24 th Annual Health Sciences Tax Conference

Transcription

1 24 th Annual Health Sciences Tax Conference Update on Section 403(b) plans, employee benefits December 8, 2014

2 Disclaimer EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited operating in the U.S. This presentation is 2014 Ernst & Young LLP. All rights reserved. No part of this document may be reproduced, transmitted or otherwise distributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, rekeying, or using any information storage and retrieval system, without written permission from Ernst & Young LLP. Any reproduction, transmission or distribution of this form or any of the material herein is prohibited and is in violation of U.S. and international law. Ernst & Young LLP expressly disclaims any liability in connection with use of this presentation or its contents by any third party. Views expressed in this presentation are those of the speakers and do not necessarily represent the views of Ernst & Young LLP. This presentation is provided solely for the purpose of enhancing knowledge on tax matters. It does not provide tax advice to any taxpayer because it does not take into account any specific taxpayer s facts and circumstances. These slides are for educational purposes only and are not intended, and should not be relied upon, as accounting advice. Page 2

3 Presenters Terence Kennedy Ernst & Young LLP 950 Main Avenue Cleveland, OH Wayne Kamenitz Ernst & Young LLP 99 Wood Avenue South Iselin, NY William Murphy Ernst & Young LLP 950 Main Avenue Cleveland, OH Page 3

4 Agenda Section 403(b) compliance update Background Internal Revenue Service (IRS) and Department of Labor (DOL) developments IRS audit preparedness Employee Plans Compliance Resolution System (EPCRS) update Impact of United States v. Windsor (Defense of Marriage Act (DOMA) unconstitutional) Section 457(b) compliance check Section 457(f) and 457(e) updates Miscellaneous topics Appendices Employee Plans Team Audit (EPTA) examinations of Section 403(b) plans Common errors found on Section 403(b) plans Questions? Page 4

5 Section 403(b) compliance update: background Page 5

6 Regulatory background: Section 403(b) plan audits Beginning with the 2009 plan year: Section 403(b) plans required to file a full annual report with audited financial statements Written plan document requirement Written plan requirement effective January 1, 2009 Delayed until December 31, 2009, with retroactive effectiveness Regulations add specificity to controlled group definitions for tax-exempt organizations 403(b) plan requirements Universal availability for employee contributions Fifteen years of service catch-up No actual deferral percentage testing Page 6

7 Section 403(b) compliance update: IRS and DOL developments Page 7

8 IRS developments Compliance check project for higher education Main focus universal availability Written plan document requirement Voluntary compliance program for Section 403(b) plans Revenue Procedure (Rev. Proc.) , EPCRS, focusing on Section 403(b) corrections Allows correction for Section 403(b) document failures EPTA examinations of Section 403(b) plans Changes in focus Section 403(b) determination letter program announced Page 8

9 Section 403(b) preapproved plans Rev. Proc : procedures for sponsors to obtain opinion or advisory letters on Section 403(b) plans Limited to: Prototype plans Volume submitter plans Not establishing determination letter program for individually designed plans Page 9

10 Section 403(b) preapproved plans Likely to be two years before letters are issued Remedial amendment period for adopters Plan document to govern conflicts with any underlying investment agreement Document to include appendix listing Investment vendors Parties responsible for various administrative functions Page 10

11 DOL Section 403(b) plan developments Audit quality of 100 Section 403(b) plans Requirement for fee disclosure Proposed new definition of fiduciary proposed again in 2015 Page 11

12 Section 403(b) compliance update: IRS audit preparedness Page 12

13 Section 403(b) audit preparedness Knowledge of location of records Written plan Adopting resolution Payroll records Salary reduction agreements Loan documentation Distribution documentation Have outside providers agree to provide records in the event of an audit Page 13

14 Section 403(b) audit preparedness Review of internal controls Identify gaps and weaknesses in controls Find and correct errors At a minimum, use IRS Section 403(b) Plan Checklist (irs.gov/pub/irs-tege/pub4546.pdf) to identify commonly found errors Page 14

15 Section 403(b) plan disqualification Typically, operational failures not considered disqualifying events Adverse tax impact to the participant but not to plan as a whole Plan disqualifying events: Failure of written plan requirement Violation of universal availability rule Ineligible employer Unable to resolve systemic errors Page 15

16 Section 403(b) compliance update: EPCRS update Page 16

17 What is EPCRS? Employee Plans Compliance Resolution System IRS system for correction of plans intended to satisfy requirements of Sections 401(a), 403(a), 403(b) and 408(k) of the Internal Revenue Code (IRC or the Code) Allows employers to keep tax qualified status of their plans Protects employees by providing them with expected retirement benefits and tax-favored treatment Provides relief from specified excise taxes Rev. Proc Allows retroactive corrections of Section 403(b) plan document defects Page 17

18 EPCRS: why fix plan errors? IRS corrections programs provide financial incentives. Mistakes that are not fixed can result in failure to follow the terms of the plan. Disqualifying defects left undetected and/or uncorrected can be very expensive and difficult to fix. Errors can present a real risk to plan sponsors and negatively impact plan participants. Page 18

19 EPCRS: consequences of plan disqualification Section 403(b) disqualification causes: Taxation of plan earnings Employees lose: Tax-deferred benefits The ability to roll over distributions Page 19

20 EPCRS: correctible failures Operational failure Plan document failure Demographic failure Employer eligibility failure Page 20

21 EPCRS: general correction principles Full correction required for all participants and beneficiaries for all taxable years Restores the plan to the position it would have been in had the failure not occurred Should be reasonable and appropriate for the failure Consistent application in correcting all failures of same type for that plan year Correction for non-discrimination failures to provide benefit for non-highly compensated employees Page 21

22 EPCRS: general correction principles Correction to keep plan assets in plan Correction not to violate another applicable Code requirement ( 401(a) or 403(b)) Principles regarding corrective allocations and corrective distributions Special exceptions to full correction Distributions from plan to be properly reported Page 22

23 EPCRS structure EPCRS Self-Correction Program (SCP) Voluntary Correction Program (VCP) Audit Closing Agreement Program (CAP) Page 23

24 Major changes to Section 403(b) plans EPCRS was revised to allow for the correction of new plan document and operational failures involving Section 403(b) plans that failed to comply with the new requirements of the final Section 403(b) regulations beginning with the 2009 plan year. Section 403(b) failures arising in pre-2009 plan years may be resolved by EPCRS if they comply with Rev. Proc definitions. Page 24

25 Major changes to Section n403(b) plans: new and revised definitions Section 5.02, Definitions for Section 403(b) Plans, has been modified to: Add a definition of plan document failure Revise the definitions of operational failure, demographic failure and employer eligibility failure to coordinate with the new definition of plan document failure Add definitions of overpayment and favorable letter Page 25

26 Major changes to Section 403(b) plans: new correction principles Section 6.10 was added to provide correction principles for Section 403(b) plans Generally, a correction for a Section 403(b) plan is expected to be the same as the correction required for a qualified plan with the same failure (i.e., plan document failure, operational failure, demographic failure and employer eligibility failure). Section 6.10(2) provides for special Section 403(b) correction principles Some Section 403(b) failures can be corrected by treating a contract as a Section 403(b) annuity contract. A Section 403(b) plan generally will be treated as having a favorable letter if it has timely adopted a written Section 403(b) plan. SCP availability to correct operational failures and the requirement to have established practices and procedures applies only for failures occurring after December 31, Page 26

27 Major changes to Section 403(b) plans: new correction principles Section 6.10(3) provides correction principles for failure to adopt a written Section 403(b) plan Failure to adopt a written Section 403(b) plan timely in accordance with the final regulations under Section 403(b) and Notice may be corrected under VCP and Audit CAP. Issuance of a compliance statement or closing agreement for the failure to adopt a written Section 403(b) plan timely will result in the plan being treated as if it had been adopted timely for the purpose of making available the extended remedial amendment period set forth in Announcement Page 27

28 Major changes to Section 403(b) plans: VCP submissions made under Rev. Proc Section 403(b) plans with plan document failures or certain operational failures arising from failure to comply with the final Section 403(b) regulations that were not closed or returned by December 31, 2013, will have the option to apply Rev. Proc The plan sponsor or its power of attorney will be asked to submit a written request asking the IRS to process the submission under Rev. Proc requirements. The written request should not be submitted until instructed by the Voluntary Correction (VC) specialist that has been assigned to work the VCP case. The VCP submission will have to be revised depending on the format in which the submission was submitted under Rev. Proc Page 28

29 Impact of United States v. Windsor (DOMA unconstitutional) Page 29

30 Impact of United States v. Windsor on benefits Section 3 of DOMA provided that the federal government could not recognize same-sex marriages. Under Section 3 of DOMA, same-sex spouses were not entitled to benefits under the Code or federal labor laws (including the Employee Retirement Income Security Act of 1974 (ERISA)). United States v. Windsor, 113 S.Ct (Windsor), invalidated Section 3 of DOMA. Windsor returned determination of marital status to state law. Windsor ensures equal treatment for same-sex spouses in employee benefit matters. Page 30

31 Impact of Windsor on benefits Two potential approaches: State of celebration governs State of residency governs The DOL Family and Medical Leave Act applies state of residency (DOL, Wage and Hour Division, Fact Sheet #28F). Revenue Ruling (Rev. Rul.) applies state of celebration for all tax and employee benefits purposes. Technical Release (DOL, Employee Benefits Security Administration) provided guidance under ERISA. Release uses state-of-celebration approach Release results in consistency under the Code and ERISA regarding employee benefits Page 31

32 Impact of Windsor on benefits Effects on health benefits: Employees can cover same-sex spouses under employerprovided health care plans pretax. Same-sex spouses have full Consolidated Omnibus Budget Reconciliation Act (COBRA) rights. Employees can receive tax-free reimbursements for same-sex spouse qualified medical expenses. Flexible spending accounts (FSAs) Health savings accounts (HSAs) Health reimbursement accounts (HRAs) Same-sex spouses are entitled to Health Insurance Portability and Accountability Act special enrollment rights. Page 32

33 Impact of Windsor on benefits Effects on retirement benefits: Same-sex spouse entitled to 50% qualified joint and survivor annuity benefit or a 75% qualified optional survivor annuity Spouse s consent required for alternative form Same-sex spouse entitled to qualified preretirement survivor annuity unless consents to waive Same-sex spouse entitled to 100% of non-annuity plan account on death of participant unless consents to another beneficiary Same-sex spouse entitled to qualified domestic relations order Same-sex spouse entitled to roll over distributions into own individual retirement account (IRA) rather than more-restricted, inherited IRA Page 33

34 Impact of Windsor on benefits Employment taxes IRS Notice Contributions for benefits now pretax Approach for 2013 Approach for open prior years Retroactive application E.g., same-sex spouses denied annuities, account balances and COBRA prior to Windsor State tax How will states that do not recognize same-sex marriages react? Page 34

35 Notice Provides further guidance on application of Windsor Plans must comply as of June 26, 2013 Plans can comply prior to June 26, 2013, but application could create additional complications If a qualified plan is required to be amended such amendment must be made by December 31, 2014 Amendment not necessary if language does not contradict ruling in Windsor e.g., spouse as defined by federal law Page 35

36 Section 457(b) compliance check Page 36

37 457(b) compliance check Section 457(b) plans for exempt organizations: Permit vested deferred compensation Subject to limits on deferrals; same as 401(k)/403(b) deferral limits but additive Must be unfunded Must be top-hat plan Distinct rules for governmental Section 457(b) plans In late August and early September 2013, the IRS Employee Plans Compliance Unit sent more than 200 questionnaires to tax-exempt employers. The purpose of the questionnaire is to see if issues crop up. IRS will focus future audits on common issues. Page 37

38 Governmental v. exempt organization (EO) Section 457(b) plans There are significant differences between plans Governmental plans are more like qualified plans EO plans are more like non-qualified deferred compensation plans of taxable employers Feature Governmental Tax exempt Funded Yes, in trust No, unsecured creditors Rollovers of distributions Yes, into IRAs, qualified plans, etc. Loans Permissible Taxable No (but can permit plan to plan transfer) Age 50 catch-up Like Section 401(k) plans Limited availability Page 38

39 Section 457(b) compliance check Issues identified to date: Permitting age 50 catch-up contributions Permitting loans Adopting governmental plans Permitting rank-and-file employees to participate No formal correction mechanism, but IRS advised to set up a group of EPCRS and VCP specialists to evaluate issues on a case-by-case basis Page 39

40 Section 457(f) and 457(e) updates Page 40

41 Section 457 regulations: background Notice stated the intent of the IRS to issue regulations covering Section 457(e)(11) and 457(f) For Section 457(e)(11) only a bona fide severance plan if: Only paid on involuntary termination Benefit cannot exceed two times the Section 401(a)(17) limit ($530,000 in 2105) Benefit must be paid before the end of the employee s second tax year following termination For Section 457(f) guidance on the definition of substantial risk of forfeiture (SRF) Limit use of non-competes Prohibit rolling risk of forfeitures Appeared to be leaning toward a Section 409A SRF definition Regulations would be applied prospectively Page 41

42 Section 457 regulations: status Regulations under Section 457 have not yet been issued even though the Notice was seven years ago Regulations still remain on the Priority Plan in 2014: Steven Tackney of the Treasury recently acknowledged frustration that the regulations are still not out but remains optimistic. Focus still on coordinating the Section 457 guidance with the expansive Section 409A rules and likely to include areas such as: What is a Section 457(f) plan and a Section 457 severance plan Where there is a plan failure, how to calculate amounts to be included in income Transitional relief Application of substantial risk of forfeiture (in general and for transition relief purposes Tackney does not believe the transition relief will be as generous as hoped Page 42

43 Impact of Section 83 regulations Finalized changes to regulations in March 2014 with a focus on substantial risk of forfeiture Tightened the definition but still allows for a non-compete to be a substantial risk of forfeiture Despite Notice , current Section 457(f) regulations still point to Section 83 for this purpose Substantial risk of forfeiture and non-competes require the following: Facts and circumstances indicate that given the employee s age and employment opportunities, the non-compete would impose a significant burden The employer intends to enforce the non-compete This is a more stringent standard than under previous Section 83 rule Page 43

44 Section 457 compliance programs Current Section 409A audit program efforts are not focused on tax governmental and not-for-profit (NFP) employers only focusing on for profit employers right now Section 409A corrections Will look to provide comprehensive corrections relief for Section 409A errors will attempt to combine the various current rules Applies to NFP arrangements subject to Section 409A Page 44

45 Miscellaneous topics Page 45

46 Church plan litigation Eight cases challenging church plan status Allegations that church plan status should be limited to steeples If successful, plans to be subject to all ERISA requirements Plaintiffs attorneys same in all five cases Two of the cases have concluded that the plans are church plans even though not formed by the steeples Catholic Health Initiatives denied summary judgment to plaintiff but still requires evaluation of whether other requirements for church plans have been met Ascension Health court dismissed claims not a church plan Two cases concluded the plans are not church plans Dignity Health and St. Peters church must first establish Conflicting decisions a cross appellate courts Page 46

47 Limited medical FSA carryover IRS Notice permits FSAs to allow carryovers of up to $500. $500 carryovers cannot be paired with a 2.5-month extension of IRS Notice The Affordable Care Act (ACA) limited medical FSA deferrals to $2,500 (as indexed) per year effective Carryovers must be used in the following plan year. Page 47

48 Limited medical FSA carryover There is no limit on the total that may be deferred. Up to $500 more than the ACA limit may be available for reimbursements in a given year. Plans must be amended before the end of the plan year from which amounts will be carried over. Amounts remaining at termination of employment must be forfeited. However, the forfeiture date can be extended if COBRA is elected for the FSA. Immediate action is required to amend plans that permit 2013 carryovers. If such plans had carryover provisions, those would also have to be eliminated. Page 48

49 2013 Health Care CEO Severance Survey Survey by Mercer Inc., Witt/Keiffer (executive search) and Hunton & Williams LLP (law firm) was released in September Survey is available online Survey should be reviewed by boards and committees granting Chief Executive Officer (CEO) severance 83% of respondents have severance agreements with CEO 24 months of base and health benefits is most common 68% contained non-competition or non-solicitation provisions Page 49

50 2015 benefit plan dollar limits Description 2014 limit 2015 limit Participant pretax contribution limit for 401(k) and 403(b) plans Section 402(g)(1) Deferral limit for deferred compensation plans of state and local governments and tax exempts Section 457(e)(15) Dollar limitation for catch-up contributions for participants age 50 or over in Section 401(k), Section 403(b), governmental Section 457 plans and simplified employee pension plans Section 414(v)(2)(B)(i) Dollar limitation for catch-up contributions for participants age 50 or over to a SIMPLE IRA or a SIMPLE 401(k) $17,500 $18,000 $17,500 $18,000 $5,500 $6,000 $2,500 $3,000 Section 414(v)(2)(B)(ii) Page 50

51 2015 benefit plan dollar limits Description 2014 limit 2015 limit Defined benefit plan limit Section 415(b)(1)(A) Defined contribution plan limit Section 415(c)(1)(A) Definition of key employee in a topheavy plan officer compensation threshold Section 416(i)(1)(A)(i) Highly compensated employee dollar threshold Section 414(q)(1)(B) Annual limit on includible compensation for benefits and allocations Lesser of $210,000 or 100% of the participant s three-year high compensation Lesser of $52,000 or 100% of participant s compensation $170,000 $170,000 $115,000 $120,000 $260,000 $265,000 Lesser of $210,000 or 100% of the participant s three-year high compensation Lesser of $53,000 or 100% of participant s compensation Section 401(a)(17) Page 51

52 Appendices Page 52

53 EPTA examinations of Section 403(b) plans Page 53

54 EPTA: history and background 4,500 single-employer qualified plans have 2,500 or more participants. Represent less than 1% of all retirement plans Cover 60% of total plan participants Hold 70% of total plan assets Audits focused on large, employer-sponsored retirement plans have resulted in a high degree of adjustments and/or corrections. Page 54

55 Overview of EPTA IRS has developed an audit program focusing exclusively on larger retirement plans. EPTA Utilizes subject matter specialists Employs electronic data auditing techniques Section 403(b) included in EPTA Selection criteria: Industry prevalence of errors Mergers and acquisitions activity Page 55

56 Focused examinations Methodology to leverage resources and employ efficiencies Focus on non-compliant plans Applicable to EPTA audits Based on initial focused review and internal controls interview, agent could: Conclude plan is compliant (no issues) Or Resolve identified issues Or Expand audit scope Page 56

57 Overview of EPTA teams and audits Team comprises six to eight highly trained specialists Benefits attorneys Actuaries Employee plans revenue agents Employment tax specialists Computer auditing experts The team receives specialized training in statistical sampling, computer auditing, advanced access database and other specialized areas of plan operation. Audits involve between 200 and 300 on-site staff days for the IRS team for each plan reviewed. The plan sponsor receives between 75 and 150 information data requests (IDRs). Page 57

58 Increased Section 403(b) audit activity IRS audit activity Health care 82% problematic Colleges and universities 65% problematic Section 403(b) plan specific trends identification of most common errors Areas of examination focus irs.gov/retirement/article/0,,id=206498,00.html Page 58

59 Common errors found on Section 403(b) plans Page 59

60 IRS-identified common Section 403(b) errors Failure to properly apply universal availability to participants Failure to properly track and limit elective deferrals 15-year rule contributions combined with age 50 catch-up feature Failure to limit contributions under IRC Section 415 Failure to have a written plan document Failure to follow controlled group rules Adoption of plans by ineligible employers Failure to comply with IRC Section 403(b) post-severance contribution requirements Failure to follow hardship distribution requirements Failure to follow plan loan requirements Failure to follow plan compensation definitions Page 60

61 Failure to properly apply universal availability to participants All non-excludible employees in the controlled group must have the opportunity to defer salary if any employee can defer. Excludible employees include: Nonresident aliens Students performing services described in 3121(b)(10) Employees who normally work fewer than 20 hours per week The plan can require a minimum annual contribution of $200. The requirement can be satisfied by eligibility for a Section 401(k) plan or governmental Section 457(b) plan. Page 61

62 Failure to properly track and limit elective deferrals Deferral contributions are limited under 402(g). $17,500 per year in 2013 ($17,000 in 2012) Special additional catch-up permitted under 403(b) is often misapplied. 15-year rule contributions combined with the age 50 catch-up feature is limited to the lesser of the following amounts: $3,000 $15,000, less previously excluded special 15-year rule catch-ups and designated Roth contributions for prior tax years $5,000, multiplied by years of service, minus previously excluded elective deferrals throughout the employment period In addition, age 50 catch-up is permitted. $5,500 per year in 2013 and 2012 Ordering, as presented here, is often problematic. Page 62

63 Failure to limit contributions under IRC Section 415 Sum of elective deferrals and employer contributions cannot exceed the lesser of: $51,000 for 2013 ($50,000 for 2012) 100% of includible compensation Age 50 catch-up is not subject to this limit. Contributions are made to multiple Section 403(b) accounts or other defined contribution qualified plans in a controlled group. Typical errors arise in properly tracking compensation and aggregating plans and controlled groups. Page 63

64 Failure to have a written plan document A written plan has been required since the 2009 plan year. While a single document is not required, writings must cover: Eligibility Limitations Benefits under the plan The plan has to operate in accordance with these written terms. Page 64

65 Failure to follow controlled group rules Rules are spelled out for the first time for tax exempts with final Section 403(b) regulations. Issues exist with: Universal availability Non-discrimination testing Section 415 limits Rules utilize an 80% director or trustee common control test. There are ownership rules for non-exempt entities. Page 65

66 Adoption of plans by ineligible employers Section 403(b) plans are allowed only for: Section 501(c)(3) exempt organizations Employees of public schools, state colleges and universities Employees of cooperative hospital service organizations Often, controlled group members who are ineligible adopt Section 403(b) plans. To meet universal availability requirements, controlled group members must adopt Section 401(k) plans. Page 66

67 Failure to comply with the post-severance contribution requirements Post-employment contributions are limited to amounts earned during employment but paid the later of 2.5 months after severance from employment or the end of the limitation year. A common error is the processing of severance payments through payroll with deferral contributions withheld. Page 67

68 Failure to follow hardship distribution requirements Hardship distributions are limited to meeting immediate and heavy financial need. Document the hardship Document the amount (the need plus the taxes on distribution are permitted) Cannot be reasonably met with other resources (e.g., plan loans, insurance, other assets, cessation of employee contributions) Even when relying on outside record-keepers, the plan sponsor is ultimately responsible. Page 68

69 Failure to follow plan loan requirements Loan must meet certain requirements It must be part of a written program maintained by employer The loan amount must be the lesser of: 50% of vested account balance $50,000 Loan must be repaid within five years (or longer if used for purchase of main home) Repayment must be substantially level, at least quarterly, over loan term Plans must be aggregated across controlled group Even though relying on outside record-keepers, plan sponsor is ultimately responsible Page 69

70 Failure to follow plan compensation definitions Plan may have multiple definitions (e.g., nondiscrimination testing, salary deferrals, employer contributions) Common failures involve a payroll system that is not in conformity with definitions in plan documents Most common error is applying deferral elections to wrong definition of compensation Page 70

71 Questions? Page 71

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