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.