Employee Benefits Update – Spring 2014

    By ESOPs & Employee Benefits


    After years of threats from Congress and tax-reform advocates, private equity fund sponsors have been dealt a potential setback from an unlikely source: The federal 1st Circuit Court of Appeals. The court’s recent decision in Sun Capital Partners III, L.P. v. New England Teamsters could make private equity funds liable for their portfolio companies’ underfunded pension obligations, a potentially massive liability in some transactions that will require careful pre-closing structuring to sidestep. The ruling has also rekindled the debate over the tax treatment of fund sponsors’ profits, which relies on investor status to achieve favorable capital gains rates on their earnings.

    ERISA historically protected private equity funds from their portfolio companies’ underfunded pensions. Under ERISA, which governs liability in this context, any “trade or business” under “common control” with a pension plan sponsor is jointly liable for the sponsor’s pension obligations. That includes underfunding liabilities.

    A “trade or business” generally is limited to an active, continuous operation that exists to make a profit or income. Common control exists where one entity owns at least 80% of another entity, usually seen with parent companies that own at least 80% of a subsidiary company. Crucially, though, common control can flow up to a parent company and back down to other subsidiaries.

    In contrast to operating companies, private equity funds historically have been considered passive investors rather than active trades or businesses under ERISA. As a result, they have avoided pension liabilities of their portfolio companies, even where the fund owned 100% of the portfolio company’s stock. This view has prevailed almost universally until recently when both the PBGC and a federal district court opined that private equity funds could be trades or businesses under the so-called “investment plus” approach (though neither of those pronouncements created binding law).

    The 1st Circuit followed this tack: After reviewing the Sun Capital fund’s active management of its portfolio company—in circumstances very typical for private equity investments—it concluded that the fund was so involved in running the portfolio company that it became an active “trade or business,” eliminating the primary justification for shielding private equity funds from pension liabilities in distressed portfolio companies. The court followed the PBGC’s “investment plus” approach—but declined to explain what any particular “plus” might be—in holding that the Sun Capital funds were not merely passive investors without ERISA liability. (The court did, however, highlight as one important factor the fact that the fund received an offset of fees charged by the management company for fees paid by the fund’s portfolio companies). Unlike the PBGC’s and district court’s non-binding positions, the 1st Circuit’s rationale is now mandatory in all district courts within the 1st Circuit, which covers Maine, Massachusetts, New Hampshire, Rhode Island, and Puerto Rico. And as the first court at this level to apply this approach, the ruling sets an example for future appeals courts across the country. Additionally, the U.S. Supreme Court has declined to review the 1st Circuit’s decision, meaning the court’s ruling is final.

    One important question was left unanswered—whether divided ownership of the portfolio company between two of Sun Capital’s private equity funds (70% in one fund; 30% in another) could be aggregated for purposes of common control under ERISA. Allowing aggregation would result in common control even where no single entity owns 80% of the portfolio company. Regardless of this outcome, the “trade or business” prong is the only safeguard preventing pension liability where a fund owns at least 80% of a portfolio company and is therefore categorically under common control. And while the Sun Capital case involved the company’s withdrawal from a multiemployer pension plan, the same ERISA rules govern single-employer pension plans.

    Interestingly, though, the Sun Capital decision did hold that prospectively structuring the purchase 70%/30% between two funds was not enough to impose “evade or avoid” liability on the funds, which may result if one fund owns at least 80% of the company and attempts to later restructure its ownership to avoid ERISA liability.

    In the wake of the Sun Capital case, fund sponsors should closely review any existing pension funding problems in their portfolio companies. Going forward, fund sponsors should diligently address a target’s pension plan—and the target’s ability to continue meeting its funding obligations—before closing on a transaction. If any problems exist, fund sponsors should either address them with the sellers or attempt to structure the deal to circumvent the common control provisions now that the “trade or business” safeguard no longer provides protection with any certainty. If pension underfunding issues cannot be fully resolved before closing, funds may consider buying less than 80% of the outstanding equity or being prepared to assume any pension liabilities. Sponsors must also remember that common control can flow up to the fund and back down to its other portfolio companies, putting the entire range of the fund’s investments at risk, so they should fully consider the wide-reaching effects of this scenario before acquiring a company with serious pension troubles.

    Kaufman & Canoles prides itself on resolving the most daunting challenges—or avoiding them altogether. Whether you’re new to the game or a seasoned professional, our attorneys draw from diverse backgrounds in employee benefits, mergers and acquisitions, private equity fund formation, and corporate law to distill your most complicated legal situations down to sound business advice. So when you’re ready to go to the next level, we can take you there. And we will.


    As a result of years of confusion and complacency, many employers now ignore ERISA’s strict plan document and summary plan description requirements when it comes to their health and welfare plans. ERISA requires that welfare plans, like retirement plans, consist of a formal plan document and a summary plan description explaining the plan in simple terms. Plan documents and SPDs must also contain specific information, including the name of the plan’s fiduciaries, allocation of responsibility for plan operation, claims procedures, and other technical plan information. But given lax enforcement and expansive summaries provided by insurers or service providers, most employers don’t focus their energy on creating compliant welfare plan documents. However, with recent health care and insurance changes ushered in by the Patient Protection and Affordable Care Act (better known as “Obamacare”), the Department of Labor is renewing its focus on welfare plan compliance. That means an audit could be in the cards for employers providing health and welfare benefits—for those caught off guard, the penalties may be stiff.

    A recent industry survey found that 56% of medium-sized and large employers were using their insurer-provided summary of coverage as their plan document or SPD. Although many insurance companies provide comprehensive summaries of coverage, their booklets almost universally fail to satisfy ERISA’s strict requirements governing plan documents and SPDs. Relying on an insurer’s summary alone violates ERISA’s written plan requirements, and could result in steep penalties if left uncorrected. Additionally, sponsors of plans covering more than 100 participants must file a Form 5500 with the Department of Labor for each welfare plan they maintain. Adding in regular plan amendments, participant disclosure obligations, any funding requirements, differences in insured and self-insured arrangements, and cafeteria plans for participants to pay for coverage makes welfare plan compliance a major challenge even for the most motivated plan sponsors.

    Fortunately, an alternative can alleviate a few of these compliance challenges. A majority of plan sponsors now approach welfare plan compliance with a “wrap” document. A wrap document is a short plan document containing all of ERISA’s required plan document information. Laying out the technical framework, it “wraps” itself around the existing summaries of insurance coverage and other welfare plan information to form a fully compliant plan. Better yet, wrap documents combine all existing welfare plan arrangements—for example, health insurance, dental insurance, life and disability insurance—into one plan for Form 5500 filings. Wrap plan documents also allow for easy amendments to the underlying plans because they simply incorporate the terms of the various welfare arrangements into the overall plan. So adding disability insurance or amending health insurance coverage only requires tacking on a disability insurance plan or swapping out one set of insurer summaries for another. And if the Department of Labor shows up on your doorstep asking for plan documents, you can rest easy knowing you have covered your bases.

    Kaufman & Canoles’ employee benefits team can guide you and your benefits team through the welfare plan compliance and wrap document drafting process using specially designed software to quickly compile fully compliant welfare plan documents. If you don’t know how your current documents stack up—or if you know they don’t—let us help smooth the way to a hassle-free welfare plan experience.


    The last several years have seen an uptick in IRS audits regarding per diem reimbursement plans in the staffing industry after years of perceived abuses.

    The IRS is focusing heavily on “wage recharacterization,” which the IRS defines as the practice of paying temporary employees higher wages when they don’t receive per diem payments, and lower wages when they do receive per diem. For example, a marine industrial project requires additional skilled labor for six months, so two workers—both employed by a staffing company—are staffed on the six-month job in Norfolk, performing the same type of work. One lives in Norfolk; the other lives in and travels from Georgia to take the six-month job in Norfolk. Typically, the Georgia worker is entitled to a tax-free per diem to account for lodging, meals, and incidental expenses incurred in traveling to Norfolk for the project. However, the IRS is identifying and auditing staffing agencies that pay the Norfolk worker a wage of, for instance, $20 per hour, with no per diem, but pay the Georgia worker a wage of $10 per hour with a $80 tax-free per diem. Note that, at the end of an 8-hour day, the Norfolk worker receives $160 in taxable wages, and the Georgia worker receives $80 in taxable wages and $80 in tax-free per diem. On audit, the IRS is attempting to reclassify the per diem payment as wages on the grounds that both workers should be paid the same wage, and any tax-free per diem should be in addition to that wage, not in lieu of it. If the IRS succeeds in its wage recharacterization argument, the employer would have to pay the Georgia worker’s income tax withholding, both sides of payroll tax, and penalties and interest for all open tax years. Additionally, if this “recharacterization” practice is widespread within the company, the IRS can use the so-called “pattern of abuse” regulations to reclassify all per diem payments made to all employees as wages, even if some per diem payments are completely acceptable.

    The IRS is also looking at making sure employees’ “tax homes” are correctly identified by their employer. In other words, the employer must ensure the employee is working away from his true “tax home” before paying any per diem. The IRS is often challenging the sufficiency of employers’ documentation processes—for example, seeking current leases, mortgage statements, utility bills, etc.—to make sure an employee actually has a tax home away from where he’s working. Also, any “temporary” employees working in one location for longer than twelve months pose additional problems as they are no longer eligible to receive per diem while continuing to work in that location.

    This issue has understandably been on the staffing industry’s radar lately given the potential for substantial liability if done incorrectly and caught on audit. The IRS is being very proactive about targeting the staffing industry regarding these practices, so ensuring compliance now will minimize liability.


    As we reported in our 2013 year-end news, the Supreme Court’s decision in U.S. v. Windsor signals changes for the employee benefits landscape with respect to inclusion of same-sex spouses in various pension and welfare contexts. One of the gaps in our understanding of how to administer plans to same-sex spouses has been uncertainty about the interplay between federal agency guidance attempting to interpret Windsor and conflicting state laws. In Virginia, for example, the so-called “marriage laws” purport to prohibit the provision of “marriage” benefits to same-sex couples in any context (Article One of Virginia’s Constitution and related statutory provisions that prohibit a “civil union, partnership contract or other arrangement between persons of the same sex purporting to bestow the privileges or obligations of marriage.” Va. Code Ann. § 20-45.3).

    In February, two events coincided to suggest that Virginia’s conflicting laws may be on the rocks. First, on February 13, the Eastern District of Virginia decided the case of Bostic v. Rainey, in which the Court found that Virginia’s marriage laws violate both the equal protection and due process clauses of the United States Constitution. The Court found specifically that any “Virginia” law that bars same-sex marriage or prohibits Virginia’s recognition of lawful same-sex marriages from other jurisdictions’ is unconstitutional. While the Court concluded that these laws were unconstitutional, and enjoined the Commonwealth of Virginia from enforcing these laws, it stayed execution of its injunction pending the final disposition of any appeal by the losing party to the 4th Circuit Court of Appeals. Second, Virginia’s Attorney General, Mark Herring, in a statement close in time to the Bostic opinion, stated that his office will not enforce Virginia’s marriage laws.

    Neither Herring’s statement nor the Bostic opinion provides specific guidance to benefits administrators, but they combine to add to a larger judicial and executive trend toward inclusion of same-sex spouses in benefits plans. We will continue to monitor and keep you posted as these questions evolve.

    The contents of this publication are intended for general information only and should not be construed as legal advice or a legal opinion on specific facts and circumstances. Copyright 2024.