Negative election to participate in 401(k) plans

STATE OF CALIFORNIA GRAY DAVIS, Governor

DEPARTMENT OF INDUSTRIAL RELATIONS
DIVISION OF LABOR STANDARDS ENFORCEMENT
LEGAL SECTION
455 Golden Gate Avenue, 9th floor
San Francisco, CA 94102
(415)703-4863

MILES E. LOCKER, Attorney for the Labor Commissioner

                                                   August 12,   2002

C. Frederick Reish
Reish & Luftman
11755 Wilshire Blvd., 10th Floor
Los Angeles, CA 90025-1539

      Re:        Supplemental Request In Connection With "Negative
                 Elections To Participate In 401(k) Plans"

Dear Mr. Reish:

 This is in response to your letter of February 28, 2000,

wherein you request that the Division of Labor Standards
Enforcement reconsider its previously published opinion on the
above-referenced subject. Please accept my apology for the long
delay in issuing this response.

 The DLSE issued an opinion letter on September 18, 1998 in

response to a request for an opinion on the use of "negative
elections" to participate in 401(k) plans, and specifically,
whether such "negative elections" were consistent with state law.
In that letter, the facts were stated as follows:

     "Under the proposed procedure, the employees eligible to
     participate in the plan(s) would be automatically
     enrolled in such plans unless they affirmatively elected
     not to participate in the plan and so notified the plan
     administrator(s).  The employees would be notified upon
     employment and/or eligibility concerning the negative
     election procedure."

 As was pointed out in the opinion letter of September 18,

1998, the 1998 Revenue Ruling (Rev.Rul. 98-30, 1998-25 I.R.B. 8
(6/22/98)) which the request for an opinion relied upon, did not
address state law minimum labor standards such as Labor Code
Section 224, which requires written authorizations for deductions
from wages. The February 2000 Revenue Ruling (Rev.Rul. 2000-8
(2/14/2000)), which you point to in your request for
reconsideration, simply extends the 1998 Revenue Ruling to "new
employees". Both address the same ultimate issue:

 "Will employer contributions to a profit-sharing plan
 fail to be considered elective contributions, within the
 meaning of §1.401(k)-1(g)(3) of the Income Tax
 Regulations, made under a qualified cash or deferred
 arrangement, within the meaning of §401(k) of the
 Internal Revenue Code, merely because they are made
 pursuant to an arrangement under which a fixed percentage
 of an employee's compensation is contributed to the plan
 unless the employee affirmatively elects to receive the
 amount in cash." (Underlined emphasis added)

 Nowhere in the rulings you rely upon does the I.R.S. indicate

that the employer is required or, indeed, even empowered by the
federal statute to make a deduction without a written authorization
as required by California law. The Ruling states that the
definition of a "cash or deferred election" in the federal
regulations "requires that the employee have an election between
the employer paying cash...to the employee or making a contribution
to a trust on behalf of the employee." The Ruling goes on to state
that "[T]he regulation does not require that the employee receive
an amount in cash in any case in which the employee does not make
an affirmative election to have that amount contributed to the
trust." The Ruling then makes the point that since such an
arrangement is not prohibited by the federal regulation, "a cash or
deferred election will not fail to be made under a qualified cash
or deferred arrangement merely because, when an employee fails to
make an affirmative election with respect to an amount of
compensation, that amount is contributed on the employee's behalf
to a trust, provided that the employee had an effective opportunity
to elect to receive that amount, in cash."

 What the Rulings insure is that the contributions by the

employer to a §401(k) plan will be treated as "elective
contributions" despite the fact that the employee did not make an
affirmative election (or with written authorization as required by
California law). This insures, of course, that the employer's
contribution will enjoy the tax benefits available.

 The I.R.S. rulings have nothing to do with the requirement

that the employer must comply with the state-mandated minimum labor
standard requiring written authorization for deductions from wages
in California. Such labor standards, falling as they do within the
traditional police powers of the state, if not inconsistent with a
federal statutory scheme, will not be pre-empted. Fort Halifax
Packing Co. v. Coyne 482 U.S. 1, 21 (1987)

 In a previous letter to DLSE, dated August 27, 1999, you

argued that deductions from an employee's paycheck to a 401(k) plan
pursuant to "negative election" do not conflict with Labor Code
section 221 at all, so that there is no need to reach the question
as to whether such deductions fall within the exceptions to section
221 that are carved out by Labor Code section 224. In that letter,
you contended:

 "The key words in Section 221, 'theretofore paid,'
 indicate that money is being deducted by the employer for
 a sum that has already been or has previously been paid
 to the employee.   But in the case of money deducted for
 automatic deferrals the money is being deducted before or
 concurrently with the payment of the paycheck.   Thus, an
 automatic deferral would not violate the provisions of
 Section 221."

 But the courts have never interpreted Section 221, and related

provisions in sections 222 and 223, in such a constricted manner;
instead, "section 221 has long been held to prohibit deductions
from an employee's wages for cash shortages, breakage, loss of
equipment, and other business losses that may result from an
employee's simple negligence." Hudgins v. Neiman Marcus Group,
Inc. (1995) 35 Cal.App.4th 1109, 1118. Moreover, these sections
have been interpreted not only to prohibit kickbacks, but also, to
prevent any sort of deduction from wages that is not authorized by
Section 224. "Even where fraud is not involved, however, the
Legislature has recognized the employee's dependence on wages for
the necessities of life and has, consequently, disapproved of
unanticipated or unpredictable deductions because they impose a
special hardship on employees." Ibid., at 1119. In the words of
our Supreme Court, "A further reason for legislative disapproval of
deductions exists in the reliance of the employee on receiving his
expected wage, whether it be computed upon the basis of a set
minimum, a piece rate, or a commission." Kerr's Catering Service
v. Department of Industrial Relations (1962) 57 Cal.2d 319, 329.

 The practice of making paycheck deductions based on "negative

election" is also at odds with Labor Code section 212, which
prohibits the payment of wages due through any "order, check,
draft, note, memorandum or other acknowledgment of indebtedness,
unless it is negotiable and payable in cash, on demand, without
discount . . . ." Under the "negative election" procedure, the
portion of the employee's wages that is directed -- without any
sort of express prior authorization from the employee -- into the
employee's 401(k) account would not be "negotiable and payable in
cash, on demand, without discount." And the absence of this
express prior authorization is precisely what makes this procedure
illegal under state law -- under Labor Code §213(d), section 212
does not prohibit "an employer from depositing wages due ... in
any bank, savings and loan association, or credit union of the
employee's choice in this state, provided the employee has
voluntarily authorized such deposit."

 In summary, for all of the reasons set forth above, the

Division declines your request to reassess its position regarding
so-called "Negative Elections to Participate In 401(k) Plans" as
contained in the opinion letter of September 18, 1998.

 Thank you for your continuing interest in California labor

law. If you have any questions or comments, please contact the
undersigned.

                          Sincerely,



                          Miles E. Locker
                          Attorney for the Labor Commissioner

cc: Art Lujan, State Labor Commissioner
Anne Stevason, Chief Counsel
Tom Grogan, Chief Deputy Labor Commissioner
Greg Rupp, Assistant Labor Commissioner
Nance Steffen, Assistant Labor Commissioner
Bridget Bane, IWC Executive Officer