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A Better Partnership


Oct 2005
October 03, 2005

Human Resources Alert - Fall 2005

Topics included in this issue:


Employers Should Do More Than
Just Have a Policy

By Dean F. Pacific

Every employer is (or should be) aware of the importance of having a policy prohibiting harassment in its workplace. But simply having a policy is not enough. For a policy to be of value in defending against harassment claims, the employer must be able to show that it effectively implemented the policy, including providing appropriate sexual harassment training to its supervisors. A recent decision from the United States Court of Appeals for the Sixth Circuit, which hears appeals in all federal cases filed in Michigan (as well as Ohio, Tennessee and Kentucky), illustrates this point.

In Clark v. United Parcel Service Inc., 400 F.3d 341 (2005), two female employees of UPS alleged that their supervisor made various sexual comments, jokes or actions over the course of a two-year period. Although neither employee made formal complaints under the company's antiharassment policy, they alleged that other UPS supervisors (all of equal or lesser rank than their supervisor) were present for some of the incidents. Clark also alleged that she informally complained to other supervisory employees. As part of investigating other allegations against the supervisor, the inappropriate conduct came to light. The supervisor was suspended and ultimately allowed to resign under the threat of discharge. After his resignation, the employees experienced no further harassment. They did, however, sue UPS alleging unlawful sexual harassment. The trial court dismissed their case, holding that UPS exercised reasonable care to prevent and correct the harassing behavior and that the plaintiffs unreasonably failed to complain about the offending conduct.

On appeal, the Court of Appeals reversed the trial court. It noted generally that in order to avoid liability for its supervisor's harassment, UPS was required to prove, among other things, that it "exercised reasonable care to prevent and correct promptly any sexual harassing behavior." According to the court, this affirmative duty includes "the requirement that it have some sort of sexual harassment policy in place." The court noted, however, that the "duty does not end there." The court made clear that it will look "behind the face of a policy" to answer the critical question of whether the policy was "effective in practice" in preventing and correcting harassing behavior. In other words, the Sixth Circuit held that it is not enough to simply develop and publish an antiharassment policy, but rather the "implementation of that policy" is critical.

The Sixth Circuit also laid out guidelines for what constitutes a reasonable sexual harassment policy. While noting that there is no exact formula, the court held that, at a minimum, an effective policy should (1) require supervisors to report incidents of sexual harassment, (2) permit both formal and informal complaints of harassment, (3) provide a mechanism for bypassing a harassing supervisor when making a complaint, and (4) provide for training regarding the policy. According to the court, "[t]he effectiveness of an employer's sexual harassment policy depends on the effectiveness of those who are designated to implement it." The fact that low- to mid-level supervisors in Clark witnessed some of the alleged acts of harassment precluded the court from ruling in favor of UPS. The case was sent back to the trial court for a jury trial on the employees' claims – a risky, time-consuming, and expensive proposition for the employer.

The Clark decision demonstrates the importance of not only having a harassment policy, but effectively implementing the policy as well. Supervisors should be trained regarding the policy and their responsibilities under it. Most importantly, they should promptly report any potential violations of the policy to appropriate higher levels of management. Any of Warner Norcross & Judd's Labor and Employment lawyers can help you develop a legally sufficient harassment policy and can help train your supervisors or employees. This will help put you in the best position to defend against a harassment claim if and when one is made.

The Waiting Game Is Over - The IRS Issues
Proposed Regulations Under Internal RevEnue
Code Section 409A

Almost a year after President Bush signed what was to become Internal Revenue Code Section 409A, the IRS and the Treasury have finally published proposed regulations. As a quick refresher, Section 409A and the proposed regulations affect nonqualified deferred compensation. Section 409A was enacted to address some of the abuses that were revealed by the Enron and WorldCom bankruptcies. What is unusual about Section 409A is that failure to comply results in significant tax penalties to affected employees, not the company, including a 20% excise tax on amounts improperly deferred.

Section 409A is a compliance statute. It requires that all nonqualified deferred compensation plans: (1) reduce the number of distribution events to six (e.g., death, disability, a specified date, change in control, separation of service, or an unforeseeable emergency); (2) limit when an employee can receive deferred compensation; (3) discourage the acceleration of payments; and (4) restrict an employee's ability to re-defer scheduled payments.

The goal of the proposed regulations is to create clear and workable rules to allow companies and employees to revise or draft plans and arrangements to comply with Section 409A. This article summarizes some key provisions of the proposed regulations, but due to the length and complexity associated with the regulations, it is not intended to address any questions regarding a specific plan or arrangement.

Good News – Plans or Arrangements Not Subject to Section 409A

Although voluminous, the proposed regulations reflect substantial progress in clearly articulating the new rules governing nonqualified deferred compensation. Most importantly, three types of plans are excluded from Section 409A: (1) certain stock appreciation right plans, (2) certain severance arrangements, and (3) bonus plans.

The proposed regulations permit stock appreciation rights or phantom stock plans for both publicly held and privately held companies. Most notably, the regulations allow employees of privately held companies to choose when to exercise their stock appreciation rights, provided that the base price of the right is never less than the fair market value of the company's stock on the grant date. The regulations also allow privately held companies to use reasonable valuation methods when determining the value of their equity grants, and even provide safe harbors that will create a presumption that the valuation is reasonable (i.e., an appraisal is done by a qualified appraiser).

In addition, the proposed regulations permit severance arrangements where an employee: (1) is involuntarily terminated; (2) his severance payments do not exceed the lesser of twice the employee's annual compensation, or two times the current compensation limit under qualified plans (currently $420,000); and (3) all payments are received no later than December 31 of the second calendar year following termination of employment.

Finally, annual or multiyear bonus plans are excluded from Section 409A if, after the bonus is vested, payments are made by the later of 2 1/2 months after the end of the employer's taxable year or 2 1/2 months after the end of an employee's taxable year. Although bonus plans are not required to include specified payment dates, providing a specific date may permit the plan to comply with Section 409A, even if the 2 1/2-month deadline is missed.

More Good News – Extended Deadline to Bring Plans or Arrangements Into Compliance

Although these are only proposed regulations, and changes will almost certainly be made before they are finalized, employers and employees may rely on them starting immediately. The IRS and the Treasury have also extended most compliance deadlines until December 31, 2006. Specifically, deadlines for (1) plan amendments that will bring a plan in compliance with Section 409A, (2) amendments to exclude the plan or arrangement from Section 409A, (3) an employee's right to change the time and form of a payment election, and (4) substituting discounted stock options or stock appreciation rights for options or rights that are granted at fair market value. This extension should allow companies, employees and counsel sufficient time to consider how best to continue deferred compensation arrangements, while preserving the economic, strategic, and personnel goals that these plans were designed to accomplish.

Some Bad News

As mentioned above, the proposed regulations do provide a very good starting point in clarifying the new deferred compensation regime. Unfortunately, several new rules may cause distress for some employers and employees. First, employees that want to cancel their 2005 deferral elections to avoid application of Section 409A must do so before December 31, 2005. Second, companies that want to terminate their deferred compensation plans and arrangements must terminate the plans and distribute all amounts prior to December 31, 2005. If you or your company are considering any of these alternatives, please contact us before terminating a deferral or plan to avoid any adverse tax consequences and to avoid limiting your company's ability to provide deferred compensation in the future.

Action Steps – What to Do Now?

Although December 31, 2006, seems to be a long way off, promptly identifying plans or arrangements that may be affected by Section 409A is the first step. This will allow you to determine which features need to be revised. A table of plans or arrangements that could be affected by the new regulations appears below. Second, early identification will allow sufficient time for all interested parties to consider the array of alternatives that may be available to the company and the participants in the plan. It will also help avoid confusion that may occur when implementing the changes.

We will continue to closely monitor the developments under Section 409A and its proposed regulations to enable a timely and efficient review of affected plans. We look forward to assisting you in complying with the new requirements.


The following plans or arrangements should be reviewed for compliance with the new Section 409A regulations:

Supplemental executive retirement plans (SERPs)

Section 457(f) plans of nonprofit organizations, but not 457(b) plans

Short- and long-term bonus and incentive plans, if bonuses will be paid later than either: (a) 2 1/2 months after the end of the employer's taxable year, or (b) 2 1/2 months after the end of an employee's taxable year, in which the bonus amounts are determined

Severance and employment agreements that include any of the following: (a) payment of severance upon an employee's voluntary termination, (b) severance pay that exceeds the lower of (i) twice an employee's annual compensation or (ii) $420,000, or (c) severance pay that continues beyond December 31 of the second calendar year after termination of employment

Restricted stock and restricted stock unit plans, but only if such plans restrict or delay payment beyond the vesting date

Stock appreciation rights and phantom stock plans that provide deferred payments after exercise

Stock option, stock appreciation rights and phantom stock plans, where awards are granted below the fair market value

Deferred compensation plans (including 401(k) mirror or "wrap" plans and other plans linked to a qualified plan)


A rabbi trust or other funding vehicle with assets outside of the United States

2006 Benefit/Compensation Limits





 Qualified Retirement Plans
- annual compensation limit



 Defined Benefit Plans
- annual benefit limit



 Defined Contribution Plans
- annual additions limit



 Highly Compensated Employee income threshold



 Annual Deferral Limits
- 401(k), 403(b), 457(b), SEP plans
- SIMPLE plan



 Social Security Wage Base



 High Deductible Health Plan (HDHP)
- annual deductible

- maximum out-of-pocket

 At least $1,050
($2,100 family)

$5,200 individual
($10,500 family)

 At least $1,000
($2,000 family)

$5,100 individual
($10,200 family)

 HSA Maximum Annual Contribution
- individual coverage


- family coverage

 Lesser of:
(1) HDHP annual deductible; or (2) $2,700

Lesser of:
(1) HDHP annual deductible; or (2) $5,450

 Lesser of:
(1) HDHP annual deductible; or (2) $2,650

Lesser of:
(1) HDHP annual deductble; or (2) $5,250

 The Roth 401(k):
To Roth or Not To Roth?

By George L. Whitfield

At our recent Human Resources Seminar, we discussed the employer choice presented by the rapidly approaching opportunity to add Roth accounts to 401(k) and 403(b) plans. That choice reminds me of a favorite Yogi Berra quote: "When you come to a fork in the road, take it." If only it were that easy. The real-life decision will be a difficult one, in many cases requiring plan sponsors to weigh pressure from plan participants against both philosophical and practical administrative implications.

The Roth concept, first introduced in 1998 as the Roth IRA, is an upside-down alternative to the traditional IRA. In a traditional IRA, eligible individuals make deductible contributions each year to a tax-exempt trust or custodial account and pay income taxes on the principal and earnings when distributed. The Roth concept involves just the opposite: contribution of after-tax dollars and no tax on the ultimate distribution of the principal and the investment gains. Proponents argue that the net result to the Roth IRA owner (or his beneficiaries) will be a greater pool of after-tax assets if tax rates applicable to the recipient are significantly higher at the time of distribution than the average rates applicable when the after-tax contributions were made.

Beginning in January, 2006, sponsors of 401(k) and 403(b) plans have the opportunity to add Roth-type accounts to their plans. For convenience, we will refer to both types of accounts as "Roth 401(k)" accounts. Roth 401(k) accounts have positive and negative differences from Roth IRAs. Roth IRAs have been popular, but are subject to limits on adjusted gross income that make them effectively unavailable to higher income taxpayers. They are also subject to annual contribution limits that are lower than those that will be applicable to Roth 401(k) accounts.

When added to a plan, the Roth 401(k) will allow participants to choose annually to direct their elective contributions either to a conventional 401(k) account or to a Roth 401(k) account. The employer determines whether this will be an all-or-nothing choice or whether some contributions can be directed to each type of account. To the extent elective deferrals go to a Roth 401(k) account, they will be taxable income to the participant for that year.

If Roth 401(k) accounts are allowed, separate accounting is required. The recordkeeper must account for the contribution credits and investment results. Roth assets generally will be invested in the same manner as the conventional 401(k) account. The ultimate Roth tax treatment depends on a five-year minimum deferral period, so the recordkeeper also must preserve the date of the first allocation to each Roth 401(k) account for that purpose. There are also annual reporting requirements applicable to each Roth account.

If the plan includes employer matching contributions, amounts directed to a Roth 401(k) account may be matched in the normal manner, although the matching funds will not be part of the Roth account. A 401(k) plan that includes Roth 401(k) accounts may be a safe harbor plan. Amounts in a Roth account are available for hardship distributions if allowed by the plan.

In addition to making plan design decisions and the necessary plan amendments, employers must also prepare explanatory communications, including a new summary plan description, and election forms, and must make all necessary arrangements with the recordkeeper. Adding a Roth 401(k) account is an entirely discretionary choice. The decision to add a Roth 401(k) account can be effective as early as January 1, 2006.

So why is this a difficult decision for plan sponsors? Obviously, there will be significant additional administrative burdens and costs. Furthermore, once Roth 401(k) accounts are included in a plan, the employer can stop future contribution credits to those accounts but there appears to be no way to eliminate the existing accounts without terminating the plan. Also, whether participants will actually use Roth 401(k) accounts is unknown.

It is widely believed, however, that many participants, motivated by financial planners and articles touting Roth 401(k) accounts, will push plan sponsors to allow these accounts in their plans. Those who anticipate higher tax rates at retirement and who also may have a long period of years to accumulate contributions and earnings (typically younger, lower-income participants) may be very interested in the Roth concept. Lower-income participants eligible to contribute to a Roth IRA may also want Roth 401(k) accounts because they can contribute more to a Roth 401(k) account or contribute to both a Roth IRA and a Roth 401(k). Higher-income participants, who are not eligible to make Roth IRA contributions and who can afford to retain the Roth accumulations until death (by avoiding required distributions through rollover to a Roth IRA at or after retirement age), may also be very interested in passing along the total Roth accumulation to heirs free of tax.

Disadvantages for participants include the fact that the contributions are currently taxable and apply toward the annual limits on 401(k) elective deferrals and catch-up amounts. The ultimate result in comparison to pretax contributions to the conventional 401(k) account may also be uncertain in many cases. Some argue strongly against Roth 401(k) accounts partly on the basis of that uncertainty. They argue that if all assumptions are constant in comparing deferrals into a Roth 401(k) account with conventional 401(k) deferrals, there should be no real difference in the present value of the accumulation for the participant or his heirs. That neutral result tilts in favor of the Roth 401(k) account, however, if the applicable tax rate of the participant at the time of the Roth deferrals is significantly lower than the applicable tax rate at the time the accumulated assets are distributed. The bottom line is that the decision to utilize a Roth 401(k) account, if available, will not be an easy one for most plan participants. Based on current law, the tax rates for many participants after retirement may be lower than their current tax rates. On the other hand, many anticipate that the tax laws will be amended to increase rates in the future.

The Roth 401(k)/403(b) choice is truly a fork in the road for plan sponsors. A recent survey shows that at this early stage, just over 20% of small employers have decided to add Roth accounts and only about 35% more are considering it. About 29% have decided against adding these accounts. The decision needs careful consideration as well as input from the recordkeeper concerning the impact and cost of adding Roth accounts to the plan. Advice from Yogi Berra won't be sufficient. The members of the Warner Norcross & Judd LLP Employee Benefits and Executive Compensation Practice Groups are available and ready to advise and counsel with you concerning this choice.

Changing Times:
Supreme Court Rules That Workers Must Be
Paid for Time Spent Putting On and
Taking Off Protective Gear

By Scott R. Carvo

In a decision that could impact the pay practices of many employers, the Supreme Court unanimously ruled that companies must pay hourly workers for the time it takes to change into and out of protective clothing and walk to and from their work stations. The consolidated cases of IBP v. Alvarez and Tum v. Barber Foods (Nos. 03-1238 and 04-66, November 8, 2005) required the court to balance the Fair Labor Standards Act's ("FLSA") requirement that workers be compensated for all hours worked against the Portal-to-Portal Act, which exempts from the definition of hours worked time spent for various tasks (walking, riding or traveling) which occur before or after the employee's principal work activities. The plaintiffs in Alvarez and Tum were hourly wage employees at a meat processing facility and a poultry processing plant, respectively. Workers at both plants were required to wear specialized sanitary and safety equipment such as goggles, gloves, liquid-repelling sleeves, and metal mesh garments in the production areas. Neither company paid the workers for their pre-shift donning and doffing rituals. At IBP, workers were paid from the time the first piece of meat passed onto the production line until the day's last piece of meat was processed. Barber employees were paid from the time they "clocked in" after putting on their equipment until the time they "clocked out" before removing their equipment.

The workers filed suit under the FLSA seeking compensation for time spent putting on and taking off the required sanitary and safety equipment, as well as time spent waiting in line and walking between equipment stations to retrieve and return their gear.

The workers argued that they should be paid for all such time because they were engaged in "principal activities" that begin and end the workday. The employers, on the other hand, argued that the changing, walking and waiting time fit was not compensable under the Portal-to-Portal Act's exceptions for preliminary and postliminary activities.

The Court did not completely agree with either party. It sided with the workers and ruled that time spent putting on and taking off the protective gear was integral and indispensable to their jobs, thus making it a principal activity for which they should be paid. The Court also held that under the continuous workday rule, the employees should be paid for time spent walking to and from production areas and the locker room. On the waiting-time issue, however, the Court held that employees need not be paid for time spent waiting to retrieve and put on the protective gear. According to the Court, this waiting time was exactly the type of activity covered by the Portal-to-Portal Act.

The Alvarez decision clearly impacts employers that require special clothing or protective gear to be worn on the job: their employees must be paid for time spent putting on the equipment before work and taking it off afterward, as well as time spent walking to and from their workstations. Because Alvarez dealt with specialized equipment, the impact is less clear on employers that require employees to wear other types of equipment or clothing. Generally speaking, courts have held that time spent putting on and taking off "nonunique" safety gear, such as hard hats, safety glasses, or work boots, is de minimis and non-compensable. There are grey areas between these two extremes, however, including special uniforms or coveralls. How those situations will be viewed in light of Alvarez is less certain. We will continue to monitor these and other developments under the FLSA and promptly report them to you.

IRS Encourages Employer Leave-Based Donation Programs

The IRS recently issued guidance (IRS Notice 2005-68) intended to encourage employers to establish Hurricane Katrina leave donation programs. These programs would permit an employee to give up paid leave (for example, vacation leave) in return for the employer's contributing the cash value of that leave to a qualified tax-exempt organization that provides relief for the victims of Hurricane Katrina. The value of the leave will not be considered as income to the employee, and the employer can deduct the amount without regard to the limits on deductions for charitable contributions. An employee who elects to donate leave may not "double dip" by claiming a charitable contribution deduction for the value of the forgone leave which was not taxable to begin with. The IRS Notice has an automatic expiration date of December 31, 2006.


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Human Resources Alert is published by Warner Norcross & Judd to inform clients and friends of new developments. It is not intended as legal advice. If you need additional information on the topics in this issue, please contact your Warner Norcross attorney or any member of the Firm's Human Resources Law Group.

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