Benefits Basics – When an Employee Dies: A Resource Guide for HR & Benefits Professionals
As a member of your company’s human resources or employee benefits department, one of the most difficult calls you may receive is from a colleague or an employee’s family member notifying you of the death of an employee. This situation demands you to be at your best – you will be called upon to usher your company’s workforce through the loss of a colleague and to help your HR department and grieving family members navigate many benefits and compensation issues that must be dealt with related to the deceased employee. This guide provides a high-level reference resource, in a plan-by-plan format, on how to approach each type of compensation or benefit arrangement when an employee dies, and offers up some practical tips on employee benefits issues that may come up as you manage your company’s compensation and benefit administration for a deceased employee.
The information given in this guide is general in nature and is not intended to address every benefit or tax issue that may come up when dealing with the death of an employee or other nuances that may arise when considering the deceased employee (or their specific family and probate situation) or the specifics of your company’s benefit plans. In addition, any tax or other rules described in this guide are current as of the date of this guide, and do not infer that the rules described are the only rules (tax or otherwise) that may apply and are subject to change. As a result, we always recommend that you engage your in-house or external legal counsel or other tax or employee benefits advisors when working through compensation and benefits issues related to the death of an employee.
An Overview of Relevant Law
Before we dive into discussing issues for administering your company’s compensation and benefit plans, it is important to have a high-level understanding of the probate process because, as we explain below, what happens in probate can affect who is entitled to certain death benefits. In addition, it helps to understand how the Employee Retirement Income Security Act (ERISA), a federal law governing most retirement and welfare benefit plans, interacts with state laws when death benefits are involved.
Overview of Probate
“Probate”is the legal process through which a court appoints an executor (in some states, called a personal representative) to administer the deceased employee’s estate, and validates a will (if there is one) or decides who inherits the deceased’s estate if there is no will. If the deceased had a will, that document would normally name one or more individuals to serve as the executor of the estate. If the employee dies without a will, then state law provides a list of people who are eligible to fill the role.
A court will ultimately appoint one or more individuals to serve as executor for the deceased employee’s estate, by issuing “Letters of Administration”, “Domiciliary Letters” or simply “Letters”, which give the executor authority to act. (Other terms might also apply to the form of the document used for this appointment.)
However, there are two times when probate may not be needed to determine who has the right to a deceased employee’s outstanding compensation or benefits:
Beneficiary Designations. If the deceased employee has arranged for their assets to pass directly to one or more beneficiaries without going through the probate process, then these items are not counted as part of the probate estate. In the employee benefits context, this would occur when an employee has made beneficiary designations related to a benefit. Thus, if your company’s compensation or benefit plan has a beneficiary designation process that was utilized by the employee, then waiting for the probate process is generally not needed in order to distribute death benefits. This is why it’s important for employer compensation and benefit plans to permit (and encourage the use of) beneficiary designations—it helps employees (especially executives) in their estate planning process and may allow the employee’s accrued benefits to pass directly to their beneficiaries without the hassle and delay of probate.
Small Estate Affidavit. If the value of the deceased employee’s estate is below the dollar threshold set by state law, then the employee’s heirs may be able to use a “small estate affidavit.” This allows heirs to receive the employee’s assets without having to go through probate at all (or permits an expedited probate). In other words, if you receive a small estate affidavit, any payments owed to the deceased’s estate instead are paid directly to the heir(s) listed in the affidavit.
Interaction of ERISA and State Laws
ERISA Section 514(a) explicitly preempts state laws that “relate to” an employee benefit plan that is subject to ERISA, with limited exceptions for certain insurance, banking, and securities laws. Courts have interpreted this preemption language to mean that any state law that refers directly to an employee benefit plan, or that bears indirectly on an employee benefit plan, is not enforceable against an ERISA-governed employee benefit plan. For example, if an ERISA benefit plan says that a death benefit should be paid to a spouse, but state law says that the death benefit under a benefit plan should be paid to the estate, then the terms of the plan will control instead of the state law. The U.S. Supreme Court confirmed this approach in their 2001 opinion in Egelhoff v. Egelhoff (ERISA preempts a state law that revokes beneficiary designations upon divorce). Similarly, in their 2009 opinion in Kennedy v. Plan Administrator for DuPont Savings & Investment Plan, the U.S. Supreme Court held that a plan may rely solely on its plan documents to determine the proper beneficiary for a death benefit, and can ignore extraneous documents that contradict the terms of the plan (such as a divorce decree).
What does this mean for you when administering benefit plans?
Where an ERISA plan is involved, you need only look at the terms of the plan (including any beneficiary designations, if applicable under that plan) to determine who is owed payments or benefits following an employee’s death.
But, for non-ERISA plans, the result is less clear. In that case, you would have to look to relevant state law to determine the extent to which you can honor any beneficiary designation. For example, many states provide that upon divorce, any beneficiary designation naming the ex-spouse as the beneficiary is automatically void, unless the divorce decree provides otherwise. For ERISA plans, you ignore that rule because ERISA preempts that state law and would implement the most recent beneficiary designation. For non-ERISA plans, however, if the deceased employee had named his spouse as the beneficiary, and then they divorced, you should generally void that beneficiary designation if required under state law.
A QUICK NOTE ON ERISA VS. NON-ERISA PLANS
Determining whether a benefit plan is covered by ERISA can be complicated. While your company’s most common broad-based retirement and welfare benefit plans, such as 401(k) plans, pension plans, and medical, dental, vision or other welfare benefits, will most likely be governed by ERISA, there are many nuances in the rules that exempt certain benefit plans depending on how the plan is structured. This issue commonly comes up with certain disability or severance benefits or policies. Bonus programs, deferred compensation plans or other voluntary benefits or payroll practices are usually not subject to the ERISA preemption rules. However, due to the complexity of these rules, if you are unsure whether a benefit program is an ERISA or non-ERISA plan, consult with your benefit plan advisors when deciding whether to allow beneficiary designations.
Practical Steps to Take When an Employee Dies
Who You Should Involve
If you receive the initial call about an employee’s death from a family member, it’s imperative that you promptly contact the following individuals within your organization: the head of HR for the employee’s business unit (who should, in turn, contact the deceased’s manager and co-workers), the payroll department, the equity administration team (if any), the compensation team (if any), and all relevant members of the employee benefits team. You may also need to tell your financial or accounting department if the deceased employee has significant amounts of unvested compensation that will vest or need to be paid due to their death. Each individual will play an important part in the weeks (and sometime months or years) to come.
After you’ve surveyed the plans and arrangements in which the deceased participated, you should also contact the relevant plan vendors or third-party administrators, if there is one, who may need to take certain actions to account for the death of the participant.
While not a topic of this guide, work with your HR team (and the deceased’s family) to determine the appropriate format and contents of any messaging to your broader workforce, and possibly even customers or other suppliers, about the employee’s death.
NOTE ON COMMUNICATIONS ABOUT BENEFITS
When an employee dies, there are a significant number of people outside the company’s HR department who will need to be involved in communications related to the deceased’s compensation and benefits or who may inquire about benefits with the HR team, including the executor, family members and other potential beneficiaries. Therefore, remember to be mindful about who is actually entitled to receive communications or information about each type of benefit, depending on the terms of the plan, who is the designated beneficiary, or who is the person authorized to represent the deceased’s estate. And, ensure that you get any necessary documentation identifying who the company or the plan is authorized to speak with on a matter related to the deceased’s benefits before providing detailed benefit information. Consider designating a single point person on the company’s HR team to handle communications related to the deceased’s benefits to maintain consistency throughout the process.
The Information You Need
There are three documents you should get from the executor or deceased’s family or beneficiaries before taking any steps relating to compensation and benefits:
A copy of the death certificate. Not only will this prove the employee’s death, but will provide some important information, such as whether the employee was married, and will be required documentation for processing certain benefits.
Either a copy of the “Letters of Administration”, or simply “Letters”, which is issued by a probate court and names the executor(s) or a copy of a properly completed “small estate affidavit.” This document will let you know who you are authorized to deal with regarding any compensation or benefits for which there is no beneficiary designation on file.
A Form W-9 from the executor regarding the estate or from each heir listed in a small estate affidavit, as well as from any family member or beneficiary entitled to benefits or payments (as described below). The information on the Form W-9 will give your payroll department and your benefit plan administrators the information they need to make sure payments are properly reported to the IRS and state taxing authorities.
You will also need to figure out which benefit plans or programs the employee was enrolled in or otherwise had an accrued benefit under, and whether the employee had any individual agreements in effect with the company (such as equity awards, employment agreements, employee loans, etc.) and make sure you have copies of all of those documents and, if applicable, any beneficiary designations made by the employee. This information may come from internal HR records or from third-party benefit plan administrators or vendors. You also need to determine whether or not the plan in question is governed by ERISA, because as discussed above under “An Overview of Relevant Law”, and as explained below, for non-ERISA plans you may have to review state law to determine who is owed the payment or benefit.
Cash and Equity Arrangements
Overview
When an employee dies, you will need to consider the impact on a variety of compensation amounts or equity benefits. First, you should survey all of the cash and equity compensation that is or may be due with respect to the deceased. Almost certainly, a final paycheck will be due. Also consider:
Does the deceased have any outstanding paychecks that were issued, but not yet cashed as of the date of death?
Does the deceased have accrued vacation or other PTO that may need to be paid based on applicable state law and the company’s PTO policies?
Does the deceased have business expenses that were incurred or submitted to the company, but have not yet been reimbursed?
Does any annual or long-term cash bonus plan provide for a payout upon death, and if so, when? (Bonus plans sometimes will pay out automatically at target upon death, or may provide for payout to occur at the end of the performance period based on the level of achievement of actual performance, and either on a pro-rated basis or in full.)
Are there commissions payable?
Is there an employment agreement that provides for payments upon death?
Does the deceased have equity awards, such as stock options or restricted stock units?
Is there an amount held in an employee stock purchase plan account for the deceased that was waiting to be used to buy employer stock?
On the flip side, does the deceased owe any money to the company, such as under a personal loan? And if so, do the terms of the loan permit the company to offset the loan amount from other compensation?
Second, after identifying the agreements, policies and arrangements under which cash or equity compensation may be due, determine whether the agreement, policy or arrangement is subject to ERISA. If you are unsure, consult with your legal or other benefits advisors on this point.
If it is subject to ERISA, then follow the death benefit payment provisions of the plan, if any. Because ERISA preempts state law, you are permitted to pay according to the terms of the plan, including the beneficiary designation on file for a plan that permits beneficiary designations.
If it is not subject to ERISA, then you need to check whether the program permitted a beneficiary designation (and if so, is a beneficiary designation on file) or whether the terms of the program provided for a default beneficiary, such as a spouse. If so, you need to check relevant state laws to make sure the beneficiary designation or the default provision can be honored. As discussed under “Interaction of ERISA and State Laws”, above, some state laws may override the beneficiary designation or program terms and require you to make payment as required by law, and not as described in your documents.
If the program is silent about beneficiaries, then check whether the state in which the employee worked has a wage payment law that would dictate to whom the compensation items listed above should be paid. If there is no law on point, then the executor of the employee’s estate or the heirs listed in a small estate affidavit, whichever is applicable, are entitled to the payments or equity.
Manner of Payment and Taxation
Any compensation paid to the executor of an estate should be made payable to “[Name of Executor], Executor, Estate of [Name of Employee]” or simply to “Estate of [Name of Employee]” or a similar variation of this. Any compensation paid to the deceased’s heirs under a small estate affidavit should be divided among the named heirs and paid directly to each of them.
For wages paid to the estate, heirs, or beneficiaries during the year when the employee dies, you must withhold FICA (both Social Security and Medicare taxes) and FUTA (federal unemployment taxes) on the payment and report the amount only as wages on the deceased employee’s Form W-2, Box 3 (social security wages) and Box 5 (Medicare wages) issued for the year of death. The FICA and FUTA taxes withheld are reported in Boxes 4 and 6, respectively. But, you do not report the payments in box 1 of Form W-2, and you do not withhold regular federal income taxes. If you make the payments after the year of death, then those payments are not reported on a Form W-2, and you would withhold no taxes.
Whether the payment is made in the year of death or after, you also report the payments made to the estate, heirs, or beneficiaries on a Form 1099-MISC in box 3. In general, no federal income tax withholding is required, although backup withholding rules may apply to these payments if the recipient fails to provide you with the taxpayer ID number or Social Security number for processing payments.
You should always work closely with your payroll department and related tax teams to determine the appropriate tax withholding and reporting for any payments related to a deceased employee’s compensation or equity arrangements.
Special Issues for Equity Awards
Vesting and Transfer of Equity Awards. For all types of equity awards, you will need to determine what happens to unvested awards upon the employee’s death, e.g., is the award forfeited, does vesting accelerate, or does vesting continue after death? How to treat any equity awards after the employee’s death will either be discussed in the equity plan document or in the award agreement issued to the employee at the time of grant. Sometimes, an employment agreement might also describe what happens to equity awards upon death.
If the employee has outstanding stock options, you also need to determine the post-death exercise period for those options. Again, this information should be available in the equity plan document, individual award agreement or possibly in an employment agreement. Inform the deceased’s beneficiary, estate, or heirs, as applicable, of how long they have to exercise the award after the deceased’s death under the terms of the plan or the award agreement and provide them information on how to exercise such awards. In addition, notify the third party administer for your equity plan (if any), of the deceased’s death and specify any actions they need to take regarding such employee’s awards.
Tax Treatment of Equity Awards. Similar to other types of compensation as discussed above, there is no required income tax withholding for any equity award transactions that occur after the deceased’s death. Rather, any compensation income recognized for this transaction should be reported on a Form 1099-MISC issued to the employee’s beneficiary, estate, or heirs.
FICA and FUTA tax implications for equity awards upon an employee’s death are more complicated:
FICA and FUTA tax withholding applies (and should be reported on the employee’s final Form W-2) for any awards that were (1) vested before the deceased’s death (not awards that vest because of the deceased’s death), and (2) were exercised/settled before the end of the calendar year of the deceased’s death.
FICA and FUTA tax withholding does not apply, however, for (1) any awards (or any part of an award) for which vesting is accelerated upon the deceased’s death, no matter when exercised/settled, and (2) awards exercised or settled after the calendar year in which the deceased’s death occurs.
Employee Benefit Plans
Qualified Retirement Plans
401(k) and Other Types of Defined Contribution Retirement Plans. 401(k) plans are the most common employer-provided retirement benefit offered to employees. If an employee dies with an account balance in a 401(k) plan, the first issue is to determine if the deceased employee was vested in his plan benefit at the time of death, and if not, whether the plan provides for full vesting upon death while employed (which is almost always the case). Also check the plan terms to see if any employer contribution (matching, profit sharing, or other non-elective contribution) is due to the employee for the year of death. While some plans may require that an employee normally be employed on December 31 or have completed 1,000 hours of service during the year to receive an employer contribution, those requirements are often waived if the employee dies while employed. You will need to review the 401(k) plan document and the summary plan description to determine what rules should apply to the employee’s 401(k) plan account. You should always also work with the plan’s recordkeeper to review the deceased’s account information to determine that the proper vesting calculations are applied to the account.
If there is a vested account, and if the participant is married at the time of death, then the laws governing defined contribution retirement plans require that the participant’s spouse automatically be the beneficiary of the account, unless that spouse has waived his or her right to be the beneficiary. A spouse waives their right to be the beneficiary if the participant has properly completed a beneficiary designation form naming another person(s) as the beneficiary, the spouse has signed that form, and the spouse’s signature is witnessed by a notary public or plan representative. In such a case, the vested account belongs to the named beneficiary, not the spouse.
If the participant is unmarried and there is no beneficiary designation on file, then the plan’s terms will dictate who is treated as the beneficiary. Plans often list family members in a certain order, such as children, then parents, then brothers and sisters, and so on. Ultimately, a plan will almost always indicate that the last beneficiary, if there are no others, will be the employee’s estate.
Once you have determined who is the proper recipient of the plan account balance, notify the individual (or the executor, if it’s the estate) that they have the right to the benefit and give them a copy of the plan’s summary plan description, so they understand when and how they may apply for benefits to commence.
In general, 401(k) plans let a beneficiary keep the 401(k) account in the plan, roll the account over (including directly to avoid withholding) to another qualified employer plan or an individual retirement account (IRA), or receive a distribution as a lump sum. Some defined contribution plans also offer distributions as installment payments or an annuity. A spouse beneficiary has the same rollover options that the employee would have had – i.e., take a distribution or roll over the distribution to an IRA or an employer qualified plan in which the spouse participates. A non-spousal beneficiary can also elect a rollover, but only to an IRA. See below for a “Warning” about how payments made to an estate are not eligible for rollover.
Under Internal Revenue Code rules governing minimum required distributions, if the beneficiary does not begin to receive distributions over a period not to exceed their life expectancy by December 31 of the year after the participant’s death (or for a spouse beneficiary, by December 31 of the year in which the participant would have attained their minimum required distribution age), then the entire account generally must be paid to the beneficiary by December 31 of the year containing the 10th anniversary of the participant’s death. Different rules apply if there is no beneficiary, such as if the payment is owed to the estate; in that case, distribution must be completed within 5 calendar years after the year of the employee’s death. It is important to note that while a plan may not pay benefits later than these dates, the terms of the plan may require that the payments be made earlier, and there are other nuances under the minimum required distribution rules that may apply depending on the facts of the particular employee and beneficiary. You should check the terms of the plan and consult with your plan recordkeeper to determine when benefits must be paid to a beneficiary or to the employee’s estate.
Pension Plans. While pension plans are becoming less common as each year goes by, many employers still maintain them, even though the benefits under the plan have almost all been frozen at this point. The following discussion assumes that the employee has not commenced their pension benefit at the time of death; if they did, then whether any death benefit is payable depends on the form of payment selected by the employee at the time benefits commenced (e.g., a joint & survivor annuity, term certain annuity, etc.). Since most pension plans do not permit employees to begin their pension benefits while employed (in no small part because the law generally does not allow it), the rest of this section assumes that the employee had not started to receive their pension benefits at the time of death.
The first issue to consider is whether the deceased employee was vested in their plan benefit at the time of death, and if not, whether the plan provides for full vesting upon death. If the deceased has a vested benefit under the plan, then the law requires that the pension plan pay a death benefit to the participant’s spouse. This type of spousal death benefit is known as a “qualified preretirement survivor annuity” or “QPSA”. There are two circumstances when a QPSA may not be payable, even if the participant is married at the time of death: (i) often, a plan will require that the participant and spouse be married for the one-year period preceding death for the spouse to be entitled to the benefit, and (ii) although rare, a plan may have allowed the participant to waive the QPSA to avoid having a deduction applied to their benefit to “pay for” the QPSA protection. You will need to review the plan documents and coordinate with the plan’s recordkeeper to determine what result will apply in the circumstance and if a QPSA benefit is due to a spouse.
While in the typical pension plan situation, no death benefits are payable if the deceased is unmarried (or was not married for at least one year), that is not always the case. Some pension plans that describe their benefits as a hypothetical account balance or as a lump sum—such as cash balance or pension equity plans—may provide for the full lump sum benefit under the plan to be paid to the surviving spouse, to the beneficiary designated by the participant, or if none, then to the estate. If the participant named a beneficiary and was married at the time of death, then the beneficiary designation is void if the spouse had not consented to the beneficiary designation as mentioned under “401(k) and Other Types of Defined Contribution Plans”, above. If the beneficiary designation is void, then typically the spouse would have the right to any death benefit.
Payment to the spouse, beneficiary or estate will be made at the time, and in the form, described in the plan document. Once you have determined who is the proper recipient of the death benefit, notify the individual (or the executor, if it’s the estate) that they have the right to the benefit and give them a copy of the plan’s summary plan description, so they understand when and how they may apply for benefits to commence.
A WARNING ABOUT PLAN PAYMENTS TO ESTATES (INCLUDING SMALL ESTATE AFFIDAVITS)
Any distributions paid to the executor of an estate should be made payable to “[Name of Executor], as Executor of Estate of [Name of Employee]” or simply to “Estate of [Name of Employee]” (or a similar variation). Note that your plan recordkeeper may have alternate ways of designating the recipient when an estate is involved. Any distributions paid to the deceased’s heirs under a small estate affidavit should be divided among the named heirs and paid directly to each of them. While the IRS rules normally allow beneficiaries to elect to rollover a qualified plan death benefit to an IRA (to avoid withholding taxes on the distribution), neither an estate nor the heirs listed in a small estate affidavit can elect a rollover distribution. Therefore, you will need to work with your plan recordkeeper to ensure that if death benefits are paid directly to individuals via a small estate affidavit, then those benefits are not permitted to be rolled over into an IRA.
Welfare Plans
Life Insurance. As noted above, you will need a copy of the death certificate. Obviously, this is critical for administration of any life insurance benefit. The life insurance carrier (or third-party administrator, if self-funded) should be notified of the employee’s death and provided a copy of the death certificate. Check whether there is a beneficiary designation on file for the life insurance benefit and share the designation with the life insurance carrier to the extent the carrier does not already have this information. Also, consider confirming that the life insurance carrier properly processes the claim and pays the life insurance benefit to the beneficiary without issue. If the life insurance carrier denies a claim, you may be surprised by a lawsuit filed by an alleged beneficiary against the plan and the company claiming that the life insurance benefit was improperly denied or that the benefit was paid to the wrong individual. Although it may be the insurance carrier’s duty to pay any life insurance benefit, an employer can be roped into this type of litigation as the sponsor of the ERISA plan and potential liability could exist, for example, if the sponsor was found to have violated its fiduciary duties related to participant communications or enrollment issues regarding the life insurance benefit.
In addition, if the company sponsors optional dependent life insurance benefits, check to see if dependent life insurance was elected by the deceased employee and work with the dependent and carrier to explore whether the dependent wants to convert (or “port”) the policy into an individual policy.
Traditional Group Health Plans. For your traditional group health plans, such as medical, dental, and vision, you will want to tell the insurance carriers and/or third-party administrators about the employee’s death and determine when coverage will terminate for any enrolled dependents (e.g., on the date of death, on the last day of the month in which death occurred, or on the last day of the pay period in which death occurred).
If the company is subject to federal COBRA rules (generally, employers with at least 20 employees are subject to COBRA), you must notify the COBRA administrator of the employee’s death within 30 days from the date of death, and then the COBRA administrator has 14 days to send out the COBRA election packet to enrolled dependents. If you administer COBRA internally, then you have a total of 44 days to send out the COBRA election packet. Recall that the maximum COBRA coverage period is up to 36 months (instead of the standard 18 months) when the employee’s death is the qualifying event triggering the right for a dependent to enroll in COBRA coverage.
Because an employer may charge up to 102% of the full premium amount (both the employer and employee portions) for any individual who enrolls in COBRA coverage, the surviving spouse and dependents might wish to consider whether they have other, more reasonably priced, coverage available to them. For example, a dependent might be eligible for group health coverage through their own employer at a cheaper rate. The dependent should have a right to enroll in their own employer’s health plan, within 30 days of losing your plan’s coverage, under a HIPAA special enrollment right, but this special right to enroll mid-plan year is generally waived if COBRA is elected. Dependents might also consider enrollment in an individual health insurance policy offered through the government marketplace. In addition, you will need to review any employment agreements with the deceased employee to confirm if the company has agreed to pay for all or any part of an eligible dependent’s COBRA premiums in the event of the employee’s death.
If you are a small employer not subject to the federal COBRA rules, there still may be similar requirements under a state “mini COBRA” law of which you should be aware. You should not assume that the insurance carrier will administer your insurance policy’s mini COBRA provisions; often, insurance policies impose certain administrative obligations on the employer, such as notice obligations related to mini COBRA requirements.
DON’T FORGET ABOUT HIPAA RULES
When dealing with group health plans, don’t forget about HIPAA. The HIPAA privacy requirements still apply to protected health information (PHI) relating to a deceased individual for a period of 50 years. As a result, if you are dealing with the decedent’s PHI stemming from a group health plan, you should determine if HIPAA permits a disclosure without an authorization. For example, a plan sponsor can generally disclose individualized health plan information without an authorization for plan administration functions. If authorization is required, you must obtain an executed authorization from the personal representative of the decedent (generally, the executor). The personal representative can exercise all of the HIPAA rights of the decedent on behalf of the decedent.
Flexible Spending Accounts (FSAs). If the decedent was participating in a health FSA or dependent care FSA at the time of death, you should promptly determine when participation in the FSA ends according to the terms of the plan document. Often the plan document indicates that participation ends as of the date of death. However, the executor should still be allowed to file claims for reimbursements for qualifying expenses incurred during the plan year until the date of death. Recall that most FSA plans have a time limit for filing claims, known as a claims “run-out period”. The executor should be informed of the run-out period and provided enough time to submit claims on behalf of the decedent before the run-out period ends. Amounts not used to reimburse eligible expenses will be forfeited under the “use it-or-lose it” rule that applies to FSAs (unless COBRA is elected, as discussed below).
For a health FSA, COBRA coverage must be offered to eligible dependents under certain circumstances. Most health FSAs qualify for a limited COBRA obligation, which lets an employer only offer COBRA coverage to the decedent’s dependents when the decedent’s account is underspent (meaning that more money has been contributed to the FSA as of the date of death than has been reimbursed), and typically only for the rest of the plan year. Electing COBRA would allow the dependents to be reimbursed for their own medical expenses incurred after the participant’s death through the end of the plan year.
Health Savings Accounts (HSAs). If you sponsor a high deductible health plan (“HDHP”) and arrange (and pay for) a specific HSA custodian to set up individual accounts for your employees (which often includes allowing employee contributions via payroll deductions), consider what to do with the decedent’s individual HSA. Even though most HSAs are not subject to ERISA and an employer generally has limited responsibilities with HSAs relative to other benefit plans, it is still a good idea to raise the issue for the surviving dependents to determine the impact of the individual’s death on that account. Unlike health FSAs, the HSA funds remain the property of the HSA account holder – HSAs do not have the use it-or-lose it feature.
When an HSA account holder dies, any remaining funds are transferred to the individual named as the HSA beneficiary. If there is no such designation, the terms of the HSA custodial agreement will control. If the surviving spouse is named the beneficiary, the account will be treated as the spouse’s HSA after the employee’s death. The spouse maintains the HSA in the spouse’s own name and continues to have access to HSA funds on a pre-tax basis. If someone other than the spouse is named as the beneficiary (e.g., an adult child), then the account stops receiving the tax-deferred benefits of an HSA and the fair market value of the account becomes taxable to the beneficiary. The taxable amount will be reduced by any distributions made after death to reimburse qualifying medical expenses incurred by the account holder prior to death. Claims can be submitted up to one year after death.
Nonqualified Deferred Compensation Plans
Like pension plans and 401(k) plans, the first issue to consider is whether the deceased was vested in their entire benefit or plan account at the time of death, and if not, whether the plan provides for full vesting upon death. If any part of the account balance or benefit is unvested, it should be forfeited in accordance with the terms of the plan. Assuming there is a vested balance, you will need to see if the plan permits beneficiary elections, and if so, whether the deceased designated a beneficiary. If there is a beneficiary designation, payment should be made to this person. If there is no beneficiary designation, then payment should be made according to the plan’s rules for payments upon death. Most plans will provide for payment to be made to the deceased’s estate absent a beneficiary designation. Payment to the beneficiary or the individual’s estate should be made at the time and in the form elected by the deceased and/or as provided in the plan document.
If you have a third-party administrator for the plan, then reach out to them as soon as possible to notify them of the employee’s death and direct any actions they need to take regarding the deceased’s account or benefit under the plan (such as forfeiting balances or starting payments).
Other Unique Issues to Consider
Public Company Disclosure Requirements for Executives
No Form 8-K Requirements. Generally, the termination of an executive officer of a publicly traded company triggers the need to file a current report on Form 8-K with the Securities and Exchange Commission (“SEC”). However, the SEC has issued guidance that provides that a company does not need to issue a current report on Form 8-K to report the death of one of its executive officers.
Form 4 Reporting. The death of an executive does not trigger a Form 4 filing, nor does any transaction with respect to the company’s stock that is initiated after the executive’s death (such as the exercise of an option by the executive’s beneficiary). However, if the deceased executive initiated a transaction before their death that had not yet been reported on a Form 4 or Form 5 (for example, if the deceased sold stock the day before his or her death), then there is a duty to timely report such transactions that occurred before the executive’s death. The deceased executive’s reports can be signed and filed with the SEC by the executor of the insider’s estate or by the issuer or an employee of the issuer. No matter who signs and executes the report, the deceased executive should be named as the reporting person in Box 1 of the report, and the person executing the report on the deceased employee’s behalf should sign the report in their own name, indicating the capacity in which they are signing.
Slayer Statutes
Most, if not all, states have so-called “slayer statutes”, which are statutes that essentially prohibit killers from profiting from their crimes. If you are dealing with a situation where a deceased’s beneficiary is also his or her killer, you may struggle with what to do – pay the beneficiary according to the terms of the plan, or follow the state law? For non-ERISA plans, you can follow state law. For ERISA plans, however, it is not as clear. While there have been various cases involving the right to benefits in light of “slayer statutes”, the U.S. Court of Appeals for the Seventh Circuit became the first circuit court to decide whether ERISA preempts a slayer statute in Laborers’ Pension Fund v. Miscevic. What was their conclusion? ERISA does not preempt a state’s slayer statute and, as a result, the statute prevented the killer from being the beneficiary of the decedent’s ERISA pension benefits. Outside of the Seventh Circuit, there is still some ambiguity. In a more recent case, the U.S. Court of Appeals for the Sixth Circuit elected not to opine on the application of ERISA preemption to a Tennessee “slayer statute,” but instead relied on federal common law to conclude that an individual who murdered a decedent could not collect life insurance proceeds as the beneficiary of the decedent’s life insurance policy. Given this ambiguity, one way to handle it is to put this exception directly in the ERISA plan document, so that, when the time comes, you can follow your plan’s beneficiary rules. But, absent this language, you should consult with legal counsel, or failing all other courses, ask a judge to decide who should be the beneficiary.
Mandatory Roth Catch-up: More than Meets the Eye
In January, the Department of the Treasury (“Treasury”) and Internal Revenue Service (IRS) issued proposed regulations on the catch-up contribution provisions under the SECURE 2.0 Act of 2022 (“SECURE 2.0”). While the proposed regulations address both the new “super catch-up” contributions available to participants attaining age 60 to 63 and the mandatory Roth catch-up for certain high-paid employees, in this article we are focusing on the mandatory Roth catch-up requirement under Section 603 of SECURE 2.0. The proposed regulations confirm what we already knew – the mandatory Roth catch-up provision is complex and most plan sponsors will have work to do to prepare for the delayed January 1, 2026 effective date.
What does the new mandatory Roth catch-up provision require?
For plan years beginning on or after January 1, 2026, any 401(k), 403(b), or governmental 457(b) plan that allow participants who are age 50 or older during the plan year to make catch-up contributions, must require that certain high-paid participants, as described below (“hgh-paid participants”), be limited to Roth catch-up contributions only. If a plan currently permits only pre-tax catch-up, it must either add Roth catch-up for all participants or limit pre-tax catch-up contributions to only non-high paid participants.
Who is a high-paid participant subject to the mandatory Roth catch-up provisions?
Any participant who had more than $145,000 (as adjusted annually for cost-of-living) of FICA wages in the prior year from their common law employer, that participates in the plan, is considered a high-paid participant who is subject to the mandatory Roth catch-up requirement with respect to pay from that employer. FICA wages are defined by reference to social security taxes and the $145,000 limit is not adjusted or prorated for mid-year hires. This dollar limit and measurement of wages differs from those used to determine whether an employee is a “highly compensated employee” under IRS rules for other plan purposes, such as nondiscrimination testing, so this is a new bucket of pay to track for plan purposes.
There are also several other nuances to this rule, as follows:
If a participant receives FICA wages from more than one entity in a controlled group[1], those wages are not aggregated to determine whether the participant has FICA wages in excess of $145,000 (as adjusted). For example, if two related companies, Company A and Company B, each pay $100,000 of FICA wages to Employee A in 2025, then Employee A is not a high-paid participant in 2026.
If your company uses a common paymaster arrangement, then you are required to determine which entity or entities are a participant’s common law employer and look at whether any such entity has paid the participant more than $145,000 in FICA wages in the preceding year.
If you have entities in your controlled group that do not participate in your plan, then you can disregard those entities in determining whether an employee is a high-paid participant subject to mandatory Roth catch-up.
What if a high-paid participant transfers employment or has wages from multiple related entities? Does the mandatory Roth catch-up requirement apply with respect to all of the employee’s wages?
The answer is “not necessarily.” Only contributions taken from the wages of the common-law employer that caused the participant to be considered a high-paid participant are subject to the mandatory Roth catch-up treatment. This proposed rule is best illustrated by the following examples:
Example 1: Company A and Company B, two related companies, are both participating employers in a 401(k) Plan. In 2025, Company A paid Employee $175,000 of FICA wages and Company B paid Employee $0 of FICA wages. On 1/1/2026 Employee transfers to employment with Company B. Even though Employee is considered a high-paid participant with respect to the 401(k) Plan in 2026 due to receiving more than $145,000 of FICA wages from Company A in 2025, Employee is not subject to mandatory Roth catch-up with respect to her wages from Company B in 2026 because she did not receive more than $145,000 of FICA wages from Company B in 2025.
Example 2: Company A and Company B, two related companies, are both participating employers in a 401(k) Plan. Company A paid Employee $175,000 of FICA wages in 2025 and Company B paid Employee $75,000 of FICA wages in 2025. In 2026, Employee continues to split time between Company A and Company B. In 2026, to the extent catch-up contributions are deducted from compensation paid by Company A, those catch-up contributions must be made on a Roth basis. To the extent catch-up contributions are deducted from compensation paid Company B, those catch-up contributions are eligible for pre-tax deduction.
How do the mandatory Roth contribution requirements work if my plan has a spillover catch-up contribution design?
All plans must give high-paid participants the opportunity to opt out of catch-up contributions. For plans that permit participants to make a separate catch-up contribution election, an opt-out is easy and already built into your administrative process. For plans that automatically “spill” contributions made by eligible employees who have reached their maximum regular pre-tax and Roth contributions to catch-up contributions, we think you can meet this requirement by allowing a participant to change or cancel his or her deferral election at any time. For plans that also have spillover to a non-qualified deferred compensation plan (such that, for example, participant contribution elections must be locked in prior to the start of the year), this gets trickier and is something where you would want to work with your recordkeeper to identify a solution.
Can I count a high-paid participant’s regular Roth contributions toward the Roth Catch-up Requirement?
Yes, under the proposed regulations, a plan can take into account Roth contributions that a high-paid participant made prior to reaching the applicable deferral limit ($23,500 in 2025), for purposes of determining whether the mandatory Roth contribution requirement is satisfied. Mandatory Roth catch-up is only required to the extent that the high-paid participant has not previously made Roth contributions during the plan year equal to the applicable catch-up limit (e.g., $7,500 in 2025, before application of the super catch-up limit).
Can we still recharacterize regular pre-tax or Roth contributions as catch-up contributions in order to pass average deferral percentage (ADP) nondiscrimination testing?
Yes, the proposed regulations allow a plan to recharacterize regular pre-tax or Roth contributions as Roth catch-up contributions, subject to the applicable deadline below:
For plans that include an eligible automatic contribution arrangement (EACA) safe harbor, the plan has six months after the close of the plan year to recharacterize regular contributions as Roth catch-up contributions to pass a failed ADP test; or
For plans that do not include an EACA, the plan has two and one-half months after the close of the plan year to recharacterize regular contributions as Roth catch-up contributions to pass a failed ADP test.
If regular pre-tax contributions are recharacterized as Roth catch-up after the year is over (and within the applicable timeframe described above), then those recharacterized contributions must either be reported on the participant’s Form W-2 as Roth contributions or the plan must transfer the pre-tax dollars to the participant’s Roth account via an in-plan Roth conversion.
What should we do now to get ready for the new mandatory Roth catch-up requirement?
If you have not already done so, you should start a conversation with your plan recordkeeper and your payroll team regarding this new requirement, which will take effect on January 1, 2026 (or if later, the first day of your plan year beginning in 2026). This is particularly important if you have employees that split their time between multiple related entities, employees that transfer employment from one related employer to another during the year, if you use a common paymaster arrangement, or if your retirement plan utilizes a spillover design. Plan sponsors of plans that do not include an EACA may also wish to consider whether to implement an EACA in order to allow for more time to complete year-end nondiscrimination testing and recharacterize regular contributions as Roth catch-up to pass an otherwise failed ADP test. Plan sponsors should also begin considering how to communicate this change to participants, especially because this change directly impacts employees’ tax planning for 2026 and beyond. Keep in mind, however, that these are just proposed, not final, regulations, so further changes may be forthcoming in the final regulations.
[1] For ease of discussion, we will refer to a group of companies that is a controlled group, group of related companies, or affiliated service group as a “controlled group”.
Wisconsin Court of Appeals Finds Taxpayer-Funded College Grant Program to Be Unconstitutional
On February 26, 2025, the Wisconsin Court of Appeals, District II, determined that a program that provided taxpayer-funded educational grants to financially needy students of specific racial, national origin, and ancestry groups was unconstitutional.
Quick Hits
On February 26, 2025, a Wisconsin appellate court ruled that a taxpayer-funded educational grant program for minority students is unconstitutional, citing the U.S. Supreme Court’s decision in Students for Fair Admissions, Inc. v. President and Fellows of Harvard College (SFFA).
The court’s decision to halt the Minority Undergraduate Retention Program underscores the broader implications of the SFFA ruling, suggesting that race-based considerations in state-funded educational assistance programs may also violate the Equal Protection Clause of the U.S. Constitution.
Legal scholars and post-secondary institutions are closely monitoring the impact of the court’s decision and the federal government’s recent guidance, which indicates that the SFFA ruling could extend beyond university admissions to other areas, including employment-related decision-making.
Background
In April 2021, five Wisconsin taxpayers filed a lawsuit against the Higher Educational Aids Board (HEAB) and its executive secretary, Connie Hutchinson. HEAB and Hutchinson administer the Minority Undergraduate Retention Program, which was created by the Wisconsin legislature in 1985 to offer grants to certain undergraduate minority students. To be eligible for the grants, the students must be Black American, American Indian, Hispanic, or have ancestors who were formerly citizens of Laos, Vietnam, or Cambodia. In the case, Rabiebna v. Higher Educational Aids Board, the taxpayers claimed that the eligibility criteria (i.e., limiting eligibility to students of these specific racial or ethnic backgrounds) violated both the Equal Protection Clause of the U.S. Constitution and Article I of the Wisconsin Constitution.
The circuit court granted summary judgment in favor of the HEAB and Hutchinson. The taxpayers then appealed the decision. After the parties’ appellate briefs were filed, the Supreme Court of the United States issued its decision in Students for Fair Admissions, Inc. v. President and Fellows of Harvard College, 600 U.S. 181 (2023). In SFFA, the Supreme Court ruled that two universities violated the Equal Protection Clause of the U.S. Constitution by considering an applicant’s race as part of the applicant’s admissions processes. Therefore, both parties in the HEAB case submitted additional briefing to the appeals court articulating the impact of the SFFA case on its review of the Minority Undergraduate Retention Program in Wisconsin.
The Decision
After evaluating the Wisconsin statutory language and considering the parties’ arguments, the appeals court reversed the circuit court’s ruling, finding instead that the Minority Undergraduate Retention Program violates the law. Notably, the court relied heavily on the SFFA opinion to support its conclusion, citing to it more than one hundred times in its fifty-three-page decision. The court’s analysis also closely tracked the overarching legal framework provided by SFFA. As a result of this decision, the HEAB and Hutchinson are currently enjoined from further administering the grant program and distributing any funds from it.
Implications of the Decision
Some legal scholars initially interpreted the Supreme Court’s SFFA decision narrowly, arguing that it was limited to university admissions policies. However, the HEAB opinion signals that some courts are willing to utilize SFFA’s Equal Protection analysis in other contexts where race is a consideration, including state-funded educational assistance programs. Indeed, the Wisconsin appeals court, citing to SFFA, emphasized that no state has the authority under the Equal Protection Clause to use race as a factor in offering “educational opportunities.” (Emphasis in original.)
The HEAB decision also appears to align with the U.S. Department of Education’s “Dear Colleague” letter dated February 14, 2025, which explicitly states that the SFFA decision “applies more broadly” than just to university admissions decisions. Given this letter and the recent confirmation of Linda McMahon as the new secretary of education, post-secondary institutions may want to consider closely monitoring developments in the federal government’s interpretations of the law post-SFFA, and its subsequent enforcement actions.
Finally, it appears that the SFFA decision will have impacts beyond the realm of education. For example, there are already cases pending in various jurisdictions around the country that cite to the SFFA case to challenge an employer’s consideration of race in hiring or other employment decisions. Therefore, employers may also want to consider following these cases, along with litigation over the Trump administration’s executive orders regarding diversity, equity, and inclusion, to see whether and how the SFFA decision is implicated and whether courts will extend SFFA’s reasoning to cover employment-related decision-making.
Alright, Alright, A Write-Off: Matthew Mcconaughey’s Push for Texas Film Tax Incentives
Texas has long been a hub for film and television production, offering diverse landscapes, a rich cultural backdrop, and some real characters. Back in 2007 the state implemented the Texas Moving Image Industry Incentive Program, which is administered by the Texas Film Commission under the Economic Development and Tourism Division of the Office of the Governor.[1] Allocations have continued to grow ever since.[2] Starting with $20 million in the first year,[3] it is now the largest in state history at $200 million with a 22.5% tax rebate.[4]
However, this funding is still below competitive states like Georgia and New Mexico.[5] If Senate Bill 1 (SB1), which was filed on January 22, 2025, is approved, then $498 million would be allocated “to revamp the Texas Film Incentive, making Texas the movie capital of the world.”[6] The incentive would consist of two parts: “$48 million in grants for small films and TV commercials, and up to $450 million in new tax credits, including Texas residency requirements for workers,” which Lt. Gov. Dan Patrick provides would give Texas $4 back for every $1 invested.[7]
In early 2025, a coalition of prominent actors—including Matthew McConaughey, Woody Harrelson, Renée Zellweger, Billy Bob Thornton, and Dennis Quaid—launched the “True to Texas” campaign.[8] This initiative features a commercial directed by True Detective creator Nic Pizzolatto, where the actors emphasize the economic benefits, such as job creation and local business growth, that could result from increased investment in the Texas film industry.[9]
This push is no surprise given the new film studios opening in the state, including a 546- acre studio in Bastrop.[10] Also, over the past few years, more hit productions, such as Taylor Sheridan’s Yellowstone, 1923, and Landman, have filmed in Texas.[11]
As of February 13, 2025, SB1 has been scheduled for a public hearing in the Senate Finance Committee.[12] Given that our firm has represented clients in some of the industry’s largest and most complex transactions in the entertainment industry and has worked on numerous deals utilizing tax incentives around the world, we continue to monitor the status of SB1 and standby ready to advise clients as needed.
FOOTNOTES
[1] Texas Moving Image Industry Incentive Program | Fort Bend Economic Development Council
[2] Film Subsidies – Texas Public Policy Foundation
[3] Film Subsidies – Texas Public Policy Foundation
[4] McConaughey, Harrelson channel ‘True Detective’ in Texas films ad
[5] McConaughey, Harrelson channel ‘True Detective’ in Texas films ad
[6] Lt. Gov. Dan Patrick: Statement on the State Budget Filed in the Texas Senate – Lieutenant Governor Dan Patrick
[7] Lt. Gov. Dan Patrick: Statement on the State Budget Filed in the Texas Senate – Lieutenant Governor Dan Patrick
[8] Dennis Quaid says Texas wants to be ‘New Hollywood’ in ad: photos
[9] Dennis Quaid says Texas wants to be ‘New Hollywood’ in ad: photos
[10] Bastrop film studio could produce $1.9B over 10 years and Bastrop reels in massive film studio and entertainment complex from California company
[11] McConaughey, Harrelson channel ‘True Detective’ in Texas films ad
[12] TX SB1 | 2025-2026 | 89th Legislature | LegiScan
A Delay in Exit Plans
There was much hope going into 2025 that we would see a rebound in the IPO market after a bit of a drought over the past few years. We left the uncertainty of the election behind us, and good news on the inflation and interest rate fronts were fueling a sense of hope that 2025 was going to be a great year for the IPO market. However, at almost three months into the new year, it is looking like that rebound might be delayed a little longer.
The Wall Street Journal reports that the market volatility we are currently seeing is going to make IPO pricing a “monumental challenge,” and the IPO recovery that venture investors have been waiting on is on hold. The market is reacting to the threats of tariffs and a trade war, as well as recent talks of a recession, and the WSJ says this is keeping some companies on the sidelines as they delay their exit plans.
Yahoo! Finance cites data from Dealogic indicating that the total value of US IPOs is up 62%, coming in at $10 billion as of March 11 – almost double the number of deals compared to the same period in 2024. However, this is still well lower than the kinds of numbers we were seeing in the boom of 2021.
There are some companies who have already gone public this year, with six venture backed IPO’s as of mid-March. And there are still some on track, at least as of now, for the second quarter. Klarna and CoreWeave both filed an IPO prospectus this month, but those plans could be derailed if the market continues its roller coaster ride. Others have already put their plans on hold.
And it is not just IPOs that are delayed – mergers & acquisitions (M&A) are also off to an extremely slow start this year despite expectations that there would be more robust activity this year. PitchBook data show that “US M&A volumes in January were the lowest they’ve been in 10 years, and February wasn’t rosy either.” They point to antitrust policy, market turmoil, and “price mismatches” as contributing factors here. The leadership at the DOJ and FTC also remains critical of Big Tech, so many of those players are sitting on the sidelines which has slowed down dealmaking considerably.
Only time will tell how the back and forth on tariffs will play out, but they are certainly having an impact on the market now and could have longer term impacts that further delay exit plans. A recent article in Forbes notes that the “market’s long-term response to tariffs depends largely on adaptability—how quickly companies can adjust supply chains, pass costs to consumers, or find alternative markets.” But how quickly companies can pivot remains to be seen, and timing will be critical for market stability and for transactions to resume.
There is certainly still hope that successful trade negotiations could end this tariff battle, but there are still fears about the current state of the economy and the potential for a recession. The world is watching closely to see how all of this shakes out, as is everyone sitting on the sidelines planning their next move.
Given that the pre-IPO planning process can be lengthy, and we know that better planning leads to better performance (and that lack of planning leads to poor results), companies and financial sponsors should be getting their ducks in a row for an anticipated IPO market window opening soon, perhaps as early as May 2025.
California Snags Former Resident for Tax Due on Stock Options
Many employees receive stock options as compensation from their employers. When receiving this type of compensation, the state tax implications may not be at the forefront of the employees’ minds, especially where it may be years between when the options are granted and when the options actually result in recognized income. However, failure to consider the state tax implications when stock options are granted may lead to unanticipated and sometimes costly consequences in this unsettled area of law. A recent opinion from the California Office of Tax Appeals (“OTA”) illustrates this point. Matter of Hall, 2025-OTA-113 (Cal. OTA Issued Dec. 13, 2024).
The Facts: Appellant served as president of Monster Beverage Company (“MBC”) from 2007 to 2013 and as chief brand officer of MBC in 2014. From 2009 to 2013, while Appellant was a resident of California, MBC granted Appellant non-qualified stock options (“NSOs”) and restricted stock units (“RSUs”). In December 2013, Appellant moved to Hawaii. Thereafter, in September 2014, the RSUs that Appellant received vested, and Appellant exercised his NSOs.
On Appellant’s 2014 California nonresident return, he reported none of the income that he recognized from the exercised NSOs and vested RSUs as California source income. Three years later, California commenced an examination of Appellant’s returns, during which it determined that the exercised NSOs and vested RSUs resulted in California source income because they were attributable to personal services performed by Appellant in the State. To determine the amount of income sourced to the State, California applied a ratio of California working days to total working days – resulting in a total tax assessment of $674,452 plus interest. Appellant appealed the assessment.
The Decision: In a nonprecedential opinion, the OTA first reviewed the taxability of NSOs and RSUs, identifying three critical points under California law: (i) income earned from the exercise of NSOs and the vesting of RSUs is treated as compensation for services; (ii) if an NSO does not have an ascertainable fair market value at grant, the grantee recognizes income in the taxable year the option is exercised; and (iii) taxable income from RSUs is generally taxable in the year the RSUs vest. Applying these points of law to Appellant, the OTA found “no dispute” that Appellant recognized income from the exercised NSOs and vested RSUs. Thus, the only issues remaining were: (1) whether the income Appellant recognized was subject to California income tax if Appellant was a nonresident at the time of exercise/vesting; and (2) if so, whether the State’s working day sourcing methodology was reasonable.
The OTA determined that it was “immaterial” that Appellant ceased being a California resident in 2014 because “the income from the NSOs and RSUs is treated as compensation for personal services… performed in California” between 2009 and 2013. Further, the OTA determined that the income at issue was reasonably sourced using the standard methodology of California working days to total working days – a methodology which the Appellant failed to argue, or show was incorrect.
Last, the OTA addressed Appellant’s claim that he was denied procedural and substantive due process because his ability to claim a credit for taxes paid in Hawaii was foreclosed because the statute of limitations to file such a claim in Hawaii had expired. The OTA determined it lacked jurisdiction over this claim, finding as a general rule that its jurisdiction is “limited to determining the correct amount of a taxpayer’s California [tax liability].”
The Takeaway: The Appellant would have benefited from considering the state tax implications and broader multistate issues of receiving stock options at the time of grant. If such consideration had been given, the Appellant could have at least tracked working days closely to avoid over-allocation to California and potentially timely sought a credit from Hawaii.
The importance of considering the state tax implications of stock options as compensation cannot be overstated, especially when considering that tax treatment varies by state. For example, when determining the portion of income from NSOs earned by nonresidents that is subject to tax, California looks to the taxpayer’s activities during the period from the grant of the NSOs to when they are exercised, while New York looks to the period from the grant to when the NSOs vest.
Taxpayers filing in various jurisdictions should take care to track their stock options, their working days, and consider credits for taxes paid in the various jurisdictions in a timely manner.
Tax Assessments: Minimum Evidentiary Foundation Required
When a taxpayer challenges an assessment issued by a state or local taxing authority, the taxing authority will typically assert that its assessment should be afforded a presumption of correctness, and the burden of proof is on the taxpayer to prove that the assessment is incorrect. While this is typically true, a presumption of correctness can only attach to an assessment if there is a rational basis and minimum evidentiary foundation for the assessment. While this should not be a high bar to cross for state or local taxing authorities, there are nonetheless times when they do not meet even these minimal requirements, and assessments are issued with no rational basis and no minimum evidentiary foundation.
A recent decision by the Alabama Tax Tribunal (“Tribunal”) highlights such an instance where local Alabama taxing authorities issued sales tax assessments that could not even satisfy these minimal requirements, and the assessments were voided without the company or a representative of the company even appearing at the trial. VV & Co., LLC v. City of Boaz; Docket No. City 23-1081-LP; VV & Co., LLC v. City of Albertville; Docket No. City 23-1082-LP (Ala. Tax Trib. Feb. 3, 2025). While it is never recommended that an appealing company not show up for its trial, the decision is a reminder that state and local taxing authorities are not unrestrained in their authority to issue assessments, and minimum requirements must be satisfied before the burden of proof shifts to a taxpayer to prove that an assessment is erroneous.
The two Alabama localities here engaged a third-party auditor that conducted a “desk audit” of the company that resulted in the sales tax assessments. In its appeal to the Tribunal, the company asserted that it did not do any business in the localities and that it only made wholesale sales of cars, and had no sales tax liability because it made no retail sales. At trial, the auditor from the third-party firm testified and the company did not appear. The auditor testified that the reason for the assessments was that the company had historically filed sales tax returns in the localities (several reporting zero sales), but beginning with the audit period, the company stopped filing returns. The assessments were calculated using estimation techniques based on the amounts reported on the company’s historic sales tax returns. The auditor further testified that neither locality had received any documents from the taxpayer indicating that the company made any sales in the localities during the audit period.
The Tribunal explained that while assessments in Alabama are “prima facie correct,” it is also “well established that the final assessments must be ‘based on a minimum evidentiary foundation.’” The Tribunal also noted that sales tax liabilities may only be estimated if “there is evidence reasonably establishing that the retailer conducted business and made sales during the period.” Finding that the “sole foundation” for the assessments issued by the localities was that the company “had filed tax returns at some point prior to the audit periods in issue but then stopped filing returns,” the Tribunal concluded that such reasoning was “insufficient to justify the final assessments,” and voided the assessments.
City’s Electric Slide Stumbles as Invalid Tax
We often focus on whether a levy is a tax masquerading as a fee because a state tax must be fairly apportioned under United States Constitutional precedent, while a fee is not so limited. Some “fees” can be quite material in amount, so it is important to have a second route of attack: challenge the levy as an improperly enacted tax. After improper enactment, the City of East Lansing (the “City”) lost badly to such a challenge. Heos v. City of East Lansing, Docket No. 165763 (Mich. Feb. 3, 2025).
The City of East Lansing realized that its budgeting was resulting in the City’s underfunding of its pension and other post-employment benefits obligations. To fill the gap, the City determined to charge a franchise “fee” for providers of electricity services and passed an ordinance to enact the levy – the levy was never voted on by City voters.
The franchise “fee” levy was negotiated into the franchise agreement for one of the City’s two electricity providers (the second provider refused to participate). The franchise agreement included a levy of 5% of revenue and was to be collected and remitted by the electricity system provider and placed on the bills of customers who receive and pay the energy bills. The provider was not liable for the levy itself, only for collecting and remitting it to the City.
Prior to the above-mentioned creative budgeting ordinance by the City, the “Headlee Amendment” to the Michigan Constitution was enacted. The Amendment prohibits units of local government:
from levying any tax not authorized by law or charter when [the Headlee Amendment was] ratified or from increasing the rate of an existing tax above that rate authorized by law or charter when [the Headlee Amendment was] ratified, without the approval of a majority of the qualified electors of that unit of Local Government voting thereon. Const 1963, art 9, § 31 (emphasis added).
As the Michigan Supreme Court aptly framed the issue: “Although the levying of a new tax without voter approval violates the Headlee Amendment, a charge that constitutes a user fee does not.” The Court observed with broadbrush that: “Generally a ‘fee’ is ‘exchanged for a service rendered or a benefit conferred, and some reasonable relationship exists between the amount of the fee and the value of the service or benefit.’ . . . A ‘tax,’ on the other hand, is designed to raise revenue.” This is as useful a distillation as the author has seen by a high court over the past nearly thirty years.
The Court explained with particularity that for a levy to be considered a fee, the levy must: (1) “have a regulatory purpose and not a general revenue-raising purpose[;]” (2) “be proportionate to the required costs of the service[;]” and (3) “be voluntary.”
A majority of justices found that (1) the City stated publicly that the fee had a revenue raising purpose to fill a budget gap and funds collected and remitted by the electricity service provider went into the general revenue fund to be used for any City purpose, (2) the fee was not “proportional to the costs the City incurred for granting [the electricity service provider] the right to provide electrical services to plaintiff[,]” and (3) the fee was not voluntary because, if the plaintiff did not pay the electric bill that contained the fee, the electric service was subject to being turned off. Applying those findings, the Court concluded that the levy was indeed a tax. Further, inasmuch as the City’s voters had never had the opportunity to vote on the levy, the levy failed as a tax on which a proper vote had not been conducted.
On a secondary issue, whether plaintiff electricity user was a taxpayer eligible to bring suit, a majority of justices answered in the affirmative. However, one justice wrote in dissent to conclude that the plaintiff was not a taxpayer (two justices did not participate in the decision).
The takeaway here is that if you are faced with a levy, ask what the levy is accomplishing and determine whether the levy is susceptible to challenge either as an unapportioned tax or, as in Heos, an improperly enacted tax.
Boosting Boston’s Housing: City & State Partner to Overcome Market Challenges
According to recent news coverage, about 30,000 housing units proposed for Boston are approved by the Boston Planning Department (BPD) yet unable to break ground due to market conditions. In response, the Wu administration, in partnership with the Commonwealth of Massachusetts, is advancing the following strategies to facilitate construction commencement: revising affordable housing agreements, providing direct public funding through a newly launched fund, and granting tax abatements, tax credits, and grants for office-to-residential conversions.
Revised Affordability
The Inclusionary Development Policy (IDP) originally created by a mayoral executive order in 2000, and now codified in Article 79 of the Boston Zoning Code, requires developers of market-rate housing projects to include a prescribed number of income-restricted housing units at prescribed affordability levels. The BPD prefers on-site IDP units, although compliance may be achieved by creating off-site units near the project or by paying into an IDP fund in an amount based on the project’s location in a high, medium, or low property value zone.
For stalled projects, the BPD and the Mayor’s Office of Housing (MOH) have been willing in certain circumstances to revise a project’s IDP commitments given the difficult financial environment and the urgency to build more housing. This strategy is not part of a formal program and does not follow rigid procedural rules.
Examples of recent proposals include:
A payment in lieu of half of the approved on-site IDP units based on the applicable property value zone and conditioned on building permit issuance within a specified timeframe, with the contributed amount being directed to an identified nearby affordable housing project; and
A commitment to deliver 4% instead of 18% on-site IDP units in an initial building, and to construct a separate project in close proximity with larger, more deeply affordable units, funded with proceeds from the sale or refinancing of the initial building.
In each case, affordable housing agreements with MOH were amended with a limited administrative process.
Momentum and Accelerator Funds
MassHousing is administering a newly created Momentum Fund, supplemented for Boston projects by the City of Boston’s Accelerator Fund, providing additional equity alongside private equity to improve the economics of stalled projects. The resulting noncontrolling investment would:
Comprise a quarter to half of the total ownership interests;
Be committed before construction financing closes;
Be funded when permanent financing closes; and
Be coterminous with the project’s senior loan up to 15 years.
The Momentum Fund is capitalized with $50 million as part of the Affordable Homes Act signed by Governor Healey in August 2024, and the Accelerator Fund is capitalized with $110 million proposed by Mayor Wu and approved by the Boston City Council in January 2025. MassHousing will review applications and handle underwriting, and will consult with the BPD on applications for projects in Boston.
To receive funds, projects must create at least 50 net new housing units, at least 20% of them income restricted at 80% AMI, and must demonstrate that they are energy code compliant and can commence construction within 6 months of the commitment of funds.
Resources for Office to Residential Conversions
Boston’s Downtown Residential Conversion Incentive Program supports downtown office-to-residential conversions in light of the post-pandemic decline in office utilization paired with businesses vacating Class B and C properties in favor of Class A properties. Eligible proposed conversions must be IDP and energy code compliant, and must commit to commence construction by December 31, 2026.
Developers under this program can obtain tax abatements of up to 75% at the standard residential tax rate for up to 29 years as memorialized in a Payment in Lieu of Taxes (PILOT) agreement, along with fast-tracked project impact review and reduced mitigation and public benefit commitments.
By the end of last year, 14 submitted applications to the Conversion Program representing 690 housing units resulted in 4 project approvals, with submissions and approvals continuing this year based on an extension of the program through December 2025.
Separately, the Commonwealth’s Affordable Housing Trust Fund has allocated a total of $15 million for grants to conversion projects of at least 70,000 square feet. This fund can provide up to $215,000 per affordable unit and up to a total of $4 million per project. The City of Boston will apply to the state for such funding on behalf of qualifying project applicants. As of early March 2025, about $7.5 million of the original pool is still available. In addition, the Affordable Homes Act establishes a tax credit program for qualified conversion projects covering up to 10% of total development cost to be administered by the Executive Office of Housing and Livable Communities (“EOHLC”). EOHLC is currently developing guidelines for implementation and is seeking input from developers and other interested parties.
DOL Expands Fiduciary Breach Correction Options
The United States Department of Labor (DOL) has updated its procedures for correcting certain fiduciary violations. This expansion allows employers to self-correct a broader range of errors, aligning the program more closely with the IRS’s recently updated correction procedures. If certain conditions are met, the new guidance allows for self-correcting some of the most common fiduciary violations, such as late contributions, late loan repayments, and inadvertent loan failures.
The DOL has long provided plan fiduciaries the option to use its Voluntary Fiduciary Correction Program (VFCP) to address various fiduciary violations. The program requires plan sponsors to both correct the fiduciary violation and submit an application to the DOL for approval. The core elements of the VFCP program remain unchanged. However, the DOL has expanded the program to include a self-correction component (SCC), which will allow plan sponsors to correct fiduciary violations without submitting an application to the DOL. Employers can begin using the new SCC provisions on March 17, 2025.
When Can SCC Be Used?
SCC is available for three fiduciary violations: failure to transmit contributions timely, failure to transmit loan repayments timely, and some inadvertent loan failures. Covered inadvertent loan failures include errors that could be self-corrected with the IRS under its Employee Plan Compliance Resolution System (EPCRS), which includes the most common loan failures.
What Are The Requirements?
To use the SCC program, several requirements must be satisfied:
If the violation caused lost earnings, those lost earnings must be calculated using the DOL’s lost earnings calculator and be less than $100.
Late contributions or loan payments must be made to the plan within 180 days following when the employer withheld the amounts.
Employers must complete and maintain a copy of the SCC Record Retention Checklist. Given the importance of complete and proper documentation, employers should seek assistance from legal counsel and other plan service providers.
Employers must file electronically with the DOL as part of the correction process. Under the traditional VFCP process, the DOL would issue a no-action letter. Under the SCC program, a no-action letter will not be issued, but an acknowledgment will be provided after the electronic filing is made.
Any correction amounts and costs related to the SCC process must be paid from the employer’s general assets, not from plan assets.
SEC Issues New Guidance on Self-Certification of Accredited Investor Status in Private Placements
On March 12, 2025, the staff of the Division of Corporate Finance (the staff) of the US Securities and Exchange Commission (the SEC) concurrently issued a no-action letter and interpretive guidance via new Compliance and Disclosure Interpretations (C&DIs) that helpfully clarify and expand the circumstances in which “accredited investor” status may be verified through investor self-certification when the minimum investment amount of an offering crosses applicable thresholds.
The private offering safe harbor afforded by Rule 506(c) of Regulation D (Rule 506(c)) under the Securities Act of 1933, as amended (the Securities Act), allows for the use of general solicitation and general advertising in connection with private placements, provided that, among other requirements, the issuer takes “reasonable steps” to verify that all of the participating purchasers qualify as “accredited investors” pursuant to SEC rules and regulations.1 This accredited investor verification requirement has historically been viewed as materially limiting the usefulness of the Rule 506(c) safe harbor, as the requirement has been understood to necessitate the undertaking of an oftentimes administratively burdensome manual verification process of each participating investor’s status and qualifications, including, for example, the collection and review of individual purchasers’ tax returns to confirm income eligibility thresholds had been met or requiring the engagement of third-party services to confirm ownership of assets (as relying solely on representations delivered by the investors themselves with respect to such qualifications and metrics was deemed insufficient in terms of conducting the “reasonable steps” verification process required by Rule 506(c)).
Significantly however, the recent no-action letter and C&DIs confirm that an issuer may now reasonably conclude in the context of an offering under Rule 506(c) that it has taken reasonable steps to verify a purchaser’s status as an accredited investor in circumstances where:
the purchaser has agreed to make a minimum investment of (i) $200,000 if the purchaser is a natural person or (ii) $1,000,000 if the purchaser is an entity (including, in each case, with confirmation from the purchaser that if such purchase is being made via a capital commitment, that such commitment is binding);
the purchaser provides representations both that (i) it is an accredited investor and that (ii) it is not receiving thirdparty financing in whole or in part with respect to the purchase; and
the issuer does not have any actual knowledge indicating that the purchaser is not in fact an accredited investor or that any of its provided representations (including as to the lack of thirdparty financing) are untrue.
Although the no-action letter and C&DIs, by simplifying the accredited investor verification process in certain circumstances, are expected to enhance the attractiveness of the Rule 506(c) exemption for issuers conducting private offerings, it is important to note that if a Rule 506(c) offering fails to qualify for the safe harbor for any reason, and the issuer has already engaged in general solicitation with respect to such offering (as would normally be permitted under Rule 506(c)), neither the exemption provided by Rule 506(b) of Regulation D (Rule 506(b)),2 which allows issuers to raise unlimited capital from accredited investors and up to 35 non-accredited investors (provided there has been no general solicitation or advertising), nor the general private placement exemption provided by Section 4(a)(2) of the Securities Act, for transactions not involving a public offering, would be available as fallback options with respect to the potentially busted securities law exemption – it is therefore crucial that issuers consult with counsel as early in the process as possible to ensure any potential offering is structured and conducted in a manner in which the availability of an exemption from registration is not called into question.
1 Rule 506(c)(2)(ii).
2 Issuers seeking to avoid burdensome accredited investor verification processes have historically turned to Rule 506(b) as the securities law exemption of choice – between July 1, 2020, and June 30, 2021 (the latest period for which data is available), issuers raised approximately $1.9 trillion under Rule 506(b), compared to $124 billion under Rule 506(c). https://carta.com/learn/private-funds/regulations/regulation-d.
What Every Multinational Company Should Know About … The Current Trump Tariff Proposals
Although we are only two months into the new administration, we have seen a dizzying array of new tariffs that have been proposed, imposed, revoked, suspended, and sometimes reimposed. It can be difficult for importers to keep up with all the proposals. So, as an aid to the importing community, we have put together an “evergreen” tariff article, which contains three key items for importers:
A table of the tariff proposals, including their current status[1] and the key importer issues for each;
A list of resources for importers looking for aids to cope with tariff and international trade uncertainty; and
A list of the most common questions we are receiving from clients regarding the new tariffs and their implementation.
We will be regularly updating these resources to reflect new tariff proposals and modifications, which are in some cases being updated or changed daily.
Where Are We on the Various Tariff Announcements?
At this point, we count 12 tariff initiatives that are proposed or in play. They range from broad-based tariffs that cover all goods from a certain country (Canada, China, and Mexico), tariffs that cover certain types of goods (aluminum and steel), promises of future tariffs (automotives, semiconductor, pharmaceutical, copper, and lumber), and promised retaliatory tariffs (European wine and alcoholic beverages). Further, although we have seen more tariff announcements in the first two months of the second Trump administration than we saw in the entirety of the first one, the largest tariff shoe is yet to drop: It is likely that the announced “Fair and Reciprocal” tariff rollout will dwarf the tariffs imposed to date, with the countries at the greatest risk of increased tariffs consisting of:
Countries that impose high tariffs. Notable examples include Argentina, Bangladesh, Brazil, Egypt, India, and Pakistan.
Countries that are viewed as heavily subsidizing their manufacturers. Depending on the particular type of products, examples include China (especially) as well as Australia, Canada, and the European Union countries.
Countries that are viewed as manipulating their exchange rate. The Department of Commerce already has issued a finding that Vietnam grants subsidies by manipulating its exchange rate, in a countervailing determination involving tires from Vietnam. As part of its semiannual report to Congress, the Treasury Department maintains a “monitoring list” of exchange rate policies that arguably confer subsidies. The November 2024 list included China, Germany, Japan, Singapore, South Korea, Taiwan, and Vietnam.
Countries that have put in place import barriers aimed at high-profile, high-volume products such as automobiles. While the United States maintains tariff levels of 2.5 percent for automobile imports, most of the rest of the world starts at 10 percent or higher.
We will be updating this article as new policies are announced, including the reciprocal tariffs. The state of play for each tariff is as follows:
Where Are We on the Trump Tariffs?
Tariff Proposal
Effective Date
Likely To Stick?
Likely To Increase?
Key Issues for Importers
2018 Section 301 Tariffs 83 FR 28710; 83 FR 40823; 83 FR 47974; 84 FR 43304
In force
Yes
Probably; likely to be equalized at top level and/or raised
Review HTS classifications to ensure accuracy, particularly for List 4B products; see “New 20% China Tariffs” below
2018 Aluminum/ Steel Tariffs 83 FR 11625; 83 FR 11619
Superseded as of 3/4/2025
N/A
N/A
N/A
New 20% China Tariffs 90 FR 11426
3/4/2025
Yes
Possibly
Use of Chinese parts and components for China+1 strategies; ensure substantial transformation of all products manufactured in +1 countries
25% Canada and Mexico Tariffs 90 FR 9113; 90 FR 9117
3/4/2025- 3/6/2025
Superseded as of 3/6/25
N/A
3/6/2025 (non-USMCA-Compliant goods) 90 FR 11429 90 FR 11423
Possibly
Possibly
Verify and document compliance (e.g., rules of origin, special rules for autos and textiles) for all claims of preferential treatment under USMCA; maintaining certificates of origin at time of entry. Consider Mexico duty-saving opportunities (e.g., IMMEX)
New 25% Aluminum/ Steel Tariffs 90 FR 9807; 90 FR 9817;
3/12/2025
Yes
Yes, by adding new derivative products
Monitor for new derivative products proposed for addition to steel and aluminum derivative products; verify potential HTS matches for aluminum and steel derivatives; look for Customs instructions regarding derivative products and apply
Reciprocal Tariffs
4/2/2025 (likely roll out in stages)
Yes
Unclear
Monitor; see above for list of high-tariff countries
Broad European Tariffs
Promised
Unclear
N/A
Monitor
25% Auto, Semiconductor, Pharmaceutical Tariffs
Promised
Yes
Subject to negotiation with Europe, Korea, Japan, and Mexico
Monitor; consider front-loading inventory for critical components
New Lumber Tariffs
Under study
Yes (if issued)
N/A
Monitor; consider front-loading inventory
New Copper Tariffs
Under study
Yes (if issued)
N/A
Monitor; consider front-loading inventory
200% Retaliatory Wine Tariffs
Threatened
No (if issued)
EU
Monitor; consider front-loading inventory
Future of USMCA
2026 review
Unclear
N/A
See Canada and Mexico Tariffs; monitor for expedited negotiations
Frequently Asked Questions
After presenting at numerous seminars and webinars, and in discussions with clients, we have noticed certain recurring questions. As an aid to the importing community, we have compiled a list of these, which include the following:
General
Do the tariffs stack?
Yes, all tariffs stack. This means an entry of steel from China would incur:
the normal Chapter 1–97 tariff;
the 25-percent Section 232 steel tariff;
the original Section 301 China steel tariff (up to 25 percent); and
the new 20-percent additional China tariff.
In addition, if the product is covered by an antidumping or countervailing duty order, then those duties also would stack.
Is the stacking compounded?
No. The tariffs add up without compounding. If both a 20-percent and a 25-percent tariff apply, then this results in a 45-percent increased tariff.
Are you seeing clients pursue a China +1 strategy to cope with the new tariffs?
Yes. Many clients have been pursuing a strategy of adding additional capacity outside of China since the imposition of the original Section 301 duties. These efforts appear to be accelerating, as there is a growing realization that high tariffs on China are the new normal. In this regard, it is important to note the original Section 301 tariffs remained in place even under the Biden administration. Further, China is likely to see the greatest amount of increased tariffs under the reciprocal tariff proposal because it hits so many categories — it heavily subsidizes its industries, it has been tagged as a currency manipulator by the Department of Treasury for years, and there are numerous countervailing duty findings by the Department of Commerce that provide a clear roadmap to identify subsidy programs.
One caution is that when companies move production out of China, they often continue to use Chinese-origin parts and components. Companies pursuing this strategy need to do a careful analysis to ensure they are “substantially transforming” the product by doing enough work and adding enough value in the third country to create a new and different article of commerce with a new name, character, or use, thus giving it a new, non-Chinese country of origin.
Will there be exceptions for goods like medical devices in the proposed tariffs?
Unclear. But the tariffs have veered toward being universal. Further, one of the purposes of the aluminum and steel tariff announcement was to wipe out the list of accumulated product-specific exceptions that had grown over the years. These factors work against an announcement of tariff-specific exceptions.
Are there any discussions relating to potential tariff relief for certain sectors (Defense, Navy, etc.)?
So far, the only somewhat industry specific reprieve has been the lifting of tariffs on USMCA compliant goods until April 2, 2025, as a result of the U.S. auto manufacturer concerns. While this is intended to apply to a lot of automotive imports, the lifting of the tariffs on USMCA compliant items is not exclusively tied to automotive imports. If discussions regarding tariff relief for other sectors have been occurring, they have not been announced.
Will the Executive Orders on tariffs be challenged in litigation?
Almost certainly, yes. But in general, the Court of International Trade and the Court of Appeals for the Federal Circuit tend to defer to the Executive in matters of international trade policy. Also, the imposition of special tariffs in the first Trump administration were generally upheld by the trade courts.
Have you heard of any plans to change Foreign Trade Zones (FTZ) laws?
In general, no. Specific tariff announcements, however, have contained provisions relating to the FTZs, such as stating any goods that go into Foreign Trade Zones need to enter in “privileged foreign status.” This means the duty rate is fixed at the time the goods enter the zone, meaning even if the goods are further manufactured within the FTZ, the duty will be based on the original classification when they entered the FTZ.
Steel and Aluminum Tariffs
How have the Section 232 aluminum and steel tariffs changed from the original 2018 version?
The aluminum tariffs increased from 10 to 25 percent.
All negotiated tariff-rate quotas for the EU, Japan and the United Kingdom, as well as the quotas negotiated with Argentina, Brazil, and South Korea, are no longer applicable. The previous exemptions for Australia, Canada, Mexico, and Ukraine no longer apply.
All product-specific exemptions that had been granted under the original aluminum and steel program are revoked.
The “derivative articles list” is considerably expanded.
Are Chapter 72 articles still subject to 25-percent tariffs?
Yes. Certain headings in Chapter 72 that were previously subject to the original Section 232 tariffs are still covered. All exclusions that previously applied to certain Chapter 72 products are now revoked.
Are iron products covered?
Based on the description of the covered products in the Executive Orders, carbon alloy steel products, not iron, are covered by the exclusions.
How should we treat imports that fall under the “derivative articles” HTS codes but do not actually contain any aluminum or steel?
In some cases, certain HTS classifications that are on the derivative aluminum and steel HTS classifications can cover types of products that may not contain any aluminum or steel. For example, certain types of metal furniture are covered, but if these are made out of a metal other than steel then they would not be covered even though they fall within an HTS that is listed in Annex 1 of the steel proclamation. In these cases, it would be appropriate to have the foreign producer include a statement on the commercial invoice to state that the product does not contain aluminum or steel, to support why the tariffs are not due on the entry.
After the elimination of the product-specific exemptions, are there any remaining exemptions?
The only exemption remaining is for derivative articles that are manufactured from steel melted/poured in the United States or aluminum smelted/cast in the United States. For such products, the importer should request a statement on the commercial invoice stating that the product contains aluminum smelted/cast in the United States or steel that was melted/poured in the United States. In case of Customs inquiry, it would be appropriate to include copies of steel mill certificates or aluminum certificates of analysis in the 7501 Entry Summary packet.
For derivative articles, is the 25-percent tariff paid on the full value of the article?
The Executive Orders state that the 25-percent tariff is paid on the “value” of the aluminum or steel “content” of the “derivative article.” There are, however, no instructions as to how this value should be calculated. In accordance with normal Customs requirements, the value should be calculated using a reasonable method that is supportable. This could potentially be based on a calculation from the foreign supplier. Frequent importers of derivative products should monitor CSMS announcements to see if CBP issues instructions on this issue.
Is duty drawback available for the aluminum and steel tariffs?
No, the Executive Orders state that duty drawback cannot be used.
Does Chapter 98 provide relief from the 25-percent aluminum and steel tariffs?
The Executive Orders do not list any Chapter 98 exceptions for the new tariffs. This is consistent with the original Section 232 tariffs, which also did not contain any Chapter 98 exceptions.
Will there be an exclusion process?
None has been announced or established. It is unlikely that the Trump administration would wipe out all product-specific exemptions only to build them back up again.
Could the list of “derivative articles” expand?
The Executive Orders directed the Department of Commerce to establish a process by May 11, 2025, to consider requests to add additional “derivative articles.” We anticipate that U.S. aluminum and steel manufacturers will aggressively use this process to push for additional excluded derivative products.
USMCA/Canada and Mexico Tariffs
Will the reciprocal tariffs replace the Canadian and Mexican tariffs? Or will they stack?
The reciprocal tariffs have not been announced yet. But because all of the other tariffs stack, there is a high likelihood that the reciprocal tariffs also will stack on top of the existing 25-percent tariffs rather than replace them where they overlap. Also, the 25-percent tariffs were announced as being imposed due to concerns about fentanyl and unauthorized immigration, which is an entirely separate issue from the tariff equalization that is the goal of the reciprocal tariffs.
How will tariffs effect the IMMEX/Maquiladora imports from Mexico?
Because the Maquiladora, Manufacturing, and Export Services Industry (IMMEX) Program is a figure of Mexican law, we anticipate Mexico will do all that it can to protect companies that operate using the Program. Although uncertain, as per previous experiences in imposing retaliatory measures, Mexico will most likely establish tariffs on US sumptuous goods and/or finished products, and hardly to raw materials used by IMMEX/Maquiladora companies.
Will the Canada and Mexico tariffs be lifted when the USMCA review occurs?
Unclear. We do note, however, that the United States lifted the prior aluminum and steel tariffs as part of the negotiation of the USMCA under the first Trump administration. The second Trump administration, however, is taking a much harder line on tariff and international trade issues.
Reciprocal Tariffs
What are reciprocal tariffs?
“Reciprocal tariffs” are intended to equalize tariff rates, such as when a foreign country imposes a higher tariff on the United States than the United States does for the same product category. Because the United States generally has low tariffs, this means that there are a great many HTS classifications that likely will increase, with the impact varying by country. Moreover, because the announcement of the coming reciprocal tariffs states that it will take into account any form of discrimination against U.S. companies or programs that favor foreign companies, then calculated reciprocal tariffs will likely be very high. For example, most countries have Value Added Taxes that rebate any VAT payments when goods are exported; the Trump administration has indicated that this would be considered a form of subsidy that should be counteracted with reciprocal tariffs. So would subsidized electricity, currency manipulation, and so forth. Adding these concepts on top of equalizing tariffs across HTS categories leads to likely major increases in tariffs.
When will they be announced?
The reciprocal tariff announcement is expected for April 2, 2025. The Trump Administration also announced that it would proceed to consider countries with major trade deficits with the United States first, so it is possible that April 2nd will be the start of a rolling set of reciprocal tariff announcements.
Force Majeure and Surcharges FAQs
The Foley Supply Chain team also has published a set of FAQs regarding contractual issues, which we are repeating here for convenience.
What are the key doctrines to excuse performance under a contract?
There are three primary defenses to performance under a contract. Importantly, these defenses do not provide a direct mechanism for obtaining price increases. Rather, these defenses (if successful) excuse the invoking party from the obligation to perform under a contract. Nevertheless, these defenses can be used as leverage during negotiations.
Force Majeure
Force majeure is a defense to performance that is created by contract. As a result, each scenario must be analyzed on a case-by-case basis, depending on the language of the applicable force majeure provision. Nevertheless, the basic structure generally remains the same: (a) a listed event occurs; (b) the event was not within the reasonable control of the party invoking force majeure; and (c) the event prevented performance.
Commercial Impracticability (Goods)
For goods, commercial impracticability is codified under UCC § 2-615 (which governs the sale of goods and has been adopted in some form by almost every state). UCC § 2-615 excuses performance when: (a) delay in delivery or non-delivery was the result of the occurrence of a contingency, of which non-occurrence was a basic assumption of the contract; and (b) the party invoking commercial impracticability provided seasonable notice. Common law (applied to non-goods, e.g., services) has a similar concept known as the doctrine of impossibility or impracticability that has a higher bar to clear. Under the UCC and common law, the burden is quite high. Unprofitability or even serious economic loss is typically insufficient to prove impracticability, absent other factors.
Frustration of Purpose
Under common law, performance under a contract may be excused when there is a material change in circumstances that is so fundamental and essential to the contract that the parties would never have entered into the transaction if they had known such change would occur. To establish frustration of purpose, a party must prove: (a) the event or combination of events was unforeseeable at the time the contract was entered into; (b) the circumstances have created a fundamental and essential change; and (c) the parties would not have entered into the agreement under the current terms had they known the circumstance(s) would occur.
Can we rely on force majeure (including if the provision includes change in laws), commercial impracticability, or frustration of purpose to get out of performing under a contract?
In court, most likely not. These doctrines are meant to apply to circumstances that prevent performance. Also, courts typically view cost increases as foreseeable risks. Official comment of Section 2-615 on commercial impracticability under UCC Article 2, which governs the sale of goods in most states, says:
“Increased cost alone does not excuse performance unless the rise in cost is due to some unforeseen contingency which alters the essential nature of the performance. Neither is a rise or a collapse in the market in itself a justification, for that is exactly the type of business risk which business contracts made at fixed prices are intended to cover. But a severe shortage of raw materials or of supplies due to a contingency such as war, embargo, local crop failure, unforeseen shutdown of major sources of supply or the like, which either causes a marked increase in cost or altogether prevents the seller from securing supplies necessary to his performance, is within the contemplation of this section. (See Ford & Sons, Ltd., v. Henry Leetham & Sons, Ltd., 21 Com. Cas. 55 (1915, K.B.D.).)” (emphasis added).
That said, during COVID and Trump Tariffs 1.0, we did see companies use force majeure/commercial impracticability doctrines as a way to bring the other party to the negotiating table to share costs.
May we increase price as a result of force majeure?
No, force majeure typically does not allow for price increases. Force majeure only applies in circumstances where performance is prevented by specified events. Force majeure is an excuse for performance, not a justification to pass along the burden of cost increases. Nevertheless, the assertion of force majeure can be used as leverage in negotiations.
Is a tariff a tax?
Yes, a tariff is a tax.
Is a surcharge a price increase?
Yes, a surcharge is a price increase. If you have a fixed-price contract, applying a surcharge is a breach of the agreement.
That said, during COVID and Trump Tariffs 1.0, we saw many companies do it anyway. Customers typically paid the surcharges under protest. We expected a big wave of litigation by those customers afterward, but we never saw it, suggesting either the disputes were resolved commercially or the customers just ate the surcharges and moved on.
Can I pass along the cost of the tariffs to the customer?
To determine if you can pass on the cost, the analysis needs to be conducted on a contract-by-contract basis.
If you increase the price without a contractual justification, what are customers’ options?
The customer has five primary options:
1. Accept the price increase:
An unequivocal acceptance of the price increase is rare but the best outcome from the seller’s perspective.
2. Accept the price increase under protest (reservation of rights):
The customer will agree to make payments under protest and with a reservation of rights. This allows the customer to seek to recover the excess amount paid at a later date. Ideally, the parties continue to conduct business and the customer never seeks recovery prior to the expiration of the statute of limitations (typically six years, depending on the governing law).
3. Reject the price increase:
The customer will reject the price increase. Note that customers may initially reject the price increase but agree to pay after further discussion. In the event a customer stands firm on rejecting the price increase, the supplier can then decide whether it wants to take more aggressive action (e.g., threaten to stop shipping) after carefully weighing the potential damages against the benefits.
4. Seek a declaratory judgment and/or injunction:
The customer can seek a declaratory judgment and/or injunction requiring the seller to ship/perform at the current price.
5. Terminate the contract:
The customer may terminate part or all of the contract, depending on contractual terms.
[1] Please note that the implementation of the various tariff programs remains in flux, and thus the status of these program should be monitored closely. The included table is current as of the date of publication of this article.