Disruption in business operations by the pandemic has increased the need for employers to focus on compensation and employee benefits. Developing a comprehensive business response will involve benefits plans and more broadly the compensation philosophy employers will adopt. The CARES Act provided some additional flexibility, but this entire area is otherwise heavily regulated, and any contemplated change should be approached with caution.
This extends beyond traditional benefits, such as retirement and medical plans. Employers should consider the direct and indirect effects of the pandemic, insofar as they relate to wages, bonuses, incentive pay in general, equity-based compensation, health and wellness, retirement, and other employee benefits (and any and all related costs to employers).
This summary briefly covers the various areas of compensation and benefits employers should consider as a result of the pandemic and the related economic downturn.
Privacy, Testing, and Other Virus-Related Topics
Private Health Information (PHI) Is Still Protected
- Employers and group health plan sponsors generally should continue to exercise caution when handling PHI, even in connection with the current pandemic.
- This area is rapidly evolving in part in an effort to allow for the sharing of information for health concerns. The U.S. Department of Health and Human Services has issued several pieces of guidance waiving certain penalties, modifying rules relating to telehealth, and regulating disclosures of PHI to law enforcement, paramedics, first responders, and public entities like federal, state, and local government health authorities.
- While employers who receive information outside of the context of their group health plan are not subject to HIPAA’s restrictions regarding PHI, such information should generally be treated as confidential as several other employment laws (not just HIPAA) might apply.
Free Coverage for Testing
- Group health plans (self-insured and fully insured) must cover coronavirus testing without any cost-sharing (i.e., deductibles, copayments, or coinsurance) imposed on the plan member during the declared public health emergency, whether performed by in-network or out-of-network health care providers. The CARES Act provides a special calculation for determining the rate paid to out-of-network providers for coronavirus testing.
- Plan amendments may be needed; summary of material modifications and employee communications should be prepared.
Relief for Health Savings Accounts (HSAs)
- The IRS recently issued a notice providing that high-deductible health plans (HDHPs) do not lose that status if they cover the cost of testing for or treatment of COVID-19 before plan deductibles have been met.
- Separately, the CARES Act allows HDHP participants with HSAs to receive telemedicine free of cost sharing for plan years beginning on or before Dec. 31, 2021. The CARES Act also allows for the purchase of over-the-counter drugs without a prescription with HSAs, Archer MSAs, and health care FSAs.
- Again, plan amendments may be needed; summary of material modifications and employee communications should be prepared.
Salary, Incentive Pay, and Other General Compensation Topics
Reductions in Pay
- Reductions in pay generally are not prohibited, but state wage and hour laws should be verified regarding notice of changes to pay rates, limitations on changes to accrued vacation/PTO, etc. From a tax perspective, actual reductions in pay or other true waivers should not raise any issue.
- Governing documents (employment agreements, bonus plans, etc.) must be reviewed to see if formal amendments will be needed and if employee consent is required.
- The employer should consider the impact on other benefits that may be tied to salary such as life insurance, disability, etc. (and whether to take steps to address issues), and whether sufficient salary remains to cover the employee’s cost of health insurance and other benefits.
- Clear employee communications should be developed promptly if this is initiated by the employer.
- Employment agreements could also be affected by a reduction in base salary. Any formal amendment also should address other relevant terms and conditions (e.g., good reason or severance).
Deferral of Pay
- Unlike reductions in pay, deferrals can create tax issues (e.g., it is generally not permitted to defer pay “until the economic situation improves”). Deferral of base pay, bonus, etc. is governed by Internal Revenue Code Section 409A. Failure to meet all applicable requirements will result in adverse tax consequences mostly for the employee (20% penalty tax), but also for the employer (potential penalties for underwithholding and underreporting).
- Again, governing documents (employment agreements, bonus plans, etc.) must be checked to see if amendments will be needed and if employee consent is required. If deferral is possible, clear documentation is recommended in order to be able to show compliance with, or exemption from, Code Section 409A and to cover any impact on other benefits.
Modifications of Incentive Pay
- If currently applicable targets for ongoing performance cycles under bonus plans, long-term incentive plans, etc. have become unreachable or otherwise inappropriate, caution should be exercised when amending such programs. Accelerations or deferrals of payments may violate applicable tax rules.
- Governing documents should be checked to see if formal amendments will be needed and if employee consent is required. Clear documentation of any change is recommended in order to be able to show ongoing compliance with, or exemption from, Code Section 409A.
Revisions of Equity-Based Awards
- If as a result of a decrease in company value, outstanding equity-based awards lose value, are underwater, or generally no longer constitute effective retention tools or incentives, award replacements, extensions, or modifications (including, but not limited to, repricing) may be possible. But they are subject to multiple layers of rules and regulations, including not only tax rules, but also accounting rules and even stock exchange rules for publicly held companies. These too should be approached with caution.
- Governing documents (equity plans and individual grant documents) must be checked to see if amendments will be needed and if employee consent is required, or even if the type of change that is being contemplated is permitted under applicable terms and conditions.
- Clear documentation of any change is recommended in order to be able to show ongoing compliance with, or exemption from, Code Section 409A.
- Caution should be exercised when granting equity-based awards at a time when company value may be artificially depreciated as this may later yield significant increases in compensation.
CARES Act Gives Temporary Relief for Employees
- A new optional form of in-service distribution is available in 2020 for participants who are affected by COVID-19 (not all participants – “Affected participants” are defined and this is likely to bring interpretation issues). The distribution is not subject to any penalty for early distribution, may be repaid to the plan over a three-year period, and is taken into ordinary income by the recipient over a three-year period to the extent that it is not repaid. Distributions may not exceed $100,000 per eligible participant. This is an optional benefit. Employers will need to decide whether or not to implement this change.
- Other forms of relief include an increased amount available for loans from retirement plan accounts, certain permitted delays in outstanding loan repayments, and a waiver of minimum required distributions.
- All these changes will require employee communications and plan amendments. Generally, plan amendments can be adopted later.
Reduction, Suspension, or Elimination of Employer Contributions to 401(k) Plans or Other Retirement Plans
- Employer contributions to defined contribution plans (401(k), 403(b), etc.) generally may be reduced, suspended, or eliminated (temporarily or otherwise). Plan amendment provisions should be followed to make sure any amendment is binding.
- Strict rules apply (protected benefits, accruals, etc.). As a result, how any such amendment is drafted and implemented must be done carefully. This is particularly true for safe-harbor plans (for purposes of non-discrimination testing) where additional rules apply, including a notice to participants and possibly the need to be operating at an economic loss.
Pension Plan Funding Delay
- Traditional pension plan funding may be a problem for employers in the current environment. The CARES Act did not change any of the requirements applicable to pension plans, but it postpones the due date of the required minimum funding contribution, which would have been due in calendar year 2020, until January 1, 2021 (with interest). Other more technical relief may available.
Risk of Partial Plan Termination
- When terminating employees who are participating in a qualified retirement plan, employers may trigger a “partial termination” of the retirement plan. In such a case, all affected participants must become 100% vested in benefits accrued as of the partial termination date.
- Generally, a partial termination is presumed to occur when more than 20% of plan participants are terminated in a particular year. Determining when a partial termination occurs is a facts-and-circumstances test that can prove technical and difficult, and it sometimes is litigated.
Hardship Withdrawals Are Available to Participants
- 401(k) and 403(b) plans are generally allowed to provide for hardship withdrawals for plan participants. If this feature is currently not in a plan, employers can amend plans to include it.
- Hardship is defined in the Internal Revenue Code and may cover some of the financial difficulties encountered by employees as a result of the pandemic. Proper documentation from the participant is required. These provisions should not be interpreted loosely. This is an enforcement area for IRS audits.
- The basic rules relating to fiduciary duties for retirement plans generally remain the same but deserve increased attention in the current environment.
- Contributions must continue to be made promptly in accordance with U.S. Department of Labor guidance. Some temporary relief may be available but solely if delays in funding contributions can be attributed to the outbreak. Proper fiduciary documentation is recommended.
- In general, best practices and procedural prudence for fiduciaries are more important in a downturn as the risk of lawsuits for losses on investments increases.
Reductions in Hours and Terminations Are COBRA Qualifying Events
- Terminations, furloughs, and other reductions in hours are likely to trigger COBRA-related obligations. Generally applicable COBRA deadlines for employers and employees have been temporarily extended, which may result in administrative challenges.
- Subsidizing COBRA coverage for affected employees may be feasible, but such actions may be deemed discriminatory under applicable tax rules, which would adversely impact highly compensated employees.
Extensions of Coverage Might Be Possible
- Governing plan documents and any contract with the insurer or third-party administrator will determine whether the coverage granted to active employees can continue during furloughs or other short-term leaves of absence. Many plans have minimum hour requirements to maintain active coverage.
- If applicable terms and conditions of the plan do not permit coverage to continue during a leave of absence, the plan could be amended to do so. The typical coverage until the end of the current month is not legally mandated and longer periods can be included in the plan. However, it is important to coordinate any extension of coverage with the plan’s insurer, third-party administrator, and/or stop loss carrier.
Affected Employees May Be Able to Change Elections Under a Cafeteria Plan
- In general, cafeteria plans may permit employees to revoke or change elections during a year only in limited circumstances, including as a result of a change in employment status of the employee (or the employee’s spouse or dependents), such as a reduction in work hours. Also, changes in qualified dependent care costs may allow employees to change their dependent care flexible spending contributions consistent with the change in costs.
- The IRS has issued guidance providing added flexibility for employees to change their cafeteria plan elections mid-year. Plan amendments will be needed to reflect such changes. Also, these changes should be coordinated with any insurer so that actual changes in elections will be accepted for purposes of the underlying health plan.
The CARES Act Imposes Certain Limitations for Companies Receiving a Loan or Loan Guarantee From the Exchange Stabilization Fund
- In general, for any employee who received “total compensation” in 2019 over $425,000, for any consecutive 12 months during the period beginning on the date of the loan or loan guarantee and ending one year after the loan or loan guarantee ceases to be outstanding, the employee may not receive “total compensation” in excess of the “total compensation” received in 2019. Additional limits apply to individuals earning more than $3,000,000. Other limits apply to severance pay.
- This area creates many interpretation issues about how to calculate compensation and identify the affected employee population for these purposes and may be difficult to implement practically if highly compensated employees have rights under existing agreements that exceed applicable limits and where any adverse change may require consent.
Deferred Compensation Plans or Agreements
- Deferred compensation is not limited to executive compensation and may include incentive pay programs, severance, etc. Code Section 409A governs these arrangements. It generally prohibits acceleration of payments and imposes strict requirements on delaying payments. Even plan terminations are seen as a potential way to avoid the anti-acceleration rule and are subject to strict rules. In the current environment, both employers and executives are likely to inquire about how to modify the existing payment structure in the plans. No such change should be implemented before compliance with Code Section 409A is ascertained.
Accelerated Payment of Deferred Compensation for Unforeseeable Emergencies Is Permitted
- Deferred compensation plans are generally allowed to provide for accelerated payments for unforeseeable emergencies. If this feature is currently not in a plan, employers can amend plans to include it.
- Unforeseeable emergency is defined in the Internal Revenue Code (and is more restrictive than “hardship” in qualified plans). It does not include an economic downturn per se (as those come periodically and therefore are foreseeable) but may cover some of the financial difficulties encountered by employees as a result of the pandemic.
- Policies may need to be developed to implement this feature in compliance with applicable rules and with consistency for similarly situated employees.
Temporary Student Loans Repayment Benefit
- Employers may pay employees’ (including spouses and dependents) loans for higher education and exclude those payments from the employees’ federal gross income through 2020. In such a case, employees lose the deduction for interest.
- There is a $5,250 annual cap for both the new student loan repayment benefit and any other tax-free education.
For more information, please contact us or your regular Parker Poe contact. You can also find the firm's other COVID-19 alerts here.