RETIREMENT PLAN ISSUES FOR TAX EXEMPT ORGANIZATIONS. Presented October 5, 2017 by Scott E. Galbreath, J.D., L.L.M. (Tax)

Transcription

1 RETIREMENT PLAN ISSUES FOR TAX EXEMPT ORGANIZATIONS Presented October 5, 2017 by Scott E. Galbreath, J.D., L.L.M. (Tax) 1

2 Introduction Introduction to Retirement Plans Unique issues for tax exempt organizations Plans for tax exempt organizations Best Practices New Developments DOL Conflict of Interest Rules CA Secure Choice Program 2

3 Introduction-ERISA Remedial statute meant to cure abuses Impose strict fiduciary duties on managers of plan Reporting and disclosure rules Applies to both tax qualified and unqualified plans Nondiscrimination rules to ensure low paid participate as well as high paid 3

4 Advantages of Tax Qualification Tax deduction for contribution to qualified plan No income tax on earnings of qualified plan Employee has tax deferral on income until received GREAT TAX SHELTER! Tax-free rollovers Federal bankruptcy exemption 4

5 Disadvantages of Tax Qualification Numerous rules to meet regarding Availability, participation, vesting, compensation, contributions, nondiscrimination, distributions Fiduciary duties Personal liability Law is constantly changing 5

6 Types of Plans Employer Contribution Plans Pension Plans Profit Sharing Plans Stock Plans and ESOPs Simple plans SEPs SIMPLE plans Elective Deferral Plans 401(k) (b) Nonqualified plans 6

7 Unique Circumstances for EOs The analysis for choosing and designing a retirement plan for an EO is different than for a for-profit employer No tax deduction No equity compensation 7

8 Unique Circumstances-Motivation Motivation is to provide for retirement for employees Maybe tax deferred Maybe not (Roth) To compete with private sector for good employees Including Executives Lack of equity techniques is distinct disadvantage 8

9 Unique Circumstances-Exempt Status Too much compensation can: Threaten exempt status As prohibited inurement or Cause penalties on organization officers/ directors and EE As excess benefit transaction 9

10 Inurement: organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual, no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation (except as otherwise provided in subsection (h)), and which does not participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office. Emphasis added. 10

11 Excess Benefit Transaction Rules: Rationale Penalty for violating private inurement rule is loss of exempt status Does not punish the responsible person that receives the unjust benefit In case of charity, punishes contributors who lose deduction Society denied the exempt benefits 11

12 Excess Benefit Transaction Rules Basics (c)(3) or (4) 2. Excess benefit transaction with Disqualified Person (DP) 3. 25% tax to DP on value of excess benefit a. 200% if not timely corrected b. 10% tax on organization managers who knowingly participate c. Exception for reliance on professional opinion 12

13 Excess Benefit Transaction Value of benefit provided DP exceeds value of consideration given Transaction with DP where benefit is measured by revenues 13

14 Disqualified Person In a position to exercise substantial influence over the affairs of an Applicable Organization at any time during the five-year period ending on the date of the transaction. Members of the governing body, officers, and certain relatives of the above are deemed to be disqualified persons. An entity that is more than 35% owned by disqualified persons will itself be a disqualified person. 14

15 Organization Manager Any officer, director, or trustee of such organization, or any individual having powers or responsibilities similar to those of officers, directors, or trustees of the organization, regardless of title. Exception: Paid professionals such as lawyers, accountants 15

16 Safe Harbor for Compensation Rebuttable Presumption of Reasonableness Authorized Body of the Organization Approves compensation in advance Relies on data as to comparability Documents the basis for decision Terms and date of approval Members present and voting Comparability data relied on Actions taken by persons with conflicts 16

17 Comparable Data For Small Organizations An organization with average annual gross receipts less than $1 million Compensation data of three comparable organizations will be sufficient Regulations take no position on how much data is sufficient for larger organizations 17

18 EO Compensation in the News In March, WSJ article, Charity Officials Are Increasingly Receiving Million-Dollar Paydays Analyzed 100,000 Forms ,700 employees $1M in 2014 Up 33% since 2011 About 25% had base pay of $1 mill or more Around 75% were healthcare Around 10% were private colleges 2/3 reported using a compensation consultant 18

19 EO Compensation-Bad Press WSJ Art College s President Draws Lucrative Pay Package Highest paid president of college $9.6M Savannah College of Art and Design Base of $859,000, bonus of $1M $7.5M deferred compensation pay out Used compensation consultant Tuition, etc. around $50K 2/3 graduate within 6 years Median earnings of $35K 10 years after entering 19

20 EO Compensation-More Bad Press August article in Vermont Seven Days Million-Dollar Question: How Much Should Nonprofit Hospital CEOs Earn? VT resident earns average of $50K VT Executive Director earns average of $83,000 VT Head of NFP hospital earns average of $550K 20

21 EO Compensation-Wide disparity Highest $17.6 million, Ascension $10.2M bonus $21.9 billion in operating revenues Red Cross CEO $557,000, budget $2.9 billion Ministry $8.1 million $4 million to H&W founders 21

22 What Does This Mean? Ripe for enforcement initiative Or legislative change Imperative to follow rules for presumption Including good comparability data In 2013, IRS found 20% of 400 colleges and universities didn t qualify for presumption 22

23 Unique Circumstances-Plans No ESOP or other equity arrangement Plans that for profit employers can t adopt 457 plan Only exempt organization or state/local government Plan only certain types of EOs can adopt 403(b) plan Only 501(c)(3), public schools, and churches 23

24 Unique Circumstances- Salary Reduction Plans Section 401(k) Plans-unique history Section 403(b) Plans Section 457 Plans 24

25 History 401(k), 457 For EOs TRA 86: Took away 401(k) plans from tax exempt organizations Made Section 457 plans available to tax exempt organizations (not churches) 1996 SBJP Act: Brought back 401(k) plans for EOs (not govs) But had to be coordinated with other elective deferrals 457, 403(b) EGTTRA: 457 no longer coordinated with other elective deferrals: 403(b), 401(k), SEP or SIMPLE Except when calculating catch-up during last three years before retirement must coordinate deferrals before 1/1/

26 401(k) Basic Characteristics Allows employees to defer salary pre-tax, post-tax, or both Discretionary matching contributions or profit sharing contributions from employers Vesting schedules available for use on employer contributions Can have loan and hardship withdrawals Can have 5-year catch-up contributions Can be sponsored by for profit or non-profit Subject to ADP/ACP discrimination tests Safe Harbor designs available 26

27 403(b) Basic Characteristics Allows employees to defer salary pre-tax, post-tax, or both Discretionary matching contributions or profit sharing contributions from employers Vesting schedules available for use on employer contributions Can have loan and hardship withdrawals Can have 15-year catch-up contributions Can only be sponsored by 501(c)(3) EOs, public schools systems, and churches No ADP test but Universal Availability requirement for salary deferrals 27

28 401k Plans-ADP/ACP Tests ADP Test- Compares the average ratio of NHC EEs deferrals to their compensation to that of HCEs annually If HCEs for prior year exceeds NHCEs by too much (1.25 or 2 and 2 ) must cure to remain qualified by making additional contributions for NHCEs Re-characterizing as after-tax EE contributions distributing HCE excess ACP Test- Compares matching contributions on the same basis 28

29 457(b) Eligible Plans For tax exempt organizations or state or local governments; Allows employees to defer lesser of specific amount (2017-$18,000) or 1/3 of compensation Can be ER contributions Allows make-up contributions in last 3 years of retirement Must be a top hat plan 29

30 Ineligible Plans Section 457(f) 457(f)- if aren t eligible plan under 457 then taxed when no longer subject to a substantial risk of forfeiture Conditioned upon future services Thus, generally taxed when vested i.e. Retirement 30

31 457(f) Plan No limit on amount deferred No limit on compensation No minimum vesting Title must remain in EO Can use rabbi trust 31

32 How to Choose? 401k b 32

33 Methodology Know the plans available Are you eligible for 403(b) plan? What are the specific goals based on work force? Who is to benefit? Executive only or others? Additional for executive? EE money, ER money, or both? 33

34 Case Studies-What s in a name? The American Dodge Ball Association of America One Executive Director earns $200,000 annually 2 part-time employees (under 1,000 hours each) Various volunteers What kind of plan can they adopt? 34

35 Case Studies Same facts: The ADBAA One Executive Director earns $200,000 annually 2 part-time employees (under 1,000 hours each) Exempt under Code Section 501(c)(3) Want to provide a retirement benefit for ED only. What plan? 35

36 Case Studies The ADBAA grows One Executive Director earns $200,000 annually Wants to defer 15% or $30,000 4 full-time employees Salaries: $25,000, $30,000, $45,000, and $50,000 2 part-time employees (under 1,000 hours each) Exempt under Code Section 501(c)(3) Want to provide a retirement for all employees but elective deferral plan. What plan? 36

37 Case Studies The ADBAA keeps growing Creates 6 regional chapters each headed by director with $100,000 salary One Executive Director earns $300,000 annually Wants a benefit of 20% of compensation Lots of full-time employees Want to keep ED happy and provide a retirement for all employees but have them share cost. What plan? 37

38 Best Practices Plan documents Keep executed copies in safe place Signed and dated Adoption Agreements and copies of BPD for preapproved plans Signed and dated amendments Resolutions authorizing execution Committee Resolution authorizing committee Charter/bylaws governing operations Minutes recording actions Fiduciaries Know who they are and their duties Insurance/indemnification 38

39 New Developments DOL Conflict of Interest Fiduciary Rule California Secure Choice Program 39

40 DOL-Two Main Problems Broker-Dealers were only subject to suitability standard and not ERISA fiduciary Could provide advice for suitable investment that pays a higher commission Conflict of interest When an advisor to a plan advises a participant to rollover a distribution to an IRA with his firm, he will likely earn higher fees Conflict of interest DOL wants to F (fiduciary-ize?) these advisors 40

41 Old Definition of Investment Fiduciary (1) renders advice to a plan as to the value of securities or other property, or makes recommendations as to the advisability of investing in, purchasing, or selling securities or other property; (2) on a regular basis; (3) pursuant to a mutual understanding; (4) that such advice will be a primary basis for investment decisions; and (5) that the advice will be individualized to the plan. 41

42 New Investment Fiduciary Definition A fiduciary is one who: Provides Investment Advice for a fee to: Plans subject to ERISA fiduciary duty rules Fiduciaries, participants or beneficiaries Non-ERISA plans defined in Code sec. 4975(e)(1) IRAs, HSAs, Represents or acknowledges fiduciary status, or Advice is provided with understanding that it is particular to investment needs, or particular investment or management decision 42

43 What Does it Mean to be F d? Are subject to: Fiduciary duties Co-Fiduciary liability Certain transactions are prohibited 43

44 Summary-Investment Fiduciary F d if: Make an investment recommendation For fee or other compensation Which means: Best interest standard applies Variable compensation causes conflict of interest Prohibited Transaction Unless exempted 44

45 Two Important Exceptions Best Interest Contract (BIC) PTE Streamlined BIC for level fee advice (BIC lite) PTE Sale of Insurance Products Annuities Purpose is to allow variable compensation if the exception is met 45

46 BIC Class Exemption To receive variable compensation for advice to a retirement investor, must: Acknowledge fiduciary status; Act in the best interest and not accept more than reasonable compensation. Warrant that it has adopted written policies to mitigate the impact of conflicts of interest. Make disclosures prior to execution and annually Maintain a web page that describes compensation Notify DOL it s relying on the exemption maintain records of compliance DOL may request the records. 46

47 Transition Period DOL announced from 6/9/17-12/31/17 Proposed extension to 7/1/19 Only need to comply with Impartial Conflicts Standards 5/22 DOL temporary enforcement policy until 1/1/18 Will not take enforcement action if: Fids working diligently In good faith 47

48 3 Components of Transition BIC Impartial Conducts Standards: Best interest standard of care Duty of prudence Duty of loyalty Reasonable compensation No materially misleading statements 48

49 What Should ERs Do Now? New Rules effective 6/9/17 Analyze all current advisors and contracts Are they/will they be a fiduciary? Do they have a conflict? Are you comfortable with a PTE? Do contracts need to be amended? Develop a strategy for rollovers Keeping money in plan after termination Rolling money into plan 49

50 California Secure Choice Law Mandated State Run Payroll Deduction IRA program for employees of employers who don t otherwise offer a retirement plan Employers of certain size not offering their own plan must automatically enroll employees and deduct 3% of pay Employees can opt out Phase in on size of employer First year, more than 100 employees Second year, more than 50 employees Third year, more than 5 employees Penalty: $250/employee w/in 90 days of notice Additional $500/employee if not in compliance after 180 days 50

51 Secure Choice Law-History 9/29/16 Governor signs SB1234 effective 1/1/17 creating the California Secure Choice Program contingent on: Board reporting to Gov/leg that DOL has issued safe harbor that such state run programs are exempt from ERISA and Secure Choice meets safe harbor 8/25/16-DOL issues safe harbor 5/18/17-Trump signs resolution eliminating safe harbor Secure Choice gets legal opinion that program is not subject to ERISA 6/27/17-Gov signs AB 119 that permits Board to self certify that program is not subject to ERISA Implementation expected in

52 What s the Issue? DOL previously ruled in 1975 that a payroll deduction IRA program is not an ERISA plan if: No employer contributions Participation by the employee is completely voluntary Employer s participation is limited to permitting IRA-sponsor to publicize the program and handle payroll deduction contributions The employer receives no consideration from the program Issue is whether the auto enrollment with opt out is completely voluntary When issuing the safe harbor, DOL stated that the 1975 ruling does not allow automatic enrollment without the plan being subject to ERISA Voluntary means employee initiated 52

53 California Secure Choice Basics Initial mandatory contribution is 3% Employee can opt out Board can change it annually between 2% and 5% Board can adopt automatic escalation of 1% each year up to 8% Employee can opt out of auto escalation Employers can always opt out by adopting a qualified plan, SEP, SIMPLE, or own payroll deduction IRA For first 3 years only investment will be U.S. Treasuries State is not liable for any losses 53

54 Why? California Secure Choice Approximately 7 million workers in CA without a retirement plan 285,000 employers 90% with less than 50 employees 54

55 Pros It will provide a retirement plan option for millions Minimal burden on ERs 55

56 Cons The government is running it Administrative burden on ERs May be subject to ERISA Can t rollover if change jobs to ER with a plan There are better plan designs for employers and employees Higher contribution limits More flexibility 56

57 Conclusion If your organization doesn t have a plan, Secured Choice is good incentive to consider one You should make sure you have the right plan design for your organization Employers need to know how the fiduciary rule affects their plan Following and documenting best practices is imperative to avoid issues 57

58 Questions? Scott E. Galbreath, J.D., LL.M. (Tax) Of Counsel Murphy Austin Adams Schoenfeld LLP Employee Benefits & Executive Compensation Team Leader , Ext