ESOPs & Employee Benefits Q3 2022 Client Update
Happy Fall from the K&C ESOPs & Employee Benefits practice group. We’ve compiled a short list of employee benefits updates from the third quarter of 2022. Please feel free to contact us if you would like to discuss them in more detail.
IRS Delays Retirement Plan Amendment Deadlines
Most employers sponsoring qualified retirements plans faced two separate deadlines in 2022 to amend their plans for recent legislation. These included plan amendments addressing both the SECURE Act (enacted in December 2019) and the CARES Act (enacted in March 2020). But, in separate guidance issued in August and September, the IRS extended those deadlines until December 31, 2025, for most plans. This is welcome relief as the IRS has not yet issued some of the final rules needed to draft and implement those amendments.
While the plan document amendment deadline is now delayed for several years, plans must still be operated in accordance with the SECURE Act and CARES Act provisions in the meantime. Employers should be cautious when making determinations based on plan document provisions that may not be updated to reflect these changes, particularly now that some plan requirements may be in effect for five or more plan years before being formally included in the plan document. This long gap will require close coordination between plan administrators, recordkeepers, and other vendors to ensure they are all operating under the same set of rules and assumptions. As a result, plan sponsors may want to consider amending their plans where possible ahead of the 2025 deadline to avoid any confusion over the controlling plan provisions.
2023 ACA Affordability Rates Reach New Low While Subsidies Extended
Large employers subject to the ACA will see a record low affordability standard for 2023. The affordability threshold—a percentage of an employee’s household income that must be enough to pay for the lowest-cost, self-only coverage—is adjusted every year based on the rate of growth in health plan premiums and incomes. In 2023, the threshold will be set at 9.12%, down from 9.61% in 2022. The 9.12% threshold also applies to the safe harbors (W-2, rate of pay, or federal poverty level) that employers may use to ensure the coverage they offer is considered affordable. The reduction in percentage thresholds means employers may need to cover more of their employees’ premiums to meet the ACA affordability requirements and avoid penalties. In any case, employers subject to the ACA should make sure their 2023 rates will meet the new threshold using one of the permissible methods.
Relatedly, the recently passed Inflation Reduction Act extended the additional subsidies first provided as part of the American Rescue Plan Act in 2021. Originally set to expire in 2022, they are now available through 2025. The additional subsidies generally are available to families over 400% of the federal poverty level who are therefore ineligible for premium subsidies under the original ACA rules. These recent laws allowed them to receive subsidies for premiums based on a maximum percentage of their household income, even if their income exceeded 400% of the federal poverty level. Doing so eliminated the “subsidy cliff” that previously could result in massive swings in premium payments for families earning just over the 400% threshold. Instead of a steep increase in premiums, the additional subsidies now have the effect of incrementally increasing required premiums as income increases. Unless extended again, or permanently modified, the original rules will take effect in 2026.
DOL Formally Petitioned to Issue Regulations on ESOP Fair Market Value Standards
At the end of September, the ESOP Association (TEA) exercised its rights under the federal Administrative Procedure Act (APA) to petition the Department of Labor to undertake a long-delayed rulemaking essential to the formation and ongoing operation of ESOPs. A key component of ERISA is the ability for ESOPs to buy employer stock using borrowed funds—employees almost never contribute any of their own funds for an ESOP’s acquisition—so long as the ESOP pays no more than “adequate consideration.” This legal standard, known as the “Adequate Consideration Exemption,” is at the heart of TEA’s petition.
The petition argues that, since the enactment of ERISA in 1974, the DOL has failed to issue regulations defining “adequate consideration” as required by ERISA, and in doing so has violated Congressional direction and stakeholders’ rights under the APA. Since the DOL has failed to provide the essential clarity in formal regulations and guidance, the petition continues, ESOP formations have had to navigate an unclear landscape that has resulted in many companies turning away from forming an ESOP. Meanwhile, the DOL has largely enforced this area through “regulation by litigation,” resulting in investigations and lawsuits that set unclear and often non-binding precedent on a case-by-case basis.
In an attempt to move the regulatory process forward, TEA formally registered a petition under the APA with the DOL requesting that the DOL issue regulations. Although the petition itself does not require the DOL to issue regulations, the DOL is required to provide a formal, written response to the petition.
It is the hope of TEA and ESOP professionals that fleshing out the definition of the Adequate Consideration Exemption would create a uniform, transparent standard governing the process by which parties to ESOP transactions can establish a company’s fair market value, which is crucial to ensure that ESOPs do not overpay for employer stock. Stay tuned for the DOL’s response.
Federal Appeals Court Affirms DOL’s Broad Cybersecurity Authority
Finally, in a win for the Department of Labor, the Seventh Circuit Federal Court of Appeals recently weighed in on the DOL’s authority to issue wide-ranging subpoenas for cybersecurity information, including from plan recordkeepers regarding their cybersecurity procedures. Although the case does not announce a major shift in the law, it provides clear authority for the DOL to broadly investigate anyone servicing an ERISA plan for potential legal violations or fiduciary shortfalls. In particular, the court ruled that the DOL has the authority to investigate cybersecurity matters, including procedures of major plan vendors, as they may shed light on both the security of plan participants’ accounts as well as whether the employer sponsoring the plan made a prudent decision under ERISA’s strict fiduciary obligations when hiring the vendor. The ruling also reinforces the importance of employers performing thorough due diligence on all of their plan vendors before entrusting them with their employees’ retirement funds.
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 2023.