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Exclusive
Owner/Manager Benefits
Arising from the ERISA Collective Bargaining Exclusion
by Paul M. League, QFP, CFP |
Pre-ERISA (1974) found many business owners
and high-income professionals happily providing themselves
extraordinary retirement and medical reimbursement benefits,
while their rank-and-file employees had only limited benefits.
ERISA, in the minds of many, misleadingly appeared to have
changed all of that forever.
ERISA actually created many opportunities for progressive
business owners to continue providing themselves an array
of exclusive benefits, so long as they willingly formalize
the employment relationship with their rank-and-file employees
contractually. The reality is that the personnel policies
of most businesses already incorporate many of the requirements
embodied in legitimate collective bargaining arrangements.
Today's high-income professionals and business owners
are often victims of "reverse discrimination"
in many ways. For example, a 401(k) contribution of $18,000
a year by Mr. Doe, a non-highly compensated employee earning
$50,000 a year, represents an income tax-advantageous deferral
of 36%. John's 50-year old employer, Mr. Boss, on
the other hand, who earns $500,000 a year, can also only
defer $18,000 a year – representing an annual tax
deferral of only 3.6%. Mr. Boss is a typical victim of ERISA
"reverse discrimination."
Employers are also more at risk today than ever before for
employee legal complaints. Many employees who feel
that they have been unfairly treated or sexually harassed
simply contact their local trial lawyer to file suit, or
they contact the Equal Employment Opportunity Commission
(EEOC) to file a complaint. In either case the employer
can expect a long, expensive, and exhausting challenge –
one in which a "win" may actually be a loss.
A third area in which successful business owners and professionals
are at risk is punitive damages resulting from lost
lawsuits. Jury awards can bankrupt small business owners
and high-income professionals. Many affluent employers seek
ways to protect assets and earned income from adverse judgments,
with the most effective technique sheltering being inside
of ERISA qualified retirement plans.
While it is true that ERISA placed substantial restrictions
on what employers can do for themselves, it also created
opportunities. Employers who are concerned with tax-sheltering
and asset-protecting as much earned income as possible,
and with paying for uninsured healthcare expenses with tax-deductible
earnings and profits, can still do so – and more –
on an exclusive basis.
Understanding the Benefits Terrain
Misconceptions abound about establishing benefits for small
businesses; namely, which benefits are subject to ERISA
non-discrimination rules, and which are not.
1. If the benefit is not a "qualified
benefit" - it would not be subject to ERISA non-discrimination
rules.
Example: Non-qualified Deferred Compensation
Plans, Executive Bonus Plans, Split Dollar Plans, Long Term
Care Plans (LTCi), Long Term Disability Plans (LTD), and IRA's.
2. If the benefit is a "qualified
benefit" - it is fully subject to ERISA non-discrimination
rules.
Example: Qualified Retirement Plans - Simple,
401(k), Profit Sharing, 412(i), other Pension plans, or health
plan benefits such as a Medical Reimbursement Plan.
Qualified plan benefits allow exclusions only as defined in
the Internal Revenue Code as quoted herein. Therefore, a business
owner cannot establish a different qualified retirement
plan for management in his own company, versus a different
plan for non-management employees, unless employees
are excluded by one of the five statutory allowed IRC exclusions.
Under IRC Sections 410(b) and 105(h) certain employees are
able to be excluded from participation in such plans as: employer-funded
retirement and medical reimbursement plans. The last of the
following listed exclusions frightens many who fear outside
interference of the owner's management and control of
the business. Don't be alarmed! The issue is simply
one of contract law, which when properly applied can enhance
the owner's management control and eliminate the prospect
of employee legal dispute, EEOC actions and a myriad of other
problems.
Exclusions listed in the two IRC Sections 410(b) and 105(h)
include:
- Part time employees working less than
1,000 hours per year
- Employees with less than 1 year of service
(retirement plans), or 3 years of service (medical reimbursement)
- Employees under the age of 21 (retirement
plans) or the age of 25 (medical reimbursement plans)
- Non-US. Citizens working outside the
U.S. with no U.S. source income
- Employees whose benefits are
governed by a legitimate collective bargaining agreement
In simple terms a collective bargaining agreement
should be looked at no differently than buy-sell agreements,
independent contractor agreements, key man agreements, and
other contracts used every day in business life. Compliant
employment contracts are those prepared and negotiated pursuant
to the National Labor Relations Act of 1935. This is not a
new idea, but rather one that is steeped in over 70 years
of solid labor and tax law. The key, however, is being compliant.
Contracts must be negotiated in good faith, and at arms length
under the auspices of a union representative.
Compliant Collective Bargaining Planning
Compliant employment contracts for rank-and-file employees
avoid the problems referred to in common law as "adhesive"
contracts. These contracts have uniformly been held to be
unenforceable because management holds a dominant edge over
individual non-management employees.
Compliant collective bargaining agreements, on the other hand,
are enforceable by the National Labor Relations Board. The
United States National Labor Policy is summarized in the National
Labor Relations Act of 1935, with its primary goals being:
to assure continued
production, uninterrupted by strikes and/or lockouts, and
to promote harmony in the workplace.
an understanding that industrial peace is most effectively
achieved through peaceful negotiation between employers
and employee representatives.
that self-organization of employees is vital to the process
and must be accomplished without employer interference,
union coercion, or other unethical practices.
that it is the duty of the union to bargain fairly on behalf
of all employees, including non-members.
Subjects for Collective Bargaining
Negotiation
From a labor law standpoint the key is to understand the differences
between what are "mandatory items for negotiation",
"permissible items for negotiation", and "prohibited
subjects for negotiation".
Mandatory subjects for negotiation include:
"wages, hours, and other terms and conditions of employment."
Courts have held this language to require negotiation "for
retirement and other benefits, in-plant food prices, work
assignments, grievance conflict resolution procedures, safety
rules and practices, contracting out work performed on the
premises, monitoring of employees in the workplace, recognition
of the union as the legitimate bargaining representative."
Permissive subjects for negotiation, which are recommended,
include: "any policies governing employee performance
review, incentive bonus program, employee termination procedures,
employee leave of absence, vacation, observed national holidays,
and nepotism."
Illegal subjects for negotiation, that must be avoided,
include: "any requirement of a closed shop,
preferential hiring of union members, discriminatory practices
(race, national origin, sex, age, etc.), a dues check-off
system, or waiving the right of the union to distribute literature
on company property."
Therefore, a legitimate ERISA qualifying exclusion,
while within the purview of ERISA non-discrimination rules,
avoids running afoul of them by identifying, up front, abusive
practices and fully addressing and eliminating them as part
of the collective bargaining process itself.
Business owners and high-income professional employers are
forever seeking legitimate ways to provide special management
benefits without having to include all employees, but what
additional advantages can companies gain from contractually
formalizing the employment relationship with their employees?
Quite a lot, when examined closely as follows.
Upside of Compliant Employment Contracts
Enhancement of employer-employee relations.
Improved attraction and retention of best employees.
Projection by management of fair practices and equal treatment.
Contractually defined terms, benefits, and conditions of
employment that reduce issues causing disputes.
Contractually defined management authority, termination
policies, drug and alcohol abuse testing procedures, and
conflict resolution procedures.
A system for annual employee performance reviews and written
reprimands that support management's defense against
employee complaints and lawsuits.
Binding arbitration as the ultimate decision making process
for employee complaints that cannot be otherwise resolved
– effectively eliminating lawsuits and EEOC actions.
Downside of Compliant Employment
Contracts
Cannot fire employees "at will"
(it should be noted that employers abusing their authority
to fire "at will" has led to the creation of
the Equal Employment Opportunity Commission (EEOC) and many
employee lawsuits. "At will" firing authority
has little real value in today's litigious environment)
Cannot reduce employee benefits during the contract (it
should likewise be noted that although an employer cannot
reduce employee benefits during the term of a collective
bargaining agreement, benefits for employees are also contractually
determined and not subject to be increased).
The primary negative to an employer is that they cannot
freely outsource work being already performed by existing
employees after the contract is executed.
Employers should expect to pay limited reasonable fees for
contract negotiation expenses, plus annual consultant, intermediary,
and compliance services.
Upside/Downside of Compliant Employment
Contracts – A matter of one's perspective
Employers recognizing the mutual benefits
of formalizing the employment relationship are advised to
increase the compensation of rank-and-file employees choosing
to join the union by the nominal amount of their union dues
(typically less than a dollar a day) to avoid participation
being an economic disincentive to them.
The Exclusive Benefits to Owner/Managers
of the Collective Bargaining Exclusion
In addition to the other many benefits to
an employer and its employees of formalizing the employment
relationship, employers are able to establish exclusive benefits
for management, versus non-management employees, that do not
violate the non-discrimination rules of ERISA. Some of the
more popular of these benefits are as follows, with Long Term
Care Insurance growing ever more popular as the public's
awareness of this largest un-funded liability continues to
rise:
Management can establish
an exclusive retirement plan for all employees not
governed by the non-management employment contract.
Retirement Plan - Typically either
a safe-harbor Simple or 401(k) Retirement Plan is established
for non-management employees with employer contributions
being 3% of payroll pursuant to the negotiated employment
contract. An executive plan for the management team can
then be established to include both pension benefits such
as a 412(i) plan to fund up to $170,000 a year (in 2005)
retirement income benefit to the executive plus a key employee
contribution Simple or 401 (k) plan that enables key management
employees to each shelter up to $18,000 a year of their
own money from current taxation.
Management can establish an exclusive
medical reimbursement plan for all employees not governed
by the non-management employment contract.
Medical Reimbursement Plan –
Most taxpayers never have the opportunity to deduct their
uninsured healthcare costs. Under IRC Section 213 the taxpayer
must first exceed 7 1/2 % of adjusted gross income
to begin deducting these expenses.
Employer funded health plans under IRC
Section 105 allow employers to establish plans to reimburse
employees on a FICA free – Employer tax-deductible
– Employee tax-free basis for these uninsured
healthcare expenses.
IRC Section 105 (h) allows employers to
establish exclusive benefits for management versus non-management
employees if governed by a compliant employment contract.
An employer can, for example, establish one plan for non-management
employees. Such a plan simply reimburses them for health
insurance expenses they incur should they choose not to
participate in the employer sponsored health insurance plan
(as in the case of an employee who waives coverage due to
being covered under their spouses employer elsewhere), subject
to defined limitations that would not exceed what the employer
would have contributed anyway toward the employee's
health insurance benefits. The employer can then establish
a separate executive medical reimbursement plan for the
management team that provides superior comprehensive reimbursement
benefits. For someone in the 35% tax bracket – every
dollar paid for non-deductible healthcare expenses equates
to over $1.65 of earned income.
Added Creative Uses of a Medical Reimbursement
Plan:
o Substantially
raise the deductible on the underlying employer sponsored
group health insurance plan (like those available via
an HSA, or Health Savings Account, or other such high
deductible plans), and then reimburse employees who have
claims on a portion, or all of the difference between
the "old, higher cost, low deductible" and
the "new, lower cost, high deductible" –
this eliminates the burden on the employee, shifts the
risk on the differential to the employer, while substantially
reducing the employers healthcare insurance costs.
o Consider including parents and children
in a director or management role to be covered by the
medical reimbursement plan for management.
Management can establish exclusive critical
illness benefits for all employees not governed by the
non-management employment contract, and can use medical
reimbursement plans as a means to reimburse key employees
for the costs of Critical Illness insurance policies, which
they purchase on a tax favorable basis.
Critical Illness Plan – Critical
Illness insurance, unlike disability coverage, is a policy
that pays the "face amount" of coverage to the
insured "upon diagnosis" of one of numerous
life-threatening or disabling events such as heart attacks,
life threatening cancer, and renal failure. It should be
noted that people between the ages of 30 and 40 have over
a 30% chance of a critical illness claim prior to age 65.
The benefits paid are income tax free to the insured so
long as the premiums were paid with "before tax"
dollars.
Added Creative Uses of a Medical Reimbursement
Plan in Critical Illness Plans:
o Medical reimbursement plans can be
utilized to minimize the IRC Section 213 costs of these
policies by reimbursing the insured, at yearend, for policies
individually purchased and paid for at the beginning of
the year (in cases where no claims are filed or paid).
Premium two, in year two, is paid in a new tax year. If
benefits are paid they tend to deliver a far greater value
then a reimbursement on merely the premiums paid and where
no claims are filled or paid.
Management can establish exclusive
LTD, or Long Term Disability coverage for all employees
not governed by the non-management employment contract.
Long Term Disability Coverage -
LTD, unlike Critical Illness, is a policy that replaces
a portion of one's lost earned income upon proof of
the insured's inability to continue working or loss
of income. Some policies replace income based on one's
"own occupation" whereas other policies reimburse
the insured if unable to work at all.
Disability insurance policies generally
reimburse 50-70% of one's lost earned income. The
benefit is tax free if premiums were paid with after-tax
dollars, and if paid with tax-deductible dollars, the benefit
is taxable upon receipt.
Although Long Term Disability is not subject
to the ERISA non-discrimination rules, many supplemental
employer-funded salary continuation plans are often challenged
when the only employees included are stockholders. The usual
result is that the payments are deemed to be dividends.
A safer plan is one in which all employees, other than those
governed by a collective bargaining agreement, are included,
another affordable and cost-effective benefit made available
through the collective bargaining exclusion.
Management can establish exclusive Long Term
Care Insurance coverage.
Long Term Care Insurance (LTCi) Protection
– LTCi protection is uniquely allowed to be funded
with income tax deductible dollars and still enjoy a tax-free
benefit. Long Term Care insurance is not subject to the
ERISA non-discrimination rules and can be funded by the
employer for designated key employees only. A valuable planning
strategy for business owners is to include parents or older
children in a director or management role to be covered
by employer-funded LTCi plans.
Management can establish exclusive
Split Dollar, Non-Qualified Deferred Comp, & Executive
Bonus Plans.
Split Dollar & Non-Qualified Deferred
Compensation Plans – Non-Profit Corporations and
Business owners operating as non-public "C"
Corporations that are not deemed to be Personal Service
Corporations enjoy special income tax brackets that enable
them to utilize retained earnings and profits on a favorable
tax basis to fund designated key-executive benefits such
as Split Dollar life insurance and Non-Qualified Deferred
Compensation Plans on an "exclusive basis."
These plans are not subject to the ERISA non-discrimination
rules.
o Split Dollar plans enable businesses
to fund special, exclusive life insurance plans for key
employees until retirement.
1.) Endorsement Split Dollar Plans
are life insurance contracts owned by the business on
the lives of key employees typically established and totally
funded by the business, with the greater of cash surrender
value or premiums paid inuring to the business and the
excess death benefit each year inuring to the key employee
and payable to his or her designated beneficiary.
Endorsement Split Dollar Plans are often
used in conjunction with Non-Qualified Deferred Compensation
Plans to fund a future retirement benefit while providing
current life insurance benefits to designated beneficiaries
of key employees prior to retirement.
2.) Collateral Assignment Split Dollar
Plans, on the other hand, are life insurance contracts
owned by either the insured or a trust created by the
insured, with an assignment by the key employee to the
corporation of an interest in the policy.
o One valuable technique in Non-Qualified
Deferred Compensation Planning is for the employer
to accumulate cash surrender values until the employee
retires and then exchange the life policy for a single
premium immediate annuity on a tax free basis. The income
paid to the company from the annuity is used to fund the
retirement benefit to the now-retired employee. A substantial
portion of the payment from the annuity is a return of
basis, which creates a tax shelter for the employer against
other earnings and profits each year.
In light of historic abuses in both Split
Dollar & Non-Qualified Deferred Compensation Plans,
we now have clear, established guidelines to follow that
eliminate IRS challenges when plans are prepared and administered
compliantly.
Executive Section 162 Bonus Plans
utilizing insurance contracts, owned by the key executive,
but funded via an annual company bonus that is taxed through
to the key executive.
What Happens When It Becomes Time
To Retire or Otherwise Exit Such Plans?
Owner exit strategies are very much the same whether employees
are governed by an employment contract or not. Typically sales
of closely held businesses and professional practices are
"asset sales" versus "entity sales"
because buyers do not want to find themselves obligated to
hidden liabilities of the seller. In an asset sale the "trade
or business" is sold and the entity typically liquidated.
In regards to the collective bargaining agreement between
the "selling entity" and the "collective
bargaining representative for the employees" –
the employment contract simply terminates.
Who Is The Ideal Candidate for Such a Plan?
Employers are best served, when considering such a plan, to
have a Qualified Financial Planner (www.iaqfp.org)
conduct an employee benefits cost analysis to determine exactly
the current flow of resource dollars between them and their
employees. The heart of good benefits planning is proper fiscal
analysis to see exactly what you are now doing versus potential
options and opportunities that may improve the picture specifically
as it relates to owners and their key managerial personnel.
Certain benefits are a "given" under collective
bargaining agreements - primarily retirement and health benefits.
Additionally, collective bargaining agreements always provide
for defined vacation policies and the observance of specified
national holidays. Therefore, a responsible employer, who
is already providing its employees with these basic benefits
should not find formalizing the employment relationship via
collective bargaining to be a great leap in exchange for achieving
exclusively enhanced owner/manager benefits. Others, not offering
such basic benefits, are not quite as ideal candidates to
take advantage of this valuable exclusion from the ERISA non-discrimination
rules for benefits funding. Unions typically seek only fair
practices and treatment for the employees they represent,
having no interest in causing unrest or interfering with management
of the business. What most employers find is that the outcome
of legitimate collective bargaining almost always promotes
increased harmony and productivity in the workplace.
In light of the foregoing, the best candidates are those who
are self-employed business owners and high-income professionals
sharing most of the following characteristics:
Over age 50
Earning over $250,000 a year
Limited financial debt
Concerned with asset protection
Concerned with saving for retirement
Concerned with uninsured health costs
With 3 or more employees per owner/key management person
Unable to afford, or not inclined to provide, the same
level of benefits for all employees
Conclusions
The overlooked collective bargaining exclusion has the potential
to produce rather rich benefits for management having the
right profile and mindset.
What we have discovered herein is that wrongly perceived draconian
ERISA '74 restrictions have within them "life
building DNA strains" that, when properly utilized,
have the unique ability to cure owner/manager problems by
actually improving upon Pre-ERISA '74 executive benefits,
while also striking an improved and effective balance between
the needs of management and employees.
Disclaimer Notes: The material discussed
is meant for general illustration or informational purposes
only and is not to be construed as investment or tax advice.
Although the information has been gathered from sources believed
to be reliable, it is not guaranteed. Please note that individual
situations can vary. Therefore, the information should be
relied upon only when coordinated with individual professional
advice. ©Paul M. League. All Rights Reserved (03.2005).
Paul M. League,
QFP, CFP® is the principal of League Financial
& Insurance Services / LeagueFinancial.com,
and a registered representative and investment advisor representative
with Royal Alliance Associates, Inc., Member NASD/SIPC, a
Broker/Dealer & Registered Investment Advisor. Paul has
specialized in wealth creation, preservation, and expansion
through individual and group benefit programs for over 20
years. He can be reached at 332 S. Beverly Drive, Suite #101,
Beverly Hills, CA 90212, phone (310) 277-3141; www.LeagueFinancial.com
;E-mail: Paul@LeagueFinancial.com.
Acknowledgements: Claude B. Bass, J.D. |
