When Is a Short-Term Disability Plan a Payroll Practice?

The Employee Retirement Income Security Act (ERISA) governs pension and welfare benefit plans unless an exemption applies to the plan. Welfare plans covered by ERISA must comply with the ERISA requirements, which include, but are not limited to, the following:

• Maintaining a written plan document;
• Filing a Form 5500;
• Disclosing required plan information to plan participants and beneficiaries through a summary plan description (SPD); and
• Following the ERISA claim procedures.

ERISA expressly excludes some plans such as government plans and church plans. Other types of plans excluded from ERISA include workers’ compensation benefits, adoption assistance plans, and tuition reimbursement plans.

Certain types of welfare plans generally covered by ERISA may be exempt from ERISA based on what is known as the “payroll practice” exemption.

The payroll practice exemption applies to income replacement programs that an employer pays to employees using the employer’s general assets.

Short-Term Disability (STD) plans are welfare benefits that continue all or a percentage of an employee’s salary for up to six months if it is determined that an employee cannot perform their duties due to sickness or injury. STD plans provided through an insurer are subject to ERISA. A self-funded STD plan – also referred to as “income replacement,” “salary continuation,” or a “paid medical” leave program – may be exempt from ERISA as a permitted payroll practice if it meets certain criteria.

An employer’s terms describing its sick-pay or income replacement plan are not determinative of whether the program qualifies under the payroll practice safe harbor.

A disability program that falls under the payroll practice exemption may use a third-party administrator (TPA), such as an insurer or other party, to administer its plan. Plans using a TPA may still qualify as an ERISA-exempt plan as long as the plan meets the exemption requirements. The payroll practice ERISA exemption applies to self-funded STD plans that:

• Pay employees their full or partial compensation;
• Make the income replacement payments from the employer’s general assets; and
• Offer the payments to employees who are unable to perform their work for medical reasons.

According to the Department of Labor (DOL), the regulations contemplate a disability program that pays a portion of an employee’s regular salary – up to a full salary replacement – as an exempt payroll practice if the plans meet the other criteria for the exemption.

In instances where the salary continuation benefits exceed the employee’s regular compensation, the DOL states that such a plan fails to meet the payroll practice exemption.

Self-funded STD plans classified as a payroll practice are exempt from ERISA.

Consequently, when employees file claims for STD benefits under ERISA, courts reject those ERISA claims. However, since the plan is exempt from ERISA, it does not receive ERISA preemption. Therefore, employee claims and plan issues may be subject to state law, jury trial, and consequential damages. For a multistate employer, that means the employer may need to handle employee claims according to the jurisdictional requirements of that employee’s state and/or municipality.

Employers should determine whether their plan is an ERISA plan or a payroll practice because the plan’s classification determines the administrative requirements that it must follow, as well as the remedies and benefits available to employees.

Employers may want to – or be required to – provide a written plan document/policy even if the plan is not subject to ERISA. Before making any plan decisions or revisions, employers should seek the advice of legal counsel.

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