If your business sponsors a Section 401(k) or other retirement plan, it is governed by a lengthy plan document, often a separate trust agreement or custodial account agreement, and multiple other documents (salary deferral agreements, loan policy statement, investment policy statement, etc.) Not surprisingly, most plan sponsors get something wrong somewhere along the way, whether with respect to the plan document, or operation of the plan. Below are five reasons why taking prompt action to correct plan errors is in the best interests of your business, and your employees.
- To preserve the tax-qualified status of your plan.
Contributions to your plan are deductible to your business and excluded from your employees’ taxable compensation (i.e., are “tax-qualified”) because the plan document, and operation of the plan, conform to certain requirements under the Internal Revenue Code. Under the Employee Plans Compliance Resolution System or EPCRS, the Internal Revenue Service permits plan sponsors to voluntarily correct a wide range of errors that, if left uncorrected, could result in a loss of the plan’s tax-qualified status and subject plan assets to taxation. There are costs associated with participating in the EPCRS, including amounts that may be owed to the plan, attorneys’ fees, and program fees, but they are usually only a fraction of the potential expense of plan disqualification.
- To correct prohibited transactions.
While the IRS monitors the tax-advantaged status of benefit plans, the Department of Labor policies the actions of plan fiduciaries, both with respect to plan assets, and in fulfilling reporting and disclosure duties. When salary deferrals and loan repayments are withheld from employees’ pay and not promptly deposited in the plan’s trust account, the Department of Labor essentially views this as an interest free loan, by the employer, of employee money. Technically speaking, it is a “prohibited transaction” that requires correction under the DOL’s Voluntary Fiduciary Correction Program. Uncorrected prohibited transactions, if discovered on audit, can result in civil monetary penalties to the fiduciaries, and also triggers excise taxes payable to the Internal Revenue Service. Prohibited transactions also must be disclosed on the annual Form 5500 Return/Report, potentially alerting the Department of Labor to initiate further inquiry or audit. Timely participation in VFCP eliminates the fiduciary penalties and offers alternatives to payment of the excise taxes in some circumstances (e.g., if the same amount is paid to the plan).
- To minimize penalties in the event of a plan audit.
The IRS, on audit, may assess penalties for uncorrected errors in plan documentation and operation, that can reach many thousands of dollars, on top of the amounts owed to the plan in order to correct operational errors. And, as mentioned, prohibited transactions trigger potential civil monetary penalties. Participation in IRS and DOL voluntary correction programs protects plan sponsors from these potential large assessments. Whatever the cost of taking part in the voluntary program, whether it be costs of corrective contributions and earnings, attorneys fees, and the program fee, it is a quantifiable cost and one that is much smaller than the cost of correcting under the supervision of the IRS or DOL.
- To ensure the saleability of your business.
Plan sponsors sometimes think that their uncorrected plan errors are only at risk of discovery if they are audited, and point to low levels of IRS and DOL audit activity as proof that they can safely play “audit roulette.” However they are forgetting that, if they want to sell their business – particularly stock sales – or merge with another business, the due diligence process preceding the transaction will likely require them to identify any errors in plan documentation or operation within a 3 year or longer period. An unresolved plan error could derail the transaction, or at best require correction under terms and conditions that are not as favorable, to the plan sponsor, as self-correction would have been. If you envision your business as a purchase target or merger partner in the future you owe it to yourself to make sure that plan errors are corrected promptly and in advance of any due diligence inquiries.
- Because it’s the right thing to do.
Your retirement plan document is a contract you have entered into for the benefit of plan participants and beneficiaries and you should take it as seriously as any contract you enter into with a third party. It spells out the right way to do things, for the most part, and the IRS and DOL self-correction programs are there to minimize the downside when plan documentation or operation falls short of perfection. Whether your goal is to sell your business without a hitch, or glide through an IRS or DOL audit with a minimum of fuss, fixing plan errors promptly is the right choice every time.
The above information is a brief summary of legal issues 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: Sasun Bughdaryan, Unsplash