Common ERISA Compliance Problems and How to Correct Them

Transcription

1 Common ERISA Compliance Problems and How to Correct Them Phyllis P. Rimkus, Rimkus Marciano & Associates, Inc. Raymond N. McCabe, Esq. Barclay Damon, LLP

2 Jurisdiction over ERISA Plans Jurisdiction over and enforcement of ERISA Plans is divided between the U.S. Department of Labor (the DOL ) and the Internal Revenue Service ( IRS ). The DOL s jurisdiction generally encompasses reporting and disclosure, fiduciary duties and protection of participant rights. The IRS jurisdiction generally encompasses tax qualification.

3 DOL Voluntary Programs DOL offers limited Voluntary Programs allowing plan sponsors to voluntarily disclose: Failure to file Annual Reports (IRS Form 5500); Breach of fiduciary duty.

4 Delinquent Filer Program Without relief, Maximum DOL Penalty is $2,063 per day for failure to file form 5500, with no cap. Delinquent Filer Voluntary Compliance ( DFVC Program) caps penalty at: $10 per day, with a cap of: $750 per return for small plans ($1,500 for multiple years) $2,000 per return for large plans ($4,000 for multiple years);

5 Voluntary Fiduciary Correction DOL offers voluntary disclosure penalty for specified breaches of fiduciary duty, including: Delinquent remittance of participant contributions to the Plan; Defaulted plan loans; Loans to parties in interest; Sales and purchases of plan assets to or from parties in interest; and Excessive or improper payment of plan expenses.

6 Voluntary Fiduciary Correction DOL also offers relief from excise taxes for the following, if done at fair market value: Failure to remit participant contributions; Sales or purchases of assets with party in interest; Sale and leaseback transactions involving real property; Loans to Parties in Interest;

7 Voluntary Correction of Plan Qualification Failures IRS requires that (i) plan be operated in conformance with plan document, and (ii) plan document conform with ERISA: A Plan s failure to comply with (i) or (ii) (a plan failure ) will result in disqualification; IRS allows plan sponsor to correct a plan failure under the Employee Plans Compliance Resolution System ( EPCRS );

8 EPCRS Basics EPCRS includes three distinct voluntary correction programs: Self-Correction Program ( SCP ): Applies to insignificant operating failures, and failures discovered and corrected during a specified correction period: The SCP correction period ends on the last day of second plan year after the failure arose. The correction period ends if the IRS begins an audit of the plan.

9 EPCRS Basics Voluntary Correction Program with IRS Approval ( VCP ) Applies to corrections corrected after the end of the correction period, significant operational failures and plan document failures. Requires an application to the IRS and the payment of a user fee based on the number of participants in the Plan. Results in IRS issuing a Compliance Statement covering disclosed failures.

10 EPCRS Basics Audit Closing Agreement Program ( CAP ): Applies to failures found for the first time during an audit of the Plan. Requires payment of a sanction amount, determined as a percentage of a maximum payment amount Maximum payment amount consists of tax otherwise payable by employer(s), plan trust, and all participants, plus any other tax arising from the failure.

11 EPCRS Correction Principals Failure must be completed fully for all years, including closed years; Correction means restoring participants to the position they would have been in had no failure arose; Correction must be reasonable and appropriate for the failure (safe harbor methods for certain failures in Appendix A & B);

12 EPCRS Correction Principals Correction must: Resemble a method already provided in the Code; Keep assets in the Plan, except as permitted by the Code (e.g. return of excess employee elective contributions, payment of required benefits); Nondiscrimination must be cured by making contributions to non-highly compensated employees (not forfeiting contributions made for the highly compensated);

13 EPCRS Correction Principals Correction must: Not violate any provision of the Code; Be applied consistently over multiple plan years; Corrective allocations must be funded by employer non-elective contributions; For a defined contribution plan, corrective allocations and distributions, must include earnings; Include method to locate lost participants affected by the failure and correction.

14 Example 1, Page 38: ADP Failure Average deferral percentage ( ADP ) for the Plan s nonhighly compensated employees ( NCHEs ) is 4%. Maximum ADP for the plan s highly compensated employees ( HCEs ) is 6% (the lesser of 4% x 2, or 4% + 2). ADP of the highly compensated employees ( HCEs ) is 9%. Be applied consistently over multiple plan years; Corrective allocations must be funded by employer nonelective contributions; For a defined contribution plan, corrective allocations and distributions, must include earnings.

15 Average deferral percentage ( ADP ) for the Plan s nonhighly compensated employees ( NCHEs ) is 4%. Maximum ADP for the plan s highly compensated employees ( HCEs ) is 6% (the lesser of 4% x 2, or 4% + 2). ADP of HCEs is 9%: ADP Failure HCE P deferred 10% of her $100,000 compensation ($10,000); HCE Q deferred 8% of his compensation of $118,750 ($9,500)

16 ADP Failure Of P s deferral of $10,000 (10% of P s compensation), $4,000 exceeded the HCE maximum ADP rate of 6% (P s compensation of $100,000 x 4%) Of Q s deferral of $9,500 (8% of Q s compensation), $2,375 exceeded HCE maximum ADP Rate of 6% (Q s compensation of $118,75 x 2%). Total excess deferral of the HCEs is $6,375.

17 ADP Failure The excess of $6,375 is allocated as follows: The first $500 of the excess is allocated to P, to bring P s adjusted deferral to the same value a Q s ($9,500 each); The balance ($5,875) is allocated equally between P and Q ($2, each); Total excess deferral of $6,375, is allocates $3, to P and $2, to Q; Earnings are calculated on the excess; The Plan distributes the excess allocation, plus earning to each of P and Q.

18 Failure to Include Eligible Participant in 401(k) Plan Example 3, Page 43: A 401(k) Plan allows elective deferrals and provides an employer matching contribution of 100% up to 3% of Compensation. The Plan also allows voluntary after-tax contributions, which are not matched. NHCE V is eligible to participate in the Plan effective January 1, 2006, but is not offered the opportunity to defer. V s 2006 compensation is $30,000.

19 Failure to Include Eligible Participant in 401(k) Plan In 2006: the ADP of NHCEs is 8%; The Average Contribution Percentage (ACP) of the NHCEs is 2.63%, of which 2% is attributable to the employer matching contribution and.63% the balance is attributable to voluntary after-tax contributions. NHCE V is eligible to participate in the Plan effective January 1, 2006, but is not offered the opportunity to defer. The failure is discovered in 2007.

20 Failure to Include Eligible Participant in 401(k) Plan Correction of Elective Deferral Failure: Employer must make a Qualified Non-elective Contribution ( QNEC ) on V s behalf equal to 50% of the missed deferral opportunity determined by reference to ADP percentage of the NHCE group (8%). QNEC is $1,200 (50% x 8% x $30,000); $1,200 must be increased to reflect lost earnings.

21 Failure to Include Eligible Participant in 401(k) Plan Correction of Matching Contribution Failure: Employer must make a Qualified Non-elective Contribution ( QNEC ) on V s behalf equal the matching contribution to which V would have been entitled had V deferred 8% of his compensation ($2,400) to the Plan. QNEC is $900 (100% of $2,400, up to 3% of compensation): Compensation ($30,000) x 3% = $900. QNEC must be adjusted for lost earnings.

22 Failure to Include Eligible Participant in 401(k) Plan Correction of After-Tax Contribution Failure: Employer must make a Qualified Non-elective Contribution ( QNEC ) on V s behalf equal to 40% of the missed deferral opportunity determined by reference to ADP percentage of the NHCE group (.63%). QNEC is $75: Compensation of $30,000 x.63% = $189 $189 x.40 = $76. QNEC must be adjusted for lost earnings.

23 Failure to Include Eligible Participant in Profit Sharing Plan Examples 13, 14 and 15, Page 52: A Profit Sharing Plan provides for discretionary employer contributions allocated to participant accounts pro-rata, based on compensation of each participant. Employer D makes a fixed dollar contribution to the Plan for the 2006 Plan Year. When allocated to accounts of participants, Employer D s contribution results in an allocation equal to 10% each participant s 2006 compensation.

24 Failure to Include Eligible Participant in Profit Sharing Plan Examples 13, 14 and 15, Page 52: Each participant directs investment of their allocable share of Employer D s contribution among four investment options offered under the plan. Most of the participants entitled to a 2006 employer contribution are NHCEs.

25 Failure to Include Eligible Participant in Profit Sharing Plan In 2007, Employer D discovers that five eligible employees were inadvertently excluded from the Plan in If the excluded participants had shared in Employer D s 2006 contribution, the allocation to each participant for 2006 would have been 9% of compensation instead of 10%. The excluded employees begin to participate in the Plan in 2007.

26 Failure to Include Eligible Participant in Profit Sharing Plan Corrective Contribution Method of Correction: Employer D makes a QNEC to each of inadvertantly excluded employees for 2006 equal to 10% of their 2006 compensation. Employer D s QNEC includes lost earnings on the contributions for each of the employees entitled to the QNEC.

27 Failure to Include Eligible Participant in Profit Sharing Plan Reallocation Correction Method: Employer D makes no QNEC with respect to Employer D s reallocates the balances of each participant to: Increase the account balances of the inadvertantly excluded employees to reflect an allocation equal to 9% of compensation, increased by earnings; and Decrease the account balances of all other participants to reduce the allocation from 10% to 9% and to further decrease the account balances to earnings attributable to the reallocated amounts.

28 Failure to Include Eligible Participant in Profit Sharing Plan Special Rule for Calculating Earnings: Under the general rule, to calculate lost earnings, Employer must look to actual investment returns that applied or would have applied for each participant during the period that earnings must be calculated: i.e. Employer must separately determine the actual calculate rates of return of each participant in order to calculate earnings.

29 Failure to Include Eligible Participant in Profit Sharing Plan Special Rule for Calculating Earnings (continued): Because most participant entitled to an allocation of Employer D s 2006 contribution are NHCEs, Employer D may calculate earnings by reference to the rate of return of fund with the highest rate of return instead of looking at the actual investment experience of each participant.

30 401(a)(17) Compensation Failure Examples 24 and 25, Page 59: Employer J maintains a money purchase pension plan, providing for a contribution equal to 8% of each participant s compensation. In 2006, the 401(a)(17) limit on compensation is $220,000. Employee W earned compensation of $250,000 in 2006, and received a contribution of $20,000 for 2006 (8% of $250,000), resulting in an improper allocation of $2,400.

31 401(a)(17) Compensation Failure Forfeiture of Excess Contribution: Employer J corrects the excess by reducing Employee W s contribution for 2006 by $2,400; The excess contribution must be adjusted for earnings; The reduction must be held in an unallocated account in the plan, and may be applied to reduce Employer J s future contributions to the Plan.

32 401(a)(17) Compensation Failure Correction by Plan Amendment: Employer J can correct the excess by amending the Plan for 2006 to increase its contribution from 8% to 9.09%.the contribution reducing Employee W s contribution for 2006 by $2,400; Employee W s excess contribution = 1.09% ($2,400/$220,000), plus 8%.

33 401(a)(17) Compensation Failure Correction by Plan Amendment: Employer J makes a corrective contribution to the account of each participant other than Employee W to increase the contribution from 8% to 9.09% of compensation. The increased contributions must be adjusted for lost earnings.