Focus On Public Benefits

Compensatory time off or “comp time” is paid time off taken in lieu of pay. In the case of State and local governments, the Fair Labor Standards Act (FLSA) allows them to provide non‑exempt workers with comp time in lieu of overtime. State and local governments may also provide their exempt workers with comp time in lieu of regular pay.

In its simplest form, comp time is provided for in a memorandum of understanding or an employer-established comp time policy that allows, in certain instances, employees to accrue (be credited with) comp time in lieu of overtime pay or certain regular pay (in the case of exempt employees). Basic comp time accrues automatically and is mandatory – somewhat like vacation or sick pay. When comp time accrues automatically like vacation and in accordance with the applicable FLSA rules, there is no taxation or taxable event until the employee takes the comp time or has her comp time cashed out upon termination of employment.

However, in cases where employers give their employees the choice to either receive comp time or not, or to cash out already accrued comp time, you have the same income tax problem that typically arises in connection with PTO cash-outs – that is “constructive receipt.” For example:

1. If the employer allows employees to decide on a payroll by payroll basis (typically by annotating their time sheets) whether to take comp time or not, all employees given that choice are taxable on the amounts that they could have taken as cash wages.

2. Just like PTO cash‑outs, if employers give employees the option to cash out some of their already accrued comp time, all employees who have that choice are taxable on the amounts that they could have cashed out – even if they don’t actually cash out any of it!

3. Some employers give their employees a mid-year election of whether to receive comp time or overtime pay. Others allow their employees to elect out of automatically provided comp time at any time. Both of these practices raise serious questions about whether these elections comply with the nonqualified deferred compensation rules under Internal Revenue Code section 409A, and their related IRS guidance.

If you are being too “flexible” with respect to your comp time practices, now is the time to look into them.

Editor’s Note: We did the best we could to make sure the information and advice in this article were current as of the date of posting to the website. Because the laws and the government’s rules are changing all the time, you should check with us if you are unsure whether this material is still current. Of course, none of our articles are meant to serve as specific legal advice to you. If you would like that, please call us at (916) 357-5660 or e-mail us at jcc@seethebenefits.com.

Previously, I’ve written about the pitfalls of giving employees “too much choice” with respect to their pay, their paid time off and other benefits.  Employee elections that are not properly designed can unexpectedly result in current taxation under either the “constructive receipt doctrine” or the “assignment of income doctrine.”

One of the important takeaways from our advice concerning cash-outs of unused leave or PTO, see www.seethebenefits.com/article, is that there should not be a tax issue – a constructive receipt problem – if the employer requires employees to make a choice between accruing PTO or receiving cash in lieu of the PTO in the year before the year when the PTO will be earned. In other words, it’s okay to give employees a cash‑out election so long as that election is made in a calendar year that is prior to the year in which the employee will earn the PTO that will be subject to the cash-out.

A recently issued IRS private letter ruling (PLR) illustrates how this type of “safe election” can be used to give employees somewhat greater choice and control over the use of their accumulated sick leave or PTO, without triggering current taxation.  In PLR 201601012, the IRS advised the requesting taxpayer that if appropriate 401(k) plan and health reimbursement arrangement (HRA) amendments are made, it should be possible to give employees the choice among having a portion of the PTO they will earn in the next calendar year: (a) contributed by the employer to the 401(k) plan; (b) contributed by the employer to the HRA; or (c) contributed by the employer into a combination of the 401(k) plan and the HRA.

There are a couple of nuances worth noting.  First, the PLR contemplates that the amounts “elected” by the employee to go into the 401(k) plan will be employer contributions, not employee elective deferrals.  Second, the PLR contemplates that the amounts going into the HRA will also be treated as employer contributions. For more on HRAs and why they must be funded by the employer, see www.seethebenefits.com/article.

For our public agency audience, the ones saying “but we can’t have a 401(k) plan,” there does not appear to be any reason that this technique could not be structured using a 457(b) plan instead of a 401(k) plan. Remember, an IRS PLR is considered tax advice only to the requesting taxpayer and may not be relied upon as authority by other taxpayers. If you have questions about this, please let us know.

Editor’s Note: We did the best we could to make sure the information and advice in this article were current as of the date of posting to the website. Because the laws and the government’s rules are changing all the time, you should check with us if you are unsure whether this material is still current. Of course, none of our articles are meant to serve as specific legal advice to you. If you would like that, please call us at (916) 357-5660 or e-mail us at jcc@seethebenefits.com.

Group variable annuity contracts are often used to wrap mutual funds to provide greater revenue to plan providers or to provide access to an insurance company’s stable value fund. Every public agency 457(b) plan or 401(a) plan that offers a stable value investment option includes a group variable annuity contract.

Some contracts contain significant “surrender” charges or “back-end loads.” Oftentimes these charges continually renew as new money comes in. Some contracts restrict participant and/or sponsor access to the funds in the event of a contract termination. In many cases, the contract issuer can require a full year’s notice and continuation of the contract before the contract can be surrendered. Because the stable value fund feature of many such contracts guarantees or credits interest at higher than short term interest rates, some contracts contain a “mark-to-market” feature that allows the issuer to pay over the adjusted market value of the fund (a lower amount) rather than the so-called book value – the amount shown on participant statements. All of these fees, restrictions and adjustments can cause significant problems or issues for plan sponsors who wish to leave an insurance company plan provider for another provider. For these reasons, it is important for plan sponsors and plan committees to know whether their plans are subject to such a contract and what the contract says.

Often a prospective record keeper or investment provider will offer to pay and “finance” any surrender charges or back-end loads that may be incurred by reason of a record keeper transition. Special care must be given to these types of arrangements because the Internal Revenue Service has issued guidance indicating that such payments will generally be treated as additional employer contributions. Unless certain precautions are taken, most plan documents would require that any such payments be allocated to participants based on relative compensation – not based on the actual surrender charges assessed to them.

Because group annuity contracts are generally regulated by State insurance law, the issuers may have less flexibility to modify or change the terms of a contract. That is why it is important for plan sponsors and plan fiduciaries to fully understand the terms of their group annuity contracts. Don’t wait to review your contract until after you have sent a notice of termination to your current provider.

Editor’s Note: We did the best we could to make sure the information and advice in this article were current as of the date of posting to the website. Because the laws and the government’s rules are changing all the time, you should check with us if you are unsure whether this material is still current. Of course, none of our articles are meant to serve as specific legal advice to you. If you would like that, please call us at (916) 357-5660 or e-mail us at jcc@seethebenefits.com.

Originally published in “The Public Retirement Journal,” March-April 2016, and reprinted with permission.

So, here’s the bad news. Governor Jerry Brown referred to the State’s grossly underfunded pension and retiree health obligations in his 2016 State of the State address as “liabilities…so massive that it is tempting to ignore them.” The State’s unfunded retiree health obligation (well in excess of $65 billion) has now surpassed its unfunded pension obligations – and, more importantly, there is no statutory or administrative construct in place (like CalPERS) to force State agencies, cities and local governments to properly fund for these growing obligations. Sure, GASB 45 now forces government to “account for” these liabilities to acknowledge that they really exist; however, it does not by itself mandate funding of these obligations or efforts to control future costs.

None of this is really “new” news. Most of us have seen this coming for some time now. So, what’s the “not so bad news”? Depending on whether you are wearing the hat of someone charged with the responsibility of controlling these liabilities and costs, someone who may be adversely affected by a future reduction in retiree health benefits, or both, the not so bad news is that State agencies, cities and local governments have the tools needed to begin to control retiree health care costs and unfunded liabilities. The real question is whether they have the political skill and will to use them.

In the simplest terms, California law regarding “vested rights” of public employees does not protect retiree health benefits to the same extent that it currently protects pension benefits. With respect to public pension benefits, the courts judicially “imply” a contract (or a vested right) that generally arises when an individual is first hired, which prevents the employer/public agency from reducing or adversely modifying pension benefits unless the employer provides a simultaneous enhancement of pension benefits that is of comparable value. Not so with respect to retiree health benefits. Instead, the California courts recognize that public employers may, if they choose, provide their employees with vested rights to retiree health benefits; however, the extent to which they are protected or vested is strictly a matter of contract law. In other words, the courts have not inferred or presumed some immutable right arising upon hire, as they have in the pension arena.

Of course, things are never so simple. Contracts can be “expressed” – where the terms of the agreement are clearly determined from the written words of the contract, or they can be “implied” – where some or all of the terms of the agreement may be based on the conduct of the parties and, in some cases, relevant written communications outside of the contract.

There have been a number of significant court cases dealing with the rights of California public employees to vested retiree health benefits, most notably the series of federal and California rulings involving the dispute between the retired employees of Orange County and the County of Orange[i] that took over six years to resolve (REOC) and the intervening rulings involving the City of Redding[ii] (Redding). Without going into all of the messy details of these cases (something lawyers love to do), here are the major takeaways from REOC and Redding:

• It is possible for public employees in California to obtain “vested” rights in their retiree health benefits.

• Whether and when retiree health benefits become vested and protected against unilateral modification is a matter of “contractual analysis.” That is, what did the parties negotiate and agree upon?

• A right to vested retiree health can arise by either implied or express contract.

• In analyzing whether there is an express or implied contract to provide vested retiree health benefits, the courts will look at the employer’s legislative acts (i.e., resolutions, ordinances, and approved MOUs). If the parties’ intent to confer a contractual right to retiree health benefits is not explicit, the party asserting the right (i.e., the retirees) has a heavy burden to overcome.

• To find a binding obligation to provide permanent retiree health benefits, the courts will look for resolutions, ordinances, or approved MOUs that:

Explicitly provide for health benefits in perpetuity;

Guarantee that the level of benefits will continue; and

Indicate that the benefit is a continuing obligation.

• A long-term practice of providing a retiree health benefit is not, by itself, enough to create a vested retiree health benefit.

• MOU language conferring retiree health benefits upon “each retiree and dependent…currently enrolled and for each retiree in the future” is enough to create vested retiree health benefits – potentially in perpetuity.

Let’s go beyond the legal takeaways and focus on what public employers need to understand about their retiree health benefits and what can be done with them.

• In most cases, California public employers do not have the kind of language in their MOUs that was present in Redding. In other words, very few employers have contractual obligations to provide retiree health benefits beyond the terms of the current MOUs. Start immediately by having legal counsel look at your resolution/ordinance/MOU language.

• Assuming that the employer is not constrained from making changes in existing retiree health benefits (or future retiree health benefits) by the terms of its contracts, there needs to be an honest assessment of:

The current and projected liabilities associated with retiree health, whether these liabilities (and the assumptions underlying them) are realistic, and how important it is for the employer to control overall benefit costs by reducing retiree health benefits.

The changes that might be available to reduce or control retiree health costs and liabilities (e.g., moving away from a defined benefit retiree health system to a defined contribution system that focuses on what employers can afford to contribute).

Whether there are other aspects of employees’ total compensation and benefits that can be negotiated or reduced in lieu of complete or immediate changes to retiree health.

• Once the numbers have been reviewed and the issue of financial “sustainability” has at least been raised, there needs to be political discussion about the willingness of the employer and its governing board/council to take on this issue.

• Again, assuming that there is the need and the will to make changes, there are a number of things that can be done to begin to control these costs and liabilities:

• Even if the employer is a participating employer in CalPERS and subject to the Public Employees Medical and Hospital Care Act (PEMHCA) and its equal contribution rule, there are adjustments that can be made by using rate groups.[iii]

• Apart from the use of rate groups, employers that are subject to PEMHCA may also be able to lower their mandatory equal contribution rate for both active employees and retirees and then make separate subsidies (outside of PEMHCA) through the use of a cafeteria plan for active employees and a health expense reimbursement arrangement for certain retirees.[iv]

• Some employers such as the County of Sacramento have “re-characterized” their retiree health benefit subsidy as an ad hoc benefit that may or may not be conferred on employees. If this is done, there would be no contractual right, but there might be a benefit conferred if there is sufficient room in the budget.

• If things are really bad, there is always bankruptcy. Based on the experiences of Vallejo, Detroit, Stockton and San Bernardino, literally hundreds of millions of dollars in retiree health obligations were eliminated as part of these bankruptcies.

Given the State of California’s law with respect to public employees’ retiree health benefits, there is bound to be continuing discussion and scrutiny as to what if anything can be done, or is being done, to control these multigenerational obligations.

Editor’s Note: We did the best we could to make sure the information and advice in this article were current as of the date of posting to the web site. Because the laws and the government’s rules are changing all the time, you should check with us if you are unsure whether this material is still current. Of course, none of our articles are meant to serve as specific legal advice to you. If you would like that, please call us at (916) 357-5660 or email us at contactus@seethebenefits.com.

[i] See Retired Employees Association Of Orange County, Inc., v. County Of Orange, 742 F. 3d 1137 (9th Cir. 2014) and Retired Emps. Ass’n of Orange County v. County of Orange, 52 Cal. 4th 1171 (Cal. 2011).

[ii] See International Brotherhood Of Electrical Workers, Local 1245, v. City Of Redding, 210 Cal. App. 4th 1114 (Cal. App. 3rd Dist., 2012); petition for review denied, 2013 Cal. LEXIS 462 (Cal. 2013).

[iii] See Chapter 12: When Treating Everyone The Same May Not Work – Working With PEMHCA’s Equal Contribution Rule, http://focusonpublicbenefits.com/?p=322

[iv] Id.