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.

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.