Two New Restrictions On Employees Seeking To Compete Against

Two New Restrictions On Employees Seeking To Compete Against their Former Employer

This article is republished with approval of the New Jersey State Bar Association, and it was first published in the New Jersey Labor and Employment Quarterly, Vol. 25 No. 1 (Fall 2001)

……….For more than 30 years two principles have governed when and how a departing employee can or cannot compete against his or her former employer. First, the employee is barred from utilizing the former employer’s trade secrets disclosed in confidence. Second, an employer may further enforce a non-competition covenant agreed to by an employee that is reasonable in time, scope and area, necessary to protect the employer’s legitimate interest, not unduly burdensome on the employee, and not injurious to the public interest. Two recent decisions, however, should give additional pause to employees considering competing against a former employer: the first appears to create a third type of restriction on “competing” employees, at least in the service industry; the second expands the definition of trade secret in the context of manufacturing.

……….In Lamorte Burns & Co., Inc. v. Walters, Lamorte Burns & Co., Inc. (Lamorte), brought an action against two former employees, Michael Walters and Nancy Nixon, and their newly created competing corporation, The Walters Nixon Group, Inc. (WNG), alleging breach of a restrictive covenant, breach of duty of loyalty, tortuous interference with economic advantage, misappropriation of confidential and proprietary information and unfair competition.

……….The business of Lamorte’s New Jersey office, where Walters and Nixon were employed, was investigating and adjusting two types of marine insurance claims: protection and indemnity (P & I) claims and harbor workers’ compensation claims. In July 1996, 17 months before leaving Lamorte, Walters incorporated WNG. During the next 17 months, while performing their duties on P & I claim files for Lamorte, Walters and Nixon were also compiling a “target solicitation list” from these files, including Lamorte “client names, addresses, phone and fax numbers, file numbers, claim incident dates, claim contact information, and names of the injured persons”, that was stored on Walters’ home computer. In October 1997, Walters and Nixon signed a three-year lease for office space and purchased office equipment, leased computers, and obtained telephone and fax lines for the new office.

……….On December 20, 1997, a Saturday, Walters and Nixon removed their personal belongings and faxed resignation letters to the private office of Lamorte’s president. With these resignations, Lamorte no longer had a P & I claims adjuster in its Clark office.

……….The next day, WNG faxed solicitation letters and file transfer authorization forms to all but one of Lamorte’s 34 P & I clients. In addition to notifying the client that Walters and Nixon had been handling the client’s file, and had resigned to start a new business that was seeking to service the client, the typical letter and form stated as follows:

[The letter] stated “Our fee structure will be less than Lamorte Burns fee structure for 1998.” The client was told that it had absolute discretion in deciding whether to continue with Lamorte or to have its claim files in progress transferred to WNG or to any other firm. …The form included “a list of open files we have been handling for you.” (emphasis added). In addition to the client’s file number, the transfer form included the client’s name, the name of the injured person, and the accident date. The client was instructed simply to mark an “X” next to each listed file that it wished to have transferred from Lamorte to WNG

……….All 33 P & I clients who received these letters and forms requested that their active claim files be transferred to WNG.

……….The trial court granted summary judgment on liability in favor Lamorte on all of its claims, and then, after a hearing, awarded it $232,684 in compensatory damages and $62,816.23 in punitive damages. The court explained its findings:

If you examine the solicitation, you will see that they didn’t just ask generally for a customer’s business. They asked for the work that was specifically behind handled by the plaintiff, and on a case-by-case basis specifically mentioning the name of the claimant … . Effectively, what they said to the customer that they were soliciting is, look, we’re dealing with the following cases right now for Lamorte, and we want them … This was information [defendants] would not have generally known but for their employment with plaintiff. They wouldn’t have known the specific file, the accident date… . And there isn’t any dispute that information came from the plaintiff

……….While affirming the liability judgment concerning the covenant claim, the Appellate Division reversed the grant of judgment concerning the tort claims, finding “disputed facts concerning the confidential and proprietary nature of the information defendants had taken from plaintiff, as well as issues concerning whether defendants’ conduct was acceptable competitive behavior or malicious and in violation of the “rules of the game’ of the parties’ business.” The court’s ruling “was founded on defendants’ assertions that they were never told that the information was confidential and proprietary, and that although the information was not generally available, it could have been obtained simply by sending out letters of solicitation to all of Lamorte’s clients asking permission to have all files transferred, not just those files defendants were working on.”

……….The Supreme Court reversed the Appellate Division decision concerning the tort claims, and reinstated the trial court’s decision concerning these claims. The Court’s decision was premised upon its finding that the information utilized by Walters and Nixon to compete against Lamorte, even if not a trade secret, was Lamorte’s confidential information that could not be utilized by its employees, with or without the existence of a restrictive covenant.

……….The Court first opined that confidential information “need not rise to the level of a trade secret to be protected” in the absence of a restrictive covenant. In making this finding, the Court followed the reasoning of the oft-cited Law Division decision in Platinum Management, Inc. v. DahmsPlatinum Management, which involved a non-competition covenant, held that a customer list may be protected if it goes “beyond mere names, but also include[s] buying habits, mark-up structure, merchandising plans, projections, and product strategies.” This is true even when the identities of the customers are “listed in readily obtainable trade directories”, since “the fact that they were the plaintiff’s customers [is] not.”

……….According to the Court, the essential inquiry as to when a non-trade secret may nevertheless be protectable at common law concerns “the relationship of the parties at the time of disclosure and the intended use of the information.” Thus, the Court adopted the reasoning that information could be confidential not only based upon the nature of the information itself (the traditional trade secret analysis), but also as a byproduct of the special agency relationship between the employer and employee. The Court cited favorably Restatement (Second) on Agency, § 395 (1958), which provides that “unless otherwise agreed, an agent is subject to a duty to the principal not to use or to communicate information confidentially given him by the principal or acquired by him during the course of or on account of his agency or in violation of his duties as agent, in competition with or to the injury of the principal.”

……….The Court thus concluded that “[t]he specific information provided to defendants by their employer, in the course of employment, and for the sole purpose of servicing plaintiff’s customers, is legally protectable as confidential and proprietary information”, aside from whether or not it qualifies as a trade secret, because defendants “would not have been aware of that information but for their employment.” The Court held that Walters and Nixon, by virtue of having utilized this information to compete against Lamorte, violated their duties of loyalty to Lamorte, even though they did not actually solicit Lamorte’s clients while employed by Lamorte. The Court further held that this same conduct constituted causes of action for tortuous interference with economic advantage, misappropriation of confidential and proprietary information and unfair competition.

……….In so holding, the Supreme Court in Lamorte Burns adopts and extends the rule of Platinum Management, reasoning that specific customer information not rising to the level of a trade secret provided by an employer to an employee for the purpose of furthering the employer’s business may be protectable even in the absence of a restrictive covenant. Thus, while still free to provide services to customers cultivated prior to becoming employed with his or her present company, an employee not restricted by a covenant who possesses specific information about his former employer’s customers and marketing must now proceed more carefully to the extent he or she seeks to leave employment and start or join a competing business.

……….In Rycoline Products, Inc. v. Walsh, the Appellate Division addressed an apparent issue of first impression: Is a company that reverse engineers a competitor’s product entitled to have the fruit of its efforts protected? The plaintiff, Rycoline Products, Inc., a manufacturer of chemical products in the printing industry, had employed three persons (two salespersons and a district managers) who left to work for a competitor, C&W Unlimited. While these individuals were still in its employ, Rycoline developed a “fountain solution” labeled ACFS 276. ACFS 276 was the result of an attempt by Rycoline to reverse engineer Anchor MXEH, an unpatented product manufactured by Anchor Lithkemko, a company not a party to this action. Rycoline spent nearly one million dollars in hiring chemists and setting up a laboratory in order to reverse engineer Anchor MXEH. Rycoline alleged that the district manager had access to “a hard copy of the formula for ACFS 276”.

……….Shortly after the district manager began working at C&W, C&W began purchasing chemicals found in ACFS 276, and months later formulated a product that was similar to ACFS 276 in that it “included a three-part buffering system as well as a two-part synthetic gum/natural gum system”. Rycoline filed suit against C&W, the two owners of C&W, and the three individuals who left Rycoline to work for C&W. Rycoline alleged, inter alia, that C&W, the C&W owners and the former district manager had misappropriated Rycoline’s asserted trade secret concerning ACFS 276.

……….The trial court dismissed the misappropriation claim, predicating its ruling upon a finding that “you cannot protect as your trade secret that product which was taken from another manufacturer through re-engineering of his trade secret”. However, the Appellate Division reversed the trial court’s determination that there was no trade secret, and remanded for a jury determination on Rycoline’s claims.

……….The Court first clarified the respective burdens of proof for a tort of misappropriation of a trade secret under New Jersey law. A plaintiff, as aprima facie case, must demonstrate the following six elements:

(1) A trade secret exists; (2) the information comprising the trade secret was communicated in confidence by plaintiff to the employee; (3) the secret information was disclosed by that employee and in breach of that confidence; (4) the secret information was acquired by a competitor with knowledge of the employee’s breach of confidence; (5) the secret information was used by the competitor to the detriment of plaintiff; and (6) the plaintiff took precautions to maintain the secrecy of the trade secret.

……….If the plaintiff can satisfy this burden, then “the burden shifts to defendant to show that it could have arrived at its product by reverse engineering some product in the public domain.” Defendant’s burden, however, is not simply whether it could have simply reverse engineered a product in the public domain, but that the product at issue was “quickly reverse engineer able” The Court further noted that “[t]he more difficult, time consuming and costly it would be to develop the product, the less likely it can be considered to be “reverse engineer able’.”

……….The Court then held that there was no basis in law for a per se rule that the fruit of a competitor’s reverse engineering could never itself become a trade secret entitled to legal protection. Instead, the Court instead adopted the reasoning of the following commentary to the Uniform Trade Secrets Act, which the Court quoted in its decision:

Information is readily ascertainable if it is available in trade journals, reference books, or published materials. Often, the nature of the product lends itself to being readily copied as soon as it is available on the market. On the other hand, if reverse engineering is lengthy and expensive, a person who discovers a trade secret through reverse engineering can have a trade secret in the information obtained from reverse engineering.

……….Having reversed the trial court’s legal ruling that Rycoline could not as a matter of law demonstrate that its reverse engineering of ACFS 276 constituted a trade secret, the Court remanded for a jury determination as to 1) whether the result of Rycoline’s reverse engineering of Anchor MXEH was a trade secret, 2) whether plaintiff could meet the other elements of its prima facie case, and 3) whether the defendant could demonstrate that it could have sufficiently quickly learned the information comprising Rycoline’s trade secret through reverse engineering.

……….The Court made clear that even though the commencement of the reverse engineering process does not implicate a protected trade secret, it is possible that the process may ultimately result in the development of a compilation that is, in fact, a trade secret. The Court held, in effect, that a compilation or formula developed through lawful reverse engineering is entitled to the same protection as any other compilation or formula that may be deemed a trade secret. It did not rule that all successful reverse engineering would yield a trade secret; it ruled that the fact that the trade secret was the result of reverse engineering does not permit the conclusion that it is entitled to less protection that some other type of trade secret.

……….Rycoline Products has made it easier for a party asserting a trade secret to establish its prima facie case by broadening the definition of potential trade secrets to include those resulting from reverse engineering. The critical inquiry may now be whether the defendant can show that the plaintiff should not be able to recover because the defendant could have “quickly” derived through reverse engineering plaintiff’s asserted trade secret. This inquiry may lead to many further questions. Should quickly be defined exclusively as a function of time, and if so, what is quick -two weeks, one month, three months? Or should quickly also be defined in consideration of other factors, such as the amount of resources that would be required for such reverse engineering? Does the standard require a complete reverse engineering, or only a substantial one? Will expert testimony be required to demonstrate that a product is “quickly reverse engineer able”?

Current Developments In Executive Compensation

Current Developments In Executive Compensation


A. Elective Deferral Compensation Plans.

1. Employer adopts deferral plan to provide retirement benefits to a select group of management or highly compensated employees.

2. Participants elect to defer regular and/or incentive compensation. Amounts deferred are subtracted from the participant’s compensation when it becomes payable and are credited to the participant’s deferral account. Interest will be credited on the deferrals at the rate provided in the plan.

3. The deferral plan balance is solely a bookkeeping entry. Participant is a general, unsecured creditor of the employer with respect to the amounts deferred under the plan.

4. The benefits payable under the plan are represented solely by the employer’s unsecured promise to pay the benefits. To this extent, the participants and their beneficiaries will be general, unsecured creditors of the employer.

B. Supplemental Executive Retirement Plans (SERPs).

1. The employer promises to pay the employee a benefit equal to a specified dollar amount or a percentage of final compensation.

2. No salary reduction.

3. The promise to pay is unfunded and unsecured. An employee is a general, unsecured creditor of the employer.

4. Typically, the benefit is subject to a vesting schedule. In some cases, there is a 100% forfeiture of benefits if the employee terminates prior to a designated retirement age for reasons other than death, disability, or change in control.

C. ERISA Excess Plans.

A SERP may be designed as an ERISA Excess Plan as defined in ERISA Section 3(36). Such a plan provides benefits which would have been paid but for the limitations on contributions and benefits contained in Section 415.


A. Employer Tax Consequences.

1. Pursuant to Code Section 404(a)(5), amounts accrued under a plan which defers the receipt of compensation are not deductible until the year in which the amounts are includible in the employee’s gross income, and then only to the extent such amounts represent reasonable compensation.

2. The employer should be able to deduct death benefits paid to beneficiaries in the year of payment if the payments are reasonable in amount and in duration.

B. Employee Tax Consequences.

1. IRC §451(a) provides that a cash basis taxpayer will be taxed on income prior to actually receiving it if the income is constructively received or received under the economic benefit theory.

Therefore, by avoiding the constructive receipt and economic benefit theories, the participant will recognize income only upon actual receipt of the deferred plan benefit payments.

2. The election to defer compensation must be made before the compensation has been constructively received in order to also defer the income tax on the deferred amounts. Rev. Proc. 71-19, 1971-1 C.B. 698.

3. Income is constructively received when it is credited to an employee’s account, set apart for him, or otherwise made available to be drawn upon at any time. See Treas. Reg. §1.451-2(a).

4. The opinions of early courts discussing constructive receipt as it applies to deferral arrangements look to when the compensation is earned, when it is calculable, and when it is payable.

5. In the Veit decisions, Mr. Veit agreed with his employer on January 2, 1939 to defer until July and October of 1941 the payment of incentive compensation earned during 1939 and 1940. On November 1, 1940, during the service period but before the compensation was calculable, the parties agreed to further defer payment from July and October of 1941 to quarterly installments payable in 1942. Finally, on December 26, 1941, after the incentive compensation was both earned and calculable, but before it became payable, the parties again agreed to defer payment. This final agreement was that the compensation would be paid in 5 equal installments over the years 1942 to 1946. The Tax Court addressed the November 1, 1940 and the December 26, 1941 agreements in separate opinions given that both years were not before the court in the initial case.

a. Veit I. Regarding the November 1, 1940 agreement, the Tax Court held that a deferral during the service period but prior to the time the compensation was calculable or payable was effective to defer the tax on such amounts. See Veit v. Commissioner, 8 T.C. 809, 818 (1947). The Service acquiesced in this Veit opinion. See 1947-2 C.B. 4.

b. Veit II. In Veit v. Commissioner, 8 T.C.M. 919 (1949), the Tax Court held that the December 26, 1941 deferral was also effective even though it occurred after the services were performed and after the amounts were calculable. The court noted that prior to the agreement “there was never a time when the compensation was unqualifiedly subject to petitioner’s demand or withdrawal.” 8 T.C.M. (CCH) at 992. The Service did not acquiesce in this Veit opinion.

6. The taxpayer in Oates v. Commissioner, 18 T.C. 570 (1952), aff’d. 207 F.2d 711 (7th Cir. 1953), was a life insurance agent. At retirement, the agent elected to have renewal commissions paid to him at the rate of $1,000 per month rather than as the carrier received the renewal premiums. The precise amount of the previously earned renewal commission was not calculable at the time of the deferral, but “it was well known that considerable amounts would be due [the agent] as commissions out of the renewal premiums.” Nevertheless, the Tax Court held, and the Seventh Circuit agreed, that the agent’s deferral at retirement was effective to defer the income tax on the commissions until they were actually paid to the agent. The Service later acquiesced in the Tax Court’s decision.

7. In Martin v. Comr., 96 T.C. 814 (1991), Executives were allowed to choose between two non-qualified deferred compensation plans, the original plan which only provided installment payments and a new plan which permitted both lump sum payments and installment payments. The IRS contended that the Executives constructively received the full amount of benefits under the new plan because they had the choice to receive a lump sum payment. The Tax Court held for the Executives.

C. FICA Tax Consequences.

1. Section 3121(v)(2)(A) provides compensation deferred under a deferral plan is subject to FICA taxes at the later of when the services are performed, or when there is no substantial risk of forfeiture of the rights to such amount. Amounts deferred are typically always 100% vested and thus are subject to FICA taxes in the year the services are performed.

2. Deferred compensation and interest it earns is subject to FICA taxes only once. Therefore, deferred amounts paid to the participant will not again be subject to FICA taxes.

3. Section 1402(a) provides that for purposes of self employment tax and earnings for Social Security purposes, an outside director is deemed to have earned his or her fees in the year in which the services are performed regardless of when the fees are paid.

4. Final regulations on the employment tax treatment of deferred compensation have been issued recently. Key aspects of the final regulations include the following:

a. The grant of a stock option, stock appreciation right, or other stock value right is not a grant that is subject to Section 3121(v).

b. Special rules for early window programs.

c. Payments made under a non-qualified deferred compensation plan in the event of death are death benefits, but only to the extent the total benefits payable under the plan exceed the lifetime benefits under the plan. Similarly, payments made under a non-qualified deferred compensation plan in the event of disability are disability benefits, but only to the extent the disability benefits payable exceed the lifetime benefits payable under the plan.


A. Top Hat Exemption.

1. Plans that are “unfunded and maintained by an employer primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees” are excepted from the participation, vesting, benefit accrual, joint and survivor annuity, funding and fiduciary requirements of ERISA. However, such plans must comply with the reporting and disclosure requirements, and must also provide a claims and review procedure.

2. Although ERISA, its regulations and its legislative history are silent on the meaning of “unfunded” and “select group of management or highly compensated employees”, 3 cases and several DOL opinion letters have provided some standards for determining which plans qualify under the exception.

3. In Dependahl v. Falstaff Brewing Corp., 491 F.Supp. 1188 (E.D. Mo. 1980), rev’d on other grounds, 653 F.2d 1208 (8th Cir.), Cert. denied, 454 U.S. 968 (1981), an employee claimed that a death benefit only plan was funded because the employer had purchased life insurance contracts on the lives of participants.

a. The district court found that the plan was funded because the benefits would “eventually be paid through the insurance contracts purchased and maintained by [the employer].” 491 F. Supp. at 1195.

b. The Eighth Circuit Court of Appeals agreed that the plan was funded because the life insurance policies constituted “a res separate from the corporation” to which the beneficiaries could look for payment. See 653 F.2d at 1214.

c. The Dependahl opinions appear to hold that a plan is funded if the employer purchases a life insurance policy on the life of a participant. However, the insurance policies in Dependahl were directly tied to the payment of plan benefits — the insured key executives were named in the plan documents; letters to the executives explaining the plan benefits directly tied the policies to the computation and payment of benefits; and the plan was explicitly “secured” by the policies.

4. In Belka v. Rowe Furniture Corp., 571 F.Supp. 1249 (D.Md. 1983), an ex-employee claimed that a deferred compensation plan was funded because the employer had purchased life insurance policies on the lives of plan participants. The employer was the owner and beneficiary of the policies.

a. The court found that Dependahl was distinguishable because it involved a death benefit only plan for which “the insurance policies would certainly assist in paying, if not completely funding, the benefits due.” Conversely, benefits under the Rowe plan were lifetime retirement benefits that would be paid from the employer’s general assets rather than out of insurance proceeds.

b. The Dependahl plan allowed the employee’s estate to look to the insurance proceeds directly if the employer was unable to pay the death benefits. The Rowe plan, on the other hand, expressly provided that neither the employee nor his beneficiary had any preferred claim to the insurance policy or its proceeds. Rather, the employee depended solely upon the employer’s general financial soundness for benefit payments.

c. Because the insurance under the Rowe plan was not interwoven with the payment of plan benefits as was the insurance in Dependahl, the Rowe court found that the plan was unfunded for ERISA purposes.

5. In Belsky v. First National Life Insurance Company, 818 F.2d 661 (8th Cir 1987) following the bankruptcy of his employer, a bank, a nonqualified plan participant brought suit to obtain a life insurance policy owned by the bank. The participant claimed that the policy was a plan asset of the employer’s funded employee benefit plan and that, therefore, the policy could not be transferred to the FDIC. The court followed the Rowe rationale, distinguishing Dependahl for the following reasons:

a. The Belsky plan provided for retirement and disability benefits in addition to a death benefit.

b. The plan did not require that the employer hold or acquire assets to finance the liabilities; and

c. The plan expressly provided that neither the employee nor his beneficiary had a preferred claim to the policy or its proceeds. Rather, it specifically provided that plan participants were general, unsecured creditors of the employer.

6. In DOL Op. Ltr. 81-11A, an advisory opinion was issued to Tandy Corporation regarding its death benefit only plan, the Department of Labor (“DOL”) stated that the insurance would not cause the plan to be funded if certain conditions were met:

a. The insurance proceeds were payable only to the employer;

b. The employer had all the rights of ownership under the policy;

c. Neither the participants nor the beneficiaries had any preferred claim against the policies or any beneficial ownership in the policies;

d. No representations were made to the participants or the beneficiaries that the policies would be used to provide benefits or were security for benefits; and

e. Plan benefits were not limited or governed in any way by the life insurance policies.

B. ERISA Excess Plans.

1. An unfunded ERISA Excess Plan is exempt from all of the Title I ERISA requirements. ERISA §4(b)(5).

a. Reporting and disclosure (Part 1);

b. Eligibility, participation, and vesting (Part 2);

c. Minimum funding and benefit accrual requirements (Part 3);

d. Fiduciary rules (Part 4); and

e. Enforcement provisions (Part 5).

2. A funded ERISA Excess Plan is exempt from the following ERISA requirements:

a. Eligibility, participation, and vesting (Part 2). ERISA §201(7).

b. Minimum funding and benefit accrual (Part 3). ERISA §301(a)(9).


A. ISOs Versus Nonqualified Options.

1. With an ISO, the employee does not recognize current compensation upon the exercise of the option. Any gain on the exercise is deferred until the stock is sold and all the gain is characterized as capital gain.

To qualify for capital gain treatment, the employee must hold the stock for at least 2 years after the date the ISO was granted and at least one year after it was exercised.

2. An employee does not receive tax-favored treatment on the exercise of a nonstatutory or “nonqualified” stock option. Under section 83(a), a nonqualified stock option results in ordinary income to the employee in the year of exercise on the spread between purchase price and fair market value at exercise and capital gain on the appreciation realized between exercise and sale.

3. The employer sponsoring the ISO never receives a tax deduction for the compensatory bargain element in the ISO. A nonqualified stock option is more favorable for the employer because it gets a deduction.

B. ISO Requirements.

1. The employer must have a written option plan that sets forth the maximum number of shares that may be issued under the plan, as well as the class of employees eligible to receive options.

The plan must be approved by a majority of the stockholders of the company within 12 months of its adoption by the board of directors.

The plan must provide that the aggregate value of the stock with respect to which ISOs are first exercisable by the optionee in any calendar year cannot exceed $100,000.

2. Assuming that the plan satisfies these requirements, the option grant must also conform to a number of statutory prerequisites under Section 422(b), including:

a. The option exercise price must be no less that the fair market value of the shares (as determined by the board of directors in good faith) on the date of the grant.

b. The option must be granted within 10 years of adoption of the plan.

c. The option, by its terms, cannot be exercisable for a period longer than 10 years after the date of the grant.

d. The option may be granted only to a person who is an employee of the company (or its parent or subsidiary) on the date of the grant.

e. The option must be exercised by the employee no later than 3 months after termination of employment (except in the case of death or disability, after which an ISO can be exercised for up to one year).

f. The option, by its terms, cannot be transferable (other then by will or laws of descent) and can only be exercised during the employee’s lifetime by the employee.

g. If an option is granted to a more-than-10% shareholder of the company (or its parent or subsidiary), the exercise price can be no less that 110% of the fair market value at the date of grant and the option cannot be exercised for a period longer than 5 years after the date of the grant.

C. Sequential Exercise Rule.

Prior to the 1986 Tax Reform Act, pursuant to the sequential exercise rule, an ISO could not be exercisable before any prior ISO granted to the same optionee by the same company had been exercised in full or had expired (by lapse of time) under the terms of the grant.

This rule was repealed by the 1986 Tax Reform Act.

D. Grant Limitation Rule.

Prior to the 1986 Tax Reform Act, the grant limitation rule required that the terms of the ISO plan provide that no employee could be granted ISOs for more that $100,000 worth of stock in any calendar year.

This rule was repealed by the 1986 Tax Reform Act. Post-1986 ISOs are subject to a $100,000 exercise limitation rule rather than a grant limitation rule.

E. Alternative Minimum Tax.

The spread on exercise of an ISO is a tax preference for alternative minimum tax purposes.

F. Third-Party Stock Options.

These programs consist of plans whereby employees receive options to purchase third-party (i.e. non-employer) stock or mutual funds. Generally, a bargain purchase price on the date of grant is part of these programs.

The use of this type of program would allow a tax-exempt employer to provide deferred compensation to its executive in an amount in excess of the annual limitation imposed under Section 457.


A. General Rules

In general, there are two types of stock options. They are Incentive Stock Options and nonqualified stock options.

The key with Incentive Stock Options is that an employee does not recognize gain on the grant or exercise of the option, but only on the sale of the underlying security. The gain at that time will be characterized as capital gain if the employee holds the security for two years from date of grant and one year from date of exercise. Incentive Stock Options are not transferable by the employee during his or her lifetime, therefore, they do not offer estate planning opportunities.

Nonqualified stock options provide greater flexibility in estate planning. There is no statutory provision limiting transferability.

If an option does not have a readily ascertainable FMV at the date of grant, income will be recognized at the date of exercise. Gain will be characterized as ordinary income.

B. Disposition of Option

In an arm’s length disposition or sale of an option, compensation is realized at the time of the transaction pursuant to 1.83-1(b).

In a non-arm’s length disposition or sale of an option, compensation is realized by the transferor at the time of exercise by the transferee pursuant to 1.83-1(c).

1. These rules were recently confirmed in PLR 200005006. The IRS addressed the issue of whether a husband is taxed under Section 83 when stock options are transferred to his former wife pursuant to a divorce decree. The IRS concluded that this was an arm’s length transaction and that the husband had to recognize compensation income at the time of the transfer.

2. In PLR 199952012, a stock option agreement was amended to provide that options were transferable to immediate family members. The taxpayer wanted to make a gift of options. The plan stated that options were exercisable only after the optionee had been continuously employed for at least one year. Since the taxpayer had satisfied this service requirement, the IRS ruled that the proposed transaction was a completed gift on the date of transfer. There was a discussion of Rev. Rul. 98-21 in the ruling. In that instance the IRS ruled that a gift of a stock option from a mother to her child was not a completed gift because the exercise of the option was conditioned on the employee’s performance of services.

Rev. Proc. 98-34 sets forth how to value a stock option for gift and estate tax purposes. It establishes a safe harbor if certain conditions are met, otherwise the taxpayer may obtain an independent appraisal. One of the conditions necessary to qualify for the safe harbor is that the company must be subject to Statement of Financial Accounting Standard No. 123 (Accounting for Stock-Based Compensation).


A. Definition of Split Dollar.

1. “Split dollar” refers to an arrangement between parties, typically an employer and an employee, for the purchase of a life insurance policy. The benefits payable under the policy are “split”, and the premiums paid for it may be split, by the parties.

2. The cost sharing at the heart of a split dollar plan enables the flow of benefits from, for example, an employer to an employee. In the employment context, this “nonqualified” plan can channel current and future benefits to key employees.

3. A hallmark of split dollar life insurance is flexibility. The costs and benefits may be split in any number of ways, with different tax consequences. An employee’s share of the premiums may even be zero. While the plan must use a life insurance policy with a cash surrender value, the policy may take the form of whole life, universal life, or variable life insurance.

B. Policy Ownership.

1. Either the employer or the employee may “own” the policy, subject to the rights of the other party.

2. If the employer owns the policy, the employee’s right to a share of the benefits is secured by an endorsement to the policy. Hence, a split dollar arrangement structured in this manner is said to follow the “endorsement method”. This approach may be used when it is intended that the employer retain control of the policy.

3. If the employee owns the policy, the employer’s right to a share of the benefits is secured by a collateral assignment of the policy. Hence, a split dollar arrangement structured in this manner is said to follow the “collateral assignment method.” This approach may be used when it is intended that the employee should eventually own the entire policy, or as part of an effort to provide the employee the benefit of the policy’s “inside buildup.”

C. Typical Structure.

1. The employer pays an annual premium not exceeding the anticipated increase in the policy’s cash surrender value during the year.

2. The employee’s premium is the balance of the annual premium due or scheduled.

3. The employer’s share of the death benefit under the policy is the greater of the cash surrender value and the sum of the employer’s premium payments. This “repays” the employer’s contribution, with or without interest.

4. That balance is the employee’s share of death benefit i.e., the amount that the employee may direct to be paid to his or her death beneficiary under the policy. This is the policy’s “net amount at risk” or pure insurance element, more or less.

5. If the policy is surrendered, the employer receives all of the cash surrender value.

D. Employee Tax Consequences.

1. The longstanding foundation of split dollar plan taxation was Rev. Rul. 64-328, 1964-2 C.B. 11, holding that traditional split dollar plans involving employers and employees, whether following the endorsement method or the collateral assignment method, provide compensatory benefits to employees includible in their gross income.

2. Rev. Rul. 64-328 requires an employee who is party to a split dollar plan to include in income the value of current benefits received as a result of the employer’s premium payments. This application of the economic benefit doctrine was held appropriate in Howard Johnson v. Commissioner, 74 T.C. 1316 (1980).

a. The value of the benefits is measured as the employer paid cost of the face amount of term life insurance equal to the coverage under the plan that the employee may direct to his or her death beneficiary.

b. For this purpose, the cost per unit of coverage is determined by applying the “P.S. 58” rates. See Rev. Rul. 55-747, 1955-2 C.B. 228. However, such cost may be based instead on actual 1-year term insurance rates of the insurer providing the coverage, if those rates are lower. Rev. Rul. 66-110, 1966-1 C.B.12. To be used for this purpose, the insurer’s rates must be those generally available to standard risks and therefore cannot be as low as “fifth dividend” rates or other preferred rates. Rev. Rul. 67-154, 1967-1 C.B. 11; PLR 8547006.

c. Since Rev. Rul. 64-328 seeks to include in income only the employer-provided cost of coverage, any amount paid by the employee (or other owner) during the year for coverage received that year reduces the imputed income dollar-for-dollar. (There is no carry-over of “excess” payments, however.) Such payments are, of course, nondeductible by the employee.

3. According to Rev. Rul. 64-328, the death benefit received by the employee’s beneficiary is excluded from the beneficiary’s gross income under Section 101(a)(1). This assumes, of course, that the transfer-for-value rule of Section 101(a)(2) is not invoked and that the policy qualifies as life insurance under Section 7702.

E. Employer Tax Consequences.

1. According to Rev. Rul. 64-328, the death benefit received by the employer as beneficiary under the policy is excluded from gross income under Section 101(a)(1) (again assuming that Section 101(a)(2) is not invoked and that the policy qualifies under Section 7702).

2. The ruling also denies the employer a deduction for any part of the premium paid under the policy, pursuant to Section 264(a)(1), because of the employer’s interest in the policy.

3. Under a split dollar plan, the employer may have the right to borrow against the policy’s cash surrender value, such as to pay a premium.

a. Interest on the borrowing is deductible by the employer subject to rules of Section 264.

b. If the policy fails the “7-pay” test of Section 7702A and is therefore treated as a “modified endowment contract,” such a loan or any other cash distribution from the policy (including a dividend) will be includible in the employer’s gross income to the extent of the income on the contract under Section 72(e)(10), with application of the 10% penalty tax imposed by Section 72(v).

F. The Split Dollar “Rollout”.

1. When an employee covered by a split dollar plan terminates employment, as by retirement, the plan itself may be terminated and the policy “rolled out” to the employee. The rollout may be accomplished by a sale of the employer’s interest to the employee or by a “bonus” of such interest to the employee. The sale may be financed by borrowing from the policy’s cash surrender value.

2. The amount of the cash surrender value transferred to an employee in the rollout of a traditional split dollar plan, net of the employee’s payment for the transfer, is includible in the employee’s gross income pursuant to Section 83. See PLRs 7916029 and 8310027.

a. Although a policy used in a split dollar plan under the collateral assignment method is not itself transferred in the rollout (since the employee or some other party already owns it), the employer’s interest in the cash value is transferred. See Treas. Reg. §1.83-3(a).

b. It appears that the employee may not count as part of his or her “payment” the previous premium payments made to reduce income imputation. See PLR 7916029.

c. If the policy is a modified endowment contract, amounts borrowed or withdrawn to effectuate the transfer may be includible in income and subjected to the 10% penalty tax.

3. The employer may deduct the amount transferred to the employee upon the rollout under Section 162 as provided in Section 83(h). However, any gain in the policy (i.e., any excess of the policy’s cash surrender value over the employer’s premium payments) will be includible in the employer’s income under Treas. Reg. §1.83-6(b). See PLR 8310027.

4. The transfer-for-value rule of Section 101(a)(2), limiting the death beneficiary’s exclusion for life insurance proceeds to the premium and other consideration paid therefor, should be take into account in structuring a rollout. Under that rule, e.g., a rollout of a policy to the insured thereunder would not trigger the limitation, but the policy’s transfer to a third party owner may well do so.

New Interim Guidance

1. In 1996, the IRS released Technical Advice Memorandum 9604001, which set forth a new position regarding the income taxation of split dollar life insurance. Under this TAM, the IRS held that, in addition to the economic benefit, an employee has income under Section 83 each year as a policy’s cash value exceeds the premiums recoverable by an employer.

In Notice 2001-10, 2001-5 IRB 459, the IRS announced a new interpretation of split dollar life insurance taxation. The Notice applies either Section 83 or Section 7872 to employer payments under split dollar plans. Taxpayers have a choice of characterizing employer payments as loans (subject to Section 7872), non-loans (subject to Section 83), or as payments of compensation (subject to Section 61).

The Notice makes several major changes to the term rates used to value the economic benefit of the life insurance protection.


A. General Definition.

1. In a nonqualified unfunded deferred compensation plan, the employee, generally, is an unsecured general creditor of the employer subject not only to the solvency and credit risks of the employer, but also to the employer’s good faith payment of benefits. As a practical matter, delay and expenses associated with litigation to enforce a right to unfunded deferred compensation against a solvent employer can substantially reduce or eliminate the value to an executive of such benefits.

2. One method of securing the anticipated deferred compensation benefit is for the employer to establish a trust, to segregate the deferred compensation assets from its other assets and protect the employee’s benefit. Although a trust can provide actual protection from loss of benefits (e.g., in the event of a hostile takeover), at best it may offer only psychological assurances in the event of employer insolvency or bankruptcy since the assets held in the trust must be available to the general creditors of the employer.

3. A rabbi trust is essentially an irrevocable grantor trust used to fund and secure nonqualified deferred compensation benefits for eligible employees. In order to establish a rabbi trust, the employer transfers assets to the trustee, either on a discretionary or actuarially determined basis (depending upon the form of the underlying deferred compensation program). Such funds may then be invested, and are generally available for the payment of benefits. As a form of grantor trust, its earnings are generally taxable to the employer and contributions deposited are not deductible until the employee receives the benefit and takes it into income.

4. In Private Letter Ruling 8113107, a congregation entered into a deferred compensation arrangement with its rabbi in order to provide benefits in the event of his death, disability, retirement, or separation from service. The congregation, as the plan sponsor, established an irrevocable trust to segregate the deferred amounts contributed by it. In accordance with its terms, the trust could not be amended or terminated; however, the trust corpus remained at all times subject to the claims of the congregation’s general creditors. The IRS held that since the trust corpus was subject to the claims of general creditors, including the claims of the rabbi for his deferred benefits, and because of the anti-alienation provisions of the trust, there was no “funding.” Therefore, the rabbi would not be currently taxed.

B. DOL Requirements.

1. Section 4(b)(5) of ERISA exempts from the coverage of all of Title I of ERISA a plan which is both “unfunded” and an “excess benefit plan” as defined in Section 3(36) of ERISA. Section 3(36) defines an excess benefit plan as “a plan maintained by an employer solely for the purpose of providing benefits for certain employees in excess of the limitations and contributions and benefits imposed by Section 415 of the Code on plans to which this Section applies, without regard to whether the plan is funded.” Sections 201(2), 301(a)(3), and 401(a)(1) of ERISA exempt from the application of parts 2, 3 and 4 of Title I, respectively, “a plan which is unfunded and is maintained by an employer primarily for the purpose of providing deferred compensation for a select group of management or highly compensated employees.”

Therefore, if a rabbi trust constitutes a “funded” deferred compensation plan for purposes of ERISA, such a plan would be subject to the ERISA rules requiring that benefits vest over prescribed periods of time and that assets be held in trust for the exclusive benefit of the participants and beyond the reach of the employer’s creditors. Such plan would also be subject to the ERISA fiduciary, enforcement, reporting, disclosure and other rules.

2. In a letter to the IRS dated December 13, 1985, the DOL gave its opinion on the application of ERISA requirements to a rabbi trust. In its letter, the DOL limited its opinion to top-hat plans and excess benefit plans. The DOL stated that it would use a facts and circumstances test in order to determine whether a plan was “funded” for purposes of Title I of ERISA, including looking to relevant non-ERISA law (e.g., relevant Code provisions). The DOL further stated that it was “the working premise of the Department that a ‘top-hat’ plan or excess benefit plan would not fail to be ‘unfunded’ solely because there is maintained in connection with such a plan a ‘rabbi trust,’ and noted that it would accord significant weight to the IRS’s position that a rabbi trust does not constitute a funded plan when the DOL makes its case-by-case determinations.

C. Employer Stock.

In PLR 9235006, the IRS issued a private letter ruling regarding the funding of rabbi trusts with employer stock. Under the facts of the ruling, the parent of an affiliated group of corporations, set up a trust to provide nonqualified deferred compensation benefits for the executives of the company and its affiliates. According to the trust, the trust assets were to be comprised principally of the company stock, purchased by the trustee on the open market. The IRS held:

1. The contribution of assets did not constitute a transfer of property within the meaning of Section 83;

2. The contribution of assets did not cause a participant to recognize, under either of the constructive receipt or economic benefit doctrines, income prior to the taxable year in which the assets are paid or made available;

3. The employer will be able to deduct the benefit payments in the year includible in the participant’s income;

4. The employer will not be taxable on dividends to the trust as long as it remains the owner of the trust; and

5. The employer will not recognize any gain or loss on account of the receipt of money on other property by the trustee in exchange for the stock as long as it remains the owner of the stock.

D. Insurance.

In Private Letter Ruling 9344038, the IRS ruled that an employee’s purchase of an insurance policy from an insurer to secure the future payment of nonqualified deferred compensation benefits from a rabbi trust conferred no economic benefit on the participant. Thus, the issuance of the policy did not cause the deferred compensation benefits to be includible in the participant’s gross income prior to the time the benefits were paid or made available to the employee.

Under the economic benefit doctrine, employees must include in gross income any income from an economic or financial benefit received as compensation, including benefits not received in cash. An employee receives an economic benefit when assets are unconditionally and irrevocably paid into a fund or trust to be used for the employee’s sole benefit.

When the employee independently purchased the policy, the IRS found the employer had not transferred property to the employee that was protected from the employer’s creditors. Thus, no economic benefit was conferred on the employee by the employer. Under the policy, the employee paid all of the premiums and negotiated the terms of the policy without any involvement by the employer. In addition, the insurer issued the policy without entering into any collateral agreement with the employer and without obtaining any information about the employer other than publicly available information. The IRS noted, however, that if the employer reimbursed the employee for premiums paid, this amount would be includible in the employee’s income at the time of reimbursement.

E. Model Rabbi Trust.

In Rev. Proc. 92-64, 1992-2 C.B. 422, the IRS designed a model rabbi trust. This Revenue Procedure provides that the IRS will not issue a private letter ruling for a nonqualified deferred compensation plan that uses a rabbi trust other than the model rabbi trust.

F. Offshore Rabbi Trusts.

There recently has been much commentary in compensation planning journals regarding the advantages of offshore rabbi trusts. As set forth above, a rabbi trust is a means to secure an Executive’s deferred compensation. However, the assets within a rabbi trust are subject to the claims of the general creditors of an employer in the event of the employer’s insolvency or bankruptcy. By placing the rabbi trust offshore, the various authors suggest that it will become more difficult for general creditors to go after these assets because of secrecy laws, etc. found in offshore jurisdictions and therefore the general creditors may not pursue collecting them.

Letters of Intent: Use Caution in Drafting to Avoid the Unintended

Letters of Intent: Use Caution in Drafting to Avoid the Unintended

By: Jack P. Baron

Though not every transaction commences with a letter of intent (LOI), the use of letters of intent has become more frequent, particularly given the uncertain economic environment during the last several years. An LOI can be a useful preliminary step in the negotiation of commercial transactions, which often require substantial time, due diligence and expense prior to the parties proceeding to a formal agreement. 

Use of a well-drafted LOI to confirm expectations regarding certain key aspects of the transaction, often will provide the parties the requisite level of comfort needed before investing the time, effort and expense of moving the transaction beyond the LOI stage. As an example, a potential purchaser of a business may be reluctant to incur the costs associated with the drafting and negotiation of a contract, as well as the obligations arising thereunder. An LOI containing a due diligence period, among other provisions, may provide the purchaser with sufficient information and confidence to proceed to the next stage of drafting and negotiating the contract.

Inasmuch as many clients and practitioners may be more familiar with drafting the definitive acquisition documents (such as an asset purchase agreement or stock purchase agreement), they may underestimate the importance of properly drafting the LOI, so that neither party is subject to unintended obligations, liabilities or consequences. In addition, practitioners may be under the misimpression that an LOI is not binding, when, in fact, the LOI may be binding, in whole or in part, either by design or as the result of inartful drafting.

To What Extent, if Any, is the LOI Binding?

Whether an LOI is binding on the parties depends on the intent of the parties. “If the parties intend to be bound by their preliminary agreement and view the later written contract as merely a memorialization of their agreement, they are bound by the preliminary agreement.”1 “On the other hand, if the parties intend that their preliminary agreement be subject to the terms of their later contract, they are not bound by the preliminary agreement.”2 The language of the prelimi­nary agreement, the course of dealing between the parties before and after the preparation and execution of the preliminary agreement, and the facts surrounding its preparation are factors a court will consider in deter­mining whether the parties intended to be bound by the preliminary agreement³.

On the one hand, parties to a transaction frequently are concerned that the LOI will constitute a binding contract, requiring them to proceed with and consum­mate the underlying transaction. On the other hand, the parties often want to be bound by specific provisions of the LOI, such as due diligence, confidentiality, exclusiv­ity and various other provisions.

Avoiding Construction of the LOI as a Binding Contract

If it is the intent of the parties not to be bound by the LOI, the following points should be considered when drafting an LOI in order to avoid creating a bind­ing contract:

1. The LOI should clearly, unambiguously and unequivocally state that the LOI is not intended to be a binding contract, is not an offer to proceed to contract, and should not be construed as a contract or offer to contract.

2. The LOI should also state that the parties do not intend to be bound by the terms of the LOI, unless and until the parties agree upon and execute a definitive agreement (such as an asset purchase agreement or stock purchase agreement, as the case may be).

3. Limiting the inclusion of material terms likely indicates that the parties intend not to be bound by the LOI, but rather by a formal, definitive agreement following the LOI. Examples of such material terms and details would be purchase price, representations and warranties, terms of indemnification, closing date and the like. The LOI should specify the terms that have not been agreed upon, and that are subject to further negotiation. The LOI should further provide that the parties intend not to be bound unless and until all terms have been negotiated and agreed to in an executed definitive agreement. 

4. Similarly, deferring inclusion of certain key aspects of a transaction from the LOI stage to the signing of the definitive agreement tends to indicate that the parties intend not to be bound by the LOI. Examples of such elements would include commencement of the due diligence period, undertaking of search and title work and tendering of the deposit. The deferral of due diligence may be unacceptable to the purchaser given that many purchasers want to commence due diligence once the LOI is signed.

5. Specify a deadline by which the definitive agreement must be reached. Further provide that if the parties fail to negotiate a definitive agreement within the specified time frame, negotiations shall cease and the parties shall have no further obligation to one another.

Executive Orders 242 and 243: New Jersey


Governor Murphy signed Executive Order No. 242 on May 24, 2021, and Executive Order243 on May 26, 2021, as part of New Jersey’s “multistage Road Back Plan for the methodical and strategic reopening of businesses and activities” based on the progress made within the state against the COVID-19 pandemic. A series of prior Executive Orders have recently allowed for thelifting of restrictions regarding masking and distancing in outdoor settings, and the lifting of restrictions on indoor and outdoor gathering limits in food and beverage establishments and other entertainment facilities. Executive Order 242 has now lifted masking and spacing restrictions for “indoor public spaces” that are open to the public “for purposes of the sale of goods, attendance atan event or activity, or provision of services” as of May 28, 2021.

In Executive Order 243, Governor Murphy has clarified his prior Order on “indoor publicspaces” and similarly lifted COVID-19 restrictions in certain circumstances for workplaces and businesses that are generally closed to the public and have limited visitors. More specifically, employers are advised of the following pursuant to Executive Order 243, which becomes effectiveJune 4, 2021:

● Paragraphs 10 and 11 of Executive Order 107 — which stated that all businesses or non-profits whether closed or open to the public, must accommodate their workforce for telework or work-from-home arrangements — have been rescinded, and employers are no longer required to permit employees to work remotely as was done during the pandemic;

● Employees who are fully vaccinated against COVID-19 (the CDC considers an individual to be fully vaccinated 2 weeks after their second dose in a two-dose series, or 2 weeks after a single-dose vaccine), and provide their employer with proof of their full vaccination status (completed vaccination card), are not requiredto wear face masks or social distance at the worksite;

● Where an employer is unable to determine an employee’s vaccination status, or the employee is not fully vaccinated, “employers must continue to require those employees to wear masks and practice social distancing” in the workplace, except when the employee is in their own office or work station;

● Employers are permitted to allow customers, visitors and other authorized individuals to enter the worksite without requiring the use of a mask or adherence to social distancing, regardless of their vaccination status;

● Regarding customers, visitors and other authorized individuals entering the worksite, employers have the option of establishing a policy that requires such individuals to wear a mask and/or social distance, provided that such policy on mask wearing complies with federal and state law regarding accommodations in the event of a disability that makes the individual unable to wear a mask.

Executive Order 243 also emphasizes the following points:

● An employer may impose stricter requirements regarding mask wearing and social distancing in indoor settings (consistent with federal and state law on accommodations in the event of a disability that makes an employee /individual unable to wear a mask);

● Employers cannot restrict employees, customers, visitors or other authorized individuals from wearing masks in the workplace setting for any reason;

● Employees, customers, visitors and other authorized individuals in the workplace shallnot in any way be penalized or retaliated against if they elect to wear a mask;

● Other health and safety standards applicable to all New Jersey employers as set forth in Executive Order No. 192, have not been superseded by Executive Order 243 and remain in full force and effect, including:

  • Employers must take measures to ensure a “health screening” of employees on a regular basis, with such measures consisting of either: (1) temperature screenings, (2) visual symptom checking, (3) self-assessment checklists, and/or (4) health questionnaires;
  • Employers must notify all employees if there is a known exposure to COVID19 in the workplace, consistent with employee confidentiality requirements under the Americans with Disabilities Act, and federal and state guidance;
  • Employers must provide all employees, visitors, customers, and any other individuals who access to the work location, with access to sanitizing materials, at the employer’s expense;
  • Employers must ensure high-access areas in the work location are routinely cleaned and disinfected, and provide all employees with break time throughout the day to wash their hands (unless gloves are provided to the employees);
  • Penalties may be assessed for violations of the health and safety standards in Executive Order 192 which remain in effect.

Executive Order 242 further notes that its lifting of mask-wearing and social distancing restrictions in “indoor public places” do not include child care centers, other child care facilities, youth summer camps, and public, private and parochial preschool program premises and elementary and secondary schools, including charter and renaissance schools, which continue to be governed by applicable standards issued by the Department of Health.

Employers are encouraged to consider how these new standards will be implemented and communicated to employees, customers, visitors and authorized individuals entering the workplace. The Firm is available to assist in this regard and further address any questions or concerns regarding the new Executive Orders as employers continue to engage in the workplace reopening process.

To discuss any of this please contact one of the employment attorneys below:

Corporate Transparency Update Summer 2021


By: Steven J. Eisenstein, Esq.

On January 1, 2021 Congress enacted the National Defense Authorization Act overriding a Presidential veto. As part of this new law the Corporate Transparency Act was put into place. The CTA had failed several previous attempts at passage but as part of the annual Defense bill passage was assured. Ostensibly the rationale for including it was to ensure that foreign companies do not become unseen participants in our national defense. Whatever the rationale the law now exists and business owners must learn to deal with it.

Basically the CTA requires certain business to report the identity of their beneficial owners to the Financial Crimes Enforcement Network, a part of the Treasury Department. While there are still many open questions a brief examination of these three components seems to be in order.

What are the “Reporting Companies” which have these obligations? Any corporation, limited liability company or similar entity which is formed or registered to do business by the filing of a formation document with a state must comply unless they fall within one of 24 exceptions. Among the exceptions are publicly traded companies, public utilities, financial services companies and companies which employ 20 or more people in the U.S., filed a tax return in the prior year reporting at least $5,000,000 in gross revenue and have a physical presence in the United States. Since newly formed companies will not have filed a tax return yet is appears to be the intent of the law to require all newly formed private companies to supply the information.

Who is a beneficial owner? An individual who, directly or indirectly, either owns 25% or more of the equity of the company or exercises substantial control, an undefined term. Minors are not included nor are people who acquire their equity through inheritance. There will doubtless be substantial confusion over the issue of control but even the seemingly fixed standard of 25% equity may be in doubt when issues like options and warrants are considered. Close attention should be paid to further developments in this area.

What information needs to be reported? FINCEN is to receive the full legal name of each Beneficial Owner, the date of birth, the current business or residence street address and an ID number from a Governmental document such as a driver’s license or passport. A person who files the application for the formation may obtain a FINCEN ID number and that ID number may be supplied in lieu of anything else. The information is to be kept confidential by FINCEN but may be released to other Federal agencies in law enforcement, national security or intelligence, to local and state agencies pursuant to a court order or to financial institutions with the consent of the companies.

When will reporting begin? New companies must file reports upon formation or registration to do business. Existing companies have two years to file after the effective date of the anticipated regulations. Regulations have not yet been drafted and all reporting requirements are suspended until they are passed. The reported information will need to be kept current and changes reported within one year of the change.

Are penalties involved? Do you need to ask? Failure to comply may result in both civil and criminal penalties. Fines of up to $500 for each day of violation are possible and prison sentences of up to 2 years may be imposed. Criminal penalties for unauthorized disclosure or use of the violation can result in up to 5 years imprisonment and substantial fines.

Until regulations are drafted there is much that remains unknown. The issue of substantial control will be of great interest in the regulations. This will prove to be of interest to creditors who may be covered if they meet the definition of Beneficial Owner upon foreclosure of security interests. Anyone seeking to form a new company is advised to seek competent advice before doing so as getting it wrong can have serious consequences.

The Business Law Section of Lum, Drasco & Positan stands ready to assist. For more information please contact Steven J. Eisenstein,  Kevin Murphy

Mandatory COBRA Subsidy for Certain Eligible Employees

Mandatory COBRA Subsidy For Certain Eligible Employees Under the American Rescue Plan Act of 2021

The American Rescue Plan Act (ARPA), which is part of President Biden’s COVID-19 relief
package recently signed into law, requires employers to subsidize the cost of COBRA coverage premiums from April 1, 2021, through September 30, 2021, for employees who lost health care coverage due to involuntary termination of employment through layoff or reduction of work hours. In exchange for providing this subsidy, employers will be reimbursed in the full amount of the covered subsidy or subsidies through a tax credit. Employers should be aware of this new subsidy requirement as well as required model notices just issued by the U.S. Department of Labor which must be provided to eligible employees.

Some key points for employers regarding the COBRA subsidy are as follows

Covered plans – The ARPA COBRA subsidy applies to any group health plan subject to the federal COBRA or state “mini COBRA” rules. The subsidy is not applicable to a health flexible spending account.

Covered individuals – The ARPA COBRA subsidy is available to individuals who lose or have lost health insurance coverage due to a layoff or involuntary termination of employment or reduction of hours and elect COBRA continuation coverage (“Assistance Eligible Individuals”). Assistance eligible individuals include the spouse and eligible dependent children of the affected employee. Individuals who lose coverage due to termination for gross misconduct, or through retirement or resignation or other voluntary reasons, are not eligible for the subsidy.

The subsidy will be available to individuals who:

(i) Have COBRA coverage as of April 1, 2021;
(ii) Experienced a covered qualifying event between April 1, 2021 and September 30, 2021; and
(iii) Declined COBRA coverage or let coverage lapse but whose maximum period of COBRA coverage due to a covered qualifying event has not expired as of April 1, 2021.

Covered period – An individual’s subsidy period begins April 1, 2021 and will end on September 30, 2021, unless the individual reaches the end of their 18-month COBRA coverage period, or becomes eligible for another group health plan or Medicare, before that date. A covered individual who becomes eligible for other coverage during the subsidy period must notify their employer or plan of such eligibility, or face penalties for not doing so.

Subsidy amount – The subsidy covers 100% of the COBRA premium during the covered subsidy period of April 1, 2021 through September 30, 2021. The subsidy amount is not taxable income to the individual. If a COBRA premium for a period of subsidized coverage is paid by the eligible individual, they must be reimbursed for their paid premium within 60 days after the date the premium payment was made.

Employer tax credit for subsidy – The IRS is expected to issue further guidance on the employer tax credit for the COBRA subsidy, but generally employers will be reimbursed for the full cost of the subsidized COBRA premiums through a tax credit. To ensure maintenance of coverage, employers bear the responsibility for paying health insurance carriers for the COBRA premiums or ensuring that premiums are credited to self-funded plans.

Lower-cost plan option – An employer may (but is not required to) allow an eligible individual to elect different coverage if the COBRA premium for that coverage costs the same or is less than the COBRA premium charged for the coverage in effect for the individual at the time of their qualifying event. The lower-cost option must be one that is offered to similarly be situated active employees and may not be an excepted benefit, a qualified small employer health reimbursement arrangement, or a health flexible spending account.


Employers may review information and frequently asked questions related to the COBRA subsidy, and obtain required Model Notices to be provided to eligible employees, at the U.S. Department of Labor’s website at: 

The required Model Notices are:

● General Notice and Election Form for Newly Eligible Individuals: This Notice (along with the Summary of COBRA Premium Assistance Provisions) should be provided to eligible individuals who become entitled to COBRA between April 1 and September 30 notifying them of their eligibility for the subsidy and any applicable lower-cost plan option. A Model Alternative Notice also exists for small employer plans subject to state mini-COBRA laws.

● Notice and Election Form for Eligible Individuals Whose Qualifying Event Occurred Before April 1, 2021: This Notice (along with the Summary of COBRA Premium Assistance Provisions) should be provided to eligible individuals who previously elected COBRA coverage, as well as eligible individuals who declined COBRA coverage or who let COBRA coverage lapse. This notice also should include an election form for individuals that did not elect COBRA coverage or dropped COBRA coverage to allow them to elect subsidized coverage. Also, if the employer decides to allow a change in health plan coverage, a description of any applicable lower-cost plan option and related election form should be included. This Notice must be provided no later than May 31, 2021.

● Summary of COBRA Premium Assistance Provisions under the ARPA and Request for Treatment as an Assistance Eligible Individual: The Summary must be provided along with the first two Notices listed above. Included in the Summary is a “Request for Treatment as an Assistance Eligible Individual” which must be completed and returned by any eligible individual who wants to receive the COBRA subsidy, within 60 days of their receipt of the summary notice.

● Notice of Expiration of Premium Assistance: Notice of the date of expiration of the subsidy period and of other available coverage under unsubsidized COBRA must be provided to any eligible individual who elects the COBRA subsidy. This Notice must be sent between August 16, 2021 and September 15, 2021. Employers should review whether any of their employees from March 30, 2020 forward lost their health care coverage due to reduction in work hours or involuntary termination of employment due to layoff, to determine whether they are subject to ARPA’s COBRA subsidy and model notice requirements. This review time period incorporates the maximum 18-month COBRA continuation coverage period that includes the subsidy period of April 1, 2021 through September 30, 2021. Employers are also encouraged to communicate with their COBRA and plan administrators or insurers to make sure that all of the required notices are sent to eligible individuals as applicable.