Why Use a Trust for Bona Fide Fringe Benefits?
All fringe benefit plans fall into two categories, “funded” or “unfunded”. The best type is funded, obviously. Otherwise I wouldn’t be writing this post.
Funded plans are those where the contractor’s fringe benefit contributions are made to a trustee or independent third party pursuant to a bona fide fringe benefit fund, plan or program on a regular basis (at least quarterly, if not more frequently when required by a state). The contribution must be irrevocable; in other words, the funds cannot be returned to the contractor or its creditors for any reason except inadvertent excess contributions above the amount called for in the fringe benefit plan. If a trustee is not used, the “third person” must not be affiliated with the contractor or subcontractor. The trustee must assume the usual fiduciary responsibilities imposed upon trustees by applicable law.
Contributions to a funded benefit trust can be credited towards meeting the prevailing fringe benefit requirement without prior U. S. Department of Labor approval. A benefit plan intended to meet the state prevailing wage requirements can more readily establish its “bona fide” fringe benefit status by demonstrating that contributions have been timely made into an independent trust that is regulated by the Internal Revenue Code (e.g., an IRC §501(c)(9) voluntary employees beneficiary association (VEBA)) or applicable banking law, as opposed to attempting to show that benefits have been paid directly by the employer. Prevailing wage benefits that are subject to the Employee Retirement Income Security Act of 1974 (ERISA) also provide additional protections to plan participants (such as oversight by the Employee Benefits Security Administration of the US DOL, and the summary plan description) which seems to be comforting to DOL Wage and Hour examiners, both federal and state.
Funded welfare plans can enjoy ERISA preemption (override) of state laws. This is especially useful where a contractor performs prevailing wage work in multiple states. The intent behind ERISA preemption was “to enable employers to establish a uniform administrative scheme, which provides a set of standard procedures to guide processing of claims and disbursement of benefits” regardless of the jurisdiction in which the work is performed. In other words, ERISA preemption allows an employer to establish benefit plans that straddle all states and municipalities in which it operates without the necessity of tailoring the plan to any local prevailing wage requirements.
To be governed by ERISA, a welfare plan must not be a “payroll practice’’, i.e., payment of benefits that do not exceed an employee’s normal compensation from the employer’s general assets for periods of time when the employee is not performing his or her duties, such as sick, vacation, and disability pay. Funding such welfare benefits through a trust prevents the benefit from being a payroll practice, if
- The trust be a bona fide separate fund, with an independent trustee;
- The trust has the legal obligation to pay plan benefits;
- The employer has the legal obligation to make contributions to the trust; and
- The contributions bear a relationship to the plan’s liability, be actuarially determined, or established through collective bargaining.
The “bona fide trust” requirement can be satisfied by utilizing a VEBA trust, which is tax exempt, or an irrevocable trust established under state law, which would be taxable on its income. A grantor trust, where the trust fund assets are accessible by the company’s creditors in the event of bankruptcy, would not satisfy these requirements, nor would using the trust primarily to reimburse the employer for benefits already paid from corporate assets.
In addition to demonstrating compliance with federal and state prevailing wage fringe benefit requirements as bona fide fringe benefits, using a trust enables the contractor to take a deduction for the contributions to the trust when those contributions are made; otherwise, the deduction is available only when the benefits are paid. Further, the trust fund offsets the benefit liability on the contractor’s books. These financial advantages make the funded program especially useful when there may be a carry-over of benefit accruals into a new taxable year.
Fringe benefits may also be made pursuant to an unfunded plan or program. In this case the contractor funds certain benefits with its general assets (rather than by making payments to a trustee or an independent third party). The most common unfunded benefits are holiday, vacation, and sick pay benefits. To ensure that such plans are not used to avoid compliance with the Davis-Bacon Act, the DOL Prevailing Wage Resource Book directs the contractor to set aside, in an account, no less often than quarterly, sufficient assets to meet the future obligations of the plan.
A contractor’s reasonably anticipated costs in providing bona fide fringe benefits under such a plan may be creditable towards meeting prevailing wage obligations, “[provided that] the Secretary of Labor has found, upon the written request of the contractor, that the applicable standards of the Davis-Bacon Act have been met. The DOL requires that unfunded plans meet certain requirements, including:
- The plan can reasonably be anticipated to provide bona fide benefits as described in the Davis-Bacon Act,
- The benefit represents a commitment that can be legally enforced,
- The benefit is provided under a financially responsible plan or program. [The DOL “may direct a contractor or subcontractor to set aside in an account assets which, under sound actuarial principles, will be sufficient to meet the future obligation under the plan. The preservation of this account for the purpose intended would, of course, also be essential.” This requirement may bring into question the financial soundness of the contractor or subcontractor itself, as earmarked general assets are not legally segregated from claims of creditors], and
- The plan or program has been communicated in writing to the affected employees.
From a tax perspective, where the fringe benefit is unfunded, the contractor’s deduction may be taken only in the taxable year in which the employee takes the benefit into income. This is unsuitable for benefits that may “carryover” into another taxable year, such as paid sick leave when the plan provides for a carry-over of accrued but unused hours (as some state-mandated plans require), prefunding continuation of group health benefits under COBRA, supplemental unemployment benefits, and health reimbursement arrangements. In addition, some unfunded benefits subject to carry-over, like paid sick leave, get “re-priced” at the current, higher hourly wage, resulting in an unfunded liability on the contractor’s books that can affect financial reports.
To recap, utilizing a trust to fund prevailing wage welfare fringe benefits can result in:
- Less U.S. Department of Labor and state labor department scrutiny,
- More transparency in the provision of the prevailing wage fringe benefit, both to regulators and employees,
- Current deduction of contributions to the trust,
- Offset to benefit liabilities on the corporate books,
- Ability to carry-over benefits to a new tax year, and
- Override (preemption) of inconsistent state laws.
If you have additional questions please do not hesitate to contact us or download our whitepapers – “Harnessing the Power of Supplemental Unemployment Benefit Plans” and “Working the Fringe.”
Please also view our short animated video, to see how constructing a bona fide fringe benefit plan, can move prevailing wage dollars out of payroll and reduce associated costs. Increase profits. Submit more competitive bids. Build employee loyalty.
How we can help
DirectAdvisors, established in 2001 and located in Albany, New York provides bona fide benefit plan consulting and third party administrative services to merit / merit shop (non-union) construction companies that are subject to the Davis-Bacon Act, Service Contract Act and state prevailing wage regulations. Our clients are located throughout the United States and range in size from 10 to 3,000 employees.
Last year, our construction company clients contributed tens of millions of dollars of prevailing wage fringe benefit contributions to The DirectAdvisors Trust (health & welfare benefits) and retirement plans managed by our team.
Our solutions are free from any conflict of interest as we do not sell any financial or insurance products. We work with existing agents, brokers and insurance companies.