House Ways & Means Committee Chairman Dave Camp (R-MI) is expected to release a comprehensive tax reform discussion draft (“Camp Draft”) as early as Feb. 26th. The draft may include a provision that will either mirror or resemble a revenue proposal advanced in previous Obama Administration budgets that would effectively penalize businesses for owning life insurance. Below you’ll find analysis regarding the context and current status of the tax reform process in the House; details on the specifics that may affect the AALU; and what to expect in the near future.

SUMMARY:  Co-shareholders in a closely held business purchased insurance on each other’s lives, arguably for the purpose of funding a death-time buyout of shares. However, no binding buy-sell agreement was ever signed. When one of the owners of the business died, the proceeds were paid to the surviving shareholder. The trial court and appeals court both concluded that the surviving owner was not required to use the life insurance proceeds for the purpose of purchasing the decedent’s stock.

CITE: Selzer v. Dunn, 2014 WL 356992, No. 12–12–00150–CV (Ct. App. Tex. Jan. 31, 2014).

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MARKET TREND:  Financial and tax planning considerations have made the use of nonqualified deferred compensation vehicles increasingly popular. While these arrangements generally result in the deferral of income taxation until the time at which the deferred compensation is paid to the plan participant, special rules under the Internal Revenue Code ("Code") require that FICA taxes (i.e., Social Security and Medicare) be paid at an earlier time and emphasize the importance of proper plan administration. 

SYNOPSIS:  In Davidson v. Henkel, an employer maintained a supplemental retirement plan for the benefit of certain employees under which it promised benefits based on the amount that would be payable to a participant under the employer’s tax-qualified pension plan. The employer did not withhold and pay FICA taxes at the time they were due under the Code and, instead, paid these taxes at the time of each benefit payment. This approach resulted in the participant owing more in FICA taxes than he would have if the employer paid these taxes timely, thereby reducing the net benefit payable to the participant. The participant sued the employer for the lost benefit, and the employer filed a motion to dismiss the participant’s suit for failure to state a claim. The court found that the participant’s complaint did state a claim for benefits. 

TAKE AWAY:  Failure to properly administer a nonqualified plan, specifically with regard to the special rules governing the FICA taxation of these arrangements, may result in significant additional FICA tax liability to the participant and employer, as well as expose the employer to possible benefit claims. Advisors to employers sponsoring nonqualified deferred compensation plans can assist their clients in avoiding claims for benefits by ensuring that the employers are aware of, and have in place procedures that properly take into account, the rules for paying and withholding FICA taxes on amounts deferred under these plans. 

MAJOR REFERENCES: Davidson v. Henkel (Case No. 12-cv-14103, filed July 24, 2013, United States District Court for the Eastern District of Michigan, Southern Division). 

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SUMMARY: The tax treatment of corporate-owned life insurance (“COLI”) continues to receive scrutiny from congressional tax writers and the Obama Administration. While progress toward reform of the Internal Revenue Code (“IRC”) may slow in light of the upcoming congressional midterm elections, a proposal that would indirectly impose a tax penalty on owners of COLI continues to be considered for inclusion in draft tax reform language. This proposal, which is described in detail below, has been included as a revenue provision in each of President Obama’s budgets dating back to Fiscal Year 2010. The President’s Fiscal Year 2015 budget is slated for release on March 4th, and is expected to once again include this provision. The AALU has worked to expand upon our messaging in opposition to this proposal as consideration of tax reform has progressed. ThisWRNewswire bulletin provides context regarding the current status of tax reform as it pertains to the tax treatment of COLI, as well as an explanation of our associated messaging—which explores the relevant text of the IRC, the legislative history behind these provisions and other regulatory initiatives involving COLI, and why—based on history, public policy, and practice—attempts to change the tax treatment of COLI are misguided.

ANALYSIS: The Obama Administration has, on several occasions, proposed as a revenue measure an “expansion of the pro rata interest expense disallowance for COLI” (“The proposal”).

CITE: DEPT. OF THE TREASURY, GENERAL EXPLANATIONS OF THE ADMINISTRATION’S FISCAL YEAR 2014 REVENUE PROPOSALS, 77 –78 (2013);  Ken Kies, History of Corporate-Owned Life Insurance (COLI) Reforms (Dec. 2013);  AALU Policy White Paper, Reject the COLI Pro-Rata Interest Disallowance Proposal (Dec. 2013).

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MARKET TREND:  Increasingly, for the purpose of potentially limiting their exposure, sponsors of benefit plans subject to ERISA have been incorporating into the governing plan documents periods of limitations within which a participant or beneficiary must bring suit to enforce a claim for benefits.

SYNOPSIS:  In Heimeshoff v. Hartford Life & Accident Insurance Co., the U.S. Supreme Court resolved a split among circuits and upheld a plan provision requiring a suit to recover benefits to be brought within three years from the date that written “proof of loss” was required to be furnished.  The Court reasoned that the provision at issue was valid because (1) it did not contradict any applicable statute (i.e., ERISA), (2) the plan was required to be administered in accordance with its terms, and (3) the period during which the suit was required to be brought was not unreasonably short.

TAKE AWAYS:  Consultants to employers maintaining any type of ERISA-covered benefit plan – including retirement plans, death benefit plans, disability plans and others – should help ensure that the relevant plan documents contain provisions setting forth appropriately limited periods during which a lawsuit must be brought to enforce a benefits claim.  This approach will help limit the company’s exposure to open-ended claims.

MAJOR REFERENCES:  Heimeshoff v. Hartford Life & Accident Insurance Co., 571 U.S. ____, (2013).

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