Background
The COVID-19 pandemic significantly disrupted the American workplace. On March 13, 2020, President Donald Trump declared a national emergency releasing Federal Emergency Management Authority resources to the states, which in turn took initiatives to manage the local spread of the disease. “Nonessential” workplaces, schools, public transportation, restaurants, hotels, entertainment and other venues were shut down across the country as a result. During the initial phase of the pandemic, the U.S. unemployment rate spiked to 15.9 million, representing a rate of 14.7%, up from 3.6% just prior to the shutdown.1 Those who could work remotely during the pandemic did so, keeping many businesses afloat, and ushering in a paradigm shift in employees’ relationship to the workplace and management.
With the modulating effects of widespread vaccination, the viral spread has decreased substantially, and unemployment rates have been coming down, but are still not at pre-pandemic levels.2 Those returning to work are not necessarily going back to their pre-pandemic positions, and others have exited the workplace altogether, many to retire or address child care, which was significantly disrupted by the pandemic.3 Employers eager to hire employees are now competing to attract new employees from a smaller available U.S. pool, and are offering enhanced compensation packages and other benefits to do so.
Attracting Employees With More Innovative Compensation Packages
In response to these challenges, employers in competitive industries are raising base wages and offering signing bonuses and other enhancements. Nonprofit organizations aiming to attract and retain key employees typically offer enhanced deferred compensation packages as well.
For businesses with growth potential or more limited cash flow, compensation tied to the equity growth of the employer and other various types of deferred compensation are part of the standard toolkit for giving employees a stake in the growth of a business, and a financial incentive toward meeting future business targets. For example, awards of equity interests, such as stock options, profits interests, phantom equity, stock appreciation rights and restricted stock, are types of deferred compensation that tie compensation to the future value of the employer.
Other types of deferred compensation include nonqualified deferred compensation plans designed to supplement standard retirement benefits, incentive pay plans designed around financial goals of the employer, deferred cash or non-cash compensation, and deferred compensation payable on a change in control of the employer. These forms of compensation, which are a powerful tool for attracting and retaining top workers, are not covered under the Wage Act.
Deferred Compensation: What Laws Apply?
State wage laws generally apply to employee base pay, vacation and some definitely determinable benefits, and due and payable commissions. Federal law, on the other hand, regulates deferred compensation, benefits, and executive compensation packages, and incorporates a complex array of requirements related to the taxation of deferred compensation.
A short review of the law related to compensation controlled under the Massachusetts Wage Act in comparison to that subject to federal laws illustrates the point.
Meaning of “Wages” Under Massachusetts Wage Act
The Massachusetts Wage Act4 regulates the prompt payment of wages to protect employees who have provided services. Once the employee has performed the services that give rise to wages, Massachusetts law specifically prohibits delaying their payment beyond certain statutory parameters.
Massachusetts courts have discussed the deadlines for paying accrued wages in two illustrative cases: Stanton v. Lighthouse Financial Services, Inc,5 and Parker v. EnerNOC, Inc.6
In Stanton v. Lighthouse Financial Services, Inc., the parties agreed to the rate of the employee’s base salary, then decided to defer its payment until the startup business had enough cash to pay the employee. Although the employee had initially agreed to the “deferral” of the payment of his salary, after working for more than a year, without pay, he changed his mind and sued. The U.S. District Court in Massachusetts held that withholding the payment of an employee’s base salary for longer than what the Massachusetts Wage Act allows, and after the employee has already provided the services, violates the timing requirement for paying wages under the law. The Stanton opinion agreed with the view in Dobin v. CIOview Corp.7 that base salaries are wages protected by the Massachusetts Wage Act, and that contracts to defer base salary are void as a matter of law and contrary to the Wage Act. Even though the employee agreed in writing to defer the payment of all of his base wages, the court voided the contract and found the employer in violation of the Wage Act.
In Parker v. EnerNOC, Inc.,8 the employer had fired the employee for complaining about wage violations, then refused to pay her the commissions for sales that she had made because she was not employed at EnerNOC when the commission payment was due, contrary to the company policy. The employer had argued that the employee’s right to commissions on her sales ended upon her termination of employment, and for that reason, the commissions were not “due and payable,” and, therefore, not wages protected by the state law. In rejecting this argument and holding for the employee, the Supreme Judicial Court (SJC) found the commissions in question due and payable wages under the Massachusetts Wage Act.
The SJC noted that the law establishes commissions as wages protected under the Massachusetts Wage Act only if they are both “definitely determinable” and “due and payable.”9 It noted that the employer’s retaliation in firing the employee for making a wage complaint itself violates the Wage Act,10 and, further, was the sole reason for the employee’s failure to meet the employment condition for the payment of commissions. The court found the employer’s conditioning payment of commissions on the employee’s continued employment void under these circumstances, and treated the commissions as having accrued.
The SJC held that, despite the existence of a written sales commission plan with an integration clause, the conduct of the parties supported a jury finding that there was a contractual obligation to pay commissions, sufficient to support a Wage Act award of damages. Further, a commission that is not “due and payable” at the time of an employee’s termination may nevertheless constitute “lost wages” and be trebled under the Wage Act if the reason that the commission was not due was the employer’s unlawful termination of the employee’s employment to prevent her from receiving that commission.
The holdings in these cases require the payment of base wages and definitely determinable and due and payable commissions by the deadlines in the Wage Act because in each case, the employee had met the conditions of payment of protected wages by rendering service. The employee’s receipt of accrued base pay, certain commissions, and vacation and holiday pay cannot be forfeited or delayed under the Wage Act, and contracts and other devices designed to avoid the payment of such compensation are void as a matter of law.11
There are specific types of compensation not covered by the Massachusetts Wage Act. Case law specifically excludes from Wage Act protections conditional compensation such as deferred compensation subject to forfeiture, discretionary bonuses, severance and unused sick time.12 These types of compensation are not for services already performed13 and are not necessarily arithmetically determinable.14
The Massachusetts appellate courts have held that the act does not cover contributions to tax-deferred compensation plans or severance pay.15 In addition, M.G.L. c. 154, § 8, specifically excludes from coverage under the Wage Act certain types of deductions from compensation made by an employer at an employee’s request, including deductions of amounts used to purchase company stock pursuant to an employee stock purchase plan, or premiums on insurance. The Massachusetts Wage Act does not cover deferred compensation arrangements under which the conditions for payment, such as vesting, have not been met.16 Rather, deferred compensation packages for executives and key employees are governed exclusively under federal law.
Overview of Federal Law and Deferred Compensation
Wages, protected by the Massachusetts Wage Act and paid late in violation of the act, are not the same as “deferred compensation,” as regulated by federal law. “Deferred compensation,” as that term typically describes executive compensation or special benefits to other employees, does not refer to base salary, holiday and vacation pay, or accrued commissions that are “definitely determinable” and “due and payable.” Rather, it is a term of art referring to cash or non-cash compensation paid on the meeting of future contingencies, such as financial objectives or other conditions that have not yet occurred, or that may never occur. Until the stated conditions are met, such deferred compensation is typically forfeitable, not “earned” or taxed, and is not a wage under state law.
Deferred compensation is typically tailored to the quantitative and qualitative goals of the employer. For example, a company doing research and development might tie the award of nonqualified stock options to the achievement of research and development goals, such as a new, patentable technology. Alternatively, a company might choose to provide incentive compensation to key employees if certain companywide financial targets are met.
Such compensation is outside the purview of the Massachusetts Wage Act, and is taxed under the Internal Revenue Code of 1986, as amended (“Code”), and can be subject to the Employee Retirement Income Security Act of 1974, as amended (ERISA). ERISA is a federal tax and labor law regulating retirement plans, certain types of deferred compensation, medical plans, and other welfare benefits that employers provide their employees.17 It encompasses federal tax code sections relating to deferred compensation, retirement and health benefits, and preempts state law that relates to any employee benefit plan.18
ERISA “Top-Hat” Plans
Deferred compensation designed to motivate key employees under an ongoing arrangement is a special type of ERISA plan, a so-called “top-hat” plan. “Top-hat” plans may pertain only to key management or the highly compensated, and are unfunded or insured, and are exempt from many substantive requirements of ERISA.19 They are ongoing administrative arrangements of the employer that are not subject to state wage laws because of ERISA preemption.20 Consequently, benefits under top-hat plans are permitted to be deferred, forfeitable and not necessarily paid in cash, without violating any state laws.
Deferred compensation awarded under top-hat plans is taxed under an array of federal tax provisions. To avoid income taxation before the executive is in receipt of the deferred compensation, the plan of deferred compensation must be carefully designed. For example, deferred compensation under a “top-hat” plan is typically subject to forfeiture unless and until certain objectives are met, and, if they are met, the compensation is payable only on specified events. To complicate matters, the tax rules pertaining to executives of for-profit entities are different from those pertaining to executives of nonprofits, and must be considered when designing executive compensation for a charity.21 In addition, a deferred compensation arrangement should be designed to avoid premature income taxation and the penalties under Section 409A of the Code.22
Stock Options
Another type of deferred compensation is an offer to buy stock of a company at a set price. Stock options can be designed as incentive stock options under Code Section 422 (“qualified options”), or nonqualified options, taxed under Section 83. Because stock options are awarded on a conditional basis, typically upon meeting future goals, they are not subject to state wage laws.
Non-cash property that is awarded as part of a compensation package and subject to a substantial risk of forfeiture is governed under Section 83 of the Code.23 Section 83 controls the transfer of property, such as real estate, nonqualified stock options, profits interests, or insurance contracts, in exchange for service. Property paid for services is generally taxable when it is transferred without any substantial risk of forfeiture; however, it can be forfeited prior to that time.24
Federal Taxation of Payroll Arrangements and Other Deferred Compensation
The federal tax law makes a distinction between wages that have been earned and are currently taxable, and compensation designed to reward a future event, or provide a welfare benefit, and defer taxation. Some programs are designed to provide welfare benefits or deferred compensation under ERISA. Other benefits are purely products of the Code, such as cafeteria plans under Section 125,25 fringe benefits under Section 132, health reimbursement accounts under Section 105(h), and tax-sheltered annuities under Section 403(b) of the Code.26 Such tax-deferred arrangements typically provide benefits to employees in exchange for payroll reductions that are not subject to withholding taxes, and are specifically excluded from the Massachusetts Wage Act, as discussed above.27
Attracting and Retaining Employees
As the pandemic winds down, employers will need to take a fresh good look at their remaining workforce and its changed expectations. The pandemic put a new emphasis on health, family and time, and diminished the size of the available workforce. It motivated many workers to take a hard look at their current employment situations and recalibrate their personal values and goals. Changed attitudes will be reflected in the workplace, and, in many cases, employers will need to rethink compensation to attract and retain employees in a competitive market.
Aside from base salary, there are a number of compensation designs that can attract and retain both top-level and rank-and-file employees. These arrangements encompass both important employee benefits, such as health and disability insurance, and retirement coverage, which employees have come to expect. In addition, deferred compensation packages can be designed to build stronger workplaces by recognizing and rewarding the attainment of future goals, such as research and development milestones, mentoring and other types of succession planning, expanding business, increasing sales and profits, and motivating the retention of valuable employees. Defining the behaviors to be rewarded, making compensation programs fair and appropriate across a company, and designing tax-efficient incentives must all be considered and balanced when competing for employees from a diminished pool.
Evelyn A. Haralampu is a partner of Burns & Levinson LLP, where she specializes in law related to compensation, employee benefits and executive compensation. She has authored a number of articles, including a chapter on the Employee Retirement Income Security Act of 1974 in the Massachusetts Continuing Legal Education treatise, Massachusetts Employment Law.
1 Rouen, E.C., “Keep or Cut Workers? How Companies Reacted to the COVID-19 Crisis,” Harvard Business School, Working Knowledge. Twenty-eight percent of U.S. public companies sampled, employing 27 million workers, laid off or furloughed staff during March and May of 2020.
2 In May 2021, 9.3 million Americans remained unemployed, a rate of 5.8%.
Id. In June, the rate was 5.9%, and in August 5.2%. Wall Street Journal, July 3-4, 2021, A1 and Sept. 3, 2021, A3.
3 The Wall Street Journal noted, “Despite solid hiring and declining layoffs, the labor market hasn’t fully recovered from deep losses suffered in the spring of 2020. As of July [2021], there were 5.7 million fewer jobs in the U.S. than in February 2020, before the pandemic took hold in the U.S. Within that span, the number of people in the labor force — meaning they were working or seeking work — fell by 3.1 million.” Sept. 3, 2021, A3.
4 M.G.L. c. 149 s. 148, et seq.
5 621 F. Supp. 2d 5 (2009).
6 484 Mass. 128 (2020).
7 No. 01-00108, 2003, WL 22454602 (Mass. Super. Ct. Oct. 29, 2003).
8 484 Mass. 128 (Supreme Judicial Court, 2020).
9 M.G.L. c. 149, § 148, fourth par. requires that commissions are wages when two conditions are met: (1) the amount of the commission “has been definitely determined”; and (2) the commission "has become due and payable." In contrast, other forms of wages, once earned, are paid on a regular schedule. M.G.L. c. 149, § 148, first par.
See, also, Wiedmann v. Bradford Group, Inc., 444 Mass. 698, 708 (2005), which held that commissions are "definitely determined" when they become "arithmetically determinable." In
Okerman v. VA Software Corp., 69 Mass. App. Ct. 771, 776-779 (2007), the Appeals Court held that commissions earned over and above a base salary were covered by the act; the court declined to limit the reach of the act, where the only limitation contained in the act's language was that commissions be “definitely determined” and “due and payable.”
10 Lost wages as a result of retaliation against an employee trigger treble damages under the Wage Act. M.G.L. c. 149 s. 148A and s. 150.
11 M.G.L. c. 149 § 148.
12 Weems v. Citigroup Inc., 453 Mass. 147, 151 (2009). The court stated, “The act expressly states that holiday and vacation pay due under an agreement, as well as commissions that are definitely determined and due and payable to the employee, are wages within the meaning of the act, but it does not otherwise expressly define the term ‘wages.’
Id. at [M.G.L c. 149] § 148. Our appellate courts have held that the act does not cover contributions to deferred compensation plans or severance pay.
See respectively Boston Police, [435 Mass. 718] at 719-721;
Prozinski v. Northeast Real Estate Servs., LLC, 59 Mass. App. Ct. 599, 605 (2003). With respect to the payment of commissions, this court held in
Wiedmann v. Bradford Group, Inc., 444 Mass 698, 708 (2005), that the statutory requirement that commissions be paid when they are ‘definitely determined’ means when they become ‘arithmetically determinable.’ In
Okerman v. VA Software Corp., 69 Mass App Ct. 771, 776-779 (2007), the Appeals Court held that commissions earned over and above a base salary were covered by the act; the court declined to limit the reach of the act, where the only limitation contained in the act's language was that commissions be ‘definitely determined’ and ‘due and payable.’”
Cf. Tse-Kit Mui v. Massachusetts Port Authority, 478 Mass.710,713 (2018) (unused sick time is not wages protected by the Massachusetts Wage Act).
13 Awuah v. Coverall N.A., 460 Mass 484, 492 (the employer could not wait for the customer’s payment before paying wages to the employee who had already performed the services and thus “earned” the wages protected by the Wage Act).
14 Levesque v. Schroder Inv. Mgt. N. Am., Inc., 368 F. Supp. 3d 302 (D. Mass. 2019) (an incentive compensation plan that paid a quantitative bonus based on sales, where the employee made the sales, and the bonus was definitely determinable and due and payable, is covered by the Wage Act even if the employee is terminated before receiving the bonus. However, deferred equity compensation pay is not protected by the Wage Act where the employee had not met the vesting requirement for payment).
15 See note 9, citing
Boston Police Patrolmen’s Ass’n. v. Boston, 435 Mass. 718 (2002) at 719-721 (tax-deferred salary reductions under Section 457(b) of the Internal Revenue Code of 1986, as amended, are not wages protected by the Wage Act);
but see Pacheo v. H.N. Gorin, Inc. (Mass. Sup. Ct. No 09-1946, 2011), where the court found that the employer’s failure to deposit an employee’s payroll reduction into the employee’s individual retirement account (IRA) under a salary reduction simplified employee pension plan (SARSEP) within six days constituted a Wage Act violation because the IRA under a SARSEP is the employee’s property).
Prozinski v. Northeast Real Estate Servs., LLC, 59 Mass. App. Ct. 599, 605 (severance is not a wage protected under the law) (2003).
16 See footnote 14.
17 ERISA governs “employee benefit plans,” which are defined either as an employee pension plan under Section 3(2) or an employee welfare plan under Section 3(3). Employee welfare plans generally provide employees non-retirement benefits, such as health care; benefits related to disability, accident, death or unemployment; and certain other benefits described in section 3(1)(A) of the Labor-Management Relations Act of 1947. 29 CFR Section 2510.3-1. Stock options, however, are outside the purview of ERISA and are governed by the Code.
18 ERISA Section 514, 29 U.S.C. Section 1144, supersedes “any and all State laws insofar as they may now or hereafter relate to any employee benefit plan.” By preempting state laws relating to employee benefit plans, ERISA makes uniform throughout the country the law governing the operation of employee benefit plans. State law continues, however, to control insurance, banking and securities laws that are not preempted by ERISA.
19 ERISA sections 201(2), 301(a)(3), and 401(a)(1).
20 The U.S. Supreme Court first interpreted the ERISA definition of an employee benefit plan in Fort Halifax Packing v. Coyne, 482 U.S. 1 (1987). In that case, the Court examined a Maine statute requiring severance, payable in a lump sum, to any employee affected by a plant closure. It found that the Maine statute neither established, nor required an employer to maintain, a set of administrative practices, but required only a one-time, lump-sum severance payment triggered by a single event. Because a one-time severance payment required no ongoing administrative scheme, it was held not to be an employee benefit plan under ERISA. Id. at 8-15 (1987). Rather, an ERISA plan must involve either deferred compensation or the provision of certain types of welfare benefits to employees under an ongoing administrative scheme of an employer.
21 For executives of nonprofit organizations, Section 457(f) of the Code can, for example, apply to tax the entire deferral once payment begins, even though the payment of the deferred compensation is made over a number of years. In addition, a nonprofit is taxed on compensation paid to an executive that exceeds certain thresholds set under Section 4960 of the Code.
22 Section 409A of the Code was introduced into the federal tax law after the Enron debacle in 2001 in which executives accelerated the receipt of their deferred compensation to avoid losing it in the impending company bankruptcy. Section 409A accelerates the income taxation of some deferred compensation, and, additionally, applies both interest and a 20% excise tax on the amount of income involved, unless the specific distribution timing requirements are met. Had Section 409A been operative on the Enron executives, they would have taken substantial tax cuts on their deferred compensation for accelerating its payment, leaving more cash for the creditors in bankruptcy.
23 Qualified stock options, or incentive stock options, are regulated under Sections 421 and 422 of the Code. Nonqualified deferred compensation arrangements involving property, such as equity, are taxed under Section 83 of the Code.
24 Elections under 83(b) permit the immediate taxation of transferred property, at the transferee’s option. Property subject to 83(b) elections does not have to be vested for the election to take effect.
25 A program under Code Section 125 relates to the nontaxable payments toward benefits such as insurance premiums or contributions to flexible spending accounts.
26 Deferrals under a 401(k) or 403(b) plan allow the employee to save for retirement by directing payroll reductions of current compensation to be paid instead to an account in a retirement plan for the employee. Because payments in a retirement plan account can be made only in the future at specified times, the tax on those amounts is deferred until payment is made.
27 See footnote 14,
supra, and accompanying text.