Payroll Practice Exemption Under ERISA
"ERISA" stands for The Employee Retirement Income Security Act of 1974, 29 U.S.C. § 1002(1), which is a federal program that was designed by Congress to help protect funds that have been set aside to pay for employee benefits that typically include long-term disability and retirement benefits.
A disability plan falls under ERISA if it is a "plan, fund or program" which has been "established or maintained" by an employer or employee organization for the purpose of providing employee benefits that usually include life, health, disability, and pension benefits.
ERISA applies to both short-term disability (STD) and long-term disability (LTD) plans.
However, instead of providing a STD plan to its employees that is governed by ERISA, some employers prefer to provide short-term disability benefits through a “payroll practice” exemption. For a payroll practice exemption to apply, an employer must pay disability benefits out of its own general assets. The benefits must be self-funded and not paid by an insurer or other third party. An employer can use an insurer as a third-party administrator (TPA) to handle claims, but not to pay them. Langley v. DaimlerChrysler Corp., 502 F.3d 475 (6th Cir. 2006).
Under the Department of Labor, a payroll practice is exempt from ERISA when it constitues a “payment of an employee's normal compensation, out of the employer's general assets, on account of periods of time during which the employee is physically or mentally unable to perform his or her duties, or is otherwise absent for medical reasons (such as pregnancy, a physical examination or psychiatric treatment).” 29 CFR § 2510.3-1(b)(2).
In Bassiri v. Xerox Corp., 463 F.3d 927, 933 (9th Cir. 2006), the court explained that if the disability benefits paid to the employee comes out of the employer's bank account (like wage payments), those disability benefits constitute a "payroll practice" and are not subject to ERISA.
The payroll practice exemption will apply only if the benefit is paid as a “normal payroll practice,” to current employees and not to retirees, former employees, or dependents, with no pre-funding or the purchase of an insurance policy, with payments paid entirely from the employer's general assets, and without employee contributions.
There are advantages to an employer who utilizes a payroll practice exemption that include not having to comply with ERISA requirements, filing a Form 5500, or having to prepare a plan document or a summary plan description (SPD). By organizing an STD plan as a payroll practice, employers avoid ERISA requirements.
While there are advantages, there are also disadvantages to choosing a payroll practice exemption to ERISA. The most obvious one is that state claims, which could include consequential and punitive damages, are not preempted by ERISA. They can be asserted against an employer under appropriate circumstances. If an employee brings a claim for wrongly denied payroll practice benefits, state law applies and will govern the dispute.
Other Plans Excluded From ERISA
Both government and church plans are excluded from ERISA. A “government" plan, under 29 U.S.C. § 1002(32), is "a plan established or maintained for its employees by the Government of the United States, by the government of any State or political subdivision thereof, or by any agency or instrumentality of the foregoing."
A "church" plan, under 29 U.S.C. 1002 (33)(A), is "a plan established and maintained ... by a church or by a convention or association of churches, which is exempt from tax under section 501 of Title 26."
Other plans that are specifically excluded from ERISA include workers compensation benefits, adoption assistance plans, cafeteria plans, medical clinics providing first aid, state mandated disability plans, tuition reimbursement plans, sick pay plans, paid time-off plans, overtime, jury duty pay, and vacation pay.
Disability attorneys must recognize when ERISA applies or doesn't apply.
A decision to utilize a payroll practice to pay for short-term disability benefits must take into consideration not only the costs involved, but also the effects of not having ERISA protections.
ERISA law is complicated. At Law Med, we are ERISA knowledgeable and experienced.