TAX BREAK

ERISA Coverage of Sole Shareholder Employee by Thomas G. McKeon

 

The U.S. Supreme Court recently held in Yates v. Hendon, 124 SCt 1330 (2004), that a sole shareholder who also works for the corporation he owns is a “participant” for purposes of an ERISA qualified plan if the plan covers at least one employee other than the owner or the owner’s spouse. Consequently, ERISA protects the owner’s interest in the plan from creditors to the same extent as other participants.

 

Since the 1992 Supreme Court’s decision in Patterson v. Shumate, courts have held that ERISA protects the qualified plan interests of non-owner employees from creditors. Owners, however, did not know whether or not they would be considered participants and afforded the same protection. Federal courts were divided on the issue.

 

Yates was sole shareholder and president of a corporation through which he practiced medicine. The corporation had a profit sharing plan that was qualified under Internal Revenue Code (“Code”) section 401(a). Yates was a participant in the plan and served as the plan’s administrator and trustee. From its inception, at least one employee other than Yates or his wife also participated in the plan.

 

The plan contained a provision required by both the Code and ERISA prohibiting voluntary or involuntary assignment or alienation of any interest or benefit under the plan, except for permitted plan loans to participants. Yates borrowed $20,000 from the plan to be repaid over a five year period. For 2 ˝ years after the loan was made, Yates did not make any payments. He then renewed the loan for an additional five years. Again, he made no payments. Four and one-half years later, he used the proceeds from the sale of his home to make two payments totaling $50,467.46, which boosted his interest in the plan to $87,000.

 

Three weeks later, Yates’ creditors filed an involuntary bankruptcy against him. The bankruptcy trustee claimed that repayment of the loan constituted a preferential payment that should be disregarded and the amount recouped from the plan for the benefit of creditors. The bankruptcy court, district court and court of appeals agreed, holding that Yates, as an owner, was not entitled to protection under anti-alienation provisions of the Code or ERISA.

 

The Supreme Court reversed the lower court decisions. It found that ERISA was adopted to protect participants and that under ERISA “participant” included owner employees of a plan that covered at least one other employee other than the owner or the owner’s spouse. 

 

The Court stated that its holding was consistent with Congress’ aims for ERISA. Allowing working owners to participate in and obtain ERISA coverage provides an incentive for owners to create plans that ultimately benefit owners and employees alike. Further, coverage of both owners and employees under ERISA is desirable because provides uniform laws to resolve all plan-related issues. 

 

Though the Court’s decision provides clarity that owner employees are participants entitled to ERISA protections, the Court remanded the case for the trial court to determine whether or not ERISA protected Yates under the particular facts concerning his handling of the loan and failure to make required payments.

 

 

 

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