A little-known provision in the Tax Cuts and Jobs Act should be of great interest to employers. In response to the #MeToo movement and the recent surge of sexual misconduct allegations, Congress included a provision in the Act that precludes employers from deducting (1) settlements or payments relating to sexual harassment or abuse if the settlement or payment is subject to a nondisclosure agreement or (2) attorneys’ fees relating to such a settlement or payment. The provision applies to amounts paid or incurred after December 22, 2017.
Previously, employers could deduct as ordinary and necessary business expenses all settlement payments arising out of a business matter as well as related attorneys’ fees. The new law will make sexual harassment settlements more expensive for employers who include confidentiality provisions in their settlement agreements. Employers will have to choose between deductibility and confidentiality.
The Internal Revenue Service (“IRS”) is expected to issue guidance to clarify some of the questions surrounding the new law. For example, it is not clear whether an employer can deduct payments relating to a confidential settlement agreement that contains a broad release of claims, including claims for sexual harassment, even if no actual sexual harassment claims were asserted in the underlying litigation. And, if a confidential settlement agreement settles litigation involving sexual harassment claims and other claims, can the settlement payments be apportioned among claims, allowing the employer to deduct a portion of the settlement payment?
Until the IRS weighs in, employers should tread carefully in this area and consider the potential added tax burden of settling sexual harassment claims. In some circumstances, employers may deem confidentiality to be worth the extra cost. One thing is clear – settling sexual harassment claims on a confidential basis just got more expensive.
The medical loss ratio (“MLR”) rule under the Patient Protection and Affordable Care Act (the “ACA”) is now in effect and over the next few weeks many of our clients will be receiving rebate checks from their health insurers. These checks will “come out of the blue” for many clients and will surely raise questions – – for example, what is this for, what can I do with the money, does any go to employees, is it taxable? Guidance by the U.S. Department of Labor (DOL) and Internal Revenue Service (IRS) has been provided for employers, summarized below.
[Note that this summary applies primarily to private employers who provide health insurance to their employees through a policy with an insurer who is subject to the MLR Plans of governmental employers, churches and non-ERISA plans are not included in this summary.]
Background
Generally, the MLR rule requires health insurers to issue “rebates” to policyholders if the insurer’s MLR ratio exceeds 85 percent for the large group market, and 80 percent for the small group and individual market. The MLR is basically the ratio of the insurer’s (i) claims and quality improvement expenses to (ii) total premium dollars earned (adjusted for certain taxes and fees).
An MLR rebate is required to be allocated by the sponsor of an applicable health care plan between the policyholder (usually the employer) and each enrollee covered by the policy insuring the employer health care plan (usually the employees participating in the plan) “in amounts proportionate to the amount of premium paid.” DOL recently issued Technical Release 2011-4 which provides guidance for how such rebates may be used by sponsors of ERISA-covered plans, and the IRS subsequently issued FAQ’s that provide information on the federal tax consequences of rebate payments.
How Can the Sponsor of an ERISA Group Health Plan Use the Rebate?
DOL guidance provides generally that if the employer pays the entire cost of insurance coverage, the rebate may be retained by the employer. If the employer and plan participants each contribute a portion of the premium, the employee share is treated as a plan asset and must be used within 3 months of receipt for a permitted purpose, which may include:
• Distribute rebate to participants;
• Enhance benefits provided by the applicable plan; or
• Reduce future participant premiums.
In deciding on how to apply the rebates to plan participants, the DOL guidance notes that a plan “may properly weigh the costs to the plan and the ultimate plan benefit as well as the competing interests of participants or classes of participants provided such method is reasonable, fair and objective.” For example, if the cost of distributing the rebate to former participants approximates the amount of proceeds, the employer may decide to allocate the proceeds to current participants using a reasonable, fair and objective allocation method. Or, again for example, if the payments would be de minimus in amount, the employer may use the rebate for other permissible purposes including applying the rebate to future participant premium payments or benefit enhancements.
For plans that are exempt from ERISA’s trust and annual audit rules (i.e., unfunded group health plans that are insured), MLR rebates normally remain exempt from ERISA’s trust, annual audit and reporting requirements.
Is a Rebate of Amounts Paid with Employee After-tax Dollars Taxable?
An employee is taxed on the rebate only to the extent the employee received a tax benefit from deducting the premiums. Thus, if the employee did not deduct the premiums on his or her tax return, the rebate is not taxable. And, regardless of any prior deduction of premiums, no taxable income results (although any deduction for current year premiums is reduced) if the employer provides the rebate to all current employees participating in the health plan, without regard to who participated in the year the rebate relates. In no event is the rebate allocated in this manner subject to employment taxes.
Is a Rebate on Amounts Paid with Employee Pre-Tax Dollars (e.g., 125 Plans) Taxable?
If the rebate is distributed as a premium reduction for the employee, then the amount paid for the coverage is less, resulting in increased taxable wages. If the rebate is distributed in cash, then the rebate is treated as taxable wages, subject to income and employment taxes.
The Internal Revenue Service has launched a new program that provides partial relief from federal employment taxes for eligible employers that agree to treat workers as employees prospectively. The program, referred to as the Voluntary Classification Settlement Program (“VSCP”), is available to many businesses, tax-exempt organizations and government entities that currently erroneously treat their workers, or a class or group of workers, as nonemployees or independent contractors and now wish to treat such workers as employees.
To be eligible, an employee must:
Consistently have treated the workers in the past as nonemployees;
Have filed all required Forms 1099 for the workers for the last three years; and
Not currently be under audit by the IRS, the Department of Labor or a state agency concerning the classification of such workers.
To apply to participate in the VSCP, an employer files Form 8952, Application for Voluntary Classification Settlement Program, at least sixty days before the employer wishes to begin treating the workers as employees.
An employer who is accepted into the VCSP will be required to pay an amount equal to ten percent (10%) of the employment tax due on compensation paid to the worker for the most recent tax year; will not be liable for any penalties or interest; and will not be subject to an employment tax audit with respect to the classification of the workers for prior years.
When the Wage and Hour Division of the U.S. Department of Labor or a state department of labor determines that an employer has misclassified employees as independent contractors and has failed to pay them minimum wage or overtime pay required by law, the remedy at the administrative level typically has been for the employer to pay the affected employees back pay sufficient to make up for the lost wages. Of course, an employer which has misclassified employees in this fashion has not been withholding federal, state, or local income taxes, or FICA, and has not been remitting those taxes (including the employer’s share of FICA) or filing quarterly payroll tax returns with the government regarding the misclassified workers.
A lingering, worrisome question in settling such disputes with the Wage and Hour Division or a state department of labor has been whether the employer will be reported to state or federal internal revenue agencies and will be required to pay taxes, penalties, and interest in addition to back pay. The specter of facing the tax man in such matters became more real yesterday, when U.S. Secretary of Labor Hilda Solis announced that she has signed memoranda of understanding (MOU’s) with the Internal Revenue Service and the state labor commissioners and other state agencies in the states of Connecticut, Maryland, Massachusetts, Minnesota, Missouri, Utah and Washington, pledging greater cooperation to share information in an effort to protect employees from being improperly classified as independent contractors. Continue reading →
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