2010 Winston & Strawn LLP

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2 Year End dati Action Items for Benefits and Compensation Brought to you by Winston & Strawn LLP's Employee Benefits and Executive Compensation Practice Group 2

3 Today s elunch Presenters Linda Lemel Hoseman Employee Benefits and Executive Compensation Chicago LHoseman@winston.com Mike Melbinger Employee Benefits and Executive Compensation Chicago MMelbinger@winston.com Julie Stapel Employee Benefits and Executive Compensation Chicago JStapel@winston.com 3

4 Year End Qualified Plan Actions 4

5 Defined Benefit Plans Section 436 Funding Restrictions Cash Balance Plan 3 year cliff vesting Interest crediting rate No reduction of accruals based solely on age 5

6 Defined Contribution Plans Diversification of Publicly Traded Employer Stock RMD Waiver (2011) In Plan Roth Conversions 6

7 All Retirement Plans HEART Act Death in Service Differential Pay Direct Rollovers by Non Spouse Beneficiaries 7

8 Year End Notice Reminder QDIA Automatic Enrollment Posting of Actuarial Information SARs 8

9 Notice On January 5, 2010, the IRS issued Notice , Relief and Guidance on Corrections of Certain Failures of a Nonqualified Deferred Compensation Plan to Comply with 409A(a) (the "Notice") ). The Notice does much more than just offer correction methods. Another 409A review, to comply with the IRS' new stricter standards. d 9

10 Notice Limitations 1. Relief Not Available for Intentional Failures or Listed Transactions 2. Relief Not Available to Service Providers and Certain Service Recipients Under Examination 3. Correction of Plans Containing Substantially Similar il Document Failures Fil 4. Linked Plans and Stock Rights not Eligible for Relief 10

11 Timing Is Important 2010 vs Document failures under 409A that are corrected by December 31, 2010, will be treated as having been corrected on January 1, 2009 Not so for corrections made in

12 Timing Is Important 2010 vs Even if impermissible payments are made before the correction date, there generally is no income inclusion under 409A if the plan is corrected before 12/31/2010 However, impermissible payments generally must be treated as operational failures and corrected under Notice

13 Notice Specific Issues 1. Permissible Payment Event with no Definition or an Ambiguous Definition 2. Plan Terms Providing for a Payment As Soon as Practicable (or similar language) Following a Permissible Payment Event 3. Correction of Impermissible Definition of Otherwise Permissible Payment Events Separation from Service Change in Control Event Disability 13

14 Notice Specific Issues 4. Correction of Impermissible Payment Periods following a Permissible Payment Event Payment Periods of Longer than 90 Days Following a Permissible Payment Event Payment Periods Following a Permissible ibl Payment Event Dependent upon the Service Provider Completing Certain Employment Related Actions 14

15 Notice Specific Issues 5. Correction of Certain Impermissible Payment Events and Payment Schedules a) Plans with Permissible and Impermissible Payment Events under 409A b) Plans with Only Impermissible Payment Events c) Certain Impermissible Alternative Payment Schedules d) Impermissible ibl Employee or Employer Discretion i with ihrespect to a Payment Schedule Following a Permissible Payment Event 6. Correction of Failure to Include Six Month Delay of Payment for Specified Employees 7. Correction of Provisions Providing for Impermissible Initial andsubsequent Deferral Elections 15

16 Ambiguous Plan Terms First, the good news: the Notice expressly approves the form of "savings clause" or "catch all" that many of us have been using in our documents. Good "savings clauses" vs. bad "savings clauses" Notice permits employers to add a saving clause now. The Notice contains the following example: 16

17 "Savings" Clause Employment agreement provides for payment of $100x upon Employee s termination of employment. Employment agreement does not define what events constitute a termination of employment and does not include a provision that the terms of the agreement must be interpreted in a manner consistent with 409A. Other employees have not reduced their employment to part time and have only been paid upon an event that constitutes a complete cessation of services to Employer with no anticipated return to providing services to Employer. Thus, there is no pattern or practice of paying amounts upon payment events that would not constitute separations from service under 409A, or not paying amounts upon payment events that would constitute separations from service. No indication i that the term was intentionally i left lfvague. 17

18 "Savings" Clause On April 1, 2010, before any amendment of the employment agreement, Employee ceases providing services to Employer (with no anticipated return) and Employer determines that Employee has become entitled to the payment of $100x. Employer pays Employee the $100x on April 1, The Notice states that the plan provision providing for payment upon a termination of employment will not cause the employment agreement to fail to satisfy the document requirements of 409Ato the extent the term is not interpreted to provide for payment under circumstances that would cause the employment agreement to fail to satisfy the requirements of 409A in operation. 18

19 "Savings" Clause The Notice also states that the Employer may amend the agreement at any time to provide either: a) the plan provision must be interpreted to comply with the requirements of409a 409A, or b) a definition of termination of employment that qualifies as a separation from service under 409A (provided dthat t in either case the amendment may not have the effect of either expanding the definition to include as a payment event any event that was not a payment event under the plan before the amendment, or narrowing the definition to eliminate as a payment event any event that was a payment event under the plan before the amendment). 19

20 Impermissible Definitions of Otherwise Permissible Events In the Notice, the IRS makes clear that it will require word for word compliance with terms defined in the409a regulations, such as: Change in Control Separation from Service Disability 20

21 Definitions Example Employee participates p in a plan that provides for a payment py of $100x to her upon the earliest of her attaining age 65, death, or change in control The Plan's dfiiti definition of h change in control l does not satisfy the definition of a change in control event under 409A solely because the definition includes an IPO On February 15, 2011, at which time Employee is age 50, Employer amends the definition of change in control under the plan to delete the occurrence of an IPO as a change in control of Employer. Employer has an IPO on July 1,

22 Definitions Example The Employer corrected the provision before the initial public offering, but after 2010, and the IPO occurred within one year following the date of correction Even though h Employer does not pay Employee any amount under the plan due to the event, Employee must include 25% of the "amount deferred under the plan" to which the precorrection plan provision applied in income under 409A (and pay all applicable Federal taxes, including the additional 20% tax on such amount) Employer must report 25% of the amount deferred as income under 409A for 2011 on Form W 2, Box 1 and Box 12 using Code Z, for Employee 22

23 Definitions Example Employee will not be required to include in income under 409A any further amount solely as a result of the precorrection plan provision. The Notice not only does not allow even a slight variance from the change in control definition arbitrarily imposed by the regulations, but also imposes a penalty even after the employer revised the definition to comply! Remember, they are from the government and they are here to help. 23

24 Impermissible Payment Period Releases Example: Employee's employment agreement entitles him/her to $100x severance upon a separation from service The severance is payable upon Employee executing and submitting a release of claims (and after expiration of the revocation period), but the agreement does not include any time limit for payment On April 1, 2011, Employer and Employee amend the employment agreement to provide for payment of $100x severance on the 60 th day following Employee s separation from service, provided that Employee has executed and submitted a release of claims and the statutory ttt period dduring which h Employee is entitled to revoke the release of claims has expired on or before that 60 th day 24

25 Impermissible Payment Period Releases Example Employee poyeehas a separation a from service with Employer poye on June 16, 2011 Employee executes and submits a release of claims on July 1, 2011 Employer pays Employee $100x on August 15, 2011 Because Employer and Employee N corrected the provision before Employee s separation from service, Employee is not required to include any amount in income under 409A solely due to the pre correction plan provision. 25

26 Impermissible Payment Period Releases Example The good news is that the Notice allows the employer and employee to amend the employment agreement to set a hard deadline for execution (and failure to revoke) the Release The bad news is that the example implies that, without that amendment, the employment agreement violated 409A 26

27 Notice Bad news: IRS may be preparing to whack us for minor document deficiencies Good news: IRS is giving gus warning now, and the opportunity to correct the deficiencies For many employers, that means 409A reviews all over again, as we endeavor to ensure that plans and agreements comply with the IRS' new stricter standards d 27

28 Information and Reporting Requirements An employer that makes a correction described in the Notice must attach to its timely filed (including extensions) original federal income tax return for its taxable year in which it corrects the failure, a statement entitled: 409A Document Correction under [INSERT APPROPRIATE SECTION(S)] of Notice The statement must set forth a list of information for each failure fil described din the Notice 28

29 Information and Reporting Requirements 1. The name and taxpayer ID number of each employee affected by the document failure 2. Name of the nonqualified deferred compensation plan 3. A statement that (a) the document failure is eligible for the correction under the terms of the Notice and (b) identifying the section of the Notice under which the document failure is corrected, tdand (c) ()the employer has taken tk all actions required dfor such correction, and (d) providing the date of correction and the date of the event violating 409A 4. The amount involved in each document failure, and the amount and percentage reported as includible in income under 409A as part of the correction (if applicable) 29

30 Information and Reporting Requirements Not later than the date on which Employer is required to provide Form W 2 or 1099 to an employee affected by a 409A failure for the calendar year in which it corrects such failure, Employer also mustprovide to each affected employee a statement, which the employee must attach to his/her income tax return, entitled : 409A Document Correction under [INSERT APPROPRIATE SECTION(S)] of Notice The statement to the employee must include another list of information 30

31 Information and Reporting Requirements 1. That the employee is entitled to the relief provided in the Notice (identifying the applicable section of the Notice under which the document failure is corrected) with respect to a failure to comply with 409A 2. The information described in the Employer's statement (previous slide) Employee must attach a copy of this statement to his/her income tax return for the taxable year in which h the failure was corrected 31

32 Information and Reporting Requirements To file, or not to file... Some are waiting Others are filing First, determine whether there is any alternative to formal correction under the Notice 32

33 Notice Notice , issued in December 2008, permits the correction of certain operational failures, and provides transition relief limiting the amount includible in income under Sec. 409A(a) for certain operational failures involving limited amounts Notice also provided guidance limiting the amount includible in income under Code Sec. 409A for certain operational failures involving amounts that exceeded plan limits Because a nonqualified deferred compensation plan must comply with the requirements of Sec. 409A both in form and in operation, many of the correction methods will require actions under both Notices and

34 Final 401(k) Participant Disclosure Regulations Regulations address disclosure of certain information regarding a 401(k) plan investment options to participants and beneficiaries. Regulations issued under Section 404(a) of ERISA the fiduciary duties section. Different from other recent disclosure pronouncements by the DOL. Service provider compensation disclosures (discussed later) Form 5500 Schedule C 34

35 Final 401(k) Participant Disclosure Regulations Who must provide the disclosures and to whom must they be provided? The "plan administrator" must provide the disclosures. The disclosures must be provided to each participant and beneficiary with the right to direct the investment of assets held in or contributed to his or her individual account. The regulations apply to "covered individual account plans." Any participant directed individual account plan Not IRAs, SEPs, or SIMPLEs 35

36 Final 401(k) Participant Disclosure Regulations What information must be disclosed? Plan Related Information General plan related information regarding ginvestment instructions and "designated investment alternatives." Administrative expenses and individual expenses Initially and annually, an explanation of (1) fees and expenses for general plan administrative and fees (e.g., legal, recordkeeping) charged against accounts and (2) fees and expenses charged against accounts on an individual basis (e.g., QDRAs, loans) but not reflected in annual operating expenses of a designated dinvestment alternative. Quarterly statement showing amount of those fees and expenses 36

37 Final 401(k) Participant Disclosure Regulations What information must be disclosed? Investment Related Information Identifying Information Performance Data 1, 5, 10 year Benchmarks 1, 5, 10 year Fee and Expense Information "Shareholder type fee" (e.g. sales load, redemption fees, etc., not included in total annual operating expenses) Total annual operating expenses (exceptions for employer securities) expressed as percentage and as dollar amount Certain statements required One of several factors.... Fees can substantially reduce growth

38 Final 401(k) Participant Disclosure Regulations What information must be disclosed? Investment Related Information, cont. Internet website address that provides access to specified information about the designated investment alternatives. Glossary of terms Specialrules for employer securities, annuities, fixed return Reserved a section for target date fund disclosures Other information to be provided upon request 38

39 Final 401(k) Participant Disclosure Regulations How must the disclosures be made? Comparative format "designed to facilitate a comparison of such information for each designated investment alternative" Accurate use of the DOL's model dldisclosure will be deemed dto satisfy the requirements regarding the form of disclosure. Calculated to be understood by the average plan participant. Certain plan related disclosures can be made in the SPD Open Issue Electronic disclosure. DOL said it is exploring whether to modify the existing rules on electronic disclosure. In the meantime, the general ERISA rules on electronic disclosure apply. 39

40 Final 401(k) Participant Disclosure Regulations When Must the Disclosures Be Made? Transition "Effective date" is December 19, 2010 (60 days after Federal Register publication) "Applicability date" is "the first plan year which starts on or after the first day of the thirteenth month following the date of publication...." Translation January 1, 2012, for a calendar year plan Initial disclosures to participants required no later than 60 days after applicability date Translation February 29, 2012, for a calendar year plan 40

41 Final 401(k) Participant Disclosure Regulations When Must the Disclosures Be Made? Once Effective "On or before the date on which a participant or beneficiary can first direct his or her investments" Certain requirements are at least annually thereafter; certain requirements are quarterly. Rules regarding changes to plan related information 41

42 Health Benefit Plans 42

43 PPACA Market Reforms Grandfathered Non grandfathered Open Enrollment Materials as SMMs Over the Counter Drugs (Flex Plans) 43

44 Year End Notices Medicare Part D PPACA notices 44

45 New Service Provider Disclosure Regulations Address disclosures required to be made by service providers to "responsible plan fiduciaries." Different from other disclosure regulations Form 5500 Schedule C 401(k) participant disclosures (discussed earlier) "Interim final" regulations Subject to comment and potential changes Effective July 16,

46 New Service Provider Disclosure Regulations Issued under prohibited transaction exemption covering "reasonable" arrangements for services (Section 408(b)(2) of ERISA). Under the new regulations, a contract or arrangement for services is not reasonable unless the disclosure requirements are met. This means that failing to satisfy regulations is a nonhb transaction, which his bdf bad for both the service provider AND the plan exempt prohibited sponsor. 46

47 New Service Provider Disclosure Regulations ERISA governed defined benefit retirement plans ERISA governed defined contribution retirement plans NOT IRAs or other similar arrangements NOT governmental plans NOT welfare plans at this time Section of the regulation reserved for welfare plans; hearings scheduled for December 7 47

48 New Service Provider Disclosure Regulations Covered Services Not all services covered; also, $1,000 threshold Services as a fiduciary or registered investment adviser Fiduciary services directly to a plan Fiduciary services to an "investment contract, product or entity that holds plan assets" in which the covered plan has a "direct equity investment" (we'll refer to this a "plan assets entity") Services directly to a plan as an investment adviser registered under the Investment Advisers Act or state law 48

49 New Service Provider Disclosure Regulations Covered Services, cont. Recordkeeping or brokerage services To an individual account plan That permits participants to direct investments If one or more designated investment alternatives will be made available through a platform or similar mechanism in connection with such recordkeeping or brokerage services Other services for indirect compensation List of services in the regulation Compensation received is either "indirect" compensation or compensation paid among the covered service provider, affiliates, or subcontractors 49

50 New Service Provider Disclosure Regulations What is required to be disclosed? Note: Disclosure is required to be in writing but service agreement is not. Description of the services Statement regarding status as a fiduciary or registered investment adviser Direct compensation the covered service provider, affiliate, or subcontractor reasonably expects to receive in connection with ihthe services Includes monetary and non monetary De minimis exception of $250 or less during the term of the contract or arrangement 50

51 New Service Provider Disclosure Regulations What is required to be disclosed? Indirect compensation the covered service provider, affiliate, or subcontractor reasonably expects to receive in connection with ihthe services Certain compensation paid among related parties Compensation received on termination of the arrangement Special disclosures for fiduciary services to a plan assets entity regarding expenses of the plan assets entity Special disclosures for covered recordkeeping and brokerage service providers regarding the expenses of the designated investment alternatives 51

52 New Service Provider Disclosure Regulations Timeframes es Existing contracts or arrangements July 16, 2011 New contracts or arrangements "reasonably in advance of the date thecontract orarrangement is entered into" Changes to previously disclosed information as soon as practicable but no later than 60 days from the date the covered service provider is informed of the change (unless extraordinary circumstances) New designated investment alternative as soon as practicable but no later than the date the investment alternative is designated by the plan fiduciary. 52

53 New Service Provider Disclosure Regulations Prohibited transaction exemption included in the regulations for an "innocent" plan fiduciary. Requires plan fiduciary to request the disclosures and, if not made within 90 days, the plan fiduciary must notify DOL. 53

54 Planning for 2011 Tax Increases? Absent some quick and unexpected action by Congress, beginning January 1, 2011: the top individual ordinary income tax rate will increase to 39.6% from 35%, the top dividend tax rate will increase to 39.6% from 20%, and the long term capital gain tax rate will increase to 20% from 15%. Additionally, beginning in 2013, the new healthcarelegislation legislation will increase the Medicare tax rate to 2.35% from 1.45% and impose a 3.8% net investment tax on unearned income. Therefore, executives and other individuals may seek to accelerate income into 2010 and defer deductions into 2011 or later. 54

55 Planning for 2011 Tax Increases? Employer Acceleration of Annual (or Long Term) Bonus Payouts into the Current Year Exercise of Vested, In the Money, Non Qualified Stock Options Employer Acceleration of Restricted Stock Vesting Executives' 83(b) Election for Recent Stock Awards Loan Forgiveness 55

56 Planning for 2011 Tax Increases? Termination of Non Qualified Deferred Compensation Plans Grandfathered Portion Change in Control Event Termination Within Code Sec. 409A; Payment Parameters Some companies already have paid out as much of their executives' accrued SERP benefits as possible in 2010to remove that amount from the balance sheet and the proxy statement. Executives receiving a distribution from a terminated nonqualified plan should consider transferring it to an after tax retirement savings vehicle. 56

57 Questions? 57

58 Thank You. 58

59 Contact Information Linda Lemel Hoseman Mike Melbinger Employee Benefits and Employee Benefits and Executive Compensation Executive Compensation Chicago Chicago (312) (312) Julie Stapel Employee Benefits and Executive Compensation Chicago (312)