Recent Developments in Compensation and Benefits

By Terry Richardson, J.D., LL.M., and Brue Shin, J.D., CPA


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  • Final regulations provide guidance on the employer shared-responsibility provisions (employer mandate) of the Patient Protection and Affordable Care Act (PPACA) and provide transition relief for certain employers.
  • The IRS issued final regulations regarding the reporting requirements under PPACA for health insurance issuers, self-insured employers, and applicable large employers. Under the regulations, employers will be able to use simplified reporting methods in certain instances.
  • The IRS clarified certain aspects of the calculation of the small employer health coverage tax credit and the rules governing health flexible spending arrangements.
  • The IRS also released a notice discussing amendments to qualified retirement plans that may be required as a result of the Windsor Supreme Court decision recognizing same-sex marriages for federal tax purposes.
  • Legislation, court cases, and various forms of IRS guidance addressed funding, nondiscrimination testing, and rollover contributions for pensions and other qualified plans.

Since the issuance of guidance and other developments covered in last year's annual update of employee benefits and compensation in The Tax Adviser, 1 the IRS issued a significant number of final rules and guidance on a wide range of compensation and benefit issues including, in particular, those implementing provisions of the Patient Protection and Affordable Care Act (PPACA). 2 This article highlights some of those notable rules and guidance, as well as case law pertaining to employee benefits.

PPACA Provisions
Employer Mandate

PPACA requires companies employing 50 or more full-time employees and/or full-time equivalents (FTEs) to offer minimum essential coverage that is affordable to their full-time employees and dependents or pay certain excise tax penalties. 3 This year, the IRS issued final regulations on these employer shared-responsibility provisions, sometimes called the "employer mandate." 4 In addition to providing guidance on matters related to the employer mandate, such as tracking hours of service and determining full-time employees, the final rules offer transition relief to certain companies subject to the mandate.

In particular, as temporary transition relief, the final rules delay until Jan. 1, 2016, the imposition of penalties for violating the employer mandate for "applicable large employers" with 50 or more but fewer than 100 full-time employees and FTEs. This relief does not apply if, between Feb. 9, 2014, and Dec. 31, 2014, the employer reduced the size of its workforce or overall hours of service of its employees to below the relief ceiling (unless for bona fide business reasons) or eliminated or materially reduced health coverage it offered on Feb. 9, 2014. To qualify for this relief, applicable large employers must certify to the IRS that they met these conditions.

A separate transition rule provides that employers with 100 or more full-time employees and FTEs must offer health coverage in 2015 to at least 70% of their full-time employees and their dependents, rather than 95% as required under the law and regulations. 5 Moreover, if an employer fails to provide health coverage when required in 2015, the excise tax will be one-twelfth of $2,000 per month per full-time employee less 80. (The reduction by 30 full-time employees, as allowed under the statute, 6 will apply beginning in 2016.)

The employer mandate final rules also provide permanent relief to certain employers. Under Sec. 4980H(c)(2)(C)(ii), an employer in its first calendar year of existence may determine whether it is an applicable large employer for that year based on its reasonable expectation when it first comes into existence of the average number of full-time employees and FTEs it will employ during that year. Under the final regulations, this remains the case even if the employer subsequently has more such employees and FTEs in the year than it initially expected. 7 An employer that becomes an applicable large employer during a calendar year is not subject to the penalties for the period January through March of that year if it offers minimum essential coverage to its full-time employees by April 1. 8 An employer with a new hire who is reasonably expected to be a full-time employee is not subject to the penalties with respect to the new hire if it offers him or her minimum essential coverage by the first day of the month after he or she completes three full calendar months of employment. 9

Insurer and Employer Reporting Requirements

Also in 2014, the IRS issued final regulations 10 on PPACA reporting requirements that enable it to enforce the employer and individual 11 mandates and administer the Sec. 36B premium tax credit for certain insurance purchased on exchanges. Reporting will be required beginning in January 2016 for coverage provided in 2015.

Health insurance issuers and self-insured employers providing minimum essential coverage must report its details to the IRS and to all covered individuals. Health insurers will report to each individual and the IRS on Form 1095-B, Health Coverage, and to the IRS on an aggregate basis for those they cover on Form 1094-B, Transmittal of Health Coverage Information Returns. Applicable large employers will report the offer of coverage and enrollment in coverage to each employee and the IRS on Form 1095-C, Employer-Provided Health Insurance Offer and Coverage, and on an aggregate basis on Form 1094-C, Transmittal of Employer-Provided Health Insurance Offer and Coverage Information Returns. Employers that provide self-­insured coverage must fill out an additional section on Form 1095-C regarding the details of the coverage provided.

The reporting forms will require, among other information, the name and Social Security number or other taxpayer identification number of the employee and each individual covered under the policy, which requires collecting and reporting dependents' Social Security numbers. The plan sponsor is responsible for reporting for a self-insured group health plan. Moreover, all employers required to offer minimum essential coverage must report information about their full-time employees and the coverage they offer for each month in a calendar year. This will require tracking coverage information every month, beginning in January 2015.

Simplified reporting is available to employers who make and certify they have made a qualifying offer to a full-time employee for an entire year. A qualifying offer is an offer, to a full-time employee for the entire year, of minimum essential coverage providing minimum value at an employee cost for employee-only coverage not exceeding 9.5% of the federal poverty line that includes an offer of minimum essential coverage to the employee's spouse and dependents. A plan fails to provide minimum value if its share of the total allowed costs of benefits provided under the plan is less than 60% of such costs. 12 For 2015 only, simplified reporting may be used even for employees who do not receive a qualifying offer for all 12 months in 2015 if the employer certifies that it made a qualifying offer to at least 95% of its full-time employees and their spouses and dependents.

Additional simplified reporting is available to an applicable large employer that offers minimum essential coverage providing minimum value that was affordable to at least 98% of all employees (and their spouses and dependents), regardless of whether the employees are full-time employees. An applicable large employer must meet the 98% threshold each month separately, rather than on average over a calendar year.

Note that reporting under Secs. 6055 and 6056 is separate from, and in addition to, reporting on Form W-2, Wage and Tax Statement. Without regard to Forms 1094-C and 1095-C, employers must continue to report the cost of employer-provided coverage on Form W-2, a requirement that has been in effect for Forms W-2 issued beginning in January 2013. 13

Small Employer Health Insurance Tax Credit

Also in 2014, the IRS issued final regulations on the PPACA small employer health insurance credit. 14 Sec. 45R offers a tax credit for two consecutive tax years to employers (1) that employ 25 or fewer FTEs, 15 (2) whose FTEs have average annual wages of no more than $50,000 (adjusted for inflation for tax years beginning after Dec. 31, 2013), 16 and (3) that are required to make a nonelective contribution of at least 50% of the premium cost on behalf of each of their employees who enroll in a qualified health plan they offer through a Small Business Health Options Program (SHOP) exchange. 17

For tax years beginning in 2014 and after, the maximum credit amount is 50% (35% for small tax-exempt employers) of the lesser of (1) the nonelective contributions paid or (2) the amount of nonelective contributions the employer would have paid under the arrangement if each employee were enrolled in a plan with a premium equal to the average premium for the small group market in the rating area in which the employee enrolls for coverage. 18 To the extent an employer does not owe tax in the current year, it may carry the credit back or forward as provided in Sec. 38. Furthermore, to the extent health insurance premium payments exceed the total credit, an employer may claim a business expense deduction for the excess.

The final regulations provide that leased employees included in a qualifying coverage arrangement may be included in calculating the credit. Although seasonal workers working 120 days or fewer for the employer during the tax year are not included in the calculations of FTEs and average wages, 19 the final regulations clarify that if the employer pays a premium under a qualifying arrangement on their behalf, they may be included in the credit calculation. The regulations also address premium surcharges for tobacco use and discounts or rebates for wellness programs, among other matters.

Expatriate Plans

The IRS also provided relief with respect to the PPACA provision requiring covered entities engaged in the business of providing health insurance for U.S. health risks to pay an annual fee based on net premiums written for such insurance. 20

Notice 2014-24 provides a temporary safe harbor for covered entities that report direct premiums written for expatriate plans on a supplemental health care exhibit (SHCE). 21 An expatriate policy is a group health insurance policy that provides coverage to employees, substantially all of whom are (1) working outside their country of citizenship; (2) working outside their country of citizenship and outside the employer's country of domicile; or (3) non-U.S. citizens working in their home country. Final regulations issued in November 2013 include a rebuttable presumption that all direct premiums reported on the SHCE, including for expatriate plans, are for U.S. health risks. 22

Data for insureds reported under Sec. 6055 (described above) could provide covered entities with information to rebut the presumption. However, because the Sec. 6055 reporting requirements were delayed until 2016 for coverage in 2015, the notice provided a temporary safe harbor for covered entities subject to the annual fee. If certain requirements are met, for fee years 2014 and 2015, the safe harbor will allow covered entities to treat 50% of the aggregate dollar amount of their direct premiums written for expatriate plans as reported on their SHCE as not for U.S. health risks. Thus, they may exclude this amount in reporting direct premiums written on Form 8963, Report of Health Insurance Provider Information, which is used by the IRS to calculate the annual fee.

Health Flexible Spending Arrangements

The IRS also issued a number of rules and other guidance on other health benefit provisions besides those introduced by PPACA, including health flexible spending arrangements (FSAs).

In Notice 2013-71, the IRS amended the FSA rules to permit plans to allow their participants to carry over up to $500 per plan year of unused funds to the next plan year without reducing the amount participants can contribute to the FSA for the next plan year. The carryover right, however, cannot be offered to participants in addition to the grace period right, which allows participants 2½ months following the end of a plan year to use any remaining funds in an FSA. 23

In Chief Counsel Advice (CCA) 201413006, the IRS concluded that correction procedures provided in Prop. Regs. Sec. 1.125-6(d)(7) for improper payments made using debit cards provided under a cafeteria plan to pay or reimburse employee medical expenses may be applied to health FSAs. An improper payment occurs when FSA funds are used for an expense that is not qualified and properly substantiated. An employer may correct an improper payment by demanding repayment of the amount of the improper payment to the plan. If the employee fails to repay the amount after such a demand, the employer may withhold the amount from the employee's wages to the extent allowed by law. After taking those steps, the employer may apply a claims substitution or offset to resolve any improper payments that remain outstanding.

If these measures fail to correct the improper payment, the employer should treat the improper payment as it would any other business indebtedness and seek collection through procedures consistent with other business indebtedness. If all other correction procedures have been exhausted, the employer should treat the improper payment as business indebtedness that, to the extent it is forgiven, results in taxable income to the employee, subject to income and employment tax withholding.

CCA 201413005 analyzed the interaction of the carryover of unused funds from a general-purpose FSA described above with an individual's eligibility to participate in a health savings account (HSA) plan in the carryover year. Individuals are eligible to contribute to an HSA for any month they are covered under a high-deductible health plan (HDHP) and are not covered under any health plan that is not an HDHP and provides coverage for any benefit that is covered under the HDHP. The CCA concluded that participation in a health FSA will generally disqualify an individual from contributing to an HSA because the FSA will constitute other coverage. This includes participating in a general-purpose FSA solely by carrying forward unused amounts from the prior year. Moreover, the disqualification will be for the entire plan year, even if the health FSA has paid or reimbursed all amounts before the end of the plan year.

However, an FSA may be compatible with an HSA if the FSA covers only dental and/or vision care. If an employer also provides such an HSA-compatible FSA, an individual may contribute to an HSA and participate in the HSA-compatible FSA, including by carryover of unused funds to it from a general-purpose FSA maintained in the prior year.

Unrelated Business Income Tax

In February, the IRS issued proposed regulations under Sec. 512(a) providing guidance on how voluntary employee benefit associations 24 and supplemental unemployment benefit trusts 25 (together, "covered entities") should calculate their unrelated business taxable income (UBTI). 26 The proposed regulations, in general, have the same effect as 1986 temporary regulations (that will continue to apply until removed by a final rule) 27 and proposed regulations they replace, but they make some changes to improve clarity.

One clarification concerns the calculation of UBTI of a covered entity, which, absent other types of UBTI, such as ordinary trade or business income, is generally limited to the lesser of investment income or the amount by which assets "set aside" at the end of the tax year to pay permissible benefits and related administrative expenses exceed the qualified asset account limit 28 for the tax year. The proposed regulations state the IRS's position that, when calculating the excess, the covered entity should include investment income in the calculation regardless of whether the covered entity spends or retains (or is deemed to spend or deemed to retain) that investment income during the course of the year. Thus, the proposed regulation rejects the Sixth Circuit's decision in Sherwin-Williams Co., in which the court held that investment income that is actually used to pay benefits or administrative expenses during the tax year is excluded when determining the excess. 29 In the preamble to the proposed regulations, the IRS said that if the final regulations adhere to the position the Service has taken in the proposed regulation, it will no longer follow the Sherwin-Williams Co. decision within the Sixth Circuit.

Same-Sex Marriages Under Windsor

In Windsor, 30 the Supreme Court overturned as unconstitutional Section 3 of the Defense of Marriage Act, 31 which had prohibited the recognition of same-sex spouses under federal law. The decision continued in 2014 to have ramifications for tax law and administration requiring further guidance. 32 In April, the IRS issued Notice 2014-19, requiring (1) qualified retirement plan operations to reflect the outcome of Windsor as of the decision's release on June 26, 2013, and (2) qualified retirement plan documents to reflect the holding in Windsor and other related IRS guidance by Dec. 31, 2014 (for calendar-year plans), effective no later than June 26, 2013. In the notice, the IRS confirmed that compliance with Windsor would not be required retroactively for periods prior to the decision, although such earlier compliance is permitted at the plan sponsor's election. An amendment to the qualified retirement plan document retroactively applying the Windsor decision to periods prior to June 26, 2013, generally must be made by Dec. 31, 2014 (for calendar-year plans).

Nondiscrimination Testing of "Soft" Frozen Defined Benefit Plans

Notice 2014-5 provides nondiscrimination testing relief to employers with "soft" frozen defined benefit plans by providing alternatives to satisfy the Sec. 401(a)(4) nondiscrimination requirements. In a soft freeze, companies allow existing employees to continue to participate with full benefits in an existing defined benefit plan but move new employees to a new defined contribution plan.

Under Notice 2014-5, for plan years starting before Jan. 1, 2016, if a defined benefit plan was amended before Dec. 13, 2013, to allow only employees participating in the defined benefit plan on a specific date to continue to accrue benefits, either of two eligibility criteria will establish compliance with Sec. 401(a)(4) nondiscrimination requirements on the basis of equivalent benefits: (1) The defined benefit plan is a part of a combined defined benefit/defined contribution plan for the plan year beginning in 2013 that was either "primarily defined benefit in character" or that "consists of broadly available separate plans"; or (2) in the case of a defined benefit plan that was amended by an amendment adopted before Dec. 13, 2013, to provide that only employees who participated in the defined benefit plan on a specified date continue to accrue benefits under the plan, the defined benefit plan is not part of a defined benefit/defined contribution plan for the plan year beginning in 2013 because the defined benefit plan satisfied the coverage and nondiscrimination requirements without aggregation with any defined contribution plan.

Minimum Plan Funding Requirements Lowered

The Highway and Transportation Funding Act of 2014 (HATFA) 33 temporarily lowers minimum funding requirements for defined benefit plans by delaying for five years the provision of the Moving Ahead for Progress in the 21st Century Act (MAP-21) that gradually widens the minimum and maximum applicable percentage corridor around the 25-year average interest rates. 34 Specifically, it keeps the corridor at plus or minus 10 percentage points through 2017. Originally, the 10% corridor was to be increased in 5-percentage-point increments each year after 2012, becoming 15% for 2013, 20% for 2014, 25% in 2015, and 30% in 2016 and later years.

Notice 2014-53, issued in September, provides guidance for plan sponsors on implementing the HATFA rates, including the procedures for electing to defer their use until the first plan year beginning on or after Jan. 1, 2014, and revoking a deemed election with respect to a plan year beginning 2013 if the plan sponsor has filed Form 5500, Annual Return/Report of Employee Benefit Plan, (or other Form 5500 series form) using the MAP-21 rates.

Pension De-Risking

In 2014, the IRS issued five private letter rulings 35 allowing defined benefit plans under specific facts and circumstances to offer lump-sum benefit distributions to participants already receiving benefits.

Determining Whether Rollover Contributions Are Valid

Rev. Rul. 2014-9 reduces the administrative burdens associated with rollover contributions by providing procedures for plan administrators to reasonably conclude that a potential rollover contribution is a valid rollover contribution under Regs. Sec. 1.401(a)(31)-1, Q&A-14(b)(2).

Specifically, the revenue ruling allows plan administrators for the receiving plan to rely on the codes entered on Line 8a of Form 5500 (or on Line 9a of Form 5500-SF) that identify the other plan's qualified status when accepting a rollover from the other plan. It also allows plan administrators for the receiving plan to accept a check payable to the plan as a valid rollover contribution from a traditional, noninherited individual retirement account (IRA) by relying on a check stub that identifies the source of the funds as "IRA of Employee [Name]" and the employee's certification that the distribution does not include any after-tax amounts and that the employee will not attain age 70½ by the end of the year of the transfer. If the plan administrator for the receiving plan later determines that the amount rolled over was an invalid rollover contribution, the plan administrator must distribute the amount rolled over plus any attributable earnings to the employee within a reasonable time after such determination.

Midyear Reduction or Suspension of Employer Contributions to Safe-Harbor Plans

The IRS issued final rules on midyear reductions or suspensions of nonelective employer contributions to safe-harbor Sec. 401(k) plans effective May 18, 2009, and, for matching contributions, effective for plan years beginning on or after Jan. 1, 2015. 36 The final rules allow employers to reduce or suspend nonelective and matching contributions only if they are operating at an economic loss or notify participants before the beginning of the plan year that the contributions could be reduced or suspended midyear and satisfy a number of other procedural requirements. Prior to Jan. 1, 2015, for safe-harbor matching contributions, midyear reductions or suspensions are permitted if certain procedural requirements are satisfied, even if the employer does not experience a business hardship or provide eligible employees with a statement prior to the beginning of a plan year explaining that the plan could be amended during the year to reduce or suspend the safe-harbor contribution.

Long-Term Disability Insurance Purchased Through a Defined Contribution Plan

The IRS issued final rules under which funds from a qualified plan that are used to pay accident or health insurance premiums will generally be distributions under Sec. 402(a) that are taxable under Sec. 72 in the tax year the premiums are paid. 37 The final rules, however, provide an exception to this general rule for long-term disability insurance premiums if the insurance policy will make benefit payments to the plan when an employee is unable to continue employment because of disability and the benefits paid to the employee's account do not exceed "the reasonable expectation of the annual contributions that would have been made to the plan on the employee's behalf during the period of disability, reduced by any other contributions made on the employee's behalf for the period of disability within the year." 38 These amounts paid from the insurance policy to the plan are treated as contributions and are subject to the general rules applicable to qualified plan contributions, including Sec. 415(c) (annual contribution limits).

Supreme Court Rejects the Moench Presumption

In Fifth Third Bancorp v. Dudenhoeffer, 39 the U.S. Supreme Court unanimously rejected a presumption of prudence for employee stock ownership plan (ESOP) fiduciaries when managing employer stock held in ERISA 40 individual account plans (known as the Moench presumption). 41 Instead, the Court concluded that the fiduciary standard for managing employer stock is the same prudent-person standard that applies to the management of any other investments under a plan, except that ESOP fiduciaries need not diversify the fund's assets.

Nonetheless, the Court noted two hurdles that complainants must overcome when alleging fiduciaries failed to satisfy the prudent-person standard with respect to managing employer stock. First, allegations that a fiduciary should have recognized from publicly available information that the market overvalued or undervalued the stock generally will be implausible and thus insufficient to state a claim that fiduciaries were imprudent to invest in the employer's stock. The Court reasoned it is prudent to "rely on the security's market price as an unbiased assessment of the security's value in light of all public information." 42

Second, to state a claim for breach of the duty of prudence, a complaint must plausibly allege an alternative action that the defendant could have taken that would have been legal (e.g., not violating the insider trading laws) and that a prudent fiduciary in the same circumstances would not have viewed such an alternative action as more likely to harm the fund than to help it (e.g., to cause "a drop in the stock price and a concomitant drop in the value of the stock already held by the fund"). 43

PLRs and TAMs related to ESOPs

In Technical Advice Memorandum (TAM) 201425019, the IRS concluded that a loan between a company and an ESOP it established was a prohibited transaction under Sec. 4975(c)(1)(B). However, it allowed the excise tax penalty amount to be calculated (15% of the "amount involved") 44 by the actual interest rate used in the transaction, which was below the prime rate. In the TAM, the IRS indicated that where a loan is the prohibited transaction, the excise tax is determined using an interest rate that is the greater of the interest on the loan or the fair market interest rate (e.g., prime). Here, the IRS relied on documentation from the creditor that the below-prime interest rate used for the loan was a fair market rate because the company was able to borrow at that rate.

In Letter Ruling 201419025, the IRS held that a prepayment of a nonrecourse note as a result of the sale of the taxpayer's assets and resulting termination of a leveraged ESOP did not violate the requirement that the transaction be primarily for the benefit of participants and beneficiaries of the ESOP under Sec. 4975(d)(3). It also held that the transfer of unallocated suspense account shares in the ESOP to the taxpayer in satisfaction of the note when the ESOP terminated was not a prohibited transaction.

Court Rulings on FICA Tax

In Quality Stores, Inc., 45 the U.S. Supreme Court decided that "wages" for Federal Insurance Contributions Act (FICA) tax purposes include supplemental unemployment compensation benefit payments as described in Sec. 3402(o), which states they are subject to federal income tax withholding as "payments other than wages." The Court rejected the taxpayer's argument that because Sec. 3402(o) states that a supplemental unemployment compensation benefit payment is treated "as if it were a payment of wages," 46 it is not wages for FICA tax purposes. This seems to put to rest the need to file any future protective refund claims. 47

In Balestra, 48 an unpublished 2014 decision, the Court of Federal Claims determined that a taxpayer was not entitled to any refund of FICA taxes paid on nonqualified deferred compensation at vesting, even though, subsequently, the employer's obligation to pay the deferred compensation was completely discharged in bankruptcy proceedings. The court rejected the taxpayer's arguments that (1) deferred compensation is not income for FICA tax purposes if it is never paid and thus never income for federal income tax purposes, and (2) the value for FICA tax purposes of the deferred compensation at vesting should be discounted to reflect any risk that such amounts will not be paid.

Payroll Tax and Reporting

In CCA 201414017, the IRS determined that a taxpayer's reliance on a third-party payroll processing company to timely deposit employment taxes from the exercise of nonqualified stock options did not qualify it for the reasonable-cause exception to the Sec. 6656(a) penalty for failure to make such deposits, even though there was a history of timely payment of other required deposits. The reasonable-cause exception requires a taxpayer to demonstrate it was unable to meet its responsibilities despite an exercise of ordinary business care and prudence. The taxpayer's "reliance on a faulty system that led to the untimely deposits did not render it unable to meet its filing responsibilities," the IRS Office of Chief Counsel stated in the CCA.

In CCA 201414019, the IRS concluded that an employer must contact employees and obtain their consent to claim refunds of the employee share of FICA overpaid by the employer under a tax equalization plan for its employees it assigned to work overseas. Under the tax equalization plan, the employer adjusted employees' pay so that they would have no net economic gain or loss with respect to tax liability because of a foreign assignment. The IRS stated that because the employer was withholding the taxes from the employees' grossed-up pay, any refund of employee FICA taxes would be subject to the usual rules, including the requirement that the employer procure consents. It rejected the taxpayer's argument that the taxpayer paid all of the employment taxes on the wages earned by its overseas employees without actually withholding taxes. Note the IRS's conclusion assumes that employees received credit for the U.S. income taxes withheld and remitted under the taxpayer's plan.

In CCA 201414018, the IRS determined that dividend-equivalent payments on restricted stock units that are paid at the same time as dividends on common stock (and that are a benefit in addition to the restricted stock units) are not nonqualified deferred compensation for FICA tax purposes. As such, the special timing rules for FICA withholding on deferred compensation under Sec. 3121(v)(2) would not apply.

Revised Final Regulations Under Sec. 83

The IRS issued revised final rules under Sec. 83 to clarify the definition of a "substantial risk of forfeiture." 49 The Service stated that the final rules "are consistent with the interpretation that the IRS historically has applied, and therefore from the perspective of Treasury and the IRS they do not constitute a narrowing of the requirements to establish a substantial risk of forfeiture." 50

The final rules provide two bases to establish substantial risk of forfeiture: (1) through a service condition, or (2) through a condition related to the purpose of the transfer, generally, a performance vesting requirement. Additionally, the final rules clarify that, when determining whether a substantial risk of forfeiture exists, the IRS will consider both the likelihood that the forfeiture event will occur and the likelihood that the forfeiture will be enforced. Also, the IRS confirmed that transfer restrictions do not constitute a substantial risk of forfeiture for purposes of Sec. 83, except for the sales restrictions under Section 16(b) of the Securities Exchange Act of 1934.

Sec. 457A and Stock Options or Appreciation Rights

Under Rev. Rul. 2014-18, a stock appreciation right (SAR) granted by a nonqualified entity is subject to U.S. tax when exercised if:

  • The SAR is exempt from Sec. 409A;
  • The terms of the SAR require it to be settled in common stock;
  • The SAR is in fact settled in common stock; and
  • The stock meets the requirements for service recipient stock.

Otherwise, a SAR is generally treated as deferred compensation under Sec. 457A and may be subject to an additional 20% tax when it is exercised. Under Sec. 457(b), a "nonqualified entity" means (1) any foreign corporation, unless substantially all of its income is effectively connected with the conduct of a trade or business in the United States or subject to a comprehensive foreign income tax, and (2) any partnership, unless substantially all of its income is allocated to persons other than foreign persons with respect to whom such income is not subject to a comprehensive foreign income tax and organizations exempt from tax under the Code.

Note that Rev. Rul. 2014-18 does not address other areas of the Code that may affect tax treatment of stock options and SARs granted by nonqualified entities, such as the applicability of the passive foreign investment company rules that are intended to prevent U.S. taxpayers from deferring the recognition of passive income by using foreign corporations. 51


Terry Richardson is a principal with PwC LLP in Dallas. Brue Shin is a compensation manager with PwC LLP in Los Angeles. For more information about this column, contact Mr. Richardson at



1 Richardson and Eason, "Current Developments in Employee Benefits and Compensation," 44 The Tax Adviser 830 (December 2013).

2 Patient Protection and Affordable Care Act (PPACA), P.L. 111-148.

3 Secs. 4980H(a) and (b).

4 T.D. 9655.

5 Regs. Sec. 54.4980H-4(a).

6 Sec. 4980H(c)(2)(D).

7 Regs. Sec. 54.4980H-2(b)(3) and preamble, T.D. 9655, V.B., "Rules for ­Employers Not in Existence in Preceding Year."

8 Regs. Sec. 54.4980H-2(b)(5).

9 Regs. Sec. 54.4980H-3(d)(2).

10 T.D. 9660 and T.D. 9661, providing guidance on reporting requirements under, respectively, Sec. 6055 (providers of minimum essential coverage—e.g., health insurance issuers and self-insured group plans) and Sec. 6056 (applicable large employers).

11 The Sec. 5000A requirement of individuals to maintain minimum essential coverage.

12 Regs. Sec. 301.6056-1(j)(1)(i) and Sec. 36B(c)(2)(C)(ii).

13 The Sec. 6051(a)(14) reporting requirement was effective for wages earned beginning in 2011, reported on Forms W-2 issued in 2012; however, transition relief (Notice 2010-69) made reporting optional for this first year.

14 T.D. 9672.

15 Unlike for purposes of Sec. 4980H, full-time-equivalent employees are calculated by dividing by 2,080 the total hours of service for all employees (including full-time employees) for the tax year (Sec. 45R(d)(2)).

16 $50,800 for tax years beginning in 2014.

17 Sec. 45R(d)(1); Regs. Secs. 1.45R-2(a) and 1.45R-1(a)(15).

18 Sec. 45R(b).

19 Sec. 45R(d)(5).

20 PPACA §§9010 and 10905, as amended by §1406 of the Health Care and Education Reconciliation Act of 2010, P.L. 111-152.

21 The SHCE, filed with the National Association of Insurance Commissioners, is a source of information the IRS may use to determine net written premiums.

22 T.D. 9643; Regs. Sec. 57.4(b)(2).

23 Notice 2005-42 and Prop. Regs. Sec. 1.125-1(e).

24 Described in Sec. 501(c)(9).

25 Described in Sec. 501(c)(17).

26 REG-143874-10, adding Prop. Regs. Sec. 1.512(a)-5.

27 Temp. Regs. Sec. 1.512(a)-5T.

28 Defined at Sec. 512(a)(3)(E)(i) by reference to Sec. 419A: generally, the amount reasonably and actuarially necessary to fund benefit claims incurred but unpaid at the end of the tax year and related administrative costs, plus a reserve for post-retirement medical and life insurance benefits.

29 Sherwin-Williams Co. Employee Health Plan Trust, 330 F.3d 449 (6th Cir. 2003).

30 Windsor, 133 S. Ct. 2675 (2013).

31 Defense of Marriage Act, P.L. 104-199.

32 See also last year's update (Richardson and Eason, "Current Developments in Employee Benefits and Compensation," 44 The Tax Adviser 830 (December 2013)).

33 Highway and Transportation Funding Act of 2014, P.L. 113-159.

34 Moving Ahead for Progress in the 21st Century Act, P.L. 112-141. See Sec. 430(h)(2).

35 IRS Letter Rulings 201422028, 201422029, 201422030, 201422031, and 201427023.

36 T.D. 9641.

37 T.D. 9665.

38 Id., preamble, "Special Rule for Disability Insurance Coverage."

39 Fifth Third Bancorp v. Dudenhoeffer,134 S. Ct. 2459 (2014).

40 Employee Retirement Income Security Act, P.L. 93-406.

41 In Moench v. Robertson, 62 F.3d 553 (3d Cir. 1995), the Third Circuit held that an ESOP fiduciary was presumed to have acted in a manner consistent with ERISA by investing plan assets in employer stock.

42 Fifth Third Bancorp v. Dudenhoeffer, 134 S. Ct. at 2471, quoting Halliburton Co. v. Erica P. John Fund, Inc., 134 S. Ct. 2398, 2411 (2014) (quoting Amgen Inc. v. Connecticut Retirement Plans and Trust Funds, 133 S. Ct. 1184, 1192 (2013)).

43 Id. at 2473.

44 Sec. 4975(a).

45 Quality Stores, Inc., 134 S. Ct. 1395 (2014).

46 Sec. 3402(o)(1) (flush language).

47 For more on this case, see Sanders and Pulliam, "Are Severance Payments Subject to FICA?" 45 The Tax Adviser 576 (August 2014).

48 Balestra, No. 09-283T (Fed. Cl. 5/31/14).

49 T.D. 9659.

50 Id., preamble, "Summary of Comments."

51 Sec. 1297.

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A look at year-end tax planning strategies for individuals and businesses, as well as recent federal tax law changes affecting this year’s tax returns.


CPAs Contend With Tax ID Theft

Tax-related identity theft fraud remains a widespread problem that is often difficult for victims and their tax preparers to correct.