United States: Two Key Legislative Developments Impact Wellness Plans, Non-Qualified Deferred Compensation Plans

Employer-sponsored "wellness programs" have been a growing trend for years. Many employers have established having some form of such a program to help employees become more aware of their physical well-being. The idea of an employer-sponsored wellness program appears to have been one endorsed by the federal government through the years. The Health Insurance Portability and Accountability Act ("HIPAA") contained guidance that endorsed wellness and the idea was update with the Patient Protection and Affordable Care Act ("PPACA"), which allowed for increased rewards for participatory wellness programs. As well, the Departments of Labor, Health and Human Services and Treasury have provided regulations helpful in guiding employers in establishing bona fide wellness programs.

One federal agency, the Equal Employment Opportunity Commission (EEOC), however, has begun a push back against certain wellness programs. The EEOC has indicated that only "voluntary" employer wellness programs are allowable under the Americans with Disabilities Act (ADA). In Q&A 22 in Notice 915.002 released in 2000 it went on to say "A wellness program is 'voluntary' as long as an employer neither requires participation nor penalizes employees who do not participate." If a program is not voluntary or it does not meet the ADA's requirement that the program otherwise "be job related and consistent with business purpose", then the EEOC contends there is an ADA violation. Beyond this, however, there has not been much additional guidance issued by the EEOC related to these "voluntary" wellness programs.  Instead, it appears the EEOC recently has been trying to regulate wellness programs via lawsuits against employers sponsoring wellness programs the EEOC contends are not voluntary and do not meet the ADA's requirement that the program otherwise be job related and consistent with business purpose. One such lawsuit was filed against Orion Energy Systems Inc., a Wisconsin-based lighting company. In the Orion case, the EEOC provided that Orion's wellness program was not voluntary because when an individual chose not to participate and complained about it, not only was the entire premium cost shifted to the employee, but she was ultimately fired. The EEOC stated that it did not have a problem with a voluntary wellness program, but if it compelled participation by imposing extreme penalties such as shifting 100 percent of the cost onto the employee or firing the employee, it was no longer voluntary.

A second EEOC lawsuit was filed against Flambeau Inc. whose wellness program had both a health risk assessment and biometric screening component. Again the EEOC noted that there was a huge penalty associated with not participating. In this case when the employee failed to complete the testing, he was told he had to pay 102% of the medical insurance premium. Employees who completed both parts of the wellness program only paid 25% of the premium amount. Again the EEOC alleged that the wellness program did not meet the "voluntary" exception under the ADA and since the program was not job-related or consistent with business necessity under the ADA, the ADA was violated.

Finally, in a third lawsuit, this time against Honeywell International Inc., the EEOC not only alleged that the program violated the ADA, but also that it violated GINA. The ADA claim was a similar claim to those found in the previous lawsuits, that there was a financial penalty associated with failure to participate in the program. In this instance, however, the penalties were not as draconian. The employees and spouses who did not participate in the program would be subject to:

  • A $500 surcharge in medical plan costs.
  • A $1,000 "tobacco surcharge" for the employee not participating.
  • An additional $1,000 "tobacco surcharge" if the employee's covered spouse failed to participate.
  • Loss of health savings account contributions.

Since Honeywell provided for additional incentives if a covered spouse participated in the wellness program, the EEOC also claimed that GINA's prohibition on collection of family medical history was also violated. It should be noted that Honeywell's penalties for failure to participate appear to be within the range allowable under HIPAA and the ACA.

In order to combat this perceived EEOC abuse, on March 2, 2015, members of Congress introduced The Preserving Employee Wellness Programs Act. This legislation states that its purpose is "[t]o clarify rules relating to nondiscriminatory employer wellness programs as such programs relate to premium discounts, rebates, or modifications to otherwise applicable cost sharing under group health plans."

The Act provides, among other things, that:

  1. Offering of a wellness program reward will not violate the ADA or GINA if the wellness program complies with the applicable provision of PPACA or the regulation thereunder related to wellness programs.
  2. A wellness program that collects information about a family member shall not violate GINA if that family member is providing the information as a participant in the wellness program.
  3. An employer may establish an up to 180-day deadline for employees to request and complete a reasonable alternative standard.

The legislation appears to be a direct response to the EEOC's suit against Honeywell. It remains to be seen how much traction it will have towards becoming a law. If passed, it will help address employers' frustration with the EEOC's approach of attacking wellness program compliance through litigation. In particular, the legislation should help guard against what appears to be the EEOC's arbitrary enforcement against wellness programs in a manner that is at odds with other government agencies.

New report is critical of non-qualified deferred compensation plans

Another legislative development from the same week as the introduction of the employee wellness programs bill is not as favorable to the employee benefits community. On March 3, 2015, the Senate Finance Committee Democratic Staff released a report entitled "How Tax Pros Make the Code Less Fair and Efficient: Several New Strategies and Solutions" (the "Report").

The Report identifies "the latest tax avoidance games" involving financial products or deferred compensations. Some of the financial products included in the report are as follows:

  1. Using "collars" to avoid paying capital gains taxes.
  2. Using wash sales to time the recognition of capital income.
  3. Using derivatives to convert ordinary income to capital gains or convert capital losses to ordinary losses.
  4. Using derivatives to avoid constructive ownership rules for partnership interests.
  5. Using "basket options" to convert short-term gains into long-term gains.

More troubling for benefits practitioners is the sixth item in the Report, "Avoiding income taxes by deferring compensation." While the Report acknowledges that deferred compensation is not necessarily new, it goes on to say that the opportunities for manipulation are substantial and warrant discussion.

Note that this is not the first time that non-qualified deferred compensation has been under attack subsequent to the enactment of Section 409A of the Internal Revenue Code (see, for example, "How the President's Budget and Congressional Tax Reform Proposals May Change the Executive Compensation and Employee Benefits Landscape," Employee Benefit Plan Review (June 2014), describing then-House of Representatives Ways and Means Committee Chairman David Camp's proposed legislation to limit non-qualified deferred compensation. Since Camp is a Republican and this Report was issued from the Democratic side, clearly there is cause for concern. Accordingly, it is worth reviewing the Report and understanding its perspective (as well as some of the debatable conclusions in the analysis of the Report).

The Report essentially compares non-qualified deferred compensation plans to qualified plans and concludes that there is a fundamental fairness issue since the former are only made available to executives.  Of course, though not mentioned in the Report, this is because the Employee Retirement Income Security Act ("ERISA") made offering such plans to rank and file employees illegal since 1974! And the main reason for that provision in ERISA is that there is a fundamental difference between the two types of plans -- qualified plans are funded through a trust that is separate and distinct from the plan sponsor, while non-qualified plans are not formally funded and the payment of benefits remains subject to bankruptcy risk. So, to cast non-qualified deferred compensation as a benefit that is unfairly made available to executives seems a little bit disingenuous.

A minor, related, point concerns the Report's statement that non-qualified deferred compensation plans allow investment returns on the deferred income to compound tax free. Again, this somewhat misses the point. A trust for a qualified plan is tax-exempt, so earnings in such a plan do accumulate tax free. In the case of a non-qualified plan, assuming that assets are informally set aside, taxes are due on the earnings in the plan, and such taxes are payable by the plan sponsor.

At the end of the day, the merits of the fairness arguments are probably not as relevant as what is being proposed as a response. The Report identifies three possible changes. The first, which was already included in David Camp's proposed legislation last year, would be to tax ALL non-qualified deferred compensation at vesting, instead of when paid or made available. It is estimated that this change would raise $9.2 billion over the next ten years. Again, when legislation from both parties converge on a proposal that raises a fair amount of revenue, this is a proposal worth watching.

The second change would be to limit the amount of deferred compensation that could be accumulated to an amount, such as $1 million per person. Finally, the Report suggests closing a "loophole" under Section 162(m) of the Internal Revenue Code. Currently, the limit on a company deducting non-performance based compensation in excess of $1 million does not apply to non-qualified deferred compensation that is paid out after the participant ceases to be a senior executive. Again, such a provision was also included in the February 26, 2014 Ways & Means tax reform discussion draft.

As discussed above, the likelihood of these proposals moving forward should not be ignored. While there are obviously many valid business reasons for non-qualified deferred compensation plans, changes far greater than those faced after the enactment of Section 409A may be down the road.

Previously published in Employee Benefit Review - May 2015

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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