As the novel coronavirus pandemic continues to impact businesses across the country and the world, many employers have implemented, or are considering, employee salary or wage reductions as one way to reduce overall business expenses and possibly to minimize more permanent reductions-in-force. These reductions may apply to specific employees, “across the board” to all employees, or on some graduated scale based on certain compensation levels or positions within the company. This article discusses some of the key employee benefits-related issues and considerations that companies should be aware of when implementing employee salary or wage reductions. (Note: There are also significant labor & employment related considerations and issues when implementing employee salary reductions, including wage & hour implications, FLSA classification issues, collective bargaining issues, and applicable state notice or other requirements. This article is not addressing those particular issues and is focusing on employee benefits considerations; however, employers implementing salary reductions should consider labor & employment implications as well.)
Below is a summary of key employee benefits issues if your company is considering employee salary or wage reductions:
A key principle to keep in mind is that the actual terms of your benefit plans matter! And, particularly when dealing with unique or new situations, do not assume that you already know the terms of your plans. While you may think that reducing salaries alone could not have an impact on the individual’s eligibility to participate, it is important to confirm by reviewing the actual terms of the company’s benefit plans. In many instances, your instinct will be correct. However, this is not a situation where you want to make assumptions, only to find out later that benefit plan participation was impacted. Checking the plan terms prior to implementing salary reductions will allow the company to adequately communicate with its employees on the impact of the salary reductions, including whether the employee will or will not see reductions in benefits or eligibility for benefits.
Carefully review any written employment agreements to determine whether or not a salary reduction triggers certain rights or obligations under the agreement. When an employee has a written employment agreement in place, the terms of that agreement will control that particular employment relationship and may address when the company may or may not make compensation-related changes for that employee. For example, many executive employment agreements contain a “good reason” trigger where the executive may terminate employment upon the occurrence of certain events and receive severance benefits. A material reduction in base salary is a common “good reason” trigger; however, some agreements will include an exception for certain “across the board” salary reductions. The company and the employee may ultimately agree to amend the employment agreement so that “good reason” is not triggered in a particular circumstance, but the key is to confirm if any employment agreements are in place and know how a salary reduction could impact the agreement before implementing any reduction.
A salary reduction may ultimately affect an employee’s eligibility to participate in the company’s deferred compensation plans or programs and may impact the actual dollar amounts that end up deferred for the year based on any deferral elections in place for the current year (e.g., a deferral election for 10% of “base salary”). A reduction in salary alone is not likely to give an employee a right to either cease current deferrals and/or take any type of in-service distribution from a deferred compensation plan; however, the company should review its deferred compensation plans and the related Internal Revenue Code Section 409A rules to determine any impact on deferred compensation plan participants.
On a related note, companies should take care to properly analyze and assess any potential Code Section 409A issues when considering deferring or delaying salary or other compensation payments in lieu of an actual reduction in salary or compensation. There can be significant tax issues and considerations (including under Code Section 409A), as well as state wage and hour considerations, when a company wishes to stop certain compensation-related payments and instead try to “make up” those payments at a later date. Bottom line: A company should not just assume that it may tell employees that it is reducing compensation now, but will or intends to pay those reduced amounts at a later point without considering the potential tax impact.
While an obvious point, mid-year changes to annual salary will impact an employee’s total salary for the year. Many bonus program calculations use a percentage of base salary and severance plans commonly use a severance formula tied to the employee’s salary at the time of termination (or possibly some average). The defined terms of the bonus or severance plans will be particularly important to see what base amounts to use in any benefit calculation down the road. When a company is determining bonus obligations at the end of the year, the company may not be able to look at the employee’s now-current annualized salary, but may need to look at the individual’s compensation that is actually paid throughout the year.
Generally, a salary reduction alone should not change whether or not the employee may continue to participate in the company’s 401(k) plan (although always check your plan’s terms!). However, a salary reduction may automatically change the actual dollar amount the individual is contributing to the plan (e.g., a participant’s deferral election for “3% of eligible compensation” has now become a lower per payroll deferral amount). Given this, participants may want to make changes to their current 401(k) plan deferral elections and employers may want to remind employees how to make such changes. Similarly, employee salary reductions may ultimately impact the amount of any employer contributions to the 401(k) plan for the year.
Salary reductions may also impact which individuals are considered “highly-compensated employees” under the company’s retirement (and welfare plans) for the current year or the following year. These determinations may impact the results of any non-discrimination testing for the plan.
Again, a salary reduction alone may not affect an employee’s eligibility for the company’s health plan (although, always important to confirm your plan’s terms). However, when that salary reduction is coupled with a reduction in the employee’s hours of service, the company needs to carefully consider if that reduction in hours affects eligibility under the current terms of the health plan. Many health plans provide that regular, active employees working 30 or more hours per week are eligible for group health coverage. If the employee is no longer meeting the plan’s eligibility rules, then the employee may experience a loss of coverage and trigger COBRA. A company may be able to change its plan terms (with approval from its third-party insurers) to allow these employees to continue to participate in the health plan, but the company should consider this issue well in advance of any actual reduction to adequately address any third-party approval requirements. While some insurance companies are currently offering to waive the service requirement under some of their products in light of the pandemic, this is not a legal requirement, so companies should be sure to check with their broker/insurance company to understand their options.
The company should also consider if salary reductions will have any impact on the group health plan’s “affordability” under the Affordable Care Act to determine if any employer-shared responsibility payments could apply to the company this year. If the company is reducing salaries (or hourly wage rates), but not making corresponding changes to the employee’s portion of group health plan premium costs, then the company’s analysis of its health plan’s “affordability” may change. This is an area where the company should review those determinations in light of potential salary or hourly wage reductions and consider whether it needs to make any changes or not to employee health plan premium costs so health coverage remains “affordable” for all eligible employees.
The FFCRA and the CARES Act, which are current legislative responses to the impacts of COVID-19, provide significant resources and benefits to eligible companies as they try to maintain employees, payroll, and benefits during this current pandemic. These resources include certain tax credits and potentially forgivable loans for certain small businesses; however, the benefits of many of these resources may be impacted by a reduction in headcount or salaries. Given this, the company should always consider any salary reductions in light of these new rules and guidance.
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