Have you heard of fringe trusts and wondered what they were, how they work and if they are a good way to manage fringe benefits? Are fringe trusts even compliant with prevailing wage laws?
In short, yes, a fringe trust is a completely legal, and affordable way to manage fringe benefits. There are some things you should know however, because not all trust options are equal or compliant. Unfortunately, searching for answers online is more likely to confuse than help so we thought we’d offer some straightforward info on what they are, what they aren’t and how they work.
What’s a trust?
A trust is a relationship where a trustor allows a trustee to hold title to property or assets for the benefit of a third party, or beneficiary. Trusts have been around since the 1930s and were used by unions to manage financial obligations. Since the 1950s non-union employers have also used trusts.
Trusts are more common than you think and are used to fund many different types of financial obligations and offerings. In fact, if you have a 401(k) you are already using a trust to manage your assets!
One type of trust is a bonafide fringe trusts. Bonafide fringe trusts are specially authorized by state and federal prevailing wage laws as a compliant method of handling fringe benefits.
According to the Department of Labor, fringe benefits are:
- Contributions irrevocably made to a trustee or third party pursuant to a bona fide fringe benefit fund plan or program.
- The rate of costs incurred in providing bona fide fringe benefits pursuant to an enforceable commitment to carry out a financially responsible plan or program, which was communicated to the employees in writing. Source
Fringe benefit options
Fringe benefits can be paid directly on a worker’s paycheck or through a 3rd party bona fide trust. Employers first take credit for allowable benefits by subtracting them from the overall fringe amount, Next, they either put the remaining amount into a trust or onto the worker’s paycheck. If they are put in the paycheck, they are subject to taxes, workers’ comp and possibly overtime, depending on the state.
Fringe benefit rates are based on union benefits, which are too high for non-union employers to meet with normal benefits. This means there are always remaining fringe to manage via a trust or on a paycheck.
While many employers do opt to pay fringe on paychecks because it is administratively simple, this is not the original intent of prevailing wage law. This is why paying fringe in cash is the most expensive option for both employer and employee. Fringe trusts, however, offer benefits for both the employer and the employee
There are various trusts that are used to manage fringe payments, including the following:
Health – Includes traditional insurance plans, health reimbursement plans, and deduction reserves, also known as “hour bank” plans. Typically, employees can only access cash from these plans as reimbursements for health/dependent claims or for insurance premiums when they don’t work enough prevailing hours. Exempt from taxes, workers’ comp and payroll-based general liability insurance.
Pension – These are long-term employee investments but typically do not allow employees easy access to funds. This is because Third Party Administrators (TPA) cannot easily handle in-service distributions, so they make requesting them an expensive and lengthy processes. Exempt from taxes, workers’ comp and payroll-based general liability insurance.
PTO/Sick Plans – These can auto-distribute periodically but are taxable and subject to workers’ comp either when the contribution is made or upon distribution. This means they have limited use when compared to simply paying fringes on paychecks. NOT exempt from taxes, workers’ comp and payroll-based general liability insurance.
Welfare, training, or industry funds (mostly for unions) – These funds go to the union and there are no cash benefits available except for death and disability benefits. Exempt from taxes, workers’ comp and payroll-based general liability insurance.
Supplemental Unemployment Benefits (SUB) – This plan has been declining in popularity since the Department of Labor (DOL) determined they are subject to annualization. NOT exempt from taxes, workers’ comp and payroll-based general liability insurance.
Fringe trust compliance
To be compliant, the fringe trust must not be a safe-harbor match or a deferred payment plan. It must be a pre-tax employer contribution into a qualifying plan followed by an optional distribution. This means it’s critical that the fringe trust is structured in a way that is compliant with all applicable laws, including:
- Employee Retirement Income Security Act (ERISA)
- Internal Revenue Service rules and regulations outlined in Section 401(k)
- Davis-Bacon and Related Act
Additionally, if employees do withdraw funds, all required taxes must be paid at that time and reported to the IRS n a 1099-R. These are important points to understand if you’re looking into starting a fringe trust, or have questions regarding the compliance and legality of your current fringe trust.
A closer look at SUBS
SUB plans were previously thought to be exempt from annualization, but in 2015 the DOL ruled that they are NOT exempt. This makes them far less desirable as a fringe management tool and it also means that companies using them for fringes can be found liable for back taxes, penalties and interest.
Here’s what that means:
If you contribute $22/hr for an employee that works 50% prevailing vs non-prevailing, you can only take $11/hr of credit for that contribution. Also, the IRS requires SUBs pay out cash only when a true employee termination has occurred. Many SUB plans violate these rules, exposing companies to a lot of financial and legal risk.
Read the official DOL Brief on SUB annualization here.
If done correctly, a fringe trust can be the most simple and affordable way to manage fringe benefit payments. They are also beneficial for workers, who can gain access to traditional benefits they might not have otherwise, like an FSA or retirement plan. Before starting a fringe trust, however, you will want to educate yourself and your team on what you can and cannot do so that you never find yourself facing compliance action.
The material presented here is educational in nature and is not intended to be, nor should be relied upon, as legal or financial advice. Please consult with an attorney or financial professional for advice.