Last week, the Sixth Circuit Court of Appeals affirmed the dismissal of state law claims brought by a retired CEO who had been assessed tax penalties on account of deferring large amounts of his compensation under an executive deferred compensation plan without complying with IRC 409A on the grounds that the plan was covered by ERISA which, therefore, pre-empted the state law claims. Wilson v. Safelite Group, Inc. No. 18-3408 (6th Cir. 7-10-19). The Court found that deferred compensation plans which permitted distributions during periods of active employment as well as during retirement could still qualify as a pension plan under ERISA. Further, because the plan permitted the deferral of both bonuses and annual salary, it was not exempt from ERISA under DOL regulations as a bonus plan.
According to the Court’s opinion, the employer created a bonus/incentive plan for five executives if they secured a buyer for the company. When a likely buyer emerged, the company created a non-qualified deferred compensation plan to help most of those executives avoid adverse tax consequences from the incentive plan bonuses. Under the deferred compensation plan, the executives could defer their regular annual salary and annual bonuses as well as the incentive bonuses. The CEO make elections to deter his incentive bonus and large portions of his salary each year under the deferred compensation plan. The plan’s default deferral provided for the payout to begin shortly after employment ended, but it could also be drawn out over as long as ten years and even permitted withdrawals before employment ended. The CEO was audited by the IRS in 2014 and it determined that some of the deferrals did not comply with IRC 409A and he was assessed with taxes and penalties. Two years later, the CEO sued his former employer for breach of contract and negligent misrepresentation. The employer moved for partial summary judgment on the grounds that the deferred compensation plan was a pension plan governed by ERISA, which pre-empted the state law claims. The trial court agreed, but permitted the CEO to amend his complaint to bring claims under ERISA. The CEO declined and instead appealed the ERISA ruling. The Sixth Circuit affirmed.
The parties disputed whether the deferred comp plan satisfied the ERISA requirements because it permitted withdrawals before retirement. “In essence, the question is whether a plan that allows for distributions both before and after termination can be an ERISA employee pension benefit plan.” The Court construed the statute to not require withdrawals to begin only after employment had ended:
Subsection (ii) does not specify deferral of income “until termination” or “to termination”; rather, it says “for periods extending to the termination.” Thus, deferrals may occur for various “periods,” and those periods may last up to and/or beyond termination. Subsection (ii) covers a wide array of plans and does not exclude plans that give participants the option to receive in-service distributions.
The employer’s deferred compensation plan presumed that distributions would not begin until after termination of employment, but permitted participants to elect earlier distributions. It also stated that it was governed by ERISA. As long as the plan provided for distributions after termination of employment, the requirements of ERISA were satisfied.
That being said, the DOL had published a regulation exempting certain deferred compensation plans which did not “systematically” defer the payment of “bonuses.” “By regulation, employee pension benefit plans do not include “payments made by an employer to some or all of its employees as bonuses for work performed, unless such payments are systematically deferred to the termination of covered employment or beyond, or so as to provide retirement income to employees.” 29 C.F.R. § 2510.3-2(c).” In other words, the payment of a bonus is typically not a retirement program and would not be treated as a pension plan unless the payment of those bonuses were systematically deferred to termination of employment. “A bonus plan may defer payment of bonuses and remain exempt, “unless such payments are systematically deferred to the termination of covered employment or beyond, or so as to provide retirement income to employees.” 29 C.F.R. § 2510.3-2(c) (emphasis added).” Thus, deferred bonus compensation plans which do not systematically defer the payment of bonuses to post-employment periods are exempt from ERISA.
The court rejected the application of this exemption because the deferred comp plan did not relate exclusively to the incentive bonuses and also permitted the deferral of annual salary and regular annual bonuses.
NOTICE: This summary is designed merely to inform and alert you of recent legal developments. It does not constitute legal advice and does not apply to any particular situation because different facts could lead to different results. Information here can be changed or amended without notice. Readers should not act upon this information without legal advice. If you have any questions about anything you have read, you should consult with or retain an employment attorney.
