Employee Plans Compliance Resolution System (EPCRS): Case Studies From the Darkside!

Transcription

1 Employee Plans Compliance Resolution System (EPCRS): Case Studies From the Darkside! Alison J. Cohen, Esq., CPC Partner Ferenczy Benefits Law Center LLP 1

2 Agenda Review of EPCRS Basics and Principles Understanding the Self-Correction Program (SCP) Knowing When to Properly Use SCP Review of VCP, Audit CAP, and VCAP VCP General Requirements and Considerations Newest Nightmares 2

3 Oh yes, there will be blood. -Jigsaw 3

4 EPCRS: The Framework Employee Plans Compliance Resolution System Rev. Proc released September 29, 2016 Comprehensive system for resolving plan errors 4

5 Four Types of Qualification Failures Plan-document failures Terms of plan not qualified Failure to timely adopt interim amendment/restatement Demographic failures Failure to satisfy 410(b) or 401(a)(26) Employer-eligibility failures Not eligible to establish type of plan (e.g., government 401(k) or ineligible for 403(b)) Operational failures Not following the terms of the plan (i.e., usually everything else you encounter) Other than prohibited transactions: exclusive benefit violations 5

6 Consequences of Disqualification Taxation (IRS refers to this in EPCRS as maximum payment amount) Employer deductions lost if no inclusion in employee income Trust is taxable (earnings may be taxable) Employees taxed on contributions during disqualified years once vested Exception: if sole failure is 410(b) coverage or 401(a)(26) participation failure, then only HCEs taxable - on entire accounts 6

7 How Do You Correct? EPCRS (Rev. Proc ) contains pre-approved correction methods Following these methods is safe Otherwise, find reasonable, appropriate method Use code, regulations, and EPCRS as guide Correct discrimination failures by giving $ to NHCEs Note: the farther you get from pre-approved methods, the more beneficial it is to ask for IRS approval 7

8 Correction Principles Must correct all taxable years (even if closed) Restore plan and participants to position they would have been in had the failure not occurred Should be reasonable and appropriate Appendix A and B solutions deemed reasonable Consistent with code (don t create another violation) Provide benefits to NHCEs Keep assets in the plan Consideration of other agencies (e.g., DOL on abandoned plans) 8

9 Exceptions to Full Correction Unreasonable or not feasible (tough one to apply) Reasonable estimates are necessary (e.g., earnings) Distribution of small amounts ($75 or less) Recovery of small overpayments ($100 or less) Lost participants Small excess allocations ($100 or less) 9

10 EPCRS Structure Three correction procedures: Self-Correction Program (SCP) Operational errors ONLY Insignificant errors: anytime Significant errors: time limited Voluntary Correction Program (VCP) Forms 8950, 8951, 14568, etc. Cannot be under examination Audit Closing Agreement Program (CAP) 10

11 Self-Correction Program Insignificant failures CORRECTION MAY BE MADE AT ANY TIME Even if the plan is under audit by the IRS 11

12 Self-Correction Program What is insignificant? Balancing of factors: Have other failures occurred? Percentage of plan assets and contributions involved Number of years involved Number of participants affected (as percentage of total in plan and as percentage of those who could have been affected) Was correction made within a reasonable time after discovery? Why did the failure happen? 12

13 Significant error: Self-Correction Program Defined: anything that is not insignificant Rule: must be substantially corrected during the correction period Correction period: General rule: last day of the second plan year following year of occurrence ADP/ACP: last day of third plan year following year for which testing is failed 13

14 Voluntary Correction Program Plan sponsor submits a plan to the IRS for coordinated correction process Fee payable Plan must be eligible for the program No correction applies until after approval granted under VCP (correction letter) 14

15 VCP General Steps General procedure File with the IRS Pay user fee based on assets on most recent Form 5500 (See. Rev. Proc for most recent fee schedule) Negotiate with IRS on correction method Sign compliance statement with agreed-upon correction Complete correction within 150 days after final letter 15

16 Audit Closing Agreement Program (CAP) IRS discovers problem during audit IRS and plan sponsor enter into a contract called a Closing Agreement to correct the problem Sponsor pays a sanction to the IRS 16

17 Audit CAP Sanction Starting place for negotiations: taxes that would be due if the plan were disqualified ( Maximum Payment Amount ) Procedure requires that the sanction: Not be excessive Bear reasonable relationship to the nature, extent, severity of the failure Problem: excessive and reasonable are in the eye of the beholder Rev. Proc expanded criteria for consideration (facts and circumstances also count) 17

18 Voluntary Closing Agreement Program (VCAP) Like a super-secret program Used for tax-related plan matters Issue can t be resolved through VCP Can t be under examination or investigation Can t be used for abusive or willful tax avoidance transactions User fee - TBD 18

19 You know that part in scary movies when somebody does something really stupid and everyone hates them for it? This is it. - Jeepers Creepers 19

20 VCP Filing Decisions and Procedures 20

21 Decision #1: Should We Submit at All? Can we self-correct and, if so, any reason to submit? Cost-benefit analysis for client Differences between submitted correction and unsubmitted correction Cost of filing, including: IRS-user fees Service-provider fees Internal client costs to gather information, etc. Considering discoverability and Circular 230 requirements 21

22 Decision #2: Disclosed or No-Name? Advantage to no-name If you don t like IRS s correction requirements, you can walk away but you lose your user fee!!! Disadvantage to no-name If the plan is audited while VCP is pending, you go straight to audit CAP If the name is disclosed, audit process is suspended until VCP is complete 22

23 Timing of Submission Hurry! You don t want to get audited while things are pending! But, want a complete, well-thought-out submission 23

24 Case Studies for Your Consideration 24

25 We don t need a stretcher in there. We need a mop! - Nightmare on Elm Street 25

26 It 26

27 It In 1997, a doctor closed his private practice and started working for a hospital Starting in 1998, the hospital took over the solo practice records, including the plan Sometime in the 2000s, everyone lost track of the plan In 2014, when the doctor hired a new CPA, the issue of the plan was raised and a new TPA was engaged 27

28 It New TPA starts trying to collect information from the doctor After two years, doctor and TPA are resolved to the facts that: The only documentation they can find are the last determination letter from 1987 and the corresponding plan document No participant-accounting has been done since 1997 Doctor reports that several years ago, he was threatened by a participant s son and paid him $5,000 out of pocket 28

29 It In collecting financial data, it is discovered that $250,000 in a bank account was accidentally escheated to the state several years ago after no activity State of Euphoria sent the good doctor a letter in 2009 telling him they considered his practice closed So, is the plan actually sponsored? After reconstructing the participant accounts, the doctor and his accountant realize that two of the three other participants are over age 70½ And one of those two is dead 29

30 It: The Exciting Conclusion Clearly, this will have to be fixed through VCP Document issue simple non-amender Dissolution of employer in 2009 ask for forgiveness and promise to terminate ASAP Late RMD request forgiveness of excise taxes Escheated funds not the IRS s concern (attributed to doctor) Locating missing participants. or their snotty, greedy children 30

31 Friday the 13 th : No Adult Supervision 31

32 Friday the 13 th : No Adult Supervision Plan originally permitted individual insurance contracts to be taken out by participants for a number of years Initially, the insurance premiums were paid out of plan assets A few years in, the plan merged into a multiple-employer plan (MEP), and the employer assumed that the MEP sponsor was taking control Somehow, the employer began paying the insurance premiums (but, no one can actually remember how or why) Eventually, the employer spun-out the plan from the MEP and started its own plan again 32

33 Friday the 13 th : No Adult Supervision In reviewing the plan documents received (finally), a few other failures were found: Plan number in the single plan that spun-out was incorrectly listed as #001 Plan sponsor NAME was incorrect Plan document didn t permit insurance contracts as plan assets Client can t find any sort of breakdown of insurance premium payments Client can t even find records of profit-sharing allocations 33

34 Friday the 13 th : No Adult Supervision One concern that was raised was whether the insurance benefit was incidental Data was incomplete, so it was impossible to determine with certainty Based on limited data, had to demonstrate basic trend using the spotty data that was received Of course, one of the three affected participants was an owner Additional calculations were required Because the premiums were not paid from plan assets, and the policies were held within the plan, the premiums had to be considered an additional contribution Now, we had an operational failure failure to follow the terms of the plan for the profit-sharing allocation 34

35 Friday the 13 th : No Adult Supervision Solution: needed to be filed through VCP Submission covered: Document drafting errors, including failure to provide for grandfathered insurance Removal of excess allocations IRS very receptive to proposed solutions Be careful about scope-creep Your original quote may not end up with what you get And then you end up eating the excess 35

36 The Sixth Sense: I See Dead People 36

37 The Sixth Sense: I See Dead People TPA established DB Plan in 2013 for a law firm In 2014, the partner/husband is diagnosed with lung cancer and has to have a lung removed In 2015, the partner/wife has a massive stroke ending up mostly disabled and requires round-the-clock care Firm is floundering, losing over $1 million per year Partner/husband dies in mid-2016 Nothing has been funded to the DB plan since the original contribution 37

38 The Sixth Sense: I See Dead People TPA suggests that they hire FBLC to retroactively terminate the DB plan Can you retroactively do that? Plan documents are up to date Majority of the assets belong to the partners AFTAP for valuation date 12/31/14 drops to 48 percent 2014 Form 5500 filed with funding shortfall 2015 Form 5500 filed with funding shortfall IRS initiates a compliance check no Form 5330 filed 38

39 The Sixth Sense: I See Dead People Race to VCP submission before compliance check comes due Narrative to IRS requesting mercy and retroactive termination based on AFTAP plan freeze IRS originally rejected VCP, but was compelled by the client s story and agreed to look for another solution 39

40 Split 40

41 Split Plan covers all of the subsidiaries of a national company starting in 2005 Moves to a big-box vendor in 2009 In 2015, new client-relationship manager assigned to client starts asking about organization Turns out that subsidiaries may also be owned by outside, unrelated individuals in part CRM recommends that client get a controlled-group analysis 41

42 Split After performing analysis, only 14 of the entities are actually controlled other eight are not related Also discovered that no document update has been done since original plan So, how was big-box vendor administering the plan? Testing was always done as a single-employer plan 42

43 Split Testing had to be re-done applying the new non-controlled entity Re-test of 2014 showed mixed results some entities passed and some failed compared to prior results Had to retest 2012 and 2013 to show a trend in testing Resulting testing failures triggered one-to-one QNECs Document also revealed that 2005 was drafted with six months of service, but plan had been operating with one year of service since 2009 changeover 43

44 Split VCP submission filed with IRS in January 2017 Still pending Requested IRS to accept sampling of three years and not make client correct prior years claim of de minimis compared to cost of repair Prior vendor held accountable for failure 44

45 Split Since the filing.. Client has been operating as a multiple-employer plan Client has been asked quarterly to identify any new entities and ownership changes Added five new entities in the past two years 2017 testing then shows up. TPA forwards copy of test for one entity failing miserably that includes ownership information on 3/11/18 Ownership information doesn t match firm records When contacting client, she says oops Revised analysis of ownership changes over results in re-alignment of nearly half of the entities All 2017 testing has to be redone (and 2016!!) 45

46 Get Out 46

47 Get Out Seasonal tour company starts a plan in 2008 TPA retires and in 2017 plan moves to a new TPA New TPA discovers a few things: Plan was never restated for EGTRRA Original document was written using elapsed time All seasonal employees were excluded in operation the original TPA said that they didn t have to be included Form 5500 was prepared counting only the 40 year-round employees and excluding the other 220+ seasonal employees 47

48 Get Out New TPA performs 2016 testing and prepares the Form 5500 showing the eligible employees as 260+ Now, plan is required to be audited and has been required to be audited for years Plan has also been a safe-harbor matching contribution formula Notice was never given to seasonal employees In calculating the potential corrective QNEC and matching contribution, plus earnings, the annual estimate is $150,000 to correct 48

49 Get Out In discussing the options, it is also discovered that the client also excluded overtime from the definition of compensation although not in the document Not only do we have a failure to follow the terms of the plan, but the definition of compensation is discriminatory And for bonus points what happens to a safe-harbor plan when the definition of compensation is discriminatory? 49

50 Get Out So, what do you do when the cost of correction is over $1 million (at least) and will bankrupt your client? How do you get around the audit requirement for 2017? Rules for Form 5500 active employee count wouldn t include seasonal employees if they are terminated at the end of each season with no guarantee of any re-employment they don t count for December 31 Since they are also not employed as of January 1, they don t count there either Your client has to make the call and fully understand the risks 50

51 Gone Girl

52 Gone Girl Husband and wife only have a defined-benefit plan In 2015, wife finds out husband has had multiple affairs and kicks husband out Husband wants to buy new love nest next in posh area of town Because husband and wife are still married, bank requires wife s approval for mortgage Wife tells husband to pound sand So, husband withdraws $440,000 from the DB plan (has $1m in his accrued benefit) 52

53 Gone Girl Oops husband doesn t have any taxes withheld from the $440k distribution In 2017, plan gets selected for IRS audit Husband comes to wife and asks her to backdate a withdrawal form Will this even help? Wife tells husband to pound sand again Husband is now 71 and plan doesn t provide for in-service distributions IRS auditor also discovers 2015 tax extension was never filed But, 2015 contribution made in August

54 Gone Girl So, now we have an impermissible withdrawal and a tax violation Plus, we also have a non-deductible contribution (Side note and we have a raging divorce action still going on) Propose to IRS to allow 2015 contribution to become a 2016 contribution Requires 2015 corporate taxes to be amended, resulting in $135k in owed federal taxes 2016 taxes are still being prepared, but 2016 contribution was made in August 2017 So, 2016 contribution ends up becoming a 2017 contribution instead (and they all rolled over and one fell out.) 54

55 Gone Girl IRS permits $440k withdrawal to be corrected by a retroactive amendment to permit in-service withdrawals at age 62 BUT IRS also insists that transaction is a prohibited transaction Requires $64k to be repaid to the plan as interest Also triggers $26k in excise taxes AND there is the $140k in taxes, $10k in interest, $17k in penalties Cherry on top a $20,000 sanction Moral of the story it s always cheaper to keep her 55

56 One thing about living in Santa Clara I never could stomach, all the damn vampires. - The Lost Boys 56

57 This House Is Clean The Happy Ending We All Want 57

58 Things to Remember Credibility is important Get a reputation with the local IRS and DOL offices for being honest That does not mean that you should necessarily offer all information, regardless of what is asked (although there may be times when getting in front of something has value) It does mean that you are never caught in a lie or a material misstatement

59 Things to Remember Don t make yourself part of the horror story Do not do anything that would: Violate your ethical requirements, both business and personal; Violate the law; or Put you into the story as a bad actor

60 QUESTIONS 60

61 Contact Information Alison J. Cohen Ferenczy Benefits Law Center 2200 Century Parkway Suite 560 Atlanta, Georgia (678) (V) (866) (toll free) (404) (F) Follow us on 61