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State pensions and mandatory schemes

Contributions

Do employers and/or employees make pension contributions to the government in your jurisdiction? If so, briefly outline the existing state pension system.

In the United States, employers and employees both contribute to the social security system, which is a federal retirement programme, in the form of a tax based on an employee’s income. The tax is paid pursuant to the Federal Insurance Contributions Act (known as the FICA tax) in the form of a payroll tax. The current FICA tax rate is 15.3% of an employee’s income, with the employer and the employee each paying 50% of the tax (7.65% each). However, the employee’s annual contribution is capped when his or her income reaches a certain amount that is adjusted annually (for 2017, this amount is $127,200). Employees who meet certain eligibility criteria (such as meeting a retirement age requirement – generally 65 years) are entitled to life annuities at retirement age, based on compensation earned during their working lives that was subject to the social security (FICA) tax. All 50 states do not offer state pension systems.

Can employers deduct any state pension contributions from their taxable income?

Yes, employers can deduct their FICA tax contributions from their taxable income.

Are there any proposals to reform or amend the existing system?

No.

Other mandatory schemes

Are employers required to arrange or contribute to supplementary pension schemes for employees? If so, briefly outline how the scheme is enforced and regulated.

No.

Occupational pension schemes

Types of scheme

What are the most common types of pension scheme provided by employers for their employees in your jurisdiction?

The most common type of retirement arrangement maintained by private employers is the 401(k) plan, which is a defined contribution plan under which an account is established for each employee participant, who determines how the funds in his or her account will be invested based on investment options offered by the plan.

This permits employees to defer a portion of their taxable income and pay tax on those deferrals and accumulated earnings when distributed after the termination of employment. Employers typically contribute:

  • matching contributions that match employee deferrals; or
  • non-elective contributions that are a percentage of employee compensation.

The benefit to which the participant is entitled is the balance in the account, for which the participant bears the investment risk.

The 401(k) plan is distinguished from a defined benefit plan, under which each participant is entitled to a fixed monthly payment for his or her life or the lives of him or her and a surviving beneficiary. The amount of the monthly payment is determined by a formula, typically based on compensation from and service with the employer. Defined benefit plans have lost popularity over the decades and are now typically offered only to collectively bargained employees and governmental employees, although they are increasingly losing favour in these sectors as well.

Statutory framework

Is there a statutory framework governing the establishment and operation of occupational pension plans?

Yes, the statutory framework is the Employee Retirement Income Security Act (ERISA) 1974, as amended, and the corresponding provisions of the Internal Revenue Code 1986, as amended.

What are the general rules and requirements regarding the vesting of benefits?

Employee contributions or deferrals must be fully vested at all times. Employer contributions to a 401(k) or other defined contribution plan must vest according to a three-year cliff vesting schedule or a two-to-six-year graded vesting schedule. Employer provided benefits under a different type of retirement arrangement, called a defined benefit plan, must vest according to a five-year cliff vesting schedule or a three-to-seven-year graded vesting schedule.

What are the general rules and requirements regarding the funding of plan liabilities?

The funding of defined benefit plans is based on statutory requirements designed to ensure that the plan has sufficient assets – determined on an actuarial basis – to pay benefits when due under the terms of the plan. Funding of 401(k) or other defined contribution plans is based on the contributions required by the terms of the plan and generally must occur shortly after the end of the year in which participants’ rights to those contributions accrue.

What are the tax consequences for employers and participants of occupational pension schemes?

Employers get an income tax deduction for contributions for the year in which those contributions are made. Employees generally pay tax on benefits only when they are distributed.

Is there any requirement to hold plan assets in trust or similar vehicles?

Plan assets must be held in trust and can revert to the employer only in limited circumstances.

Are there any special fiduciary rules (including any prohibited transactions) in relation to the investment of pension plan assets?

ERISA imposes strict standards of conduct on fiduciaries responsible for the investment of pension plan assets, including a duty of prudence and a duty to act solely in the interest of the pension plan and its participants and beneficiaries.

ERISA also prohibits a wide range of transactions between pension plans and related parties and transactions that may involve conflicts of interest. Fiduciaries must ensure that plan investments comply with the conditions of applicable prohibited transaction exemptions.

Is there any government oversight of plan administration and/or insurance coverage for plan benefits in the event of an employer’s insolvency?

The Internal Revenue Service and the US Department of Labour regulate the form and administration of retirement plans. The Pension Benefit Guaranty Corporation insures benefits under defined benefit plans – up to a specified level – in the event that an employer becomes insolvent or any other inability to maintain and fund the plan arises. There is no insurance for 401(k) or other defined contribution plans.

Are employees’ pension rights protected in the event of a business transfer?

Employees’ pension rights must be funded and are non-forfeitable, to the extent accrued and vested, in the event of a business transfer. Certain business transfers may require accelerated vesting.

Deferred compensation agreements

Deferred compensation plans

Do any special tax rules apply to these types of arrangement?

Yes, non-qualified deferred compensation plans must be structured in a manner that is compliant with Section 409A of the Internal Revenue Code (qualified deferred compensation plans are subject to Section 401(a) of the code and are not subject to this summary).

Section 409A of the Internal Revenue Code require among other things, that an election to defer compensation and designate the time and form of payment of such deferred compensation must generally be made in the calendar year before the year in which the services are first performed for such compensation, unless:

  • the individual making the election is newly eligible to participate in the deferred compensation plan under Section 409A of the Internal Revenue Code, in which case the election to defer may be made within 30 days from the date on which the individual first becomes eligible. However, the election can apply only to compensation earned after the date of the election; or
  • the compensation constitutes performance-based compensation under Section 409A of the Internal Revenue Code, in which case the election may be made no later than six months before the end of the performance period to which the compensation relates. 

In addition, at the time the initial deferral election is made, the individual must select both the time and form of payment of the deferred compensation, to the extent that such election is permitted under the deferred compensation plan.

Section 409A of the Internal Revenue Code provides that the time of payment of the deferred compensation may be on account of one of six permitted payment events:

  • separation from service;
  • specified time;
  • change in control;
  • death;
  • disability; or
  • unforeseeable emergency.

It is generally not permissible to accelerate the time of payment of any deferred compensation once a valid deferral election is made. However, it is possible to defer payment of the deferred compensation further, so long as the deferral election is made at least 12 months before the date of the originally scheduled payment date and – in the case of a payment on account of separation from service, specified time or change in control – the new payment date is at least five years after the original payment date.

If deferred compensation is paid to a ‘specified employee’ (as defined under Section 409A of the Internal Revenue Code) on account of a separation from service, the payment cannot commence until six months after the date on which the specified employee has a separation from service.

Failure to satisfy the Section 409A requirements (either in operation or documentarily) will result in immediate taxation to the individual of the amounts subject to his or her deferred compensation plan. Further, such an individual must pay a 20% penalty tax and interest on such amounts. The employer has a reporting obligation as to the 409A violation and a withholding obligation with respect to any ordinary income taxes that result.

Do these types of arrangement raise any special securities law issues?

If a public company maintains a deferred compensation plan that covers executive officers or directors, the plan must be disclosed in the public filings of the company. In addition, certain information regarding accumulated benefits for covered executive officers must be provided in those public filings.

Depending on the structure of the deferred compensation plan, the company also may be required to register the interests under the deferred compensation plan by way of Form S-8.

Equity-based incentives

Share options

What are the most common types of share option plan in your jurisdiction? Please outline the rules relating to each scheme.

There are two main types of share option:

  • incentive stock options (ISOs); and
  • non-qualified stock options (NQSOs).

ISOs must meet the requirements of Section 422 of the Internal Revenue Code, which are as follows:

  • ISOs can be granted only by a corporation to employees of the corporation or employees of a subsidiary or parent corporation.
  • The exercise price cannot be less than the fair market value of the underlying shares on the date of grant.
  • The option must be granted under a plan that was approved by the shareholders of the corporation. The plan must set out the number of shares that may be granted as ISOs and have a term not greater than 10 years from the date on which it was adopted.
  • The term of the ISO grant cannot be greater than 10 years from the date of grant and, if an employee terminates employment for any reason other than death or disability, the ISO can be exercised as an ISO only within 90 days following the termination of employment (the 90-day period may be up to one year if the termination is on account of disability).
  • The ISO cannot be transferable, other than on account of death.
  • The grantee of the ISO cannot own stock possessing more than 10% of the voting power of the corporation or its parent or subsidiary (if the grantee meets this requirement, the ISO must have an exercise price not less than 110% of the fair market value of the underlying stock on the date of grant and the term of the ISO cannot be longer than five years from the date of grant).
  • No more than $100,000 of the ISO can first become exercisable in any one calendar year.

NQSOs may be granted to employees, non-employee directors; consultants and advisers. NQSOs are not subject to the ISO rules described above. However, an NQSO must be granted with an exercise price of not less than the fair market value of the underlying stock on the date of grant and the stock must constitute ‘service recipient stock’ under Section 409A of the Internal Revenue Code (which is generally common stock of the company), otherwise the NQSO will be considered a deferred compensation arrangement subject to the requirements of Section 409A of the Internal Revenue Code (which could result in significant adverse tax consequences to the grantee if the NQSO is not structured in a compliant manner at the time of grant). In addition, if a public company wants to provide for the grant of NQSOs, the New York Stock Exchange (NYSE) and the National Association of Securities Dealers Automated Quotations (NASDAQ) both require that the shareholders approve the plan pursuant to which the NQSO will be granted, with certain limited exceptions.

What are the tax considerations for share option plans?

ISOs are not taxable at grant or at exercise – although, for purposes of calculating alternative minimum tax for the employee in the year of exercise, the appreciation in the ISO at the time of exercise (ie, the difference between exercise price paid and fair market value of the shares on the date of exercise) is counted toward the alternative minimum tax calculation for such employee. If the employee does not sell the shares acquired through the exercise of the ISO until the later of two years from the date of grant or one year from the date of exercise, the entire appreciation (the difference between the exercise price paid and the sale price of the shares) is taxed as capital gains to the employee.

If the employee does not satisfy the holding period for the ISO, when the shares are sold, the employee recognises ordinary income equal to the difference between the exercise price paid for the shares subject to the ISO and the fair market value of the shares on the date of exercise and capital gains tax (short or long-term, depending on the period of time the shares were held from the date of exercise) on the difference between the fair market value on the date of exercise and the sale price received for the shares.

NQSOs are not taxable at grant, but are taxed as ordinary income at exercise equal to the difference between the exercise price paid for the shares subject to the NQSO and the fair market value of the shares on the date of exercise. When the shares are sold, the individual will recognise capital gains tax (short or long-term, depending on the period of time the shares were held from the date of exercise) on the NQSO on the difference between the fair market value on the date of exercise and the sale price received for the shares.

Share acquisition and purchase plans

What are the most common types of share acquisition and purchase plan in your jurisdiction? Please outline the rules relating to each scheme.

The most common type of share acquisition arrangement are restricted stock awards and restricted stock unit awards. Restricted stock awards provide that the participant will become vested in shares if he or she meets certain vesting requirements tied to the restricted stock award. Vesting may be tied to continued employment or performance goals. Restricted stock awards may be granted or purchased for consideration or no consideration. If a public company wishes to provide for the grant of restricted stock, the NYSE and NASDAQ both require that the shareholders approve the plan pursuant to which the restricted stock will be granted, with certain limited exceptions.

Restricted stock units are equivalent in value to a corresponding number of shares of stock. Restricted stock units are typically structured with a vesting schedule and a date following the vesting date on which the restricted stock units convert to an equivalent number of shares of stock or the cash equivalent. 

The most common type of share purchase plan is an employee stock purchase plan (ESPP), intended to meet the requirements of Section 423 of the Internal Revenue Code. The requirements of an ESPP include the following:

  • Options can be granted only by a corporation to employees of the corporation or employees of a subsidiary or parent corporation.
  • The exercise price per share of an option can be the lesser of 85% of the fair market value of the underlying shares on the first day of the purchase period or 85% of the fair market value of the shares on the last day of the purchase period.
  • The ESPP must be approved by the shareholders of the corporation.
  • With certain limited exceptions, all employees of the corporation must be eligible to participate in the ESPP to purchase shares, with the same rights and privileges.
  • The option period cannot be longer than 27 months if the option price is not determinable until the purchase date or five years if the exercise price is not less than 85% of the fair market value of the underlying stock on the last day of the purchase period.
  • An employee cannot participate in the ESPP if he or she owns stock possessing 5% or more of the voting power of the corporation or its parent or subsidiary.
  • Under the ESPP, no employee can purchase more than $25,000 of the fair market value of the corporation’s stock in any calendar year in which the option is outstanding.
  • Options under the ESPP cannot be transferable, except in the event of death.

What are the tax considerations for share acquisition and purchase plans?

Restricted stock awards are not taxed at grant if they are subject to a substantial risk of forfeiture and are not transferable at the time of grant. When the restrictions lapse, the participant will recognise ordinary income equal to the difference between the amount paid for the restricted stock and the then fair market value of the shares.

When the shares are subsequently sold, the participant will recognise capital gain (short or long-term, depending on the period the shares were held from the date of vesting) on the vested shares equal to the difference between the fair market value on the date of vesting and the sale price received for the shares.

A participant who is granted a restricted stock award may make a so-called ‘83(b) election’, which is a filing with the Internal Revenue Service to recognise in income the fair market value of the restricted stock award at the time of grant (as opposed to the value of the shares at the time of vesting), provided that the 83(b) election is made within 30 days following the date of grant. If an 83(b) election is made, when the restricted stock vests, there will be no tax consequence to the participant.

When the shares are subsequently sold, the participant will recognise capital gain (short or long-term, depending on the period the shares were held from the date of grant) on the shares equal to the difference between the fair market value on the date of grant and the sale price received for the shares.

There is no tax to the employee in an ESPP at the time of grant of the option or exercise of the option under an ESPP that satisfies the requirements of Section 423 of the Internal Revenue Code. If the employee does not sell the shares purchased under the ESPP until the later of two years from the date of grant of the option or one year from the date of exercise, then the employee will recognise ordinary income equal to the difference between the fair market value of the underlying shares on the date of grant of the option and the exercise price of the option (or, if lower, the difference between the fair market value of the stock on the date of sale and the amount paid for the shares). 

Any additional amount between the exercise price of the option and the fair market value of the shares on the date of the sale will be taxed as long-term capital gain to the employee. If the employee sells the shares purchased under the ESPP before satisfying the holding period, the employee will recognise ordinary income equal to the difference between the exercise price paid and the fair market value of the shares on the date of exercise and capital gain (short or long-term, depending on the period the shares were held from the date of exercise) on the shares purchased under the ESPP on the difference between the fair market value on the date of exercise and the sale price received for the shares.

Phantom (ie, cash-settled) share plans

What are the most common types of phantom share plan used in your jurisdiction? Please outline the rules relating to each scheme.

The most common type of phantom share are restricted stock units. Restricted stock units are equivalent in value to a corresponding number of shares of stock. Restricted stock units are typically structured with a vesting schedule and a date following the vesting date on which the restricted stock units convert to an equivalent number of shares of stock or the cash equivalent. If the restricted stock units convert to stock at the same time as the restricted stock units vest, the restricted stock units are generally not subject to Section 409A of the Internal Revenue Code. 

However, if the restricted stock units vest and are converted to stock in a different tax year, the requirements of Section 409A must be met with respect to the restricted stock units. If a public company wishes to provide for the grant of restricted stock units that are convertible into stock, the NYSE and NASDAQ both require that the shareholders approve the plan pursuant to which the restricted stock units will be granted, with certain limited exceptions.

What are the tax considerations for phantom share plans?

Restricted stock units are not taxed at grant or at vesting. Although, for employment tax purposes, the fair market value of the restricted stock units are subject to employment taxes in the year of vesting. 

When restricted stock units are converted to stock or cash, the participant is taxed equal to the then fair market value of the shares of stock received or cash paid. A participant may not make an 83(b) election on restricted stock units.

Consultation

Are companies required to consult with employee unions or representative bodies before launching an employee share plan?

Companies are not required to receive the consent of a union or representative body before adopting an employee equity plan. However, to the extent to which employees covered by a collective bargaining agreement may receive grants, the grants generally must be negotiated with the union before grant, as the grant would be viewed as additional compensation subject to bargaining.

Health insurance

Provision of insurance

What is the health insurance provision framework in your jurisdiction? For example, is it provided by the government, through private insurers or through self-funded arrangements provided by employers?

Health insurance is generally provided to employed individuals and their dependents through self-funded and insured arrangements provided by employers. Individuals can also purchase their own health insurance policies. Finally, the government provides health insurance for individuals aged 65 and over (Medicare) and to certain low-income individuals or children (Medicaid).

Coverage levels

Do any special laws mandate minimum coverage levels that must be provided by employers?

Yes, as a result of the Affordable Care Act 2010 (sometimes called Obamacare), employers with 50 or more employees are required to provide health insurance to their full-time employees. This health insurance must contain specified benefits, at specified levels and at specified not-to-exceed premiums for employees. 

Failure to offer such coverage or violations regarding specified levels of benefits or premium amounts leads to significant non-deductible excise taxes for such employers. Lastly, individuals are also required to maintain specific health coverage or be subject to additional income taxation. These requirements – and associated tax penalties – are at the centre of an intense debate under the new administration and it remains to be seen whether the Affordable Care Act will be repealed, replaced or revised.

Can employers provide different levels of health benefit coverage to different employees within the organisation?

Yes, within certain restrictions. First, as noted above, large employers are now subject to a mandate to provide health insurance. Employers can provide enhanced coverage within their organisations, subject to non-discrimination rules that are designed to prevent discrimination in favour of highly compensated individuals. There are also often different levels of benefits between collectively bargained employees and the remainder of the employee population.

Post-termination coverage

Are employers obliged to continue providing health insurance coverage after an employee’s termination of employment?

Generally no, and the percentage of employers that voluntarily provide such coverage has significantly declined in recent years. However, employers must provide 18 months of continued coverage after the termination of an employment contact to individuals and the families who had health insurance coverage at the time of the termination. 

The full cost of the coverage, with a small administrative surcharge, is paid by the former employee. The coverage may be extended to 29 months if the employee is disabled. Finally, the coverage may be extended to 36 months for the loss of coverage for a spouse due to divorce or a child who turns 26 and is no longer covered under his or her parent’s health coverage. This continued coverage has been in place, with amendments, since the introduction of the Consolidated Omnibus Budget Reconciliation Act (COBRA) in 1986.