage occurs at a later date and the plan provides for an extension of the COBRA period, the regulations provide that the 60 day period is measured from the date the coverage is lost.

The regulations provide that the 29-month period is also measured from the date of the qualifying event. If the loss of coverage occurs at a later date and the plan provides for an extension of the COBRA period, the period is still measured from the qualifying event. The regulations specify further that if a subsequent qualifying event occurs (other than a bankruptcy qualifying event) during the 29-month period, then the qualified beneficiary is entitled to a 36-month period measured from the date of the initial qualifying event.

5. COBRA Premiums

OBRA '89 allows plans to charge disabled qualified beneficiaries eligible for the extended 29-month period 150% of the applicable premium after the initial 18-month period. The regulations clarify that this additional premium applies only to the period after the initial 18-month period and that no more than 102% may be charged for the initial 18-month period.

For example, if a second qualifying event occurs during the initial 18-month period, the qualified beneficiary would pay only 102% for the entire 36-month period - even if he or she would qualify for the extended 29-month period. On the other hand, if a second qualifying event occurs after the initial 18-month period (during the disability extension), the 150% premium that applies due to the disability extension would apply for the 19th month through the end of the 36-month period.

6. Nondisabled Qualified Beneficiaries

The regulations specify that the extended 29-month period applies independently to all qualified beneficiaries resulting from the same qualifying event, thereby applying to qualified beneficiaries who are not disabled. However, under the provisions dealing with payment, the IRS reserves a section for nondisabled qualified beneficiaries. In the preamble, the IRS asks for comments on the extent to which the 150% premium should apply to these qualified beneficiaries. Thus, presumably, until further notice, the 150% premium could be charged to these qualified beneficiaries.

7. Newborn and Adopted Children

The regulations provide guidance on the provision added by HIPAA specifying that an employee qualified beneficiary's newborn child or a child placed for adoption with the employee qualified beneficiary during the COBRA continuation period is a qualified beneficiary. They specify that these newborn or adopted children have the same open-enrollment period rights as other qualified beneficiaries with respect to the same qualifying event. They also clarify that these qualified beneficiaries are entitled to the 36-month period upon a subsequent qualifying event, but that this period is measured from the date of the initial qualifying event with respect to the employee (e.g. termination of employment).

8. Long-Term Care Plans

The regulations provide that plans under which substantially all of the coverage is for qualified long-term care services as defined under HIPAA are not subject to the COBRA requirements.

9. Medical Savings Accounts

The regulations provide that COBRA requirements do not apply to medical savings accounts ("MSAs"), but may apply to the high-deductible health plan associated with an MSA.

10. COBRA Obligations Upon Stock or Asset Sales

The IRS indicates that it is considering issuing guidance on COBRA obligations in the events of stock and asset sales. In the case of a stock sale, the IRS is considering making the buyer's health plan responsible for COBRA coverage with respect to the seller's existing qualified beneficiaries after the sale. In the case of an asset sale, it is considering requiring the seller's group plan to be responsible for its qualified beneficiaries.

C. Proposed Regulations Expand Change In Election Rules For Cafeteria Plans

Guidance has been long awaited on the circumstances under which employees can make election changes under Section 125 cafeteria plans during the plan year due to changes in family status, at least in the case of health plans. The Health Insurance Portability and Accountability Act of 1996 ("HIPAA") further complicated matters by requiring employer health plans to provide for special enrollments which do not conform with the requirements for changing an election under existing Section 125 rules.

The IRS has issued temporary regulations under Code Section 125 and has incorporated them in proposed amendments to existing proposed regulations. These regulations clarify what constitutes a change in status so as to allow an election change for accident or health coverage (including health care spending accounts) and group term life coverage during the year. They also conform the rules to HIPAA requirements for special enrollments. With respect to other qualified benefits under a cafeteria plan, the regulations remain largely unchanged.

The IRS temporary regulations clarify the circumstances under which an employer may permit a cafeteria plan participant to revoke an existing election with respect to accident or health and group term life insurance coverage and make a new election during the coverage period (e.g. plan year).


HIPAA requires health plans to provide individuals special enrollment rights upon certain events (i.e., loss of other health coverage, becoming a spouse or dependent through birth, marriage, adoption or placement for adoption). Importantly, the regulations specify that an employee may change a health benefit election under a cafeteria plan during a coverage period and pay for the coverage on a pre-tax basis if it corresponds with a special enrollment right as provided under HIPAA, even if it would not otherwise qualify as a change in status, as discussed below.

The regulations expand the circumstances under which election changes are permitted with respect to accident or health and group term life coverage by making them available upon a change of status (as opposed to a change in family status as required under the old proposed regulations). They provide that a change in election for the remainder of the coverage period may be allowed if a change in status occurs that affects eligibility and the election change is consistent with the change in status.

The regulations define the events that constitute a change in status as changes in legal marital status, number of dependents, employment status, work schedule, unmarried dependent status, and residence or worksite. For example, a change from part-time status to full-time status could result in an employee becoming first eligible for additional benefits under a cafeteria plan. A change in worksite could result in an individual becoming eligible for a managed care or indemnity option.

According to the regulations, an employee's election to increase or cease coverage is consistent with a change in status event if the new election corresponds directly to an individual's spouse, dependent child) gain or loss of eligibility to participate in a health plan. For example, if an employee's spouse becomes employed (and thereby gains eligibility for the spouse and employee under the new employer's plan), the election change will be consistent only if the spouse elects coverage under the new plan for the spouse or the spouse and employee.

Importantly, the regulations provide an exemption from the consistency rule for COBRA coverage. An employee may elect to increase contributions under a cafeteria plan upon the employee, spouse or dependent becoming eligible for COBRA coverage under the employer's health plan in order to pay for the continuation coverage, regardless of whether the above requirements are met.

The regulations provide that an election with respect to a participant's group term life coverage must also correspond to a change in status event. However, in the event of marriage, birth, adoption or placement for adoption, the regulations specify that only an election to increase the amount of group term life coverage may be made. In the event of divorce, legal separation, annulment or death of a spouse or dependent, the regulations provide that only an election to decrease the amount of coverage may be made.

The regulations further expand the rules for election changes under accident or health plans upon the occurrence of certain events. Under the regulations, an election change with regard to a child's health coverage may be made as a result of a judgment, order or decree upon divorce, legal separation, annulment or change in legal custody, including a qualified medical child support order ("QMCSO"), that requires health coverage for a child to be added or canceled. The regulations also provide that an election to cancel health coverage may be made upon entitlement to Medicare or Medicaid.

The amendments clarify that in the case of benefits other than accident or health and group term life benefits, an employee may still change an election under the existing rules (e.g. upon a change in family status, or upon separation from service).

The amendments also clarify that with respect to accident or health plans, election changes may still be permitted when there is a significant change in health coverage attributable to the spouse's employment.

The temporary regulations are effective for plan years beginning in and after 1999. However, employers can rely on these regulations immediately.

Comment: The IRS has made the rules for making election changes more liberal with respect to health and group term life benefits under cafeteria plans. It is particularly welcome that the IRS has conformed the rules to HIPAA requirements. Employers at the very least should amend their cafeteria plans and implement procedures immediately to comply with the HIPAA provisions, which are effective for plan years beginning after June 30, 1997.

D. Proposed Rules on Claims Procedures and Summary Plan Description


1 . Background

On November 20, 1997, the President's Advisory Commission on Consumer Protection and Quality in the Health Care Industry issued a report, the "Consumer Bill of Rights and Responsibilities," calling for (among other things) better disclosure of information about health benefits and a more fair and efficient process to resolve differences between consumers and health plans, health care professionals, and medical institutions. On February 20, 1998, the President directed that the Department of Labor (the "DOL") propose rules to improve the internal claims process of group health plans and to require better disclosure of health benefit information under ERISA.

The DOL has authority to establish rules governing the benefit claims procedures that pension and welfare plans (including health benefit plans) must provide and the information that is required to be disclosed to plan participants and beneficiaries in, or as part of, the plan's summary plan description ("SPD"). The SPD is the primary vehicle for communicating information in plain language about rights, benefits and obligations of a plan, including, for example, a description of the plan's benefit claims procedures for making claims and appealing denials of claims.


2. Proposed Claims Procedure Regulation

The DOL's proposed claims procedure regulation would strengthen the benefit claims and appeal process for all employee welfare benefit plans.

The proposal would establish shorter time limits for making health benefit claim decisions:

For urgent care claims, as soon as possible, but no later than 72 hours for an initial decision and no later than 72 hours for appeals;

For non-urgent health care claims, within a reasonable period of time, but no later than 15 days for the initial decision and no later than 30 days for appeals.

The proposal would require plans to provide participants with more timely information about the plan's claims procedures and more information about the claims decision when a claim has been denied.

The proposal would provide that appeals must be decided by a party who is neither the initial claim reviewer nor a subordinate of the initial claim reviewer and that for decisions based on medical judgments, the reviewer of a denied health care claim must consult with a medical professional.

The proposal would ensure that claimants have access to judicial review when plans fail to establish or to follow reasonable claims procedures that comply with the new rules.

The proposal would require that all ERISA-covered health plans, including plans that provide benefits through federally qualified HMOs, comply with the new claims procedure rules.

3. Proposed Summary Plan Description Regulation and Interim Amendment of NMHPA Disclosure Rule

A proposed regulation and a separate interim rule would update and clarify certain SPI) content requirements for employee benefit plans.

The proposed SPD content regulation implements the information disclosure recommendations of the President's Advisory Commission by clarifying the information required to be disclosed to plan participants and beneficiaries in, or as part of, the plan's SPD, and updates the disclosure rules applicable to both pension and welfare benefit plans. The proposed SPD content regulation would:

Provide that health plan SPIs must describe: (i) any cost-sharing provisions, including premiums, deductibles, coinsurance and copayment amounts for which the participant or beneficiary will be responsible; (ii) any annual or lifetime caps or other limits on benefits under the plan; (iii) the extent to which preventive services are covered under the plan; (iv) whether, and under what circumstances, existing and new drugs are covered under the plan; (v) whether, and under what circumstances, coverage is provided for medical tests, devices and procedures; (vi) provisions governing the use of network providers, the composition of the provider network and whether, and under what circumstances, coverage is provided for out-of-network services; (vii) any conditions or limits on the selection of primary care providers or providers of specialty medical care; (viii) any conditions or limits applicable to obtaining emergency medical care; and (ix) any provisions requiring preauthorizations or utilization review as a condition to obtaining a benefit or service under the plan.

Clarify that pension and welfare benefit plan SPI)s must describe, among other things, their procedures related to qualified domestic relations orders ("QDROs") and qualified medical child support orders ("QMCSOs"), the plan sponsor's authority to terminate the plan or eliminate benefits under the plan, COBRA health continuation rights, and must include updated information on Pension Benefit Guaranty Corporation ("PBGC") coverage and ERISA rights.

Repeal the limited exemption with respect to SPIs of health plans providing benefits through qualified health maintenance organizations ("HMOs"). The proposal would result in health plans that provide benefits through a federally qualified HMO having to comply with the improved SPD disclosure rule being proposed for other health plans.

A separate interim amendment of the current rule dealing with SPD disclosure relating to the Newborns' and Mothers' Health Protection Act of 1996 ("NMHPX') is also being promulgated by the DOL. In responding to concerns about the adequacy of the current disclosure rule, the DOL published an interim amendment to expand on the information required to be disclosed to clarify that while generally a health plan or health insurance issuer may not restrict benefits for any hospital stay to less than 48 hours following a vaginal delivery or 96 hours following a cesarean section, an attending provider, after consulting with the mother, may discharge the mother and newborn earlier.

E. Americans With Disabilities Act Bars Discrimination Based on HIV

The U.S. Supreme Court recently decided its first case under the Americans with Disabilities Act ("ADA"), Bragdon v. Abbo . While it may be most important for its impact on hiring and job assignments, the decision could also have far-reaching implications for health plans.

1. The Case

The Bragdo case involved a dentist who refused to treat a patient in his office because she was infected with the HIV virus. The Supreme Court held that HIV - even before it ripens into AIDS - is a disability under the ADA, so it was illegal for the dentist to discriminate against Ms. Abbott on the basis of her infection, unless he could prove that it posed a direct threat to his or his clients' and employees' health and safety.

The basis for the Supreme Court's decision was a finding that, even without severe physical symptoms, HIV infection is a physical impairment. It qualifies under the ADA because it substantially interferes with the ability to reproduce, which, the Court found, is a major life activity under the ADA. Since the dentist's office is a public accommodation, and the ADA prohibits discrimination in public accommodations (as well as employment, housing, etc.), the dentist's policy could violate the ADA.

2. Potential Ramifications

Some plans exclude treatment for infertility altogether. Other plans have adopted "managed" infertility treatment benefits. This type of benefit pays for a limited amount of treatment for infertility, with utilization controls and patient copayments. In addition, some plans exclude or limit treatment for drugs that assist in the treatment of reproductive disorders, including, potentially, Viagra.

The Bragdon decision gives participants ammunition for challenging exclusions or limitations on treatments for infertility. Under the Bragdo case, a participant who is suffering from a physical or mental impairment that limits his or her ability to reproduce can now claim that these types of exclusions and limitations violate the ADA.

Other benefit restrictions might be challenged, as well. For example, the Bragdo decision may also be used to challenge limits on treatments for schizophrenia, autism or other debilitating conditions that have been categorized as "mental or nervous." Participants might also challenge exclusions or limitations on treatments for potentially disabling conditions that can be controlled with medication, such as diabetes and epilepsy.

It is worth noting that it is difficult for a participant to use the ADA to sue a health plan. For example, while it is illegal to discriminate in health benefits based on disability, plans are allowed to do so if they can prove, using actuarial data, that the cost of providing the benefit is too expensive. Moreover, under EEOC guidelines, plans can exclude coverage for treatments that might be needed by both disabled and non-disabled people, such as vision care or mental health services.

F. Health Plan Fiduciaries Must Assess Quality of Service

In a recent Information Letter, the Department of Labor ("DOL") states that plan fiduciaries have a duty under ERISA to evaluate the quality of service when choosing a health care service provider. Specifically, the DOL was asked whether a health plan fiduciary is required to select the health care service provider that quotes the lowest bid and whether quality of service can be given priority over cost when choosing from among various providers.

The DOL states in the Information Letter that, since the selection of a health care service provider involves the disposition of plan assets, the evaluation and selection of a health care service provider is a fiduciary act which must be exercised with care and diligence solely in the interest of the participants and beneficiaries. Such an evaluation, according to the DOL, requires the fiduciary to engage in an objective process designed to avoid self-dealing, conflicts of interest or other improper influence. The fiduciary must be able to demonstrate compliance with ERISA's standards in its selection process. Because there are a number of factors involved in selecting a health care service provider, the fiduciary is not required to select the lowest bidder, but must ensure that the compensation paid to the selected provider is reasonable in light of the services provided to the plan. The DOL further states that since quality of service is a factor relevant to the selection of a health care service provider, failure to take quality of service into account would constitute a breach of fiduciary duty.


A. Department of Labor Announces that Plan Administrators Have A Fiduciary Responsibility To Address The "Year-2000" Computer Problem

The DOL recently issued a press release formally advising administrators of employee benefit plans that they have a fiduciary responsibility to address and resolve the so-called "year-2000" computer problem in order to protect workers' benefits and to guard against the unnecessary expenditure of plan assets to solve this problem.

The year-2000 problem - commonly referred to as the "year-2000 bug," the "millennium bug" or the "Y2K problem" - arose because many computer programmers have used double-digits to represent years (e.g., 98 instead of 1998). As a result, most computer programs are unable to deter-mine whether "00" represents the year 2000 or 1900. Therefore, unless they are fixed or replaced, software, hardware and other equipment that are run by computers or have date-related functions are likely to experience problems on January 1, 2000, if not sooner. The year-2000 problem is difficult to fix because so many computer programs use dates in their thousands of lines of code.

Among the plans, functions and related systems that might be affected by the year-2000 computer problem are: computerized record keeping systems; programs that are used to calculate pension benefits; defined contribution plans with participant-directed accounts that provide daily updates; interactive voice response systems used for annual open enrollment period; and payroll systems.

According to Olena Berg, the former Assistant Secretary of Pension and Welfare Benefits Administration, the year-2000 problem "is a cybernetic minefield that will take considerable time and effort to clear... [P]lan administrators and service providers cannot afford to gamble on a last-minute, technological fix. They must act now."

Specifically, plan administrators should perform the following steps as soon as possible: review the computer systems needed for plan operations; determine who is responsible for fixing or replacing those computer systems; instruct those responsible to identify and fix potential problems (as may be required under existing licenses, agreements or maintenance contracts); develop detailed plans and procedures for solving the year-2000 problem, as well as contingency plans for failures; and address the year 2000 issue with all critical vendors, suppliers, clients, banks, custodians and money managers.

B. Microsoft Freelancers Were Employees Despite Transfer to Temp Agencies

In cost-conscious corporate America, temporary workers are increasingly being used to control costs by reducing the number of workers receiving fringe benefits to a core staff while retaining the flexibility to adjust the size of the workforce to meet increases and decreases in market demand. This is particularly true in high-tech companies, where it has been reported that over a quarter of the workers in Silicon Valley are temporary or freelance workers.

Earlier this year, the Supreme Court decided not to review a Ninth Circuit decision that workers classified by Microsoft as freelancers were entitled to participate retroactively in the company's 401(k) plan and its employee stock purchase plan. The case, now back at district court, involved a dispute over whether that decision applies to the entire plaintiff class or only a portion of it.

Specifically, the plaintiffs moved that they were all common-law employees during all their service for Microsoft. Microsoft argued that the class must be divided into subclasses which would include work done by "independent contractors" prior to the March 1990 conversion in positions the IRS found to be employee positions, and work done by the same workers after their conversion to temporary employment agencies, for as long as they worked in the same positions as before the conversion.

Comment: The employee right at issue is the right to participate in the company's ESOP. The question is not whether a worker was an employee or an independent contractor, but whether the worker is employed by Microsoft or by a temporary agency.

The court chose five factors to consider in deciding whether a temporary employee is a common law employee of the client company and thus entitled to participate in the company's benefit plans: (1) whether the client or the agency recruited the worker, (2) the extent of the training that the client provides to the worker, (3) the duration of the worker's relationship with the client company, (4) the client company's right to assign additional projects to the worker, and (5) whether the client company may influence the relationship between the worker and the agency. Under these factors, the court determined that the workers were common law employees of Microsoft both before and after their conversion to temporary personnel and thus could participate in the Microsoft ESOP.

C. IRS Extends Worker Classification Settlement Program

Worker classification will probably always be a hotly contested issue, despite efforts by Congress and the IRS to simplify and standardize the process while making the system more user-friendly. One of the components of this effort has been the IRS's Classification Settlement Program ("CSP"), which was implemented in March 1996 on a two-year trial basis. The IRS has announced that it is extending the CSP until further notice.

The CSP is an optional settlement program. It allows businesses and tax examiners to resolve worker classification cases as early in the administrative process as possible and is intended to reduce taxpayer burden. Under the CSP program, examiners can offer a business under audit a worker classification settlement using a specialized standard closing agreement. The CSP procedures also ensure that the safe haven rules under Section 530 of the Revenue Act of 1978 are properly applied.

Comment. Under a CSP closing agreement, businesses that filed Form 1099 information returns but did not meet all other requirements for relief under the Section 530 safe haven can reclassify their workers prospectively and pay only a specified tax assessment that would not exceed one year's liability.

An IRS review of the program and public feedback have indicated that the program is successful in facilitating early resolution of worker classification cases. The IRS emphasized that participation in the CSP is entirely voluntary. Any taxpayer that declines a settlement offer still retains all rights to administrative appeal that exist under current IRS procedures and all existing rights to judicial review.

A IRS Issues Proposed Regulations On Exempt Organization "Excess Benefit Transactions"

The Taxpayer Bill of Rights 2 ("TBOR 2") imposed a penalty excise tax as an intermediate sanction when organizations exempt from tax under Code Section 501(c)(3) and Code Section 501(c)(4) (other than private foundations, which are subject to their own penalties) engage in an "excess benefit transaction" with a "disqualified person" (Code Section 4958). An "excess benefit transaction" is a transaction in which an economic benefit is provided by an exempt organization directly or indirectly to or for the use of a disqualified person (or certain related parties) if the value of the economic benefit provided exceeds the value of the consideration (including the performance of services) received in exchange. The IRS has now issued proposed regulations that would govern imposition of the tax on excess benefit transactions.

Comment. Before Code Section 4958 was effective, loss of tax-exempt status was the only sanction available for an organization's failure to operate exclusively for exempt purposes. The Code Section 4958 excise tax allows an organization to avoid loss of exempt status as a result of excess benefit transactions. However, whereas the IRS may have been reluctant to revoke exempt status for relatively minor violations in the past, it now can impose a sanction without feeling constrained by the impact of its action.

I . Background

A disqualified person is one who at any time during the five-year period ending on the date of the transaction was in a position to exercise substantial influence over the affairs of the organization. Any disqualified person who engages in an excess benefit transaction is liable for a tax equal to 25% of the excess benefit amount. If the excess benefit is not corrected within the taxable period, the disqualified person is liable for a tax equal to 200% of the excess benefit amount. In addition, any organization manager (officer, director, trustee, etc.) who knowingly participates in an excess benefit transaction is liable for a tax of the lesser of $10,000 or 10% of the excess benefit amount. The excise tax applies to transactions occurring after September 13, 1995, but not to benefits arising from transactions under a written contract that was binding on September 13, 1995, and continued in force through the time of the transaction.

2. Proposed Regulations

The highlights of the proposed regulations are as follows:

Correction of excess benefit. The proposed regulations define "correction" of an excess benefit as undoing it to the extent possible, and taking any additional measures necessary to place the organization in a financial position no worse than it would have been in had the disqualified person been dealing under the highest fiduciary standards.

Organization manager defined. An organization manager is any officer, director, or trustee of the organization, or any individual with similar powers or responsibilities. Independent contractors, acting as attorneys, accountants, and investment managers and advisors, are not officers.

Reasonable cause for organization manager's act. If an organization manager, after full disclosure of the factual situation to legal counsel (including in-house counsel), relies on the advice of the counsel expressed in a reasoned written legal opinion that the transaction is not an excess benefit transaction under Code Section 4958, the manager's participation in the transaction will ordinarily be considered due to reasonable cause, even if the transaction later is held to be an excess benefit transaction.

Disqualified person defined. A disqualified person is one who at any time during a five-year period beginning after September 13, 1995 and ending on the date of the transaction was in a position to exercise substantial influence over the affairs of the organization. In addition to those statutorily defined as disqualified persons under Code Section 4958(f), the proposed regulations identify the following persons as having substantial influence: voting members on the organization's governing body; individuals with the power or responsibilities of the organization's president, CEO, COO, treasurer, or CFO; and any person with a material financial interest in provider-sponsored organizations in which an exempt hospital participates.

Excess benefit. Under the proposed regulations, certain economic benefits, such as reasonable expenses for members to attend governing body meetings, are disregarded. An organization's payment of an insurance premium for coverage for a disqualified person's potential liability for taxes under Code Section 4958 is not an excess benefit if the premium is treated as compensation when paid and the total compensation paid to the disqualified person is reasonable.

Compensation for services for purposes of Code Section 4958 is reasonable only if it is an amount that would ordinarily be paid for like services by like enterprises under like circumstances. Compensation includes all forms of cash and noncash compensation, including severance payments, funded or unfunded deferred compensation (whether or not paid under a qualified plan), and all other benefits,whether or not included in income for tax purposes (except working condition fringe benefits and de minimis fringe benefits).

An economic benefit provided by an exempt organization is not treated as consideration for the performance of services unless the organization clearly indicates its intent to treat it as compensation when the benefit is paid. Evidence of this intent can be given by reporting the economic benefit as compensation on original or amended Forms W-2 or 1099 or on Form 990, filed before the commencement of an IRS examination in which the reporting of the benefit is questioned.

Presumption against excess benefit. Under the proposed regulations, a compensation arrangement is presumed to be reasonable, and a transfer of property, a right to use property, or any other benefit is presumed to be at fair market value, if the following three conditions are satisfied:

(1) The compensation or transfer is approved by the organization's governing body (or a committee of it with no conflict of interest);

(2) the governing body or committee obtained and relied on appropriate data as to comparability before making its determination; and

(3) the governing body or committee adequately documented the basis for its determination.

This presumption of reasonableness may be rebutted by additional information showing that the compensation was not reasonable or that the transfer was not at fair market value.

E. Massachusetts Small Necessities Leave Law

The Commonwealth of Massachusetts has enacted a Small Necessities Leave Law requiring certain employers to provide up to 24 hours of unpaid leave each year for employees under specified circumstances.

The new Massachusetts law requiring unpaid leave for small necessities became effective on August 4, 1998. The new law (Chapter 109 of the Acts of 1998) allows eligible employees to take up to 24 hours of unpaid leave during any 12-month period for the following reasons: participation in school activities directly related to the educational advancement of the employee's child, accompanying a child or elderly relative (defined as an individual at least 60 years of age who is related by blood or marriage) to routine medical or dental appointments, or accompanying an elderly relative to appointments for other professional services related to the elder's care.

The leave provided by the new law is in addition to that provided by the Federal Family Medical Leave Act ("FMLA"). As with FMLA, employers with fewer than 50 employees are exempt. If the necessity for leave is foreseeable, the employee is to provide the employer with not less than seven(7) days notice; otherwise notice "as is practicable" is to be provided. Employers may require employees to substitute accrued vacation leave, personal leave or medical or sick leave for the leave provided by the new law.