Scary Surprise for Some New 401(k) Sponsors: Plan Audit Costs

Imagine you are a California business owner, with three fast-casual restaurant operations throughout the state. You employ over 100 employees, such that by September 30, 2020, you were either required to have a retirement plan in place, or to begin to participate in the CalSavers program by forwarding employee contributions to Roth IRAs managed by a state-appointed custodian.

Your decisions about whether to adopt your own retirement plan were made in the early days of the COVID-19 pandemic when business operations, cash flow, and staffing needs were chaotic and fast-changing. On balance, however, you decided to adopt your own plan and ultimately chose a deferral-only 401(k) plan as the best fit for your business. You adopted the plan by July 1, 2020 in advance of the September 30, 2020 CalSavers deadline for employers with over 100 employees.

Your restaurants pivoted to take out and food delivery services and you were lucky not to have to furlough or lay off any employees, but employee wages were lower than before the pandemic and you had high turnover. In June of 2020 you conducted enrollment meeting for the 401(k) plan but employee response was tepid. Only a few dozen employees actually enrolled in the plan, although most all employees (well over 100) were eligible to make salary deferrals.

Fast forward to the end of 2021. You find out that as part of your Form 5500 filing obligations you need to engage the services of an independent qualified public accountant (IQPA) to audit plan operations and finances. The cost of these services run about $10,000. This is a scary surprise for you. Did things have to end up this way?

In a word, no, although the 401(k) plan design may still have been the best fit for your business, and there may be light at the end of the tunnel for you, regarding the audit requirement.

Let’s break it down.  First, the audit requirement.  Under Section 103 of ERISA, a qualified retirement plan with 100 or more participants as of the first day of the plan year generally must provide an audit report prepared by an IQPA together with their “long form” Form 5500.  “Participants” means those employees who meet eligibility requirements under the plan, even if they don’t contribute to the plan or have an account under the plan (it also includes former employees who retain an account under the plan because they have not taken a distribution or rollover).  A special rule – the “80-120 rule” applies to plans that filed a Form 5500-SF (Short Form) in the prior year and have 120 or fewer participants as of the first day of the plan year in question, but if you adopt your plan in a year where you meet or exceed the 100 participant rule – again, counting those who are eligible regardless of participation status – you will be required to provide an audit report for your first Form 5500 filing.  That is the situation of the restaurant owner in our example.

Second, plan design. The restauranteur could have adopted a SEP-IRA, which is exempt from Form 5500 filing requirements, and with it, the requirement for an audit. However, SEP-IRAs require employer contributions and the 401(k) required only employee elective deferrals, so the cost of a SEP-IRA may not have worked for the business. The hiccup here is that the “no cost” 401(k) plan carried the hidden cost of a plan audit.

Lastly, a potential change to counting 100 participants for purposes of the audit requirement may be in the offing.  Proposed regulations from the Department of Labor, Department of the Treasury, and the Pension Benefit Guaranty Corporation would change the participant headcount methodology to look only at participants with account balances, and disregard those who are eligible but not participating.  If finalized and adopted, these regulations would generally apply to plan years beginning on or after January 1, 2022.  So for the restaurant owner in question it may be that another audit is required for the 2021-2022 plan year but that the audit requirement goes away if plan participation remains low. 

The hidden cost of a plan audit is also a concern for a wider group of employers, irrespective of state auto-IRA plan mandates, in 2024 when the SECURE Act rules for long-term, part-time employees go into full effect.  If the Form 5500 proposed regulations do become law, then the fact that part-time employees are eligible to make elective deferrals under their employers’ 401(k) plans will not trigger audit requirements unless they actually participate in the plan, and the plan’s active and former participant ranks meet or exceed 100 as of the first day of any given plan year.  The coming increase in participant ranks due to long-term, part-time employees increase in plan participant ranks was identified as one reason for the proposed change in headcount methodology.

The above information is provided for general informational purposes only and does not create an attorney-client relationship between the author and the reader. Readers should not apply the information to any specific factual situation other than on the advice of an attorney engaged specifically for that or a related purpose. © 2021 Christine P. Roberts, all rights reserved.

Photo credit: Colton Sturgeon, Unsplash

IRS Prioritizes Guidance on Student Loan Repayment Contributions

On September 9, 2021 the Department of the Treasury issued its 2021-2022 Priority Guidance Plan listing guidance projects that are priorities for the Treasury Department and IRS during the twelve months ending June 30, 2022.  Among the Employee Benefits topics is “[g]uidance on student loan payments and qualified retirement plans and §403(b) plans.” This post reviews the state of the law on student loan repayments through retirement plans and briefly discusses what type of guidance might be forthcoming. 

Current State of the Law

The current state of guidance on using student loan repayments as a base for employer contributions to a qualified retirement plan or 403(b) plan is limited to a private letter ruling issued in 2018 to Abbott Labs.  In addition, proposed measures are contained in various pieces of federal legislation including the Securing a Strong Retirement Act of 2021, commonly referred to as SECURE 2.0.

In the private letter ruling (PLR 201833012), discussed in our earlier post, the employer sought approval of an arrangement under which they made a 5% nonelective contribution on behalf of participants who contributed up to 2% of their compensation towards student loan repayments.  Those participants could still make elective deferral contributions under the plan, but would not receive a matching contribution (also equal to 5% of compensation) for the same pay periods in which they participated in the student loan repayment program.  Both the nonelective and matching contributions were made after the end of the plan year and only on behalf of employees who either were employed on the last day of the plan year or had terminated employment due to death or disability.  The nonelective contributions based on student loan repayments also vested at the same rate as regular matching contributions did.

 The PLR addressed whether the nonelective contribution made on behalf of student loan repayments violated the “contingent benefit rule.”  Under that rule, a 401(k) plan is not qualified if the employer makes any other benefit (with the exception of matching contributions) contingent on whether or not an employee makes elective deferrals.  The IRS concluded that the program did not violate the contingent benefit rule because employees in the program could still make elective deferrals, but simply would not receive the regular employer match on those amounts during pay periods in which they received the nonelective contribution based on student loan repayments.

Only Abbott Labs has reliance on the terms of the PLR, although the PLR may indicate the approach the IRS will take in any new guidance regarding student loan repayments as a basis for retirement plan contributions.  

Proposed Legislation

Congress has noticed the impact that student loan repayment obligations has had on employees’ ability to save for retirement.  As mentioned, the most significant bill that would address this issue is the Securing a Strong Retirement Act of 2021, commonly known as SECURE 2.0.  Specifically, Section 109 of the Bill would treat “qualified student loan payments” equal to elective deferral contributions, for purposes of employer matching contributions under a 401(k) plan, a 403(b) plan, a governmental 457(b) plan, or a SIMPLE IRA plan, and would permit separate nondiscrimination testing of employees who receive the matching contribution based on student loan repayments.  “Qualified student loan payments” would be defined to include any indebtedness incurred by the employee in order to pay their own higher education expenses.   Under SECURE 2.0, total student loan repayments that are matched, plus conventional elective deferrals, would be capped at the dollar limit under Internal Revenue Code (“Code”) Section 402(g) ($19,500 in 2021).   

What Future IRS Guidance Might Hold

Based on the Abbott Labs PLR and SECURE 2.0, we might hope or anticipate that any future IRS guidance on programs that condition employer retirement plan contributions on participant student loan repayments would include the following:

  • Guidance on how such programs may comply with the contingent benefit rule, including whether it will suffice simply that program participants may continue making elective salary deferrals (while likely foregoing regular matching contributions while student loan repayments are being matched).
  • Guidance on whether such a program, by nature limited to employees with student loans, is a “benefit, right or feature” that must be made available on a nondiscriminatory manner under Code Section 401(a)(4), and if so how it might satisfy applicable requirements.
  • Guidance on whether, and how, employers can confirm that loan repayments are being made, including whether (as SECURE 2.0 would permit), employers may rely on an employee’s certification of repayment status.
  • Guidance on nondiscrimination testing of contributions under a student loan repayment program, including provision for separate testing, as SECURE 2.0 would permit.

Additionally, plan sponsors would no doubt appreciate guidance on use of outside vendors for student loan repayment programs and how they might interact with conventional retirement plan record keepers and third party administrators.

Photo credit:  Mohammad Shahhosseini, Unsplash

The above information is a brief summary of legal developments that is provided for general guidance only and does not create an attorney-client relationship between the author and the reader. Readers are encouraged to seek individualized legal advice in regard to any particular factual situation. © 2021 Christine P. Roberts, all rights reserved.

Summertime Blues for Your 401(k) Plan, Pt 3

The third in our series of posts on common plan errors that are discovered when plan audits are underway each summer, is the failure to timely deposit plan assets consisting of employee elective deferrals and loan repayments. Unlike the operational errors we discussed in the prior two posts, which are corrected under the IRS Employee Plans Compliance Resolution System or EPCRS, this particular error of late deposits is corrected under a Department of Labor program called the Voluntary Fiduciary Correction Program or VFCP. There is an IRS piece that must be attended to, however, discussed below.

First – to identify the problem. Money taken out of employee pay in the form of elective deferrals, whether pre-tax or Roth, and loan repayments, becomes ERISA plan assets as of a certain point in time. Once they become plan assets, they must be invested in the Plan “trust” – meaning they must be documented as having been deposited with the plan recordkeeper. If they have not been deposited by the magic “plan asset” hour, then the Employee Benefits Security Administration of DOL (EBSA) views the situation as an illegal, interest-free loan of plan assets, by the plan sponsor. In formal terms, this is a “prohibited transaction” or misuse of plan assets by a fiduciary, and it has adverse consequences with DOL. It also triggers excise taxes with IRS, described below.

Thus, there are several parts to this inquiry – first, what is the magic hour at which employee funds become plan assets, and second, what relief from adverse consequences with DOL and IRS is available under VFCP? Lastly there is how this issue is reported on the Form 5500 Return/Report series. We discuss each in turn below.  And – no surprise, there is a COVID-19 angle to consider, as well.

When Do Employee Funds Become Plan Assets?

The magic “plan assets” hour depends upon the size of the plan in question. If the plan has fewer than 100 participants as of the first day of the plan year, employee funds are timely deposited if they are deposited with the recordkeeper no later than the 7th business day following the day on which the amounts would otherwise have been payable in cash (i.e., the applicable pay date). Recordkeepers often refer to the deposit event as the “trade date.” If employee funds are not deposited by the end of that 7th business day, they are plan assets improperly held by the plan sponsor.

If the plan has 100 or more participants as of the first day of the plan year, employee funds are timely deposited if they are deposited with the recordkeeper as of the earliest date on which such amounts can reasonably be segregated from the employer’s general assets. In some cases, EBSA has asserted that, if payroll taxes can be segregated from general assets, so can employee contributions, making pay date the earliest segregation date. More commonly, the earliest reasonable segregation date can be determined by looking at payroll processing history and identifying the shortest amount of time that generally elapses between a pay date, and the recordkeeper trade date. Very often nowadays this is a period of only one or two business days. If employee funds are not deposited by the end of that period, they are plan assets improperly held directly by the plan sponsor.

Holidays may be taken into account in calculating the earliest reasonable segregation date, thus the deposit date would be the first business day after a holiday Monday, for example.  For unusual events that are out of the plan sponsor’s control, the “drop dead” deposit deadline is the 15th day of the month following the month containing the normal earliest reasonable segregation date.

What about the impact of COVID-19?  In EBSA Disaster Relief Notice 2020-01, issued on April 29, 2020, relief is granted only if a timely deposit cannot be made “solely on the basis of a failure attributable to the COVID-19 outbreak.”  This is a very fact-specific inquiry; each situation will be different. At the early stages of the pandemic, such a failure might have included a staff furlough that included payroll personnel or personnel at a third party payroll provider.  Now that the pandemic is almost eighteen months along, even taking into account setbacks like the Delta variant, deposit delays that can be demonstrated to be exclusively due to the virus are unlikely to be common. That said, the Disaster Relief Notice 2020-01 remains in effect from March 1, 2020 through the 60th day following the announced end of the COVID-19 National Emergency.

What Relief is Offered under VFCP?

Through timely participation in the VFCP program, which includes preparation of a written submission with proof of payment of earnings on late deposited elective deferrals and loan repayments, a plan sponsor may avoid potential civil actions, penalties, and the assessment of civil penalties under Section 502(i) of ERISA.  Successful participants receive a “no action letter” from EBSA that is useful to demonstrate plan compliance in the event of a later plan audit or in a due diligence process related to a corporate merger or acquisition.

Importantly, participation in VFCP must precede the point at which a plan is “under investigation” by EBSA meaning an EBSA audit of the plan in question.  Other circumstances can give rise to a plan being “under investigation” such that VFCP is unavailable.

A prohibited transaction consisting of late deposited ERISA assets gives rise to a first-tier excise tax under Internal Revenue Code Section 4975 that is equal to 15% of the amount involved, with the amount involved equal to the time value of the money that was untimely deposited in a plan.  The excise tax is payable by the plan sponsor and reported on Form 5330.  The VFCP offers a limited relief from this excise tax.  VFCP can be used for multiple years (but a plan sponsor should ask itself why its timely deposit problems are persisting), but the excise tax relief can only be used once every three years. 

Information on VFCP is found here – but keep an eye on that location as the program, which dates in its current form back to 2006, is under a rewrite and overhaul.  It is anticipated that the new version will streamline some of the correction methods currently described under VFCP (late deposits is only one of a number of other transactions that the program covers). 

How Are Delinquencies Reported on Form 5500/5500 S-F?

Form 5500 and Form 5500 S-F require a plan sponsor to disclose whether there was a failure to transmit any participant contributions to the plan during the plan year in question, and to disclose the aggregate amount that was not deposited timely.  Even if the late deposits were corrected under VFCP, you must report them.  If you report late deposits on Form 5500 without adding an attachment explaining that they were corrected under VFCP, you may get a letter from EBSA that politely “invites” you to participate in VFCP by a firm deadline.  You are recommended to submit your VFCP application by that date, or risk further action that may result in penalties.    

One question that comes up around late deposited employee funds is whether it is necessary to participate in VFCP for delinquent deposits that are small in amount and/or short in duration.  The answer is that, until EBSA announces a self-correction version of VFCP, participation in VFCP is recommended in order to avoid adverse consequences when the uncorrected delinquencies must be reported on Form 5500 or 5500 S-F.  If you have questions about a possible need for correction under VFCP, contact your plan’s third party administrator or ERISA attorney.


Photo credit: Inna Kapturevska, Unsplash

The above information is a brief summary of legal developments that is provided for general guidance only and does not create an attorney-client relationship between the author and the reader. Readers are encouraged to seek individualized legal advice in regard to any particular factual situation. © 2021 Christine P. Roberts, all rights reserved.

IRS Plays Musical Chairs With Voluntary Correction Programs

Section 401(k) and other retirement plans are notoriously complicated to operate and no plan sponsor gets it 100% correct, 100% of the time. When problems arise, plan sponsors may correct certain errors – technically “failures” — under an IRS program called the Employee Plans Compliance Resolution System, or EPCRS. Failures corrected this way cannot later be the basis for revoking the tax-qualified status of the plan, or imposing other tax penalties or interest. EPCRS is set forth in a Revenue Procedure that the IRS updates every few years. On July 16, 2021 the IRS published the latest EPCRS upgrade in Revenue Procedure 2021-30, in which, like musical chairs, some ground is gained while some is taken away. Below is a summary of some of the key changes.

Expansion of Self-Correction Period

Under the Self Correction Program, a plan sponsor may at any time, without IRS review or approval, correct “insignificant” failures in the way a plan has been operated (operational failures), and failures relating to plan documentation such as missed amendment deadlines (plan document failures). Further, a plan sponsor may self-correct “significant” failures of these types, provided that the significant failure is identified and fixed within a set “correction period.”

In the past, the correction period ended on the last day of the second plan year following the plan year for which the failure occurred. The EPCRS upgrade adds a whole additional year to the correction period. Now, self-correction of significant failures may be made by the end of the third plan year following the plan year in which the failure occurred. Thus, a plan sponsor with a calendar plan year and a significant operational error occurring in 2018 will have until the end of 2021 to correct the error.

There are two follow-on effects of this extension:

  • The three-year self-correction period for significant operational failures does not begin to run until after the statutory correction period for ADP and ACP testing failures, which is the 12-month period following the close of the plan year for which the test was failed. In effect there is four years to correct these errors – the original statutory period of 12 months, followed by the three plan year self-correction period.
  • For errors involving a failure to offer or implement elective deferrals, corrective contributions equal to 50% of what would have been deferred generally must be made to the plan. That percentage is reduced to 25% of what would have been contributed if certain requirements are met, including that the period during which the error occurred lasted more than three months, but not longer than the self-correction period for significant failures. That period has now been extended a year, from two to three plan years.

Plan sponsors wishing to use the Self-Correction Program should be mindful not just of the correction period deadline, but of several other pre-requisites. First, the plan sponsor must have established compliance practices and procedures in place, and the error must have arisen due to a lapse in their normal application. Plan document failures may only be self-corrected if a “favorable letter” for the plan exists. The plan sponsor must also assess a number of facts and circumstances in order to determine whether the failure is “insignificant” or “significant.” For those seeking more information, the IRS provides helpful online guidance on Self-Correction (but the two-year correction period had yet to be updated as of the date of this post), as well as Self-Correction FAQs.

Anonymous VCP Repealed after 2021

In addition to Self-Correction, EPCRS includes the Voluntary Compliance Program (VCP), which involves an online submission, IRS approval of the proposed correction method, and payment of a VCP fee. Normally the name of the plan sponsor and the plan involved are revealed in the VCP submission process. However the IRS has for some years maintained an Anonymous VCP process, particularly for plan sponsors whose proposed corrections do not fit within the preapproved or “safe harbor” methods outlined in EPCRS. In Anonymous VCP, a representative of the plan sponsor, such as a law firm, files the submission without identifying the plan sponsor or plan. If the IRS approves the proposed correction, the plan sponsor reveals is identity and the process converts to a conventional VCP submission. If the IRS rejects the proposed correction method, the plan sponsor remains anonymous and has the option of later participating in regular VCP with an alternative proposed correction.

For reasons that it does not explain, the IRS is retiring Anonymous VCP and will not accept any more Anonymous VCP submissions after December 31, 2021. In its place the IRS is introducing a new program effective January 1, 2022, which it refers to as an “anonymous, no-fee VCP pre-submission conference.” This new program is intended for proposed corrections that fall outside the safe-harbor correction methods set forth in Appendices A and B to the EPCRS Revenue Procedure. The VCP pre-submission conference is available only if the plan sponsor is eligible for and intends to submit a conventional VCP submission. Following a VCP pre-submission conference, the IRS will provide oral feedback on the failures and proposed correction method that is “advisory only, is not binding on the IRS.” The IRS will only confirm in writing that a VCP pre-submission conference took place but will not appear to provide anything substantive in writing about what was discussed.

VCP pre-submission conferences are held only at the discretion of the IRS and “as time permits.” Given limited IRS funding and significant understaffing in recent years, one wonders how widely and promptly available this program will be. It is also unclear whether or not the introduction of the VCP pre-submission conference means that VCP coordinators at IRS will no longer informally discuss proposed corrections with attorneys and other practitioners, as has been the practice in the past.

Other Changes

  • EPCRS generally requires full correction of operational errors, but makes an exception for certain de minimis amounts. Effective July 16, 2021, the de minimis threshold increases from $100 to $250, and erroneous contributions (plus earnings) of $250 or less will not need to be pulled from a participant’s account or recouped after distribution to a participant.
  • In the past, when a participant received a lump sum distribution of a more than de minimis amount (“Overpayment”), the plan was required to seek recoupment in a lump sum repayment. Now, repayment in installments is also an option. For defined benefit plans, the Revenue Procedure describes certain conditions under which recoupment of Overpayments may be avoided altogether.
  • The Revenue Procedure restores a safe harbor correction method for failures arising from automatic contribution arrangements, which had expired on December 31, 2020. The new expiration date is December 31, 2023; until then no corrective contributions are required for certain automatic contribution failures that do not extend beyond 9 ½ months following the end of the plan year of the failure. Other correction criteria apply including provision of written notice to affected employees.
  • The Revenue Procedure substantially liberalizes self-correction of certain operational failures through a plan amendment that retroactively reflects how a plan has been operated. Such retroactive amendments must increase benefits, rights or features under the plan, rather than reduce them. In the past it has been required that the benefit increase or enhancement apply to all eligible participants under the plan, which made many proposed corrections unaffordable. The new Revenue Procedure lifts the universality requirement, so that a retroactive amendment may increase benefits only for those participants affected by the operational error. This will make this form of correction much more flexible and attainable for plan sponsors.

Photo credit: Federica Campanaro, Unsplash

The above information is a brief summary of legal developments that is provided for general guidance only and does not create an attorney-client relationship between the author and the reader. Readers are encouraged to seek individualized legal advice in regard to any particular factual situation. © 2021 Christine P. Roberts, all rights reserved.

Summertime Blues for Your 401(k) Plan, P.2: Eligibility Failures

This is the second installment of several posts covering the most common 401(k) plan operational issues that arise during Form 5500 prep season for calendar year plans, which happens to be summertime: the season of outdoors fun and enjoyment for folks outside the ERISA bubble. This time around we will focus on a few selected errors related to eligibility under the plan – who gets to participate in the plan, and when. (More information on fixing eligibility errors in a 401(k) plan, courtesy of the IRS, is found here.) Note that the following discussion relates to plans in which participants must affirmatively enroll; a separate post will cover operational errors arising from auto-enrollment features.

Error No. 2: Eligibility Failures

Eligibility speaks to who gets to participate in a 401(k) plan, and entry dates signal when their participation must begin. These related areas can result in a host of plan errors.

The two main criteria of plan eligibility are age and service, and a minimum age of 21 and one Year of Service (defined below) are common eligibility criteria, especially for receiving employer contributions. The minimum service requirements to make salary deferrals are commonly reduced to, say, three months of service or even a shorter period. Also, commonly, plans exclude employees covered by a collective bargaining agreement, and employees earning no U.S.-source income. These criteria are all fairly straightforward, but complications sometimes arise when plans exclude employees based on schedule or job category, such as part-time employees, temporary employees, and per diem employees. Applicable law requires that employees in these categories be allowed to participate once they have worked 1,000 hours in a 12-consecutive month period (“Year of Service”). This requirement is part of preapproved plan documentation (adoption agreement), but plan sponsors not infrequently fail to adhere to it in actual fact. So, it is not uncommon to find that a plan has been excluding employees classified as per diem, or part-time, even after they have attained 1,000 hours in a given plan year.

The correction for this error is generally to put the improperly excluded participant in the position they would have been in had the error not occurred, by making qualified nonelective contributions (QNECs), plus earnings, to replace the salary deferrals and matching contributions that they failed to receive while improperly excluded from the plan. Generally plan sponsors only need to replace 50% of the missed elective deferrals (lost opportunity cost), but in some cases when the error is caught and corrected quickly and a disclosure is made to affected participants, the lost opportunity cost is reduced to 25% of the missed elective deferral (period of failure exceeds three months, but is less than two years), or even 0% (period of failure is less than three months). 100% of the missed matching contribution or nonelective contribution needs to be replace, plus earnings.

Note that under the SECURE Act, Section 401(k) plans (other than collectively bargained plans) must cover “long-term, part-time employees” who work at least 500 but less than 999 hours in each of the last three consecutive years. Employers must start counting hours of service towards this standard in 2021, such that the first coverage of long-term, part-time employees will occur in 2024. Proposed legislation would reduce the three year measurement period to two years. A plan sponsor can be more generous than the minimum requirement and allow entry into their plan sooner than the SECURE Act deadline.

Entry dates add another area of potential error. Entry dates may be semi-annual (e.g., January 1 and July 1, for a calendar year plan) or more frequent, such as quarterly (January 1, April 1, July 1, October 1), or even monthly. Errors often occur when plans are amended to adopt a more frequent entry date schedule, but plan operation lags behind and continues to follow the old entry date schedule. Errors also arise because of the time period for counting the 1,000 hours (the initial eligibility computation period) is often misunderstood and thus misapplied. In most plans, but not always – check your Adoption Agreement! – the 1,000 hours are counted from the date of hire to the first anniversary of hire, and then the counting period switches to the plan year (in these examples, the calendar year). Sometimes plan sponsors keep using the anniversary date cycle and therefore don’t catch the correct point at which 1,000 hours is attained, and thus miss the correct entry date.

Other eligibility errors arise from permitting employees to participate before they have met eligibility criteria. Sometimes these errors can be corrected with a retroactive amendment permitting early participation by the otherwise eligible employee. However this might not be the correct approach if, for instance, most of the affected participants are highly compensated employees. In that scenario, return of contributions plus earnings may be appropriate.

Correction of eligibility errors is relatively straightforward, as noted. The real goal, however, is to avoid these operational errors in the first place. I’ll come back to my favorite recommendation to avoid unneeded plan interpretation mishaps – design your plan as simply as possible. Of course, “simplicity” will depend upon the sector your business is in and the rate of employee turnover you experience. Immediate eligibility may be simple to administer for a small shop of engineering professionals, but a six-month or longer eligibility period may make sense for a restaurant or other business that experiences high turnover. If immediate eligibility works for your business, keep in mind that there are other ways to incentivize employees to stay with you long term, for instance by way of a vesting schedule imposed on employer contributions.

In addition to a simple plan design, I also recommend the all-hands meeting among human resource and payroll personnel, whether in-house or outsourced, at which every attendee has a copy of the plan adoption agreement, and a description of employment categories such as full-time, part-time, temporary, per diem, etc. It may also be helpful to have a representative of the plan recordkeeper at the meeting. At this meeting, the key sections of the plan document are those on eligibility, hours of service, and entry dates. The attendees should review the age and service criteria for eligibility, the method of crediting hours of service (whether actual hours or elapsed time.), any exclusion categories, whether any exclusion categories are subject to the 1,000 hour exception, and how the eligibility computation period works. Walking through hypothetical new hires and whether and when they enter the plan is one way to make sure everyone is on the same page and to reduce the chances for misinterpretation of the plan documents. After the meeting, drinks with umbrellas in them may be in order!

Photo credit: A.J. Garcia, Unsplash

The above information is a brief summary of legal developments that is provided for general guidance only and does not create an attorney-client relationship between the author and the reader. Readers are encouraged to seek individualized legal advice in regard to any particular factual situation. © 2021 Christine P. Roberts, all rights reserved.

Summertime Blues for Your 401(k) Plan, Pt. 1

Summertime is for fun, relaxation and a break from work, but it is also a crucial period for calendar year 401(k) plans. Form 5500 Annual Return/Reports are due July 31 for these plans, and even if an extension to October 15 is obtained, the summer months are when plan operations and finances are under scrutiny.  This is particularly true for “large” plans – those with 100 or more participants on the first day of your last plan year. (Note that special transition rules apply when switching from small plan to large plan Form 5500 filing status and back again, under the “80/120 rule.”  A good explanation of the rule is found here.)   Sponsors of large plans must engage an independent qualified public accountant (IQPA) and attach the auditor’s report to their Form 5500. 

As a benefits attorney, I associate summer with calls from plan sponsors whose auditing CPAs have identified operational failures and other plan errors that require correction under Internal Revenue Service and Department of Labor voluntary compliance programs, including self-correction, when available.  This is the first in a series of posts covering the 401(k) mishaps that are as reliable a feature of my summers as are the 4th of July, outdoor barbecues and sunscreen.

Error No. 1:  Mismatching Definitions of Compensation

Disconnects between payroll procedures, and the way that your 401(k) plan defines “compensation” for purposes of salary deferrals and employer contributions, generate a significant number of plan operational failures that I see. 

Examples include adding payroll codes to your system without applying participants’ deferral elections and employer contribution to those new payroll amounts, or carving out categories such as bonuses, commissions, and overtime from your plan’s definition of compensation, without stopping deferrals and employer contributions from those amounts.  Whole categories of pay – for instance, tips recorded on credit cards – can sometimes be overlooked in plan operations, as well.  These errors can be corrected fairly simply but the corrections can be expensive and/or time consuming if the errors cover multiple years. 

The best recommendation I can make to avoid compensation-based errors in operating your 401(k) plan is to use Form W-2, Box 1 as your plan’s definition of compensation, with no exclusions (other than gift cards or cash rewards, if your company uses them) and to regularly revisit your payroll codes and procedures to make sure that all pay items that appear in Box 1 are counted for purposes of participants’ salary deferrals and loan repayments. 

Specifically, you should consider holding a meeting each year, or more frequently, among human resources and payroll personnel (in-house or out-sourced) to review the definition of compensation in the Adoption Agreement, on the one hand, and a list of all payroll codes, on the other. Revisit this exercise every time you modify payroll practices, your payroll vendor or software, or of course any time you change the plan’s definition of compensation. 

If your plan defines compensation in a way that involves carve-outs, be especially careful to ensure that the salary deferrals and employer contributions are not applied to the payroll code amounts that correspond to the exclusions, whether bonuses, commissions, overtime, or other items. 

Be mindful, as well, that certain pay items may be excluded from “safe harbor” definitions of compensation, such as cash and/or non-cash fringe benefits, reimbursements or other expense allowances, and moving expenses, but that other exclusions, such as overtime, will trigger the need for annual testing of the definition of compensation under nondiscrimination rules. 

Lastly, there is a good bit of confusion over the scope of certain categories referenced in the safe harbor definitions of compensation, such as nontaxable fringe benefits, and differential wage payments.  As used in an adoption agreement, differential wage payments generally will relate to military service and are not the same as shift differentials.    When in doubt about any definition of compensation issue, check with your third party administrator, ERISA attorney or other benefits professional.  You want your only headache next summer to be from an ice cream cone, not your 401(k) plan.

The above information is a brief summary of legal developments that is provided for general guidance only and does not create an attorney-client relationship between the author and the reader. Readers are encouraged to seek individualized legal advice in regard to any particular factual situation. © 2021 Christine P. Roberts, all rights reserved.

Photo credit:  Krissara Lertnimanorladee, Unsplash

How Employers With 51 -100 Employees Can Meet Their CalSavers Deadline

The CalSavers Program applies to employers that do not maintain a retirement plan.  It automatically enrolls eligible employees in a state-managed system of Roth IRA accounts. June 30, 2021 is the deadline by which employers with 51 to 100 California employees must either establish that they are exempt from CalSavers (for instance, because they have their own plan) or enroll in the program.  Employers with more than 100 California employees were required to enroll by September 30, 2020

Although under legal attack for some time, on the grounds that the federal benefits law, ERISA, prohibited a state-run retirement program, the CalSavers program was just upheld by the Ninth Circuit Court of Appeals.  Money penalties apply to employers who don’t timely either establish their exempt status, or participate in the program.  Below is a how-to for employers in the 51+ group, who have approximately six weeks until their CalSavers deadline arrives:

  1. Already have a retirement plan (including a SEP or SIMPLE)?  Register or certify your exemption.  The link is here.  You will need your federal Employer Identification Number or Tax Identification Number and an access code that is provided on a notice you should have received from CalSavers via email or snail mail.  If you can’t find your notice, call (855) 650-6916. 
  2. Don’t have a retirement plan?  Consider establishing one in the time period left.  IRS Publication 560 contains information about setting up a SEP, SIMPLE, or a 401(k) plan for your small business.  Investment advisors to your business and even business CPAs can also help.  Don’t do it on your own, get expert advice as your choice of plan will have consequences!
  3. Don’t have a plan and don’t want one?  Register with CalSavers.  Again, you need your EIN, or TIN, and an access code.  If you don’t have an access code you can request one using this link. After you register, you will have 30 days to upload your employee roster and facilitate payroll contributions.  If you use an outside payroll provider, you will need to add them as your payroll representative.  More information on adding payroll representatives is provided once you register.
  4. Need more information about counting employees towards the 51 employee threshold?  Check out our prior blog post on the topic, which includes a discussion of use of staffing companies and the like, and also visit the CalSavers FAQ re eligibility.

The above information is a brief summary of legal developments that is provided for general guidance only and does not create an attorney-client relationship between the author and the reader. Readers are encouraged to seek individualized legal advice in regard to any particular factual situation. © 2021 Christine P. Roberts, all rights reserved.

Photo credit Levi Meir Clancy, Unsplash

IRS FAQs Address COVID-19 Partial Plan Termination Issues

On April 27, 2021 the IRS supplemented its online FAQs on COVID-19 relief for retirement plans and IRAs with information related to relief from partial plan terminations.  Under Division 33, Section 209 of the Consolidated Appropriations Act of 2021 (CAA), a plan is not treated as having a partial termination during any plan year which includes the period beginning on March 13, 2020, and ending on March 31, 2021, if the number of active participants covered by the plan on March 31, 2021, is at least 80% of the number of active participants covered by the plan on March 13, 2020.  For employers with a calendar year, this buys them three months of additional time to recover and add back participants, as usually a partial termination would have been determined based on participant levels as of their plan year end on December 31, 2020.  We reviewed the partial termination relief provisions of the CAA in this earlier post.

The new FAQs clarify the following issues:

  1. Definition of Active Participants Covered by the Plan  For purposes of the 80% retention rule, the FAQ advises that plan sponsors use a “reasonable, good-faith interpretation,” of the term “active participant covered by the plan,” applied in a consistent manner, when determining the number of participants covered by the plan on the March starting and ending dates.   In 401(k) plans, participants who meet the eligibility requirements to make salary deferrals generally have been required to be counted as active participants covered by the plan (See Q&A 40), even if they do not actively defer.   The FAQ does not address the distinction between “eligible” versus actively deferring.  Plan sponsors with questions about counting active participants should consult benefit counsel or other benefit advisors.
  2. Application of March to March Period to Calendar Plan Year  The FAQ clarifies that if any part of the plan year falls within the March 13, 2020 to March 31, 2021 period, then the relief applies to any partial termination determination for that entire plan year.   For a plan with a calendar plan year, the relief therefore applies to both the January 1 to December 31, 2020 plan year and the January 1 to December 31, 2021 plan year, because both years include a portion of the March 13, 2020 to March 31, 2021 determination period.
  3. Impact of New Hires on 80% Test  The FAQs make clear that the 80% test looks at the total population of active participants and not only at the pool of active participants who were covered on March 13, 2020.   In other words, new hires that met eligibility under the plan by March 31, 2021 may be counted, and plan sponsors do not need to take a snapshot of active participants as of March 13, 2020 and ensure that 80% of those exact people were still employed on March 31, 2021, in order for the relief to apply.  This is an expansion of normal rules for partial terminations, which would ordinarily require that a participant who is terminated be individually rehired in order not to count as having been affected by the partial termination.
  4. Relief Not Limited to COVID-Related Staff Reduction  The FAQs make clear that although March 13, 2020 happens to be the date that the COVID-19 national emergency was declared, the relief applies regardless of the reason for the reductions in active plan participants; the reductions need not be related to the COVID-19 pandemic. 

Plan sponsors should take heed of the CAA partial termination relief and make use of it when possible.  Form 5500 Return/Reports require plan sponsors to report the number of active participants at the beginning, and end, of each plan year, which permits IRS to IRS FAQs Address COVID-19 Partial Plan Termination Issues possible partial plan terminations.  Armed with this data, IRS earlier this year announced a compliance check program focused on partial terminations.  This is a form of soft audit that could lead to a more formal audit program in the future.

The above information is provided for general informational purposes only and does not create an attorney-client relationship between the author and the reader. Readers should not apply the information to any specific factual situation other than on the advice of an attorney engaged specifically for that or a related purpose. © 2021 Christine P. Roberts, all rights reserved.

Photo credit: Andrew Winkler, Unsplash

IRS Lists Solo 401(k) Plans as Audit Target

If your business sponsors a “solo 401(k)” plan, it may be in the crosshairs of the Internal Revenue Service.  The Service’s TE/GE (Tax Exempt and Government Entities) division has identified one-participant 401(k) plans as among its current audit initiatives.  In its web posting announcing the initiative, TE/GE states:  “[t]he focus of this strategy is to review one-participant 401(k) plans to determine if there are operational or qualification failures, income and excise tax adjustments, or plan document violations.”

By way of background, a solo 401(k) plan is a traditional 401(k) plan covering a 100% business owner with no employees, or that person and their spouse.  As this handy IRS info page describes, solo 401(k) plans are subject to the same rules and requirements as any other 401(k) plan, however because no common law employees participate, you do not have to worry about minimum coverage and nondiscrimination testing, top heavy rules, or most of the requirements of Title I of ERISA.  Solo 401(k) plans can be a great fit for some businesses, but those that stray outside the strict eligibility requirements for these plans have potentially high exposure to correction costs and sanctions in an audit setting.    

Below we list some common solo 401(k) compliance pitfalls.   If you are a solo 401(k) sponsor, check your plan design and operations to determine if these might be issues for you.  Take steps now to correct any compliance failures through use of EPCRS and other voluntary compliance programs, where applicable, so that, if an IRS audit does occur, it is resolved without incident.

  1. Employees Eligible for Benefits: One of the most frequent errors with solo 401(k) plans is that they lose their solo status when the business sponsoring them acquires employees, and the employees work the necessary number of hours required for eligibility under the plan.  (These generally cannot exceed 1,000 hours in a year of service.)  This will trigger application of minimum coverage, nondiscrimination, and top heavy rules, as well as ERISA reporting and disclosure requirements (Summary Plan Description, Form 5500-SF, etc.).  Failure to meet requirements under any of these sets of rules will be fodder for the IRS in an audit setting.  Business owners who need employees should probably avoid solo 401(k) plans unless they can be certain that the employees’ work hours never reach or exceed 1,000 hours in a year.   
  2. Controlled Group/Affiliated Service Group: This issue is related to the first in that, if the business that sponsors the solo 401(k) plan is under common control with a business that has common law employees, the answer to the question “who is the employer” — and who has employees — will be both businesses under common control, not just the business that sponsors the solo 401(k).  Generally, solo 401(k) status will be lost as a result.  The same potential coverage, testing, and top-heavy issues listed above can apply. Potentially, employees of the other business could be eligible for benefits under the (formerly) solo plan.
  3. Form 5500 Filing Duties: Solo 401(k) plans are exempt from filing Form 5500-EZ so long as plan assets remain under $250,000.  If plan assets exceed this threshold and a Form 5500-EZ is not filed, significant penalties could be assessed by IRS and by Department of Labor.  Participation in the Department of Labor Penalty Relief Program for Form 5500-EZ Late Filers should be considered in such instances. 
  4. Exceeding Contribution and Deduction Limits: The contribution and deduction limits that apply to group 401(k) plans apply to a solo 401(k) plan.  Employee salary deferrals cannot exceed the applicable dollar limit under Internal Revenue Code (“Code”) § 402(g) ($19,500 in 2021, plus $6,500 for those 50 and older).  The 415(c) limit equal to the lesser of 100% of compensation or $58,000 (in 2021) applies (and is increased by the age 50 catch-up limit, for a total of $64,500).  The maximum Code § 404(a) deduction of 25% of eligible plan compensation also applies, but in general the 415(c) limit will be reached first.  Failure to observe any of these dollar limits could be picked up on audit.
  5. Plan Document Errors: Businesses that sponsor a solo 401(k) need to update their plan document periodically to comply with the law just like any plan sponsor, meeting the adoption deadlines for preapproved plan remedial amendment cycles (the next one falls on July 31, 2022). Voluntary plan amendments also have to be properly documented and timely adopted.  Failure to meet these document requirements may be able to be corrected under EPCRS. 

The above information is provided for general informational purposes only and does not create an attorney-client relationship between the author and the reader. Readers should not apply the information to any specific factual situation other than on the advice of an attorney engaged specifically for that or a related purpose. © 2021 Christine P. Roberts, all rights reserved.

Photo Credit:  Markus Spiske, Unsplash