S. Derrin Watson, JD, APM, SunGard s Relius Education

Transcription

1 Prohibited Transactions S. Derrin Watson, JD, APM, SunGard s Relius Education Prohibited transaction rules» Designed to prevent plan fiduciaries from causing plan to engage in transactions which involve a possible conflict of interest Plan could get hurt by such transactions Not required that plan suffer actual harm for transaction to be prohibited» Code 4975 and ERISA contain PT rules Similar but not identical rules Code addresses transactions with disqualified persons and ERISA with parties in interest We ll focus on tax rules 1

2 Who and what» PT rules require identification of the plan s disqualified persons (WHO)» Also must identify the transactions which are prohibited (WHAT) Direct and indirect transactions are covered Cannot escape using a straw-person/entity» If transaction is prohibited, possible escape if exemption» If not, and transaction goes ahead, the disqualified person must pay excise tax under 4975 and a plan fiduciary must unwind the transaction Failure to unwind results in additional excise tax and possible fiduciary sanctions Generally IRS will not disqualify the plan; is a tax/fiduciary issue WHO ( are disqualified persons)» Plan fiduciaries» Plan service providers» Employer sponsoring the plan» Employee representative (e.g., union) of EEs covered by plan» 50% or more owner of employer or EE representative; attribution rules apply» Family member (spouse, ancestor, lineal descendant and spouse of lineal descendant) of fiduciaries, service providers, employer, or 50% owner» Corporation, partnership, trust or estate which is 50% or more owned by fiduciary, service provider, employer, employee organization or 50% owner ; attribution rules apply» Officers, directors, 10% or more owners or HCEs (meaning earning 10% or more of annual wages paid by ER) of employer, employee organization, 50 owner or 50% owned entity» 10% or more partners of employer, employee organization, 50 owner or 50% owned entity 2

3 Who is a fiduciary?» The term fiduciary" means any person who A. exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets, B. renders investment advice for a fee or other compensation, direct or indirect, with respect to any moneys or other property of such plan, or has any authority or responsibility to do so, or C. has any discretionary authority or discretionary responsibility in the administration of such plan. Ownership Attribution» I am deemed to own my pro rata share of stock held by corporation, partnership, estate, or trust. No threshold.» I am deemed to own stock held by: My wife My descendants My ancestors Spouse of descendants My partner! These are the broadest attribution rules 6 3

4 WHAT (is prohibited)» Sales, exchanges leases of property» Loans or other extensions of credit» Furnishing goods, services, facilities» Transfer to, use by a disqualified person of plan assets or income» Fiduciary self-dealing or kickbacks Act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interest or for his own account; or Receipt of any consideration for his own personal account by any disqualified person who is a fiduciary from any party dealing with the plan in connection with a transaction involving the income or assets of the plan. Contributions of property» X contributes property to its plan worth $50,000» If the plan is a money purchase pension plan, is the transaction a prohibited transaction? [ ] Yes Contribution of property to a plan in satisfaction of the ER s funding obligation is treated as a sale of the property and is a prohibited transaction [ ] No Contribution is not prohibited, provided that the property is fairly valued at $50,000 and the trustee accepts the property contribution as being in the best interest of the participants 4

5 Profit sharing plan/discretionary contribution» If the plan is a profit sharing plan with a discretionary contribution formula, is the transaction a prohibited transaction? [ ] Yes ER may not contribute property (other than its own stock) to the plan without committing a prohibited transaction [ ] No Contribution that is purely voluntary and that does not relieve the ER of any plan funding obligation is not a prohibited transaction Sales or exchanges include» It is a sale or exchange (and therefore prohibited) if the employer contributions property to the plan and either It satisfies funding obligation to pension plan, or The property is encumbered 5

6 Nature of prohibition» Intent of parties and economic outcome of the transaction to either the plan or the other parties not relevant It doesn t matter that the plan wasn t hurt It doesn t matter that the plan got a good deal» Example: Company owner serves as trustee and takes a $1000 fee from the plan for doing so Fee is reasonable It doesn t matter: It is self-dealing Additional ERISA PT items» ERISA says that a fiduciary shall not in his individual or in any other capacity act in any transaction involving the plan on behalf of a party (or represent a party) whose interests are adverse to the interests of the plan or the interests of its participants or beneficiaries» ERISA lists as parties-in-interest employees of: Plan service provider Plan sponsor Employee organization Majority owner Related company 6

7 Prohibited transaction examples» Each of these examples involves the X Co. 401(k) plan. A owns 60% of X. X doesn t deposit elective deferrals in a timely manner X plan loans $100,000 to shareholder of Y; Y s plan loans $100,000 to shareholder of X A leases apartment in building that plan owns X transfers mortgaged real estate to plan as profit sharing contribution Plan pays trustee s wife (and X employee) for services Plan loans money to A s son-in-law (not participant) PT correction» Undo the transaction to the extent possible Not put plan in worse position than if transaction did not occur, applying highest fiduciary standards» Correction depends on transaction type Rescind a sale, terminate a lease, pay-back a loan» Sometimes correction may result in another separate PT In some cases, DOL says these corrections are exempt 7

8 3 types of PT exemptions» Statutory Code 4975 (and ERISA) grant relief Address common transactions otherwise prohibited : participant loans, furnishing goods and services, transactions involving employer securities, etc.» Class Grant relief to a variety of transactions without having to apply for individual exemption; just meet the conditions Many class exemptions relate to common financial industry transactions» Individual Apply to DOL in advance to seek relief Must have conditions in place to protect plan» Fiduciary relief may also apply but not for certain violations (self-dealing, etc.) Excise tax calculation» Initial tax is 15% of amount involved Applies to each year or partial year the transaction is in place; taxable year of the disqualified person Amount involved depends on transaction type Sale: is greater of sale price or Fair Market Value (FMV) Loan/lease: is greater of FMV interest or rent OR interest/rent paid Late deferral deposit: fair market interest for use of the $; use 6621(a) underpayment rate Continuing transactions (loans, leases) create new PT each year resulting in pyramiding of excise tax» 100% tax on amount involved if PT uncorrected Can abate 100% tax if correct within 90 days after IRS gives notice as to 100% tax; not reduce 15% tax 8

9 Excise tax and other reporting» Report and pay excise tax using IRS Form 5330 Due last day of 7 th month following the disqualified person s taxable year for which the tax is being paid Form 5558 extends time to file 5330 but not time to pay the excise tax» Also report PT on Form 5500 Schedules H, I Schedule G, Part III for large plans Excise tax» What are the consequences under Code 4975, if a disqualified person engages in a prohibited transaction? [ ] Disqualification The IRS will disqualify the plan [ ] Excise tax Any disqualified person who participates in the transaction is liable for a 15% excise tax on the amount involved for each year (or part thereof) in the taxable period [ ] Loss of deduction The ER will lose its tax deduction for the taxable year in which the transaction occurs 9

10 Deficiency notice» If a disqualified person does not correct a prohibited transaction after the IRS has mailed a deficiency notice, what is the amount of the prohibited transaction excise tax? [ ] 100% tax If the disqualified person does not correct the transaction within the correction period, an additional tax equal to 100% of the amount involved applies [ ] 15% tax The disqualified person continues to be liable for the 15% excise tax [ ] Statute of limitations The disqualified person ceases to be liable for the 15% tax when the statute of limitations runs Penalty tax return» How does a disqualified person report the excise tax? What if the disqualified person fails to report? [ ] 1040 On the disqualified person s Form Failure to report subjects the filer to penalties for late filing of a complete return [ ] 5500 On Form 5500-DP. Failure to report is a misdemeanor [ ] 5330 On Form Failure to report results in a failure to file penalty under Code 6651(a)(1) 10

11 Fiduciary self-dealing» Mike is a 10% owner in X, a CPA limited liability company (LLC)» Mike and three of his fellow LLC owners are trustees of X s 401(k) plan» Mike also has a securities license» Mike sells investments to the plan and receives commissions in the amount of $20,000» Has Mike engaged in a prohibited transaction? [ ] Yes Mike has engaged in self-dealing by using his fiduciary position to increase his own compensation [ ] No Mike is providing a necessary service to the plan and may do so provided other fiduciaries know about it Correction» How does Mike correct the prohibited transaction? [ ] Excise tax and correction Return commissions to the plan, file Form 5330 and pay the excise tax [ ] Value services Return the commissions and declare and pay the excise tax only if the commissions exceeded the fair value of Mike s services [ ] Approval Obtain the approval of other plan fiduciaries or of the DOL, then continue the arrangement 11

12 Outside trustee» First Bank is a discretionary trustee for and acts as a contract administrator for X corporation s profit sharing plan» May First Bank receive trustee fees and administration fees? [ ] Yes Provided that X (or some other plan fiduciary) and not First Bank makes the decision to hire First Bank to perform the various services for the X plan [ ] No The Bank is wearing too many hats and only may perform one type of compensated service Power to increase compensation» First Bank decides to invest in mortgages» May First Bank acquire the mortgages from its real estate department, generating commissions for the Bank? [ ] Yes Provided that the Bank decided to use its own department after first surveying the competitors to get the best deal for the plan [ ] No The Bank would commit a prohibited transaction by using its fiduciary power to increase its own compensation 12

13 Participant as fiduciary» Corporation X maintains a profit sharing plan that provides for participant direction of investment» Ann, who is not a plan trustee, owner or officer, directs the plan to loan $100,000 of her account to her brother s business» Is Ann fiduciary with respect to the plan? [ ] Yes Although she is not a fiduciary under ERISA merely because she directs her own account investment, Ann is a fiduciary under Code 4975 [ ] No Ann does not become a fiduciary with respect to her own account by directing her own investments Prohibited transaction» Has Ann engaged in a prohibited transaction? [ ] Yes She engages in self-dealing under Code 4975(c)(1)(E), if she causes the plan to loan money to a business in which a relative has an interest, even if the borrowing entity is not a disqualified person [ ] No Although Ann is a fiduciary as to her own account, since the borrowing entity (entity 50% owned by the brother of a fiduciary) is not a disqualified person, the loan is not prohibited 13

14 Participant loan exemption» Separate from the taxation consequences, a participant loan must satisfy the prohibited transaction statutory exemption requirements in order not to constitute a prohibited transaction Loan exemption requirements Participant loans: Must be available on a reasonably equivalent basis to all participants and beneficiaries Can limit to parties in interest May not be made available to HCEs in an amount greater than for the NHCEs Can base on vested account balance Must be made in accordance with specific plan provisions Can be in separate loan policy Must charge a reasonable interest rate Must be adequately secured 14

15 Reasonable interest rate» X establishes a plan loan program for its EEs» X would like to allow EEs to borrow at an interest rate of 3%» Market interest for similar loans is 5%» May the plan loan money to EEs at 3% interest? [ ] Yes The EE borrower may suffer an investment loss with regard to the loan investment since it is the borrower s decision to borrow [ ] No The loan may not be granted at a rate below market. The bargain rate loan is a prohibited transaction Calculation of excise tax/correction» On 10/01/13, plan X loaned corporation X $50,000» At the time of the loan, fair market value loan interest rate was 8%» Plan made the loan to X at an interest rate of only 5%» On 3/31/15, X repaid the loan, plus interest of $3,750» On 1/01/15, fair market value of the loan interest rose from 8% to 9%» Compute the excise tax by completing Form 5330 for 2013, 2014 and 2015 with respect to the prohibited loan transaction 15

16 Transaction Number 2013 (Form 5330 Sch. C Tax on Prohibited Transactions) Date of transaction Description Amount Involved Initial tax on PT (i) Loan $1,000 $150 (ii) (iii) Tax due Add amounts in column (d) $150 Transaction Number 2014 (Form 5330 Sch. C Tax on Prohibited Transactions) Date of transaction Description Amount Involved Initial tax on PT (i) Loan $1,000 $150 (ii) Loan $4,000 $600 (iii) Tax due Add amounts in column (d) $750 16

17 Transaction Number 2015 (Form 5330 Sch. C Tax on Prohibited Transactions) Date of transaction Description Amount Involved Initial tax on PT (i) Loan $1,000 $ (ii) Loan $4,000 $ (iii) Loan $1,125 $ Tax due Add amounts in column (d) $ Correction of prohibited transaction» In addition to excise tax calculated under (a), X, to correct the prohibited transaction, must pay to plan: [ ] Zero dollars [ ] $2,375 8% - 5% x $50,000 for 15 months plus 9% - 5% x $50,000 for 3 months [ ] $3,000 9% - 5% x $50,000 for 18 months [ ] VFC amount Correction amount described under the Department of Labor s Voluntary Fiduciary Correction Program 17

18 Effect of market interest» Would the amount of the excise tax or the amount of the prohibited transaction correction change if the interest rate on the loan was the fair market value interest rate? [ ] Yes as to the correction amount If ER paid to the plan fair market interest throughout the loan term, there would be no correction amount; however, the excise tax remains unchanged [ ] No ER must pay the same excise tax and same correction amount to unwind the prohibited transaction Handling 401(k) plan assets» Timely deposit of deferrals is still an important DOL issue» The plan asset regulations prescribe the latest date for depositing amounts withheld from an EE s wages» If the ER does not satisfy the timing rules, a correction is necessary 18

19 General plan asset rule» ER must deposit in the trust deferrals or loan repayments withheld from wages on the earlier of: ASAP: The earliest date the ER reasonably could segregate the funds from its own assets; or The 15th business day of the month following pay day» Almost always, the relevant day is ASAP» Rule deals with deposit and not the investment of deferrals DOL 2010 final regulation» 7-day safe harbor Depositing the amounts in the trust by the end of the 7th business day following payday satisfies the earliest date requirement Applies to plans with less than 100 participants on first day of plan year Pension or welfare 19

20 Consequences of violation» What are the possible consequences to X? [ ] Fiduciary breach The ER breaches its fiduciary to the EEs if it does not transmit the deferrals on a timely basis [ ] Prohibited transaction The ER, a party-in-interest and a disqualified person engages in a prohibited transaction (considered a loan) if it holds the deferrals after they become plan assets [ ] Both of the above Correction How should X correct the violation?» To correct the prohibited transaction: File form 5330 and pay 15% excise tax Correct the transaction» To correct the fiduciary breach, restore the elective deferrals plus the greatest of: Restoration of profits amount Code 6621(a)(2) [deficiency] interest rate** Actual lost earnings» ** Use online calculator under VFC 20

21 Loan payments» What is the deadline for X to remit to the trust participant loan payments that are withheld from wages under a payroll reduction agreement? [ ] ER convenience The ER must transmit the payments as soon as administratively convenient [ ] Plan asset rule Loan repayments withheld from wages are subject to same plan asset rule that applies to deferrals Correcting late deferrals» Repay deferrals (and loan repayments)» Calculate and pay lost earnings If lost earnings not paid at time deferrals repaid, must pay lost earnings on lost earnings» Pay prohibited transaction excise tax» Report late deferrals on Form

22 Late Deposits» Online calculator tailor made for late deposits» No need to go back and compute earnings participant by participant» Theory: Calculator available only for VFCP» Practice: Calculator good enough for some DOL investigators Small % of late deferrals use VFCP Difference between calculator and computation under old rules very small Is there a de minimis exception to avoid preparing Form 5330?» No» If you file under VFCP for a late deposit, you can prevent a PT, and avoid giving notice to the participants if: You complete Form 5330 Send it to the DOL with the VFCP application The amount of the tax does not exceed $100 The employer deposits the tax into the plan 22