Article
03.16.23
Amid bank uncertainty, our Employment and Executive Compensation and Benefits practices address frequently asked questions regarding potential consequences for delayed payroll, 401(k) and health premium payments, the impacts of furloughs and reductions in force and more.
TABLE OF CONTENTS
What is the primary impact to employers with funds at an unstable bank?
Can an employer delay payroll? What are the consequences of the failure to pay wages when due?
What if an employer has to make late health and welfare premium payments?
What if a bank cannot timely process funds needed for an upcoming payroll cycle?
Do equity awards continue to vest while an employee is on furlough?
Is an employee still eligible to receive health and welfare benefits if they are furloughed?
How is paid time-off (PTO) treated on a furlough?
What is a reduction in force (RIF)?
What considerations are applicable to a RIF?
What should an investor or lender know if they agree to advance funds to fund payroll?
1. What is the primary impact to employers with funds at an unstable bank?
a. Many employers maintain checking/savings accounts at unstable banks, and they need access to the funds in these accounts to make payroll and related payments to health, welfare and retirement plans.
b. Certain professional employer organizations (PEOs) use banks to process their payroll, and news reports have indicated that certain of these PEOs may not be able to process payroll for employers.
i. If a PEO is not qualified as a “certified PEO” (CPEO) with the IRS, employers should consider the desirability of an alternative PEO that has qualified as a CPEO for additional protections. If an employer uses a CPEO, the CPEO is typically responsible and bears the liability for the payment of federal employment taxes once the CPEO’s client remits the funds to pay wages though payroll. If an employer uses a non-certified PEO and the PEO fails to deposit employment taxes, the employer could be liable for the unpaid taxes, late penalties and interest related to their employees. The IRS maintains a website and publishes a list of CPEOs that is updated quarterly.
2. Can an employer delay payroll? What are the consequences of the failure to pay wages when due?
a. Technically, an employer can delay payroll, but there are legal and tax consequences.
i. If the employer believes it may be necessary to delay payroll (such as until they can obtain bridge financing), they should let employees know as soon as possible ahead of time, as employees may need to figure out how handle their own financial obligations (e.g., paying their bills).
b. Late payment of payroll taxes and state unemployment and disability insurance taxes can result in interest and penalties.
i. Federal penalties range from 5% to 15% of the unpaid deposit (plus interest) depending on the number of days late.
ii. California charges a flat penalty of 15% of the unpaid deposit (plus interest) on late payroll tax payments.
c. Income taxes, employee share of social security taxes and employee share of Medicare taxes are also “trust fund taxes” (i.e., employers hold the money in trust until they are paid to the Internal Revenue Service (IRS)).
i. Employers should not “borrow” withholding taxes to pay other creditors first.
ii. Employers that fail to deposit trust fund taxes can be held 100% liable for the amounts, plus interest and penalties.
iii. The IRS will likely attempt to collect trust fund taxes from employers first. If an employer is insolvent, the IRS will identify as many “responsible persons” as possible to collect unremitted trust fund taxes. A “responsible person”[1] who willfully[2] fails to withhold and deposit trust fund taxes can be held personally liable for a penalty equal to the full amount of the unpaid trust fund tax (the trust fund recovery penalty, or TFRP). Both the responsible person and willful failure tests must be met for the TFRP to apply. A responsible person under Section 6672 of the Internal Revenue Code (the Code) can also be criminally liable.[3]
d. Violation of federal and state wage and hour laws:
i. Under the federal Fair Labor Standards Act (the FLSA), failure to pay non-exempt employees minimum wage and/or overtime by the applicable payroll date violates the FLSA and gives rise to claims for liquidated damages even if the amounts are later paid. In California, the rules regarding the applicable payroll date are summarized here.
ii. Many states have laws regulating when employees must be paid and impose civil penalties and liquidated damages for failure to timely pay earned wages.
iii. Some states’ laws also deem such a failure a violation of criminal law.
iv. Under the FLSA and many states’ wage and hour laws, personal liability can be imposed, not just corporate liability.
v. Often wage-hour violations give rise to class action claims or, in California, collective actions under the Private Attorneys General Act.
3. What if an employer has to make late 401(k) plan salary deferral contributions and fails to remit loan repayments to its 401(k) plan?
a. Under the Employee Retirement Income Security Act (ERISA), an employer/fiduciary is obligated to segregate and deposit participant contributions (e.g., salary deferrals, catch-up, Roth and after-tax contributions and loan repayments) to the 401(k) plan’s trust on the earliest date that such funds can reasonably be segregated from its general assets. Failure to comply is a breach of fiduciary duty and a prohibited transaction and carries with it civil and potentially criminal penalties under ERISA.
b. For most start-up employers who have plans with fewer than 100 participants, the safe harbor remittance period is seven business days.
c. If an employer/fiduciary cannot timely deposit participant contributions and loan repayments to the 401(k) plan trust, the employer should document its explanation for such delay and, depending on the circumstances and timing, consider taking corrective action in accordance with the Department of Labor’s (DOL) voluntary fiduciary correction program (VFCP). Such corrective action could include: (i) a credit of earnings out of the employer’s own funds for the remittance delay to the affected participants’ plan accounts (in accordance with the DOL’s calculator), (ii) a payment of excise tax to the IRS and (iii) a submission to the DOL under its VFCP to request a “no action” letter.
d. Most start-up companies do not make employer matching contributions under their 401(k) plans.[4]
4. What if an employer has to make late health and welfare premium payments?
a. If an employer anticipates that it will not timely (including any grace periods) remit health and welfare premiums to the insurance carrier or plan, the employer should reach out to its broker who can facilitate conversations with the insurance carriers to mitigate or defer potential cancelation of the group health policy for non-payment (as dictated by the terms of the policy). Alternatively, the employer should contact the PEO and insurance carriers directly.
5. What if a bank cannot timely process funds needed for an upcoming payroll cycle?
a. Consider alternative funding sources (e.g., other bank accounts).
b. Consider bridge financing, including potentially from VC investors.
c. After reviewing contract terms, consider delaying payments to suppliers, vendors and contractors before delaying employee payroll.
6. What if a bank cannot timely process funds for the next payroll cycle, and alternative funding sources are not available?
a. Consider whether to furlough and/or reduction in force (RIF) employees.
b. Consider whether to reduce or defer a portion of salaries. This may be helpful if an employer has access to funds to cover some, but not all, of their payroll obligations.
i. A commitment to repay foregone salary at a later date could implicate Code Section 409A. For payroll periods in 2023 that have not yet commenced, to avoid subjecting the payments to Code Section 409A, an employer should make payments by March 15, 2024. For employees located in California, an employee would need to agree to this in advance of services being performed.
ii. Ensure that any salary/pay reductions are done in compliance with federal and state wage and hour laws.
- The following special considerations for exempt employees apply if an employer wants to maintain an employee’s exempt status:
- Employers cannot tie a short-term salary reduction to a reduced hours requirement in light of the salaried basis rules.
- Reduced salary needs to be at least equal to the applicable minimum salary requirement.[5]
iii. Review employment agreements and offer letters to confirm that contractual protections (e.g., good reason trigger allowing employee to resign and receive severance) are not implicated.
a. Employees are placed on mandatory, temporary unpaid leave (i.e., do not draw paycheck) but typically their benefits can remain in place.
b. Access to computers is shut down; no work should be performed or wages will be owed. Employers should tell employees they are not authorized to work during a furlough, and any work requires prior approval.
c. Partial furlough involves reducing an employee’s work commitment—for example, working two days per week, or alternating weeks of unpaid leave and working weeks.
i. Partial furloughs involving reduced work week do not work for exempt employees because an employer must generally pay exempt employees their full salary amount in any week that the employee performs any work without regard to the number of days or hours worked.
d. Depending on the number of affected employees and the length of the furlough, a furlough may trigger notice requirements under federal and/or state Worker Adjustment and Retraining Notification (WARN) Acts, and so attorney consultation is advised.
8. Do equity awards continue to vest while an employee is on furlough?
a. Unless the employer has a policy that provides that vesting is suspended on a leave of absence (most start-up companies do not), then equity awards should continue to vest.
9. Is an employee still eligible to receive health and welfare benefits if they are furloughed?
a. Generally, yes, but the terms of the plan will dictate under what circumstances and for how long group health coverage can occur. Accordingly, employers should review their plan documents and consult with their brokers or insurance carriers (if plans are fully insured).
i. Most start-up employers will have fully insured group health plans, or provide benefits through a PEO, and will be tied to the terms of the applicable plan. Employers with self-insured plans may have more flexibility to interpret the terms of their plans or amend them (subject to the stop loss carrier’s terms).
b. Eligibility is typically based on “regularly scheduled” hours and “actively at work” provisions, and the plan may provide how long an employee can be absent from work and under what circumstances (e.g., FMLA leave) before losing eligibility.
c. If furloughed employees remain on an employer’s plans, the employer will need to determine how to handle the employee's insurance premium payments.
d. If the plan rules do not permit a furloughed employee to be covered under the plan, then federal COBRA continuation coverage or the equivalent state continuation coverage (e.g., Cal-COBRA) must be offered (where applicable), which will protect both the employee and the employer. Risks in maintaining ineligible employees (and their dependents) on the group health plan include:
i. Insurance carrier could retroactively rescind coverage (and COBRA) and/or deny claims for those it determines are not eligible to participate in the plan.
ii. Insurance carrier could require that the employer cover such claims as if the plan was self-insured or cancel the entire policy due to “fraud” by the employer.
iii. Potential COBRA violations for not timely providing the affected furloughed employee with statutory COBRA notices.
iv. Potential tax ramifications if the plan fails discrimination or coverage testing.
v. Possible fiduciary breach under ERISA if plan assets were used to pay for benefits of non-eligible individuals.
10. How is paid time-off (PTO) treated on a furlough?
a. Whether or not employees can use PTO during furlough typically depends on the employer’s policies—i.e., if an employer’s policies permit employees to apply PTO to an unpaid leave, then employees should be permitted to use PTO while furloughed, as accrued PTO is viewed as wages earned by employees under the laws of most states.
b. A furlough that does not have a definite return-to-work date within the shorter of 10 days of the employee’s normal pay period may be viewed as a termination, which could trigger the requirement to pay final wages under California law.
11. What is a reduction in force (RIF)?
a. A RIF is an involuntary and permanent termination of employees.
12. What considerations are applicable to a RIF?
a. Final wages (including accrued vacation/PTO in California) are due on the separation date.
b. Employers may want to consider providing terminated employees with severance (e.g., base salary continuation, continued payment of the employer’s portion of healthcare premiums if the employee elects COBRA continuation) in exchange for a release of claims in an up-to-date form obtained from an attorney.
i. Employers should ensure that they have access to sufficient funds to pay severance.
ii. If an employer provides severance pursuant to an “administrative scheme” (e.g., eligibility determinations, calculation of payments, additional services such as insurance and releases), then the severance program will likely be subject to ERISA and should be documented and administered accordingly.
c. Employers will need to confirm the treatment of employee equity awards—i.e., accelerated vesting of options and/or extension of post-termination exercise period of options.
d. Depending on the number of terminated employees, the RIF may trigger notice requirements under federal and/or state WARN Acts.
13. What should an investor or lender know if they agree to advance funds to fund payroll?
a. If an investor or lender provides funds to make payroll, they should ask the company/employer to give proof that the trust fund taxes have been remitted to the IRS to avoid third party liability.
b. If the IRS cannot collect unpaid trust fund taxes from responsible persons, it may impose liability on the employer’s lenders and other third parties who lent money to the employer for the specific purpose of paying wages. Under Code Section 3505(b), such lenders will be liable if they had actual notice or knowledge that the employer does not intend to or will not be able to make timely payment or deposit of trust fund taxes. The liability is limited to 25% of the money lent for wages.
14. Can an employer issue shares or offer other non-monetary income to employees in lieu of payroll if it does not have cash available?
a. No, employees need to be paid their owed wages for an employer to avoid liability for wage/hour claims.
15. Can an employer require its employees to waive their claims against its employer as a condition of continued employment to minimize liability?
a. Generally, no, an employer cannot require its employees to waive wage claims as a condition of continued employment. Additionally, an employer cannot require an employee to ever waive future claims against an employer as a condition of continued employment, and so this type of waiver would not be enforceable, even if signed.
16. Can an employer promise to “make this up” to its employees in the next payroll with additional compensation or shares?
a. Generally, no. Making these types of promises does not obviate the present liability to pay employees on time. Additionally, making these types of promises can be risky if the employer cannot follow through once made, as it could lead to breach of contract claims.
[1] Under Code Section 6672, a responsible person includes an officer or employee of a corporation, or a member or employee of a partnership, who as such officer, employee or member has the duty to collect or pay employment taxes. Directors can also be deemed to be responsible persons. Most courts focus on a person’s duty over his or her job title. The IRS also uses check-signing authority as proof an individual is a responsible person. An employee performing ministerial acts without exercising independent judgment will not be deemed a responsible person.
[2] “Willfulness” means a voluntary, conscious and intentional act to prefer other creditors over the IRS. It does not require bad motive or ill intent. Reckless disregard of whether the taxes are being paid over, as distinguished from actual knowledge of whether they are being paid over, may also suffice to establish willfulness.
[3] However, the IRS reserves criminal charges for the most egregious cases, usually where the responsible person diverted the money for their own personal use, rather than situations where a responsible person in a business that was facing hard times used the money to pay other creditors in a misguided attempt to keep the business afloat.
[4] If an employer has a 401(k) plan that provides for a matching contribution program, the employer should review the terms of its match program to determine if there is a specified frequency. Typically, an employer will contribute the match contribution by the employer’s tax filing deadline to receive a deduction. If the plan and summary description do not specify a time frame for making the match (as opposed to “allocating” the match), the employer can make the match when it is able to do so. If there is a deadline by which the employer has committed to make a match, the employer could prospectively suspend or terminate its matching contribution program (e.g., corporate action, plan amendment).
[5] Under Federal law, minimum salary is $684 per week for administrative, professional and executive exemptions. Under California law, minimum salary is $1,240 per week for administrative, professional and executive exemptions (2x state minimum wage based on a 40-hour work week), and $9,338.78/month for computer professionals. Under New York law, minimum salary is $1,125.00 per week (New York City; Nassau County, Suffolk County and Westchester County), $1,064.25 per week (remainder of state) for administrative, and executive exemptions, and the professional exemption is the same as the federal salary minimum.