Exclusions allow benefits for small business owners and key managers.

    Before ERISA went into effect in 1974, many business owners and high-income professionals routinely provided themselves with extraordinary retirement and health benefits while their rank-and-file employees received substantially less. ERISA, with its draconian nondiscrimination rules, appeared to have changed all of that forever.
    ERISA, however, also created opportunities for owners to continue providing an array of exclusive executive benefits under certain codified exclusions, the most valuable being where employers contractually formalize the employment relationship. The fact is that many small businesses already incorporate most of the benefits found in collectively bargained employment agreements.
    So, while it is true that ERISA placed substantial restrictions on what employers can do for themselves, it also created opportunities. Employers who are concerned with tax-sheltering and asset-protecting as much earned income as possible, and with paying for uninsured health care expenses with tax-deductible earnings and profits, can still do so-and more-on a completely exclusive basis.
    What is the real dollar value to business owners and high-income professionals of being able to offer exclusive retirement and health benefits for themselves versus their employees?
    Today's high-income professionals and business owners are, frankly, victims of "reverse discrimination" as a result of ERISA. For example, a 401(k) contribution of $18,000 in 2005 by Mr. Doe, an employee earning $50,000 a year, represents an advantageous income tax deferral of 36%. On the other hand his 50-year-old employer Mr. Boss, who earns $500,000 a year, also can only defer $18,000-representing an annual tax deferral of only 3.6%. Mr. Boss is a typical victim of ERISA "reverse discrimination." In the area of health expenses, Mr. Boss must exceed $37,500 of uninsured costs before he is able to deduct anything. Mr. Doe, on the other hand, gets to deduct all family uninsured health care expenses after just $3,750.

Understanding The Benefits Terrain
    Misconceptions abound about establishing benefits for small businesses; namely, which benefits are subject to ERISA nondiscrimination rules and which are not.
If a benefit is not a "qualified benefit" it would not be subject to ERISA nondiscrimination rules.   Example: nonqualified deferred compensation plans, executive bonus plans, split dollar plans, long-term care plans (LTC), long-term disability plans (LTD) and IRAs.
    If a benefit is a "qualified benefit" it is fully subject to ERISA nondiscrimination rules. Example: qualified retirement plans and employer-sponsored medical reimbursement plans. Qualified plan benefits allow exclusions only as defined in the Internal Revenue Code. For example, an employer cannot establish a different qualified retirement plan for management versus nonmanagement employees unless such employees are excluded by one of the five following statutory exclusions stipulated in Internal Revenue Code Sections 105(h) or 410(b):
        Part time employees working less than 1,000 hours per year.
        Employees with less than one year of service (retirement plans), or three years of service (medical reimbursement).
        Employees under the age of 21 (retirement plans) or the age of 25     (medical reimbursement plans).
        Non-U.S. Citizens working outside the U.S. with no U.S. income source.
        Employees whose benefits are governed by a legitimate collective bargaining agreement.

    Employer-initiated collective bargaining is the most effective planning tool available to set aside the "reverse discrimination" effects of ERISA.
    Contractually formalizing the employment relationship should be looked upon no differently than any other area of contract law used daily by businesses. Compliant employment contracts are those prepared and negotiated pursuant to the National Labor Relations Act of 1935. This is not a new area of law, but rather one that is steeped in more than 70 years of solid labor and tax law.

Exclusive Benefits For Owners And Managers
    In addition to the other many benefits to an employer and its employees of formalizing the employment relationship, employers are able to legitimately establish exclusive benefits for management without violating ERISA nondiscrimination rules. Some of the more popular of these benefits are described below, with long-term care insurance growing ever more popular as the public's awareness of this largest un-funded liability continues to rise:
        Management can establish an exclusive retirement plan for all employees not governed by the nonmanagement employment contract.
        Typically, either a safe-harbor Simple or 401(k) Retirement Plan is established for nonmanagement employees, with employer contributions being 3% of payroll pursuant to the negotiated employment contract. Only then can an executive plan for the management team be established, such as a 412(i) plan to fund an annual retirement pension income of up to $170,000 a year. Executives can also participate in a key employee contribution-only Simple or 401 (k) plan that enables them to each shelter up to $18,000 a year of their own money from current taxation.
        Management can establish an exclusive medical reimbursement plan for all employees not governed by the nonmanagement employment contract. Most taxpayers never have the opportunity to deduct their uninsured health care costs, because under IRC Section 213, the taxpayer must first exceed 7.5% of adjusted gross income (AGI) to begin deducting these expenses. Employer-funded health plans, under IRC Section 105, allow employers to establish plans to reimburse employees on a FICA-free, employer tax-deductible, employee tax-free basis for these uninsured health care expenses.
        IRC Section 105(h) allows employers to establish exclusive benefits for management if nonmanagement employees have a compliant employment contract. An employer can, for example, establish a plan for nonmanagement employees that reimburses them for health insurance expenses should they choose not to participate in the employer-sponsored health insurance plan (as in the case of an employee who waives coverage due to being covered under their spouse's employer elsewhere), not exceeding what the employer would have contributed toward the employee's health plan anyway. The employer can then establish a separate executive medical reimbursement plan for the management team that provides superior comprehensive reimbursement benefits.
    For someone in the 35% federal tax bracket, every dollar paid for nondeductible health care expenses usually equates to more than $1.65 of earned income when considering state income tax, FICA and Medicare tax.
    There are other ways to creatively use medical reimbursement plans. You can substantially raise the deductible on the underlying employer-sponsored group health insurance plan (like those available via a health savings account or other such high-deductible plans), and then reimburse employees who have claims on a portion or all of the difference between the old higher-cost, low-deductible plan and the new lower-cost, high-deductible plan. This eliminates the burden on the employee and shifts the risk on the differential to the employer, while substantially reducing the employer's health insurance premiums.
    Business owners may consider including parents and children in a director or management role, so they can be covered by the medical reimbursement plan for management.
    Management can establish exclusive critical illness benefits for all employees not governed by the nonmanagement employment contract. Medical reimbursement plans can be used as a means to reimburse key employees for the costs of critical illness insurance policies, which they purchase on a tax-favorable basis.
    Critical Illness insurance, unlike disability coverage, is a policy that pays the "face amount" of coverage to the insured "upon diagnosis" of one of numerous life-threatening or disabling events, such as heart attacks, life-threatening cancer and renal failure. It should be noted that people between the ages of 30 and 40 have over a 30% chance of a critical illness claim prior to age 65. The benefits paid are free of income tax to the insured, so long as the premiums were paid with before-tax dollars.
    Medical reimbursement plans also can be utilized to minimize the IRC Section 213 costs of these policies by reimbursing the insured, at year-end, for policies individually purchased and paid for at the beginning of the year (in cases where no claims are filed or paid); the year two premium is paid in a new tax year (paid benefits tend to deliver a far greater value then the reimbursement of paid premiums where no claims are filled or paid).
    Management can establish exclusive LTD, or long-term disability coverage for all employees not governed by the nonmanagement employment contract. LTD, unlike critical illness, is a policy that replaces a portion of one's lost earned income upon proof of the insured's inability to continue working or loss of income. Some policies replace income based on one's "own occupation," whereas other policies reimburse the insured if unable to work at all. Disability insurance policies generally reimburse 50% to 70% of lost earned income, with benefits tax free if premiums were paid with after-tax dollars; if paid with tax-deductible dollars, the benefit is taxable upon receipt. Although long-term disability is not subject to the ERISA nondiscrimination rules, many supplemental employer-funded salary continuation plans often are challenged when the only employees included are stockholders. The usual result is that the payments are deemed to be dividends. A safer plan is one in which all employees, other than those governed by a collective bargaining agreement, are included (another affordable and cost-effective benefit provided by the collective bargaining exclusion).
    Management can establish exclusive long-term care insurance coverage. LTC protection is, uniquely, allowed to be funded with tax-deductible dollars and still enjoy a tax-free benefit. Long-term care insurance is not subject to the ERISA nondiscrimination rules and can be funded by the employer for designated key employees only. A valuable planning strategy for business owners is to include parents or older children in a director or management role, so they can be covered by the employer-funded LTC plan.
Management can establish exclusive split-dollar, nonqualified deferred compensation, and executive bonus plans. Nonprofit corporations, and business owners operating as nonpublic "C" corporations that are not deemed to be personal service corporations, enjoy special income tax brackets that enable them to utilize, on an "exclusive basis," retained earnings and profits on a favorable tax basis to fund designated key-executive benefits such as split dollar life insurance and nonqualified deferred compensation plans. These plans are not subject to the ERISA nondiscrimination rules. Split-dollar plans enable businesses to fund special, exclusive life insurance plans for key employees until retirement.
        1. Endorsement split dollar plans are life insurance contracts owned by the business on the lives of key employees. They are typically established and totally funded by the business, with the greater of cash surrender value or premiums paid inuring to the business and the excess death benefit each year inuring to the key employee and payable to his or her designated beneficiary. These plans are often used in conjunction with nonqualified deferred compensation plans to fund a future retirement benefit, while providing current life insurance benefits to designated beneficiaries of key employees prior to retirement.
        2. Collateral assignment split dollar plans, on the other hand, are life insurance contracts owned by either the insured or a trust created by the insured, with an assignment to the corporation of an interest in the policy by the key employee.
    One valuable technique in nonqualified deferred compensation planning is for the employer to accumulate life insurance policy cash surrender values until the employee retires, and then to exchange the life policy for a single-premium immediate annuity on a tax-free basis. The income paid to the company from the annuity is used to fund the retirement benefit to the now-retired employee. A substantial portion of the payment from the annuity is considered a return of basis ("Exclusion Ratio"), which creates a tax shelter for the employer against other earnings and profits each year.
In light of historic abuses in both split dollar and nonqualified deferred compensation plans, we now have clear, established guidelines to follow that eliminate IRS challenges when plans are prepared and administered compliantly. 
Executive Section 162 bonus plans, utilizing insurance contracts, are owned by the key executive but funded via an annual company bonus that is taxed through to the key executive.

When It's Time To Exit
    Exit strategies are very much the same whether employees are governed by an employment contract or not. Sales of closely held businesses and professional practices are "asset sales" as opposed to "entity sales," because buyers typically do not want to find themselves obligated to hidden liabilities of the seller. In an asset sale the "trade or business" is sold, and the entity typically liquidated; the employment contract simply terminates.

The Ideal Candidate For Such A Plan
    Employers are best served, when considering such a plan, to have a qualified financial planner (www.iaqfp.org/qfp_registry.html) conduct an employee benefits cost analysis to determine exactly the current flow of resource dollars between them and their employees. The heart of good benefits planning is proper fiscal analysis, to see exactly what you are now doing versus potential options and opportunities that may improve the picture, especially if it rewards key personnel like owners and managers.
    Certain benefits are expected under collective bargaining agreements, including retirement and health and other insurance benefits, in addition to defined policies for vacation, observed holidays, severance and leaves of absence. Typically, employer-initiated collective bargaining will include defined management authority and procedures for employee performance reviews, termination, drug testing and compliance and conflict resolution procedures that virtually eliminate employee lawsuits and EEOC complaints, as well as better assuring harmony and continued productivity in the workplace (such as a "no strike- no lockout" clause).
    The best candidates to take advantage of the ERISA exclusions discussed herein are:
        Age 40-plus
        Few financial obligations
        Earning more than $250,000 a year
        Concerned with asset-protection
        Concerned with saving for retirement
        Concerned with uninsured health costs
        Employs three or more employees per key person
        Already funding health and retirement plan for employees
    What we have discovered from this study is that the draconian benefit restrictions of ERISA are always applicable, but are also limited by the five stipulated exclusions. The ERISA exclusions are like "life-building DNA strains" which, when properly utilized, uniquely enable employers to establish exclusive executive benefits on an ERISA-compliant basis, and which can result in greater monetary value exclusively for owners and their key management.

Paul M. League, QFP, CFP, is the principal of League Financial & Insurance Services, Beverly Hills, Calif., (www.LeagueFinancial.com) and  has specialized in asset creation, preservation and expansion through individual and group designed financial programs for over 25 years. He acknowledges Claude B. Bass, J.D., for his contributions to this article.