THE GOVERNMENT'S ROLE—PENSION POLICY ISSUES

Management objectives are one major factor in pension design; the other is the government regulatory structure. This section discusses the development of the government's role in this area.

Most employees covered under an employer-sponsored retirement plan are covered under what is known as a qualified retirement plan. A qualified plan is one that receives certain valuable federal tax benefits, but its design, funding, and administration must meet an extraordinarily complex set of federal statutory and regulatory requirements. Most federal regulation in this area specifically preempts state and local regulation. The tax benefits from such plans to both employer and employee are generally (though not always) adequate to justify the inconvenience of this severe regulatory regime. A nonqualified plan is any other retirement or deferred compensation plan. Nonqualified plans are subject to much simpler federal regulation, along with less favorable tax treatment. Nonqualified plans are used primarily for executive compensation arrangements that replace or supplement qualified plan coverage for a selected group of highly compensated executives.

The government's role in the retirement income area has been dictated primarily by historical factors. Beginning in the late 19th century, the economy of the United States changed fairly rapidly from predominantly agricultural to predominantly industrial and service oriented. Coinciding with this change—and probably in response to it—the large, supportive extended family of the agricultural economy was largely replaced by smaller, more fragmented family units. The shift away from agriculture reduced the amount of economically useful work available to older people, and family structural changes reduced the amount of family support for the aged.

Because of these economic and social trends, people generally must make specific plans for their retirement. This is a difficult matter for most individual employees to do alone and, consequently, employer-sponsored pension plans have become increasingly important.

In the 20th century, federal government involvement in retirement plans for the aged also greatly expanded. The federal government's involvement is twofold. For most people, the most obvious federal government program in this area is the Social Security system adopted in the 1930s to provide direct benefit payments to the aged. But even before the Social Security system was adopted, the federal government became involved in a more traditional way by measures designed to encourage the private pension system.

Governments tend to be reluctant to adopt direct payment arrangements for dependent individuals, particularly in the United States—a reflection of the generally conservative social values of the American public. Historically, governments have tended to look first at private organizations to act in this area. This is one reason why charitable institutions, such as orphanages and hospitals, have for centuries been granted various forms of tax exemption.

In the tradition of encouraging private initiatives, in the 1920s the federal government began encouraging private, employer-sponsored retirement plans by providing two kinds of tax benefits. First, pension funds were made tax exempt under the Revenue Acts of 1921 and 1926. Then, in the Revenue Act of 1928, employer contributions to plan funds were made currently deductible by the employer, even though benefits were not paid to employees until later years. These basic provisions still apply and form the basis for today's vast federal regulatory scheme for qualified plans.

The embryonic private pension system of the 1920s declined significantly during the depression of the 1930s. This was one reason for the adoption of the Social Security system. However, since the 1940s, private pension plans have revived to an enormous degree. Assets in private pension plans now amount to more than three trillion dollars, which constitutes a very substantial portion of the nation's entire capital.

Because of the large sums involved, any tax benefits provided to qualified plans cost the government a great deal in lost tax revenues; the government estimate is well over $75 billion annually. This large "tax expenditure" is often given as a primary justification for the exhaustive scheme of government regulation that now applies to qualified pension plans. Fundamentally, the argument is that the large tax expenditure is designed to help prevent individuals from becoming dependent on the government in retirement. Consequently, the government attempts to make sure that plan benefits go where they are most needed so that this tax expenditure is cost effective. Much pension regulation is aimed at discouraging plans that primarily benefit highly-compensated employees who have other sources of retirement income. Other rules are intended to assure that the large sums set aside for plan benefits are managed in the exclusive interest of plan participants and beneficiaries.

In practice, the government frequently adopts new or modified statutes and regulations relating to pensions without clear or articulated long-range policy objectives. The absence of a coherent federal retirement policy is currently a critical federal policy issue. Current issues in pension regulation include those covered in the following sections.

Tax Revenue Loss

At times, revenue-raising needs outweigh retirement policy issues in Congress. The tax benefits for qualified plans cause a substantial apparent decrease in tax revenues. The criticism is also frequently made that too much of the tax benefit goes to high-income individuals who don't need government help. Whatever the merits of this argument, it is indisputable that "fine tuning" the rules to reduce tax benefits for certain plan participants can increase tax revenues in the short run, without the political pain of visibly "raising taxes." The need to raise revenue has motivated many recent changes in the qualified plan law, and it probably will be a factor in future legislation. Changes of this type are often enormously complex as a result of the need to carefully target the group whose benefits are to be reduced, typically the owner-employees of closely held businesses. Revenue-motivated changes are often criticized as resulting in bad retirement policy.

Discrimination in Favor of Highly Compensated Employees

Although a major thrust of virtually all qualified plan legislation since the 1940s has been to discourage employers from discriminating in their plans in favor of highly compensated employees, a considerable amount of such discrimination is still possible, as discussed throughout this text. Because of this, much qualified plan legislation has been designed to reduce the "tax shelter" aspects of qualified plans, particularly those for smaller businesses whose owner-employees receive substantial benefits. Many of the most complex and awkward provisions of the law, such as the top-heavy rules, were designed in this vein.

Seemingly, it would be easy to eliminate the discrimination problem by simple, appropriate benefit or contribution limits. However there is a counter-vailing policy consideration. Small businesses, collectively, employ a large and increasing segment of the work force. Owners of these businesses may not be interested in maintaining a qualified plan for their employees unless the plan provides substantial, and possibly disproportionate, benefits for the owners themselves. This policy issue, therefore, involves tension between tax-benefit equity and efficiency on the one hand, and the need to encourage small business retirement plans on the other. No simple resolution of this is likely in the near future, and complex legislative compromises on this issue will probably continue to emerge from Congress.

Encouraging Private Saving

Surprisingly, in view of the trillions invested in pension plans, relatively little policy emphasis has been given to the role of the qualified plan rules in encouraging private savings. One problem is that policy makers agree neither on the appropriate level for private savings nor on whether government policy should encourage savings rather than allowing the free market to set the level. Another factor is that economists are divided about the efficacy of the qualified plan provisions in encouraging savings. Some economists argue that these plans merely displace private saving that would take place in any event. Nevertheless, the savings issue is an ongoing factor in the policy debate.

Interest-Group Pressures

As the foregoing discussion indicates, retirement policy poses difficult problems even if viewed from a neutral intellectual viewpoint. The actual political climate, of course, is not neutral. The qualified plan business is large and involves many firms and individuals. Most of these organizations eagerly and frequently convey their views to Congress in great technical detail. This complicates the resolution of issues and makes change more difficult.

Mandatory Retirement Plan Coverage

A presidential commission formed in the late 1970s to study pension policy recommended the establishment of a Minimum Universal Pension System (MUPS) for all workers, to be funded by employers at an initial rate of at least 3 percent of payroll. The MUPS benefit would be completely portable from job to job. In general, the MUPS approach is not popular with employers and benefit plan designers, who prefer the flexibility of current rules; at the present time, Congress is not considering it seriously.

Age and Sex Discrimination

Age and sex discrimination have not been addressed by Congress specifically as retirement plan issues. However, recent federal legislative and regulatory activity related to employment discrimination in general has affected retirement plans

MANAGEMENT OBJECTIVES IN PENSION PLAN DESIGN

Generally, a primary management objective in designing and maintaining a pension program is to maximize those factors by which the plan improves employee productivity. In other words, to maximize the extent to which the costs of the plan represent investment rather than pure expense. A pension plan improves productivity by attracting and keeping a better work force and providing incentives for good work performance. Although the quantitative evidence for the productivity relationship for specific pension plan features is relatively scanty at this time, there has been much qualitative experience in this area.

Benefit managers and pension planners must begin with an overall idea of what employer objectives can be promoted by a pension plan. While not every potential objective can be met with a single plan—in fact, some are conflicting—it's useful to begin by noting broadly what pension plans can do. Here are the basic objectives:

• Help employees with retirement saving. This is the most fundamental reason for pension plans and it shouldn't be overlooked. Most employees, even highly compensated employees, find personal savings difficult. It is difficult not merely for psychological reasons but also because our tax system and economy are oriented toward consumption rather than savings.

• For example, the federal income tax system imposes tax on income from savings (even if it is not used for consumption) with only three major exceptions: (1) deferral of tax on capital gains until realized, (2) benefits for investment in a personal residence, and (3) deferral of tax and other benefits for qualified retirement plans and IRAs. In other words, a qualified retirement plan is one of only three ways our government encourages savings through the tax system—but it is available only if an employer adopts the plan. (IRA benefits are very limited.)

• Tax deferral for owners and highly compensated employees. While many employees in all compensation categories can benefit from pension plans, owners and other key employees have more money available for saving, have higher compensation, have longer service with the employer, and often are older than regular employees; thus they can benefit more from pension plans. When designing a plan for a business owner, a typical objective is to maximize the benefits for the owner (or, in some cases, to minimize the discrimination against the highly compensated employee that is built into some of the qualified pension plan rules.)

• Help recruit, retain and retire employees. These "three Rs" of compensation policy are important in designing pension plans. The plan can help recruit employees by matching or bettering pension benefit packages offered by competing employers; it can help retain employees by tying maximum pension benefits to long service; and it can help retire employees by allowing them to retire with dignity—without a drastic drop in living standard—when their productivity has begun to decline and the organization needs new members.

• Encourage productivity directly. Certain types of plan design can act as employee incentives; this is particularly true of plans whose contributions are profit-based or those providing employee accounts invested in stock of the employee.

• Discourage collective bargaining. An attractive pension package—as good as or better than labor union-sponsored plans in the area—can help to keep employees from organizing into a collective bargaining unit. Collective bargaining often poses major business problems for some employers.

ISSUES IN PLAN DESIGN | Cafeteria Plans

Before committing itself to the establishment of a cafeteria program, an employer must be sure a valid reason exists for converting the company's traditional benefit program to a cafeteria approach. For example, if there is strong employee dissatisfaction with the current benefit program, the solution may lie in clearly identifying the sources of dissatisfaction and making appropriate adjustments in the existing benefit program, rather than in shifting to a cafeteria plan. However, if employee dissatisfaction arises from widely differing benefit needs, conversion to a cafeteria plan may be quite appropriate. Beyond having a clearly defined purpose for converting from a traditional benefit program to a cafeteria program and being willing to bear the additional administrative costs associated with a cafeteria approach, the employer must face a number of considerations in designing the plan.

The Type and Amount of Benefits To Include

Probably the most fundamental decision that must be made in designing a cafeteria plan involves determining what benefits should be included. An employer who wants the plan to be viewed as meeting the differing needs of employees must receive employee input concerning the types of benefits perceived as most desirable. An open dialogue with employees will undoubtedly lead to suggestions that every possible employee benefit be made available. The enthusiasm of many employees for a cafeteria plan will then be dampened when the employer rejects some—and possibly many—of these suggestions for cost, administrative, or psychological reasons. Consequently, it is important that certain ground rules be established regarding the benefits that are acceptable to the employer.

The employer must decide whether the plan should be limited to the types of benefits provided through traditional group insurance arrangements or be expanded to include other benefits. At a minimum, it is important to ensure that an overall employee benefit program provide employees with protection against all major areas of personal risk. This suggests a benefit program with at least some provision for life insurance, disability income protection, medical expense protection, and retirement benefits, but it is not necessary that all these benefits be included in a cafeteria plan. For example, most employers have a retirement plan that is separate from their cafeteria plan because of Section 125 requirements. Other employers make a 401(k) plan one of the available cafeteria options.

In some respects, a cafeteria plan may be an ideal vehicle for providing less traditional types of benefits. Two examples are extra vacation time and child care. Some plans allow an employee to use flexible credits to purchase additional days of vacation. When available, this option has proven a popular benefit, particularly among single employees. A problem may arise, however, if the work of vacationing employees must be assumed by nonvacationing employees, in addition to their own regularly assigned work. Those not electing extra vacation time may resent doing the work of someone else who is away longer than the normal vacation period.

In recent years, employers have been under increasing pressure to provide care for employees' children, which represents an additional cost if added to a traditional benefit program. Employees who include child-care benefits in a cafeteria plan can pay for the cost of such benefits, possibly with dollars from an FSA. However, lower-paid employees may be better off financially by paying for child care with out-of-pocket dollars and electing the income tax credit available for dependent-care expenses.

One question that sometimes arises is whether dependent life insurance should be included in a cafeteria plan. As mentioned previously, amounts of $2,000 or less do not fit the definition of a qualified benefit and cannot be included. If the amount of coverage available exceeds $2,000, the benefit can be provided as long as it is treated as a cash benefit. An employee who elects coverage with employer-provided dollars will have taxable income as determined by Uniform Premium Table I. Because this amount will exceed the actual cost of the coverage in some cases, dependent life insurance is often made available outside a cafeteria plan. When it is included in a cafeteria plan, there is frequently a requirement that it be purchased with after-tax salary reductions.

Cost is an important consideration in a cafeteria plan. The greater the number of benefits, particularly optional benefits, the greater the administrative costs. A wide array of options may also be confusing to many employees and require extra personnel to counsel employees or to answer their questions.

Level of Employer Contributions

An employer has considerable latitude in determining the amount of dollars that will be available to employees to purchase benefits under a cafeteria plan. These dollars may be a function of one or more of the following factors: salary, age, family status, and length of service.

A major difficulty arises in situations in which the installation of a cafeteria plan is not accompanied by an overall increase in the amount of the employer's contributions to the employee benefit plan. It is generally felt that each employee should be provided with enough dollars so that he or she can purchase optional benefits that, together with basic benefits, are at least equivalent to the benefits provided by the old plan.

Including a Premium-Conversion or FSA Option

A premium-conversion or FSA option under a cafeteria plan enables employees to lower their taxes and, therefore, increase their spendable income. Ignoring any administrative costs, there is probably no reason not to offer this option to employees for benefits such as dependent care or for health insurance premiums. However, salary reductions for unreimbursed medical expenses pose a dilemma. While such deductions save taxes for an employee, they may also result in his or her obtaining nearly 100 percent reimbursement for medical expenses, which may negate many of the cost-containment features in the employer's medical expense plan.

Change of Benefits

Because employees' needs change over time, a provision regarding their ability to change their benefit options must be incorporated in a cafeteria plan. As a rule, changes are allowed prior to the beginning of the plan year. Additional changes may be allowed as long as they are permissible under Section 125 regulations.

Two situations often affect the frequency with which benefits may be changed. First, charges to employees for optional benefits must be adjusted periodically to reflect experience under the plan. If charges for benefits rise between dates on which employees may change benefit selections, the employer must either absorb these charges or pass them on to the employees, probably through increased payroll deductions. Consequently, most cafeteria plans allow benefit changes on annual dates that are the same as the dates when charges for benefits are recalculated as well as the dates on which any insurance contracts providing benefits under the plan are renewed.

The second situation arises when the amount of the employer's contribution is based on compensation. If an employee receives a pay increase between selection periods, should he or she be granted more dollars to purchase additional benefits at that time? Under most cafeteria plans, the dollars available to all employees are calculated only once a year, usually before the date by which any annual benefit changes must be made. Any changes in the employee's status during the year will have no effect on the employer's contribution until the date on which a recalculation is made in the following year.

THE RATIONALE FOR CAFETERIA PLANS

The growth in employee benefits has caused two problems. First, some employers feel that many employees do not recognize and appreciate the magnitude of their employee benefits; indeed, as benefits increase, employee appreciation often seems to decrease. Advocates of cafeteria plans argue that by giving employees a stated dollar amount with which they must select their own benefits (from a list of options), employees become more aware of the actual cost of these benefits and are more likely to appreciate the benefits they choose.

A second problem is that the inflexible benefit structure of conventional employee benefit plans does not adequately meet the various benefit needs of all employees, often leading to employee dissatisfaction. For example, single employees often resent the medical coverage that married employees receive for their families because the single employees receive no benefit of corresponding value. Similarly, employees who have no dependents often see little value in life insurance and would prefer other benefits. Those who favor the concept of cafeteria plans feel that such dissatisfaction can be minimized if employees have the option to select their own benefits. Advocates of cafeteria plans argue that this increased employee satisfaction will result in a better employee-retention record and in greater ability to attract new employees.

Some employers see the cafeteria approach to benefit planning as an opportunity to control the escalating benefit costs associated with inflation and with the new requirements of recently enacted federal and state legislation. Because a cafeteria plan is essentially a defined-contribution plan rather than a defined-benefit plan, it provides a number of opportunities for controlling increases in costs. For example, it may encourage employees to choose medical expense options that have larger deductibles or a greater degree of managed care so that they can more efficiently use the fixed number of dollars allotted to them under the plan. A cafeteria plan may also enable the employer to pass on to the employees any increased benefit costs that result from having to comply with legislation that mandates additional benefits. In addition, because increases in employer contributions are not directly related to increases in benefit costs, the employer can grant percentage increases in the amounts available for benefits that are less than the actual overall increase in employee benefit costs.

It should be noted that early cafeteria plans were designed primarily to meet the varying needs of employees. In contrast, newer plans are much more likely to be instituted as a cost-saving technique.

SERVICES TO EMPLOYEES

No-Additional-Cost Services

Employers in many service industries provide their employees with free or discounted services. Examples include telephone service to employees of phone companies and airline tickets to employees of airlines. As long as the following rules are satisfied, the cost of these services is not includable in an employee's gross income for tax purposes:

• The services cannot be provided on a basis that discriminates in favor of highly compensated employees.

• The employer must not incur any significant additional cost or lost revenue in providing the services. For example, giving a standby ticket to an airline employee if there were unsold seats on a flight would satisfy this requirement, but giving an airline ticket to an employee when potential paying customers were denied seats would not.

• The services must be those that are provided in the employer's line of business in which the employee actually works. Therefore, if a business owns both an airline and a chain of hotels, an employee of the hotels can be given a room as a tax-free benefit but not an airline ticket. However, unrelated employers in the same line of business, such as airlines, may enter into reciprocal arrangements under which employees of any party to the arrangement may obtain services from the other parties.

Employee Discounts

Just as no-additional-cost services are an important employee benefit in certain service industries, discounts on the merchandise sold by manufacturers and retailers are an important benefit to employees in these industries. Discounts may also be provided on services sold by other types of businesses; for example, there may be a reduction in the commission charged by a brokerage house or insurance company.

Rules similar to those discussed for no-additional-cost services apply to discounts. Employees have no taxable income as long as the discounts are made available on a nondiscriminatory basis and are provided on goods or services ordinarily sold to nonemployees in the employer's line of business in which the employee works. However, there are some additional rules. Discounts received on real estate or on personal property normally held as an investment (for example, gold coins or securities) are not received tax free. Furthermore, there is a limit on the size of a discount that can be received tax free. For merchandise, the discount cannot exceed the gross profit percentage of the price at which the merchandise is offered for sale to customers. For example, if an employer had a gross profit margin of 40 percent on a particular product and an employee purchased the merchandise at a 50 percent discount, the extra 10 percent would be taxable income to the employee. In the case of services, including insurance policies, the tax-free discount cannot exceed 20 percent of the price at which the service is offered to nonemployee customers in the normal course of the employer's business. The type of service that cannot be received tax free involves loans that financial institutions give to employees at a discounted rate of interest.

Dependent-Care Assistance

Changes in society and in the work force often create changing needs for both employers and employees. When the work force was largely male and most families had two parents, caring for children and older parents frequently was the female spouse's responsibility. As the number of families headed by two wage earners or by single parents has increased, so has the need for dependent care. This change in demographics has also created problems for employers. Caring for family members can lead to increased absenteeism, tardiness, turnover, and time taken as family leave. Workplace morale can also suffer if the employer is viewed as insensitive to employee responsibilities.

The nature of employee benefit plans has changed as employers have increasingly responded to the need for dependent care. Child-care benefits are increasingly common, and a small but growing number of firms also make eldercare benefits available. Firms that have dependent-care assistance plans generally feel that such plans alleviate the problems cited in the previous paragraph. Furthermore, the availability of such benefits at a firm often makes it easier for the firm to attract new employees.

In addition to a formal dependent-care assistance plan, there are other ways in which employers can respond to employee needs to care for family members. These include flexible work schedules, part-time employment, job sharing, salary reduction options under cafeteria plans, and family-leave policies that are more liberal than those required by federal and state laws.

Child-Care Plans

Several alternative types of benefits can be provided under child-care plans. A few employers maintain on-site day care centers, and the number is growing. On the other hand, some employers have closed down on-site centers and provide alternative forms of assistance because of the following problems encountered with on-site centers:

• Difficulty in obtaining qualified child-care providers.

• Difficulty in obtaining liability insurance.

• Difficulty, time, and expense associated with obtaining necessary zoning variances and child-care licenses.

• Distractions caused by parents and children being in close proximity to each other.

• Underutilization. While this type of facility would be expected to be popular, many employees prefer other alternatives. A site close to home is often more appealing than a location that may involve a long commute for parent and child. An on-site location may be less convenient if both parents share in child-care activities. Employees may also prefer a different type of child-care arrangement.

Some employers provide benefits by supporting a limited number of off-site child-care centers. The employer may make arrangements to reserve spaces for employees' children at these centers and/or arrange for corporate discounts for employees.

Probably the most common approach is to provide reimbursements to employees who make their own arrangements for child care, either at child-care centers or in their own home or the home of a care provider. Reimbursement is sometimes tied to pay levels, with lower-paid workers receiving higher reimbursements.

When employees are required to make their own arrangements under a child-care plan, employers may provide information and referral services—often through a contract with community or private referral services. In addition to providing assistance in locating a quality child-care center, these services can provide help in finding drop-in facilities when the usual child-care arrangement has fallen through or when school is closed for a day. They may also maintain a list of persons who will care for temporarily ill children at home or for children after school hours. Such services may also be a source of information about facilities that can be used during summer and other school vacations.

Eldercare Benefits

While benefits to care for elderly dependents are much less prevalent than benefits for child care, the need for these benefits continues to grow as parents live longer. In addition, because many couples have delayed having children until later in life, they have become part of what is often referred to as the "sandwich generation"; they must care for elderly parents at the same time that they are raising their own children.

Although eldercare benefits may take a variety of forms, frequently they are much like those provided under child-care plans. Within limits, the employer may pay for costs associated with home care for elderly dependents or care at day care facilities for the elderly. One interesting development in this area is the establishment of centers that care for both children and the elderly, with the elderly assisting in such activities as the feeding and teaching of the children. Studies have shown that the two groups are very compatible. Children, particularly those without grandparents nearby, benefit from the attention and knowledge they receive from the elderly, while the elderly achieve a feeling of usefulness.

Other employer activities with respect to eldercare may include the following:

• Providing seminars on issues affecting the elderly

• Providing information on available eldercare services and how to use these services

• Sponsoring support groups where employees can share experiences and learn from others

• Expanding employee-assistance plans to include eldercare

• Making long-term care insurance available to employees and including parents as an eligible group for coverage

Taxation of Benefits

Under the Internal Revenue Code, dependent care is a tax-free benefit to employees up to statutory limits as long as certain requirements are met. The amount of benefits that can be received tax free is limited to $5,000 for single parents and married persons who file jointly and to $2,500 for married persons who file separately. The benefits must be for care to a qualifying individual—a child under age 13 for whom the employee is allowed a dependency deduction on his or her income tax return or a taxpayer's spouse or other dependent who is mentally or physically incapable of caring for himself or herself. Although benefits must generally be for dependent care only, educational expenses at the kindergarten or preschool level can also be paid.

Dependent-care benefits are subject to a series of rules. If the rules are not met, highly compensated employees are taxed on the amount of benefits received. However, the benefits for other employees still retain their tax-free status. The following are the rules that must be met:

• Eligibility, contributions, and benefits under the plan cannot discriminate in favor of highly compensated employees or their dependents.

• No more than 25 percent of the benefits may be provided to the class composed of persons who own more than a 5 percent interest in the firm.

• Reasonable notification of the availability of benefits and the terms of the plan must be provided to eligible employees.

• By January 31 of the following year, each employee must receive an annual statement that indicates the amounts paid or expenses incurred by the employer to provide benefits.

• The average benefit provided to non-highly compensated employees must be at least 55 percent of the average benefit provided to highly compensated employees.

In meeting the 55-percent-of-benefit test, an employer can exclude employees earning under $25,000 if benefits are provided through a salary reduction agreement. For both the 55-percent-of-benefit test and the nondiscrimination rule for eligibility, an employer can exclude employees who (1) are under age 21, (2) have not completed one year of service, or (3) are covered under a collective-bargaining unit that has bargained for dependent-care benefits.

Even if an employer does not provide assistance for dependent care, other tax-saving options may be available to employees. Under the Code, a tax credit (subject to limits) is available for child-care expenses. In addition, the employer may have the opportunity to make before-tax contributions to a cafeteria plan that includes dependent care as an option.

Adoption Assistance

While many types of benefits have long been available to natural parents because of the birth of a child, comparable benefits historically have not been available to adoptive parents. Over the last few years, this disparity has begun to change. Even before the passage of family-leave legislation, many employers had established comparable leave policies for natural parents and adoptive parents; for example, if an employer allowed maternity leave (either paid or unpaid) for a new mother, no distinction was made between natural mothers and adoptive mothers. Leave may also be available for time involved in qualifying for the adoption and taking possession of the child.

A smaller number of employers provide reimbursement for some or all of the following expenses associated with adoption:

• Legal fees

• Adoption agencies' fees

• The birth mother's medical expenses

• The adoptive parents' medical expenses for physical examinations required by the adoption source

• The child's uninsured medical expenses

• Foster care charges for the child prior to placement with the adoptive family

• Transportation expenses associated with taking custody of the child.

• Extra expenses associated with foreign adoptions.

Reimbursements are generally available only to employees who have satisfied some minimum service requirement, most commonly one year. Amounts typically range from $1,000 to $3,000 per adoption, but higher amounts may be paid for adoptions involving handicapped children or children from a foreign country. There may also be a lifetime cap, such as $6,000.

Prior to 1997, adoption assistance for costs other than medical expenses generally represented taxable income to an employee. Beginning in 1997, employer payments of up to $5,000 per child for qualified adoption expenses can be excluded from an employee's gross income if an employer has an adoption-assistance program that satisfies IRS requirements. The amount is increased to $6,000 for certain children with special needs.

The adoption-assistance program must be a separate written plan, and employees must have reasonable notification of the availability of the program and its benefits. The program cannot discriminate in favor of highly compensated employees or their dependents, and no more than 5 percent of the benefits under the plan can be paid to shareholders or owners (or their dependents) who are more-than-5-percent owners of the firm.

Qualified adoption expenses include reasonable and necessary adoption fees, court costs, attorney's fees, travel expenses, and other expenses directly related to the legal adoption of an eligible child, defined as a child who is under age 18 or who is incapable of caring for himself or herself. Expenses incurred in adopting a spouse's child or carrying out a surrogate parenting arrangement are not qualified adoption expenses, nor are expenses that are reimbursed from other sources. In addition, expenses to adopt a foreign child are not qualified adoption expenses unless the adoption becomes final.

The $5,000 (or $6,000) exclusion from gross income is available to employees with an adjusted gross income of $75,000 or less, and married couples must file joint returns to obtain the exclusion. For employees with higher adjusted gross incomes, the exclusion is gradually phased out until it is eliminated when adjusted gross income reaches $115,000.

There is also a similar tax credit available to all taxpayers for adoption expenses, but the credit is not available for expenses that were paid by employer-provided adoption assistance, regardless of whether the employer paid the expenses through an adoption-assistance program. However, the credit can be used for expenses not reimbursed by an employer's plan.

Wellness Programs

Traditional benefit programs have been designed to provide benefits (1) to employees for their medical expenses and disabilities or (2) to their dependents if the employee should die prematurely. In the last few years, there has been an increasing trend among employers, particularly large corporations, to initiate programs that are designed to promote the well-being of employees (and possibly their dependents). Some of these programs have been aimed at the discovery and treatment of medical conditions before they become severe and result in large medical expenses, disabilities, or death. Other programs have focused on changing employees' lifestyles to eliminate the possible causes of future medical problems. A few programs, such as those that make flu shots available to employees, actually provide medical treatment. Recent studies have shown that the costs of establishing and maintaining many of these programs are more than offset by the lower amounts paid for medical expense, disability, and death benefits. In addition, if long-term disabilities and premature deaths can be eliminated, the expenses associated with training new employees can be minimized. Many firms also feel that these programs increase productivity by improving the employees' sense of well-being, their work attitudes and their family relationships.

Medical Screening Programs

The use of a medical screening program to discover existing medical conditions is not new, but it has often covered the costs (frequently up to some dollar limit) of routine physical examinations for only selected groups of management employees. Although this benefit may be highly valued by these employees and its use as an executive benefit has been increasing somewhat, there are doubts—even among the medical profession—as to its cost-effectiveness, particularly when it is provided on an annual basis. Certain medical conditions will undoubtedly be discovered during a complete physical, but most of them could also be diagnosed by less frequent and less costly forms of medical examinations.

In recent years, there has been a significant increase in the number of employers that sponsor periodic medical screening programs that detect specific medical problems, such as hypertension (high blood pressure), high cholesterol levels, breast cancer, prostate cancer, and colorectal cancer. Generally, such screenings are conducted at the employment site during regular working hours. Sometimes, a screening is conducted by a physician, but it is usually performed by lower-paid medical professionals. In addition, screenings can sometimes be obtained at little or no cost through such organizations as the American Red Cross, the American Heart Association, or the American Cancer Association.

Lifestyle Management Programs

Lifestyle management programs are primarily designed to encourage employees and often their dependents to modify their behavior so that they will lead healthier lives. Most of these programs strive to discover and eliminate conditions that increase the likelihood of cardiovascular problems (the source of a significant percentage of medical expenses and premature deaths). Some of these conditions (such as obesity and smoking) are obvious, but medical screening can also detect less obvious conditions like hypertension, high cholesterol levels, and the degree of an employee's physical fitness. The types of programs often instituted to promote cardiovascular health include the following:

• Smoking-cessation programs.

• Fitness programs. These may consist of formal exercise programs or only exercise facilities (such as swimming pools, exercise rooms, or jogging tracks). Some employee benefit consultants question whether facilities for competitive sports (such as racquetball courts) can be cost justified because their availability is limited and they are often a source of injuries.

• Weight-reduction programs.

• Nutrition programs. These are often established in conjunction with weight-reduction programs, but they can also teach methods of cholesterol reduction even if there is no weight problem.

• Stress-management programs.

These programs may be available to any employees who express an interest in them, or they may be limited to those employees who have been evaluated and found to be in a high-risk category for cardiovascular disease. This evaluation may consist of questionnaires regarding health history, blood pressure reading, blood chemistry analyses, and fitness tests. Generally, these evaluations and meetings to describe the programs and their value are conducted during regular working hours. However, the programs themselves are usually conducted during non-working hours, possibly at lunchtime or just after work.

Many wellness programs are designed to include employees, their spouses, and, sometimes, other family members. In many instances, it will not be possible to change an employee's lifestyle unless the lifestyle of his or her entire family also changes. For example, it is not very probable that an employee will stop smoking if his or her spouse also smokes and is making no attempt to stop. Similarly, a weight-reduction or nutrition program will probably be more effective if all family members alter their eating habits.

Programs designed to eliminate alcohol or drug abuse are another example of lifestyle management. Participation may be voluntary, or it can be mandatory for employees who are known to have alcohol or drug problems and who want to keep their jobs. When these programs have been successful, many employers have found a decrease in employee absenteeism.

Some employers have also instituted programs that seek to minimize back problems—the reason for a large percentage of employee absenteeism and disability claims. These programs are generally intended for employees who have a history of back trouble, and they consist of exercises as well as education in how to modify or avoid activities that can aggravate existing back conditions.

More recently, many employers have become concerned with the spread of AIDS and its effect on the cost of benefit plans. As a result, they have instituted educational programs aimed at encouraging employees to avoid activities that may result in the transmission of AIDS.

The employer may either conduct these wellness activities on the premises or use the resources of other organizations. For example, overweight employees might be sent to Weight Watchers, employees with alcohol problems might be encouraged to attend Alcoholics Anonymous, and employees with back problems might be enrolled in programs at a local YMCA.

Employers in increasing numbers are subscribing to wellness newsletters and are distributing them to employees. To encourage wellness for the entire family, these newsletters are often mailed to employees' homes.

Taxation of Benefits

Because medical screening programs are treated as medical benefits for tax purposes, employees have no taxable income as a result of participating in these programs. Unless the cost of providing lifestyle management programs is de minimis, participation will probably result in taxation to employees. The costs of programs that promote general health, such as programs for smoking cessation or weight control, are not considered medical expenses. While the cost of providing these programs to employees is deductible by the employer, an employee will incur taxable income unless the purpose of the program is to alleviate a specific medical problem. There is one exception to this general rule: Employees incur no taxable income as a result of being provided with or using athletic facilities that are located on the employer's premises.

Employee-Assistance Programs

As the trend toward fostering wellness in the workplace continues, an increasing number of employers are establishing employee-assistance programs. These programs are designed to help employees with certain personal problems through a plan that provides the following:

• Treatment for alcohol or drug abuse

• Counseling for mental problems and stress

• Counseling for family and marital problems

• Financial, legal, and tax advice

• Referrals for child care or eldercare

• Crisis intervention

Numerous studies have shown that proper treatment of these problems is very cost-effective and leads to a reduction in hospital costs, disability claims, the number of sick days, and absenteeism. It is also argued that employee morale and productivity are increased as a result of the concern shown for employees' personal problems.

Traditionally, employee-assistance programs have used job performance as the basis for employer concern. Essentially, an employee was told that his or her work was substandard and asked if a problem existed that he or she would like to discuss with someone. If the employee said yes, referral was made to an appropriate counselor or agency. No attempt was made by the employee's supervisor to diagnose the specific problem. Newer employee-assistance programs go beyond this approach by allowing employees who have problems to go directly to the program and seek help. Dependents can usually use the employee-assistance program and can often seek help without the employee's knowledge.

Another recent trend in employee-assistance programs is to coordinate them more closely with the employer's medical expense plan. For example, several employee-assistance programs act as the gatekeeper for mental health and substance abuse services. An employee must go through the employee-assistance program before benefits can be received under his or her medical expense coverage. The objective of this approach is to establish a course of treatment that will have maximum effectiveness for the costs incurred.

Access to an employee-assistance program is through a counselor; this counselor may be a company employee, but most often he or she is employed by a professional organization that specializes in providing such programs. Information disclosed to the counselor by the employee is kept confidential. Many problems can be solved by discussion between the counselor and the employee, and most plans have 24-hour counseling available, through either a telephone hotline or on-duty personnel. If the counselor cannot solve an employee's problem, it is the counselor's responsibility to make a preliminary determination about the type of professional help that the employee should receive. In many cases, this treatment can be provided under existing medical expense or legal expense plans or through community agencies. The costs of other types of treatment are usually paid totally or in part by the employer.

As long as the treatment is for the purpose of alleviating medical conditions, including mental illness, an employee has no taxable income. If the treatment is for a nonmedical condition, the employee will have taxable income as the result of employer payments.

Financial Planning Programs for Executives

Employers are increasingly providing financial planning as a benefit to employees. Although, traditionally, this benefit was limited to a small number of top executives, many firms are now expanding their programs to include middle management employees in the $50,000 to $100,000 annual salary range. In addition, financial planning education and advice are now offered to many employees as part of a broader preretirement-counseling program. Any program in overall financial planning must take into consideration the benefits that are provided or that are potentially available under group insurance plans, under social insurance programs, and through the individual efforts of employees.

The concept of providing financial planning for top executives has been widely practiced for many years, particularly in large corporations. Businesses have deemed this financial planning benefit as necessary for such executives (who have limited time for their own financial affairs), so that they can be free to devote their full talents to important business decisions. A company may also find it easier to attract and retain executives who look on the financial planning program as a way to make existing compensation more valuable (for example, by providing a larger spendable income through tax planning or a greater accumulation of wealth through investment planning).

Although group meetings are sometimes used (for example, to explain certain types of investments or changes in the tax laws), most financial planning programs provide for individual counseling of employees to suit their own particular circumstances and needs.

Types of Planning

Financial planning is composed of many separate but interrelated activities:

• Compensation planning, including the explanation of employee benefits and an analysis of any available compensation options

• Preparation of tax returns

• Estate planning, including the preparation of wills and planning to both minimize estate taxes and maintain proper estate liquidity

• Investment planning, including both investment advice and investment management

• Insurance planning, including information on how to meet life insurance, medical expense, disability, property, and liability needs

A financial planning program may be designed to provide either selected services from the list above or a comprehensive array of services. Comprehensive financial planning can be thought of as a series of interrelated and continuing activities that begin with the collection and analysis of personal and financial information, including the risk attitudes of an employee. This information is used (1) to establish the priorities and time horizons for attaining personal objectives and (2) to develop the financial plan that will meet these objectives. Once the plan is formulated, the next critical step is the actual implementation of the plan. A proper financial planning program should also include a process for measuring the performance of any plan so that, if unacceptable, either the plan can be changed or the employee's objectives revised.

Sources of Financial Planning

A few firms provide financial planning services using the organization's own employees. Most firms purchase the services either from outside specialists (such as lawyers, accountants, insurance agents, or stockbrokers) or from companies or individuals that do comprehensive financial planning.

Significant differences exist among financial planning firms. Some operate solely on a fee basis and give only advice and counseling, in which case it is the employee's responsibility to have his or her own attorney, insurance agent, or other financial professional implement any decisions. These financial planning firms often work closely with the other professionals in handling the employee's affairs. The cost of using a fee-only financial planning firm varies, depending upon what services it provides, but initial fees of $5,000 per employee and annual charges of $1,000 to $2,000 are not uncommon.

Other financial planning firms operate on a product-oriented basis and sell products (usually insurance or investments) in addition to other financial planning services. The fact that these firms receive commissions from the products they sell may eliminate or reduce any fees paid by the employer. Unfortunately, the insurance or investment advice of these firms may be slanted in favor of the products they sell. Therefore, employers must make sure that the advice of outside specialists will be unbiased and will be presented in a professional manner.

Taxation

Fees paid for financial planning are tax deductible by the employer as long as the total compensation paid to an employee is reasonable. The amount of any fees paid to a financial planning firm or other professional on behalf of an individual employee becomes taxable income to the employee. However, an employee may be able to take miscellaneous itemized deductions for certain services relating to tax matters and investment advice. Services that the employer provides to executives on an individual basis also result in taxable income.

Preretirement Counseling Programs

Businesses, aware of the pitfalls that await unprepared retired employees, have increasingly begun to offer preretirement counseling. It has been estimated that this benefit is offered by approximately 75 percent of companies with 20,000 or more employees. For companies with fewer than 1,000 employees, the figure is closer to 15 percent or 20 percent. Most of these companies have made this benefit available to all employees over a specific age (such as 50 or 55), but an increasing number of organizations allow employees of any age to participate. Retired employees may also be invited to take advantage of any program benefits that are of interest to them.

Preretirement counseling programs differ from financial planning programs for executives in that there is very little individual counseling. Rather, employees meet in groups to listen to media presentations and speakers, and they are given the opportunity to ask questions and discuss their concerns. This counseling may take place during non-working hours, but there is an increasing tendency to have it provided during working hours, often in a concentrated, one-day or two-day period. Most companies encourage spouses to participate. Often, one program is developed for all employees, although some organizations vary their programs for different classifications of employees (such as management employees and blue-collar workers).

When these programs are successful, the fears that many employees have about retirement are alleviated. They learn that, with proper planning, retirement can be not only financially comfortable but also a meaningful period in their lives.

Financial Planning

Some preretirement counseling programs devote at least half their time to the financial aspects of retirement. Because proper financial planning for retirement must begin many years prior to actual retirement, the amount of time devoted to this subject will be greatest in programs that encourage employees to begin participation at younger ages.

Some financial planning meetings help employees identify and determine what their financial needs will be after retirement and what resources will be available to meet those needs from the company's benefit plans and from Social Security. If retirement needs will not be met by these sources, employees are informed about how their individual efforts can supplement retirement income through savings or investments. They are also told about the specific advantages and risks associated with each method of saving or investment. In addition, issues such as the need for wills and estate planning may be discussed. Such preretirement financial planning is unlikely to provide investment advice on an individual basis or through an investment management service, as described in the previous section on financial planning programs for executives. However, some employers do give employees financial planning reports that are prepared through a computerized financial planning system. These reports, which may vary in length from 20 to 60 pages, are generated from the data on a questionnaire completed by the employee. They may provide advice on such topics as the additional amount of money that should be saved for retirement or compare the cost of working with the cost of retiring.

Many employers now make available computer software that employees can use to derive varying scenarios related to retirement, education funding, and the like by entering basic personal and financial data. The major advantage of these computer programs is that an employee can quickly evaluate alternative assumptions about factors such as retirement dates and savings rates. One potential drawback to the use of computer programs is the lack of employee understanding about the assumptions and reasoning that lie behind the input into the program and the output that results. Therefore, it is important that the introduction of such computer programs be accompanied by proper training in their purpose, use, and interpretation.

Other Aspects of Preretirement Counseling

Preretirement counseling also focuses on other aspects of retirement besides financial needs. The following are some of the questions that must be faced by most retired workers and that are often addressed in preretirement counseling programs:

• Living arrangements. What are the pros and cons of selling a house and moving into an apartment or condominium? Is relocation to the Sunbelt, away from family members and friends, advisable?

• Health. Can changes in lifestyle lead to healthier retirement years?

• Free time. How can the time that was previously devoted to work be used? What opportunities are available for volunteer work, part-time employment, or continuing education? What leisure activities or community activities can be adopted that will continue into retirement? (Studies have shown that alcoholism, divorce, and suicide tend to increase among the retired. Much of this increase has been attributed to the lack of activities to fill free time and to the problems encountered by husbands and wives, who are constantly together for the first time in their lives.)

Sources of Preretirement Counseling

An employer may establish and maintain its own program of preretirement counseling. However, many organizations (such as benefit-counseling firms and the American Association of Retired Persons) have developed packaged programs that are sold to other organizations. These programs typically consist of media presentations and information regarding the types of speakers that should be used in counseling sessions. Generally, these packaged programs are flexible enough to be used with almost any type of employee group. Most firms actually conduct preretirement counseling programs with a combination of their own employees and outside speakers or organizations. It is becoming common to see the use of an employer's own retirees in the counseling process.

Taxation

As long as no specific services are provided to employees on an individual basis, they do not have taxable income to report as a result of participating in preretirement counseling programs.

Transportation/Free Parking

Some employers have long provided transportation benefits to employees as a fringe benefit. These benefits have been in the form of various types of reimbursement for commuting expenses, the use of company-owned vehicles for vanpooling, and free parking. However, except for free parking, employees have usually had taxable income as a result of these benefits. To increase the use of public transportation and decrease the reliance on the use of private passenger automobiles, the Comprehensive National Energy Policy Act of 1992 changed the tax rules governing transportation benefits. As a result of the act, the Internal Revenue Code provides favorable taxation for transportation benefits that meet the definition of a qualified transportation fringe, which includes the following:

• Transportation in a commuter highway vehicle if such transportation is in connection with travel between the employee's residence and place of employment. The commuter vehicle must have a capacity of at least six adults other than the driver. In addition, at least 80 percent of the mileage use of the vehicle must reasonably be expected to be for transporting employees to and from work and must occur when at least one-half of the seating capacity of the vehicle is filled. Traditional vanpools, in which one employee usually has possession of an employer-provided vehicle to drive other employees to work, come under this definition as long as these criteria are satisfied.

• Transit passes. These include any pass, token, fare card, voucher, or similar item entitling a person to transportation as long as such transportation is on a mass-transit facility or in a commuter highway vehicle as previously described.

• Qualified parking. This includes parking provided on or near the business premises of the employer or near a location from which the employee commutes to work by using a mass-transit facility or a commuter highway vehicle. Qualified parking does not include any parking on or near a premises used by the employee for residential purposes.

The value of the benefit under a qualified transportation fringe is excluded from gross compensation up to the following amounts, which are subject to cost-of-living adjustments:

• $100 per month in the aggregate for any transit passes and transportation in a commuter highway vehicle.

• $175 per month for qualified parking.

Amounts in excess of the above and the value of employer transportation benefits that do not meet the definition of a qualified transportation fringe are fully taxable to employees.

Three additional points should be made about qualified transportation benefits. First, they can be provided on a discriminatory basis. Second, the employer can either provide the benefits directly or give a cash reimbursement to the employee, with one exception: Cash reimbursement for a transit pass is not acceptable if such a pass is available for direct distribution by the employer to the employee. Third, when an employer does not wish to assume the cost of the benefits, they can still be provided under an arrangement that allows an employee to enter into a compensation-reduction agreement up to the applicable limits. However, such a compensation-reduction agreement is irrevocable during its specified term even if the employee is no longer eligible for the transportation benefits.

Company Cars

Employers often provide employees with company cars (or other types of vehicles). In addition to using a vehicle for business purposes, an employee may also be allowed to use the car for commuting to and from work and for other personal purposes. However, an employee who drives a company car for personal use must include the value of this use in his or her taxable income.

The method for valuing the use of a car is determined by the employer, and several choices are available. The most common method for valuing the car is for the employer to report an annual cost that is a percentage of the car's annual lease value. This value is determined by a table prepared by the Internal Revenue Service and is based on a car's fair market value, unless an employer can clearly justify a lower value. Under this table, a car with a fair market value of $20,000 to $20,999 has an annual lease value of $5,600. This figure is then multiplied by the ratio of personal-use miles to total miles. For example, if 20 percent of the miles driven are personal miles, the employer must report $1,120 of income for the employee. Additional income must also be reported if the employer pays for gas.

A second alternative is for the employer to annually report the entire lease value of the car as taxable income. If the employer uses this alternative, the employee can claim an income tax deduction for any business use of the vehicle if the employee itemizes his or her deduction. However, the deduction is subject to the 2 percent floor requirement for miscellaneous deductions. This alternative is less favorable to the employee but administratively less burdensome to the employer.

A third alternative is to report a value that is based solely on the employee's use of the vehicle. Under IRS regulations, a flat mileage rate may be used for each personal mile driven. The mileage rate ($.325 in 2000) is adjusted annually. This alternative is available only if a car's fair market value does not exceed a specified value ($15,400 in 2000) and one of the following criteria is satisfied: (1) more than 50 percent of the car's use is for business, (2) the car is used each day in an employer-sponsored commuting pool, or (3) the car is driven at least 10,000 miles per year and is used primarily by employees.

The final alternative is available if the employer has a written policy that the employee must commute in the vehicle and cannot use the vehicle for other than minimal personal use. In this case, the value of the car's use is $1.50 times the number of one-way commutes or $3.00 times the number of round-trip commutes.

Subsidized Eating Facilities

Employers often provide fully or partially subsidized eating facilities for employees. While lunch is the most commonly served meal, breakfast and dinner may also be served. Such facilities offer a place for employees to discuss common issues and may minimize the chance that employees will take prolonged lunch periods at off-site restaurants. The popularity of these facilities tends to vary with the price of meals, the convenience of alternative places to eat, and the quality of the food served.

The subsidized value of meals served to employees is excluded from taxable income as long as the meals are (1) provided on the business premises and (2) furnished for the convenience of the employer. In general, meals are considered to be furnished for the employer's convenience if there are inadequate facilities in the area for employees to obtain meals within a reasonable period of time. If the requirements regarding the business premises and/or the convenience of the employer are not satisfied, the subsidized value of any meals consumed by employees is included in taxable income.

Employees are not allowed to deduct any portion of the cost they pay for individual meals. However, if an employee is required to have a fixed periodic charge for meals deducted from wages or salary (such as $15 per week), this amount is excluded from taxable income.

EXTRA PAYMENTS TO EMPLOYEES | Nonretirement Benefits

Educational Assistance

For several years the Internal Revenue Code has provided favorable tax treatment to employees who receive benefits from their employers for educational assistance. Section 127 of the Code, which allows employees to receive annually the first $5,250 of these benefits on a tax-free basis, is scheduled to expire for courses beginning after December 31, 2001. (However, the date has been extended several times before and will probably be extended again, or the Code section may be made permanent.) For benefits to be tax free, the employer's plan cannot discriminate with respect to eligibility in favor of officers, shareholders, highly compensated employees, or their dependents. In addition, no more than 5 percent of the benefits may be paid out to shareholders or owners (or their dependents) who are more-than-5-percent owners of the firm.

Eligible benefits include tuition, fees, and books. The costs of supplies and equipment are also included as long as they are not retained after completion of the course. Meals, lodging, and transportation associated with educational expenses cannot be received tax free, nor can tax-free educational assistance be provided for graduate-level courses. For purposes of Sec. 127, a graduate-level course is defined as any course taken by an employee who has a bachelor's degree or is receiving credit toward a more advanced degree, if the particular course can be taken for credit by any individual in a program leading to a law, business, medical, or other advanced academic or professional degree. Courses involving sports, games, or hobbies are also ineligible for favorable tax treatment. Although an employer's plan can pay for any of these types of courses, an employee will be taxed on the value of the employer's contribution to their cost.

Many employers provide reimbursement for certain educational expenses that do not qualify for favorable tax treatment under Section 127. While such reimbursements result in taxable compensation for an employee, the employee may be eligible for a federal income tax deduction (subject to the 2-percent-of-adjusted-gross-income floor on miscellaneous itemized deductions) if he or she itemizes deductions. The deduction is allowed for educational expenses that are incurred (1) to maintain or improve a skill required in employment or (2) to meet the express requirements of the employer as a condition for retaining employment. Other types of educational expenses, such as costs incurred to qualify the employee for a new trade or business, are not deductible.

Moving-Expense Reimbursement

To attract new employees and to encourage current employees to move to suit the employer's needs, many businesses provide reimbursement for moving expenses. Such reimbursement is includable in an employee's income, but the employee is allowed certain offsetting income tax deductions if specified rules are satisfied. To receive the deductions, the employee must have moved because of a change in job location. In addition, the employee must satisfy both a distance test and a time test. The distance test requires that the employee's new workplace be at least 50 miles farther from the employee's old residence than the employee's old workplace (or at least 50 miles from the employee's old residence if the employee was previously unemployed). The time test requires that the employee work full-time in the general location of the new residence for at least 39 weeks during the 12 months following the move. An employee may take the applicable deductions in anticipation of satisfying the time test, but additional taxes will be payable if the time test is not ultimately met.

If all the preceding rules are satisfied, an employee may deduct the following expenses:

• Transportation expenses in moving household goods and personal effects

• Travel and lodging (but not meal) expenses in moving to the new residence

An employer may pay for other expenses, such as expenses to sell an old residence, premove travel to look for a new residence, or temporary living costs at the new location. Because these reimbursements will be taxable income without a corresponding deduction, the employer may give the employee a bonus to offset the increased tax.

Suggestion Awards

Some employers, particularly those in manufacturing industries, give awards to employees who make suggestions that will improve the operating efficiency of the firm if implemented. The awards are often a percentage of the firm's estimated savings over some specified future period of time but may be subject to a maximum dollar amount. If a suggestion plan is properly administered, the benefits of the plan may far exceed its costs while at the same time increasing the motivation and involvement of employees.

Suggestion awards are included in an employee's gross income for tax purposes.

Service Awards

Many employers provide awards to employees for length of service. These awards are often nominal for short periods of service (five or ten years) and may consist of such items as key chains, flowers, or pens. Awards typically increase in value for longer periods of service, and employees may actually be given some choice in the award received.

If the value of a service award is de minimis, it is not included in an employee's income. To be de minimis the value of the benefit must be so minimal that accounting for the cost of the benefit would be unreasonable or administratively impractical. Service awards of higher value may also be excludable from an employee's income if they are considered qualified plan awards. However, the total amount excludable from an employee's income for qualified plan awards (which also include awards for safety) cannot exceed $1,600 per year. Qualified plan awards must be provided under a permanent written program that does not discriminate in favor of officers, shareholders, or highly compensated employees. In addition, the average annual cost of all awards under the plan cannot exceed $400.

Productivity and Safety Achievement Awards

Some employers provide awards for productivity and safety achievement. Productivity awards are fully treated as compensation. However, while awards for safety achievement given to professional, administrative, managerial, or clerical employees are fully taxable, such awards are treated as qualified plan awards for other employees and are included in the $1,600 excludable figure mentioned previously under service awards.

Holiday Bonuses and Gifts

Many employers give gifts or bonuses to employees, particularly at Christmastime. Because the value of such gifts is typically small, some employees tend to resent gifts of money. Therefore, gifts such as liquor or a ham are often given.

As with service awards, a holiday gift does not result in taxation for an employee as long as the market value of the gift is small.

PAYMENTS FOR TIME NOT WORKED | Nonretirement Benefits

Holidays
Employers normally pay employees for certain holidays. At a minimum, employees usually receive pay for the following:

• New Year's Day
• Memorial Day
• The Fourth of July
• Labor Day
• Thanksgiving
• Christmas

Most employees receive at least six and sometimes as many as 11 or 12 additional holidays, which may include the following:

• Martin Luther King's Birthday
• Washington's Birthday
• Lincoln's Birthday
• Presidents' Day
• Good Friday
• Columbus Day
• The Friday after Thanksgiving
• Veterans Day
• Christmas Eve
• New Year's Eve
• The employee's birthday
• Various state holidays

For some institutions, such as banks, holidays are prescribed by law. However, for most companies, management decides which holidays to provide, subject to collective bargaining if applicable.

When a scheduled holiday falls on a Saturday, employees who normally do not work on that day are given the preceding Friday off. When a holiday falls on Sunday, it is normally observed on Monday. Restaurants and retail establishments are increasingly open for business on holidays. When this occurs, employees who work are usually paid at least time and a half and sometimes as much as triple time.

Some companies, realizing that not all employees want to take the same holidays, try to satisfy these needs by adopting holiday plans that include a minimum number of scheduled holidays coupled with a specific number of "floating holidays" to be taken at an employee's discretion. Usually, there is no requirement that the days taken actually be holidays, so in effect they become additional vacation days in lieu of holidays.

Like vacation pay, holiday pay is taxed as regular income.

Personal Time Off with Pay
Because personal situations that require an employee to be away from work occasionally arise, many employers allow employees to take time off with pay for certain reasons, the more common of which are the following:

• Reserve/National Guard duty. Laws sometimes require that employees be given time off for reserve or National Guard duty, but there is no stipulation that pay continue during this period. However, the majority of employers compensate their employees for the difference between their regular pay and any compensation received for the reserve or National Guard duty.

• Jury duty. Most employers grant (and may be required to grant) time off for jury duty. Because employees are usually compensated for jury duty, some employers pay only the difference between this amount and an employee's regular pay. However, the amount paid for jury duty is small and often just barely covers an employee's extra expenses. Therefore, many employers continue regular compensation with no deduction.

• A death in the family. Employers often allow up to five days off with pay for the death of family members. At a minimum, this usually includes the death of a parent, child, spouse, or other relative residing in the house-hold. Some employers allow a shorter period of time, such as a day or half a day, to attend funerals of other relatives and sometimes even persons other than relatives.

• Sabbatical leaves. Sabbatical leaves are well established as employee benefits at educational institutions. Typically, faculty members are permitted an extended leave of a semester or a year after a specified period of service, such as seven years. During the sabbatical leave, the faculty member receives full or partial pay while performing no services for the employer. Meanwhile, the faculty member is often required to complete a research project or some similar activity as a condition of the sabbatical. Noneducational employers, particularly those having employees with professional degrees, sometimes provide similar benefits to professional employees to give them an opportunity to engage in research or study that is not directly job related.

Some less common reasons for which employers may allow time off with pay include the employee's getting married and serving as a witness in a court proceeding. Because still other personal reasons for needing time off may arise, employers may grant two or three days of personal leave that can be taken at an employee's discretion.

Personal Time Off Without Pay (Family Leave)
For many years, most industrialized countries have had legislation that enables employees to be away from work for extended periods without jeopardizing their jobs. The reasons for such leave vary among countries, as does the extent to which the employer must continue to provide pay and benefits to an employee on leave.

Over the last two decades, an increasing number of American employers have voluntarily begun to allow employees to take time off without pay. Reasons for such leave may include active military duty, extended vacations, honeymoons, education, the birth or adoption of a child, and the illness of a family member. Usually, such time off has been subject to the approval of the employer. Family leave is becoming more and more common as many states and the federal government adopt family-leave legislation.

State Laws
In recent years, the legislatures of almost every state have considered family-leave legislation, and more than half the states have enacted such legislation. As a general rule, these laws allow an employee to take an unpaid leave of absence for reasons such as the birth or adoption of a child and the illness of a family member. The length of leave allowed varies considerably among states, but it usually ranges from three to six months. When the family leave is completed, the employer is required to allow the employee to return to the same or a comparable job.

Almost all family-leave laws apply to public employers, and about half of the laws apply to private employers with more than a minimum number of employees, usually in the range of 25 to 100. In all states, employers are allowed to limit family leave to employees who have met certain eligibility requirements. While these requirements vary, the most common requirement is at least one year of full-time employment. At a minimum, most family-leave laws allow an employee to continue medical expense coverage at his or her own cost. Some laws require all employee benefits to be made available.

Federal Law
In 1993, the first federal family-leave legislation—the Family and Medical Leave Act—became effective. Unlike some federal legislation, it applies not only to private employers but also to nonprofit organizations and government entities, including Congress. The provisions of this legislation cover only a small percentage of the nation's employers but approximately two-thirds of all employees.

Despite concerns by employers that the act would increase costs and lower productivity, the actual effect seems to have been minimal, partly because many large employers already had leave policies similar to the act's provisions. A report issued in May 1996 by the Bipartisan Commission on Family and Medical Leave reported the following:

• Approximately 90 percent of employers reported that there was no noticeable effect on productivity, profitability, and growth as a result of the act.

• Only about 16 percent of the persons eligible for leave actually took it. The vast majority of persons who did not take leave for which they were eligible said they could not afford the resulting wage loss.

• The median length of leave time is 10 days.

• The group most likely to take leave is employees between the ages of 25 and 34.

The act applies only to employers with more than 50 employees within a 75-mile radius. To comply with the 50-employee requirement, an employer needs only to have that many employees during each workday for a period of 20 or more calendar weeks during the current or preceding calendar year. Part-time employees and employees on unpaid leaves of absence are included in the calculation. The 50-employee requirement is based on "joint employment," which means that two or more related companies can be treated as a single employer on the basis of factors such as common management, interrelations between operations, centralized control of labor relations, and the degree of common ownership or management. The 75-mile radius is based on the shortest route on public roads or public transportation.

With some exceptions, a worker must be allowed to take up to 12 weeks of unpaid leave in any 12-month period for the birth or adoption of a child; to care for a child, spouse, or parent with a serious health condition; or for the worker's own serious health condition that makes it impossible to perform a job. An employer may use any one of the following four methods to determine the 12-month period to which the family leave applies:

• The calendar year

• Any fixed 12-month period

• The 12-month period beginning with any employee's first day of leave

• A rolling 12-month period measured backward from the date leave is used

With one exception, the method chosen must apply uniformly to all employees. The exception occurs if a multistate employer operates in one or more states that have family-leave legislation that mandates a method different from the one chosen. In that case, the employer is permitted to comply with the state's requirement for employees located in that state but must use the chosen method for employees in other states.

A serious health condition is defined as one that requires continuing treatment from a health care provider. The regulations implementing the act generally define this as meaning that the condition will require absence from work, school, or regular daily activities for more than three calendar days. However, the regulations also include treatment for pregnancy and certain chronic conditions, such as diabetes and asthma, as being serious health conditions even though treatment at any time may last less than three days. In addition, the definition includes health problems that are not ordinarily incapacitating on a day-to-day basis, but for which a person must undergo a series of multiple treatments. Examples in the regulations include chemotherapy or radiation for cancer, kidney dialysis, and physical therapy for severe arthritis. The regulations specifically exclude the following from the definition of a serious health condition: common colds, flu, upset stomach, and routine dental problems. Stress is also excluded, but mental illness arising from stress can qualify.

The act applies to both full-time and part-time employees. The latter must be allowed to take leave on a basis that is proportional to that given to full-time employees. However, leave can be denied to anyone who has not worked for the employer for at least one year and worked at least 1,250 hours during that period.

In most cases, the rules allow employees to take leave intermittently or by working a reduced week, but only with the employer's approval. The exception is that leave because of a person's or family member's serious health condition may be taken whenever medically necessary.

An employer is allowed to substitute an employee's accrued paid leave for any part of the 12-week period of family leave. In addition, an employer can deny leave to a salaried employee within the highest-paid 10 percent of its work force if the leave would create a substantial and grievous injury to the organization's operations.

An employee is required to provide 30 days' notice for foreseeable leaves for birth, adoption, or planned medical treatment. The employer can require that an employee provide a doctor's certification of a serious illness. An employer can also require a second opinion but must pay for the cost.

During the period of leave, an employer has no obligation to continue an employee's pay or most benefits, and the employee is ineligible for unemployment compensation. However, an employer must continue to provide medical and dental benefits during the leave as if the worker were still employed. The employee must continue to pay any required plan contributions and must be given a 30-day grace period for such payments. The employer is also required to send the employee a notice no later than 15 days before the grace period expires, stating that coverage will be terminated if the premium is not paid. The employer is allowed to recover the cost of premiums paid by the employer during the leave if the employee does not return to work for reasons other than (1) the continuance, recurrence, or onset of a health condition (as previously defined) affecting the employee or the employee's spouse, parent, or child, or (2) other cirucumstances beyond the employee's control.

Upon return from leave, an employee must be given his or her old job or an equivalent job. The employee must also be allowed to regain any benefits that were enjoyed prior to the leave without meeting any requalification requirements. With respect to retirement plans, any period of leave must be treated as continued service for purposes of vesting and eligibility to participate.

Employers must comply with the new federal law as well as with any applicable state laws. Because most existing state laws have at least one provision that is broader than the federal legislation, an employer must have a complete understanding of both laws.

An employer should have a clear, written family-leave policy that is consistently enforced. In establishing this policy, the employer should address such issues as

• Eligibility requirements

• Employee certification of need for leave

• Employee rights upon returning from leave

• Employer rights if employee terminates at end of leave

The federal law requires that an employer post a notice explaining the Family and Medical Leave Act, a sample of which is contained in material from the Labor Department, which administers the law. In addition, if an employer does not provide employees with guidance about their rights and obligations under the act in employee manuals or handouts, this information must be provided to an employee at the time he or she requests it.

Supplemental Unemployment Benefit Plans
Collective-bargaining agreements may require that employers contribute to a supplemental unemployment benefit (SUB) plan that is designed to supplement state unemployment insurance benefits for workers who are unemployed. These plans rarely exist for nonunion employees. Benefits are often payable for at least a year and with regular unemployment benefits may be as high as 95 percent of what the worker was earning while employed.

SUB plans typically require that employers contribute to a SUB fund on the basis of the compensation of currently active employees, and employee contributions may also be required. The fund is usually maintained by trustees selected by the collective-bargaining agent, and it is frequently a common fund maintained for several employers. Employer contributions to the fund are income tax deductible, and if the fund is properly designed, earnings on fund assets may also be exempt from income taxation. Benefit payments to employees are fully taxable.