In December 2014, Congress finally got around to fixing an inequity in the tax treatment of commuting expenses. The change is retroactive to January 1, 2014 and only applies for 2014.
For further information on the resolution of this issue, please see the attached article.
IRS Ends Use of Closing Agreements for Late Corrections of Missed FICA Taxes on Deferred Compensation
If the time to amend a return has passed (usually three years), the IRS will no longer allow employers to correct mistakes in administering the “special timing rule” of IRC §3121(v). This change in policy means that employers, and their employees, will face higher FICA taxes if employers do not understand §3121(v) when administering their non-qualified deferred compensation plans. (See our earlier Executive Compensation article “Social Security Taxes & Deferred Compensation” and how an employer was held liable to executives for its mistake in administering §3121(v)).
Background on the special §3121(v) timing rule
FICA taxes are due when wages are actually or constructively received. For current compensation, that’s usually a straightforward analysis. For deferred compensation, which is not taxable until a later year, it can be a lot more complicated. Nonqualified deferred compensation plans must follow the “Special Timing Rule” of §3121(v). FICA must be withheld and paid when the rights are vested, not at the later date of payment. For non-account-balance plans, such as a pension equal to 50% of final salary, the §3121(v) date can be at a later resolution date, meaning the time when the amount is ascertainable, with the option to pay at the earlier vesting date with a true-up at the resolution date.
The benefit of the Special Timing Rule is lower FICA taxes. Once compensation is reported and taxed under FICA, it is not subject to those taxes again when the money is distributed. In other words, the earnings on the deferred income are free from FICA at distribution time. In addition, because FICA taxes are often reportable while the employee is still working, this usually means the employee’s wages are above the ceiling for FICA taxes, except for Medicare tax. Properly administered, payments from the deferred compensation plan will only be subject to income tax.
No more voluntary closing agreements to correct FICA taxes
An employer can always fix mistakes and amend previous Forms 941 within the statutory correction period, usually three years. In real life, these mistakes are not usually found within this timeframe. If detected by the IRS in an audit after the correction period has closed, the IRS Office of the Chief Counsel has taken away the discretion of agents to enter into closing agreements that would simply allow payment of the tax plus any applicable interest dating back to the date required by §3121(v) special timing rules. Instead, IRS will now insist that all payments be subject to FICA as they are paid.
What should an employer do?
It’s a real dilemma. We see §3121(v) mistakes more often in the context of corporate transactions. A buyer’s attorney can spend more time on issues like this than the IRS. An employer will only have two choices if it is too late to amend the Form 941 for the period when the special timing rule should have been used. It may decide to correct late, and hope that this will be perceived as good faith compliance, notwithstanding the Chief Counsel’s position. Alternatively, it can do what the Chief Counsel has opined. Run each payment through FICA and acknowledge that the benefit of the special timing rule has been lost.
Recommendation: Be sure you understand the details of your nonqualified deferred compensation plans and monitor them regularly to know exactly when amounts become taxable for FICA purposes. Don’t miss your opportunity to take advantage of the tax benefits of the timing rules for these plans.
IRS General Counsel’s Memorandum AM2017-001 is at this link.
The New 83(b) Election Requirements
IRS has removed one requirement for making 83(b) elections, but other conditions, with a tight 30 day deadline, remain. The new rule applies to grants of non-vested property (usually stock) in 2016 and later and may be used for 2015.
More detail in this PDF
Social Security Taxes & Deferred Compensation
An employer did not properly report and withhold FICA taxes for participants in its deferred compensation plan. A federal court has ruled that it is liable to the participants, because they will end up paying more FICA taxes due to the employer error. IRC §3121(v) is a special rule for SERPs and other types of non-qualified deferred compensation plans. It requires payment of FICA taxes up front when plan benefits first become vested. This saves a lot of taxes, for the employee and the employer, because the taxes owed for the retirement portion of FICA are capped at a taxable wage base — $118,500 in 2015 – and usually there is no payment owed on that due to other wages in the vesting year. In other words, §3121(v) makes it possible for participants in these plans (i) to skip the retirement portion of FICA altogether, (ii) to pay Medicare taxes (which are applied to all wages without a cap) only at the time of vesting, (iii) to skip all FICA on investment earnings after the vesting date, and (iv) to pay no FICA taxes on any of the payments they receive. This is a great deal for employers, too, because it lessens their FICA obligations.
However, if §3121(v) isn’t followed, each payment will be taxed for FICA just like any other wage payment. Retired persons, often without wages or earned income, now need to pay full FICA (not just a Medicare piece) until they hit the wage cap each year. In addition, investment earnings after the vesting date, which would not have been taxed for FICA due to §3121(v), now get taxed. The employer matches the employee payment, except for the extra 9/10 of 1% supplement on wages over $200,000. It’s an expensive process for those who do not know this obscure statute.
The recent federal case hinged on the fact that the plan document actually spelled out what the employer was supposed to do about taxes. If the plan had been silent on that point, it’s possible the employer would not have been found liable. However, the case is disturbing, because its principles could be applied to taxes which are more harmful than social security. Consider §409A (for deferred compensation) or §280G (for excess parachutes after a change in control).
Advice: review your payroll processes, deferred compensation plans, and change in control agreements carefully. The case is Davidson v. Henkel (DC MI), 07/24/2013.
You will read a lot in the next few days about the “repeal” of the ACA. Whether you call it repeal or reform, the newly proposed American Health Care Act contains welcome relief for employers from the serious penalties and mind-numbing complexity of the current ACA.
There will be fireworks, but something will pass this year if Republicans get over their internal differences. The proposed law only needs simple majorities in the House and Senate to get through Congress, because it is designed not to further increase the deficit over the next ten years, which qualifies it as filibuster-proof budget reconciliation. Due to the restrictions of budget reconciliation, many substantive provisions of the ACA will remain on the books until that far distant future when 60 members of the Senate can find common ground, or until the filibuster rule is eliminated.
This is how the proposed American Health Care Act addresses employer concerns:
#1 Concern: ACA penalties in any month for not making offers to 95% of FTEs, or for not making affordable offers to even a single employee.
Ways and Means: No employer penalties, and the repeal of employer penalties is retroactive.
#2 Concern: Complicated ACA reporting on the infamous 1094/1095 forms.
Ways and Means: There will be simpler W-2 reporting. Because this is designed as filibuster-proof budget reconciliation, the current reporting requirements cannot be repealed by a simple majority. But there is a wink and a nod in the Ways and Means Bill, which says it’s reasonable to expect that the IRS won’t be enforcing the 1094/1095 reporting rules after the simpler W-2 method is in force. Ideally, the 1094/1095 reporting can be eliminated in a later law, but it will stay on the books until that happens.
Our guidance: finish up filing your 1094 forms for the 2016 year. All the work you did for the 1095 forms was required.
#3 Concern: Possible 40% Cadillac tax starting in 2020 on high cost plans
Ways and Means: Postpone Cadillac tax to 2025.
23 key changes:
There are 23 important changes described in the Ways and Means summary. The link is at the bottom of this article. Among them are:
- Retroactive elimination of the individual insurance mandate;
- Continuation of the rule that coverage cannot be denied for pre-existing conditions, with addition of a rule that insurers can charge up to 30% extra for people who stay uninsured until they decide they “need” insurance;
- Kids still can stay on parents’ plans until 26;
- Repeal of the .9% extra FICA tax on high income wages, effective 2018;
- Repeal of the 3.8% tax on net investment income for high income persons, effective 2018;
- Near doubling of HSA limits to the full amount of deductibles and out of pocket limits in a high deductible policy, effective 2018;
- Lowering of penalty for HSA non-health withdrawals, effective 2018;
- Removal of the $2,500 cap for Section 125 health flex accounts, and freeing up those accounts for non-prescription drugs, effective 2018;
- Re-characterizing non-prescription drugs as eligible medical expenses, effective 2018;
- Reducing the income level from 10% of AGI to 7.5% of AGI for purposes of the medical expense deduction, effective 2017 for those over age 65 and 2018 for those who are younger; and
- Even the 10% tax on tanning salons is eliminated, effective 2018.
Federal credits for the uninsured.
The greatest controversy among the Republican majorities will be the provision of advancable federal credits to purchase state-approved, major medical health insurance and unsubsidized COBRA coverage. A person must not have access to other employer or government insurance, and be a citizen, national, or qualified resident alien. No one in jail is eligible.
The credits are income based, and phase out at the rate of $100 / $1,000 for income over $75,000 ($150,000 joint filers). They are also age based, and can range from $2,000 to $14,000 for a family.
For a single person at or below the income limits, the credits are:
-Under age 30: $2,000
-Between 30 and 39: $2,500
-Between 40 and 49: $3,000
-Between 50 and 59: $3,500
-Over age 60: $4,000
The credits are additive for a family, and capped at $14,000. They will adjust each year at CPI plus 1.
How can this be revenue neutral?
You might ask how is this revenue neutral for the next 10 years? Medicaid expansion will be slowed down, and there will be changes to the system of federal grants for the Medicaid program (giving states a fixed budget and more local authority). The other “saver” is that the credit system does not give as much aid to lower paid persons as the current ACA. Even more than before, companies which provide good insurance will be valued by employees.
A copy of the Ways and Means summary is at this link.
Extension of ACA Reporting Deadline: 2016
The IRS has granted an automatic extension for a portion of 2016 ACA reporting:
- The due date for giving the 1095-C to employees is automatically extended from January 31, 2017 to March 2, 2017. No application is needed for this extension.
- The due date for electronic filing of the 1094-C and bundled 1095-C forms with the government is not extended. It continues to be March 31, 2017 for electronic filers. A process for extending that filing is available by filing Form 8809. You can get up to two automatic 30 day extensions if you file before the due date.
Best news of all: “Good faith” errors in employer reporting of 2016 data will not be penalized. That “good faith” standard was supposed to apply only to 2015 reporting, and is a special relief.
The big question, of course, is whether the new Republican government eliminates the ACA employer and employee penalties and, if it does so, whether it does that retroactively to 2016. If those penalties are eliminated retroactively, there would obviously be no need for the reporting.
Stay tuned. Everyone in benefits will have their ear to the ground on this. For the time being, we recommend that we continue to proceed as if the law, with these extensions, stays in effect.
Postponement of ACA penalties for small employers who helped employees to buy health insurance policies
ACA rulings, effective in 2014, prohibit employers from helping employees to buy non-group health insurance. This surprised many small employers, who often do this rather than offering group insurance. The IRS announced that the 2014 and 2015 penalties will not apply if the practice is stopped no later than June 30, 2015. To qualify for 2014 relief, the employer must show that it employed fewer than 50 full-time equivalents in any period of 6 months or more in calendar year 2013. Relief for 2015 is conditioned on a similar showing for the 2014 calendar year.
Advice: Employers too large to fit this exception should evaluate IRS Form 8928 and claims for relief from IRC §4980D penalties. IRS Notice 2015-17
US employers trying to contain health care costs just got more bad news. On November 6, 2014, in answers to “frequently asked questions,” the US Department of Labor (“DOL”) killed cost savings strategies that were especially helpful to small and mid-size businesses. Employers may not reimburse employees for the cost of individual health policies, even with aftertax dollars. The DOL opinion extends to all employers, including those which are too small – less than 50 full-time equivalents – for the “pay or play” penalties of the Affordable Care Act (“ACA”).
Does your health plan document and SPD show how you determine full-time status?
To avoid ACA tax penalties, large employers – 50 or more full-time equivalents in the previous calendar year – are allowed to determine if their employees are full-time either (i) on a monthly basis or (ii) on a “look-back” basis described in ACA regulations. Employers can use look-back or monthly method for IRS-designated classes of employees: hourly, salaried, employed in different states, or covered by a collective bargaining agreement. Typically, we see employers with variable hour work forces, such as restaurant owners, use the look-back method for hourly employees.
The main advantage of the “look-back” method is that coverage is not required for employees who do not regularly work 30 hours per week, but who occasionally do so. Under the look-back method, employees will not be considered full-time unless they average at least 130 hours per month during an entire look-back period, in which event they then are deemed full-time during a following “stability period,” regardless of hours in the stability period.
Look-back periods are selected by the employer in advance. They will typically be 12 months long and must end within 90 days preceding a stability period, which usually starts on the first day of a plan year and lasts for the longer of 6 months or the length of the look-back period.
The look-back method also requires initial measurement periods and initial stability periods for new hires while they transition to the look-back and stability periods used for ongoing employees. However, unless a new employee is part-time or variable hour, the monthly method is required under look-back for new hires until the employee has completed the standard measurement period applicable to ongoing employees. The look-back rules are complicated but are popular with large employers whose part-time, variable hour, and seasonal employees occasionally work full-time in busy months.
There is more involved than taxes. What if a part-time employee who worked more than 30 hours per week in a busy month (and is not offered coverage because the employer is using the look-back method) needs medical care? Are you ready for the lawyer who asks: “Why wasn’t my client and his family offered health insurance? He was working full-time that month.” The employer whose health plan does not specifically mention that the look-back method is being used, with actual details about the measurement periods and stability periods in use, is in a very weak position.
Advice: do not just rely on the booklet the insurance company provides. ERISA requires that you have a plan document and a summary plan description which describes the rules of your health plan.
Reminder about FMLA Notices
Regardless of employer size, remember that wage and hour laws require employers to give an ACA notice to new employees within 14 days of starting work. The notice describes ACA Exchanges and the availability of federal assistance to persons without access to other affordable insurance meeting ACA standards. There is a model form for employers without health plans and a model form for those with plans. Posting is not enough. Use first class mail or electronic communication that meets ERISA standards. If you forgot to do this for your existing workforce, give them copies, too. DOL Tech. Release 2013-02.
Updated COBRA Notices and Forms
The DOL has updated its model initial and election notices to point out that individual ACA policies are an alternative to COBRA, and that the loss of employer coverage triggers a special 60-day ACA enrollment period to buy policies through an Exchange. They also point to a quirk in the rules that employees who elect COBRA cannot shift to an ACA policy until (i) the COBRA period is exhausted, or (ii) they are in an ACA open enrollment period or a special enrollment period due to an event like childbirth. This required disclosure not only leads most former employees to a less expensive solution than COBRA, it also leads to a good result for employers, especially those with self-insured or experience rated coverage, because COBRA beneficiaries often incur higher claims.
Note: The new notices and forms are on the DOL COBRA website.