Presentation on theme: "ERISA COMPLIANCE AND ERRORS Top Ten Mistakes"— Presentation transcript:
1 ERISA COMPLIANCE AND ERRORS Top Ten Mistakes Marcia S. Wagner, Esq. - President/FounderThe Wagner Law GroupBoston, MAMarilee P. Lau, CPARetired Partner KPMG LLPSan Francisco, CA
2 Speaker Biography – Marcia S. Wagner Marcia is a specialist in pension and employee benefits law, and she is the principal of The Wagner Law Group, one of the nation’s largest boutique law firms, specializing in ERISA, employee benefits and executive compensation, which she founded over 18 years ago. A summa cum laude and Phi Beta Kappa graduate of Cornell University and a graduate of Harvard Law School, she has practiced law for over twenty-seven years. Ms. Wagner was appointed to the IRS Tax Exempt & Government Entities Advisory Committee and ended her three-year term as the Chair of its Employee Plans subcommittee, and received the IRS’ Commissioner’s Award. Ms. Wagner has also been inducted as a Fellow of the American College of Employee Benefits Counsel. For the past five years, 401k Wire has listed Ms. Wagner as one of its 100 Most Influential Persons in the 401(k) industry, and she has received the Top Women of Law Award in Massachusetts and is listed among the Top 25 Attorneys in New England by Boston Business Journal.
3 Speaker Biography - Marilee P. Lau Marilee Lau provides consulting services and teaches various educational programs on accounting and auditing for employee benefit plans. Before retiring in 2009, Marilee was the National Partner in Charge of KPMG’s Employee Benefit Plan Audit Practice.She is a founding member and a former Chair of the AICPA Employee Benefit Plan Audit Quality Center’s Executive Committee which was established in Marilee is currently the AICPA’s representative to the DOL’s ERISA Advisory Council. She has served on the AICPA’s Employee Benefits Plans Experts Panel and was the chair of the EBP Audit Guide Overhaul Task Force.Marilee is also on the Advisory Board for the Bureau of National Affairs Pension & Benefits Reporter which provides input on various pension issues and has served on the Accountants Committee for the International Foundation of Employee Benefit Plans.She is a member of the AICPA, California Society of CPA’s, and the International Foundation of Employee Benefit Plans and a frequent speaker for numerous professional conferences and programs. She is a graduate of Santa Clara University with a BS in economics and an MBA in accounting.
4 IntroductionAuditors need to know what to focus on when they audit a plan. They need to know the top ten errors, how they occur (usually people do not know the terms of the plan’s administration) and how they should be rectified. For each of the “top 10” problems, we discuss: (i) the issue, (ii) how it arises (iii) audit implications and (iv) how it can be fixed.
5 Top Ten Problems 1. Automatic Enrollment & Automatic Escalation (b) Plan Universal Availability3. Problem Shared and Leased Employees4. Compensation Done Incorrectly5. Controlled Group Issues6. Bad Plan Documentation7. Prohibited TransactionsA. Plan ServicesB. Bad 408(b)(2) Disclosure8. Illiquid Plan Assets9. Late Elective Deferrals10. Bad Administration
7 Automatic Enrollment & Automatic Escalation Applies to any plan allowing elective salary deferralsEmployees enrolled in plan unless elect otherwisePlan document specifies percentageEmployees can opt out or elect different percentDefault percentage must be uniformly appliedQualified Automatic Contribution Arrangement (QACA)Exemption from nondiscrimination testing conditioned on :Default deferral percentage:Starts at 3% and increases to 6%; maximum 10%Matching Contribution (100% match up to 1% of compensation plus 50% between 1% and 6% of compensation) or 3% Nonelective Contribution100% vesting in matching or nonelective contribution after 2 YOSNo hardship distributions for required employer contributions
8 Automatic Enrollment & Automatic Escalation Eligible Automatic Contribution Arrangement (EACA)• Withdrawals allowed within 90 days of first auto contributionNotice Requirements for QACA and EACA• Written explanation of rights not to have auto contributions or to electdeferral percentage other than default percentageTiming: reasonable period before beginning of each plan yearMust give reasonable period of time after receipt to make alternative election and, in the case of a QACA, to make investment electionsExcess DeferralsParticipant must notify plan by April 15 of following yearCorrective distributions of excess deferrals to be reported on Form 1099Potential double tax if excess not withdrawn by April 15
9 Audit Implications Understand the nature of the enrollment process Test that employees have been properly enrolled when plan provides for auto-enrollmentOpt out electionSpecified deferral percentageProper refund if participant withdrawsUnderstanding regulatory requirements, correction process and accounting implications for the operational failureDetermine if amount is materialBook an employer contribution receivableAmend tax status footnote
10 Automatic Enrollment & Automatic Escalation Failure 1Plan sponsor fails to implement plan’s auto enrollment provisions by not deferring salary of an employee who did not make an electionCorrected by providing nonelective employer contribution. Missed deferral is the plan’s auto enrollment deferral percentage multiplied by employee’s compensation. Required corrective contribution under IRS VCP is 50% of this missed deferralFailure 2• Employee never receives enrollment materials and is, thereforetreated as an excluded participant rather than a participant whosedeemed election has not been implemented• Corrected by making nonelective employer contribution equal to 50%of missed deferral which is the ADP for the employee’s group (NHCEor HCE) multiplied by employee’s annual compensation
12 403(b) Plan Universal Availability Problem Elective salary deferrals must be available to any employeeExceptionsEmployee who will contribute $200 or less annuallyEmployee eligible to make elective deferrals to 457(b) or 401(k) plan or another 403(b) planNonresident aliensStudents performing certain services and certain employees not meeting minimum age and service requirementsEmployees normally working fewer than 20 hours per weekException conditioned on working less than 1,000 hours in a 12-month period and subsequent 12-month periodsNo part-time exceptionUniversal availability applies separately to each 501(c)(3) entity even if multiple entities participate in same plan
13 403(b) Plan Universal Availability Problem Universal availability standard met only if at least once each plan year plan lets employee make or change a cash or deferred electionUniversal availability requires meaningful notice of right to deferRule only applies to elective deferrals, not employer match or discretionary or mandatory employer contributionsSome plans are drafted so that the eligibility standard for these nonelective contributions is the same as universal availability. In these cases, operational failure occurs if universal availability not applied to nonelective contributions.
14 Audit Implications Understand who is eligible and who isn’t Test for proper inclusion/exclusionUnderstanding correction process and accounting implications for the operational failureDetermine if amount is materialBook an employer contribution receivableAmend tax status footnote
15 403(b) Plan Universal Availability Problem Failure 1:Excluding employees based on a job classification which is not one of the classes excepted from universal availability rule, such as part-time workersCorrected by making employer contribution under IRS VCP program of missed deferral Rev Proc provides special rule for calculating 403(b) corrective contribution which will generally be 1.5% of employee’s compensation adjusted for lost earnings and any match. Mistake may be eligible for self correction if error was insignificant and sufficient compliance procedures were in placeFailure 2Failure to properly notify a group of employees of their right to make deferralsCorrected by making employer contribution under same methodology as Failure 1.
17 Shared and Leased Employees Employee status controls application of plan rulesControl (over when, where and how to perform services) is key to determining whether worker is common law employee (1992 Supreme Court Darden case, Rev Rul 87-41Shared employee definition: a person working for ( and under control of) more than one business at a timeExample: staff nurse working for several medical practicesEach practice is the employer simultaneously and credits all hours of service for purposes of plan eligibilityPro rata share of shared employee’s compensation from each employer is allocated to the separate plans maintained by each employerFailure:Violation of qualified plan rules to exclude nurse from participation in any retirement plans maintained by medical practices if nurse has 1,000 hours of service overallCorrection: require each plan to include nurse as participant
18 Shared and Leased Employees Leased employee definition: a person on the payroll of one company but working for another companyExample: employee on payroll of PEO who actually performs services for PEO’s client. If client controls the leased employee’s work, however, employee will be treated as employed by client, not as a shared employee (Rev. Proc )For purposes of plan coverage, vesting, nondiscrimination and top heavy rules, a “leased employee” is treated as an employee of client organization, not PEO (Code §414(n)Definition of leased employeeFull time – 1 yearContract between client organization and PEO for employee services“Primary” control by client organization
19 Shared and Leased Employees Safe Harbor exception to treatment of leased employee as employee of client if employee is covered by PEO plan, subject toLeased employees no more than 20% of client’s NHCE workforceMoney purchase planMinimum contribution(nonintegrated) - 10% of compensationFull vestingImmediate participation by the leased employeesFailure• IRS takes position that if leased employee is effectively a common lawemployee of client, covering this employee under PEO plan violates exclusivebenefit ruleCorrection: Exclude employee from PEO plan. Also include leased employees as participants in client plan unless client plan specifically excludes them. If client maintains 401k) plan, inclusion of leased employees may require making nonelective contributions that compensate leased employee for missed deferral. Consider amending plan to exclude leased employees
20 Audit Implications Hum!!!!!!!!!!!!!!! Auditors need to be aware of the possibility that plans have improperly excluded “leased or shared”employees
22 Compensation Done Incorrectly Amount of plan benefits or contributions frequently expressed as percent of compensationCode §401(a)(17) limits annual compensation that can be taken into accountLimit in 2014 will be $260,000Plan definition of compensation must be nondiscriminatory under Code §414(s)Designed based safe harborsInclude regular or base salary or wages and commissions, tips, overtime, premium pay and bonusesExclude reimbursements, expense allowances, fringe benefits, moving expenses and deferred compensationReasonable formula not favoring HCEsExamples: Rate of pay vs. actual payPay only while plan participant vs. pay for entire plan yearPlan that includes bonuses but excludes overtime might be treated as discriminatoryTest is whether average percentage of total compensation included under the definition for HCEs exceeds by more than de minimis amount the average percentage of total compensation included for NHCEs
23 Audit ImplicationsProbably No. 1 issue detected by the auditor—wrong definition of compensationUsually found in contribution test workCould result in a material impact on the financial statementsFinRec Recommendations on booking excess and corrective contributionsDetermination of correction amount can be very time consuming
24 Compensation Done Incorrectly Failure 1: Plan allocation is based on compensation that exceeds the limitCorrection (two alternative methods)Reduce account balance of affected employee by improperly allocated amount (adjusted for earnings); if excess amount would have been allocated to other employees in year of failure, it must be reallocated to those employees after adjusting it for earningsAlternative fix: adopt plan amendment increasing maximum percentage of compensation and contribute additional amount for each other employee who received an allocation in failure yearExample: plan contribution rate equals 5% of compensation5% applied to Employee X’s $300K comp. In 2012 when limit was $250,000 - reduce X’s account by $2,500 excess and reallocateAlternatively, retroactively amend plan to raise rate to 6%
25 Compensation Done Incorrectly Failure 2: improper exclusion of bonuses, overtime, commissions or another element of compensation from base on which employees may make elective deferralsCorrection: employer contribution equal to 50% of missed deferral opportunity which would be the employee’s elected percentage of compensation that would have been deferred from the excluded compensation element. Also contribute any applicable match and lost earningsFailure 3: Improper deferral on items not included in plan definition of compensationCorrection: Distribute excess elective deferrals plus earnings to participant. Forfeit match related to excess deferrals and either reallocate or use to offset future employer contributions
27 Controlled Group Issues Rules apply as if all controlled group employees worked for employer adopting the planApplies to eligibility, vesting, minimum participation, determining contributions and benefits, nondiscrimination, compensation limits, top heavy rules and simplified employee pension and simple retirement accountsMinimum Participation ExampleFailure: Company A maintains a qualified plan with a one year service requirement only for its employees but is a member of a controlled group of corporations that includes Company B. Employee X completes 3 years of service with Company B and then transfers to Company A.Correction: The plan must recognize X’s service with Company B and admit her as a participant immediately.Highly Compensated Employee ExampleFailure: Company C and Company D are controlled group members each of which pay Employee Y a salary of $60,000 for 2013.Correction: For purposes of nondiscrimination testing, Employee Y will be considered highly compensated, since the HCE limit for 2013 is $115,000 and Employee Y’s aggregate compensation is $120,000.
28 Controlled Group Issues Discrimination Testing ExampleFailure: Company E maintains a 401(k) plan for its employees that has never been extended to its wholly-owned subsidiary F Company. When the minimum coverage test is run, including the employees of F Company, the 401(k) plan fails to satisfy Code §410(b) and, as a result ceases to be tax-qualified.Correction: NHCEs of Company F must be included as participants on a retroactive basis and receive a QNEC sufficient to pass ADP/ACP testSIMPLE IRA ExampleFailure: SIMPLE IRAs can be established only by an employer which had no more than 100 employees who made at least $5,000 for the preceding year. Company G maintains a SIMPLE IRA for its 80 employees (all whom made more than $5,000 last year). Company G has a brother/sister affiliate, Company H, which is a member of the same controlled group as Company G and has 40 employees who made over $5,000. Because Companies G and H must be treated as a single employer, Company G is ineligible to maintain the SIMPLE plan.Correction: Stop employer and employee contributions. File VCP application requesting that contributions made for previous years remain in the employees’ SIMPLE IRAs.
29 Audit Implications Understand what other plans a company has Parent-subsidiaryBrother/sister companiesCompliance issuesBook receivable for QNEC contributionInquire or test correction for other issues
31 Bad Plan Documentation IRS definition of “plan document failure”A plan provision (or absence of a plan provision) that violates Code qualification requirementsArises under 2 scenarios:New law passes or regulations issued and plan not timely amended to meet new rulesPlan not timely amended during remedial amendment period for adopting good faith or interim amendmentsInterim amendments are required to keep a plan up to date between remedial amendment cyclesExamples of recent law changes with expired deadline:Conversion of 401(k) accounts to Roth without distributionAllowing nonspouse beneficiary distributions via rolloverAllowing suspension of required distributions for 2009Special benefits for participants w/qualified military serviceFaster vesting of employer contributions under PPA 2006
32 Bad Plan Documentation Correcting Amendment FailuresAdopt amendments for missed tax law changesLook for IRS sample language in model amendments and List of Required ModificationsEffective date of amendment should be retroactive to conform plan terms to legislative requirementFile VCP submission with IRSSubmission is expected to include the executed amendments that will correct the failureIssuance of compliance statement by IRS results in amendments being treated as if they had been adopted timelyAvoiding Future FailuresDo annual review of plan documentDesignate person responsible for identifying time-sensitive amendmentsUse annual cumulative list published by IRS (e.g., see Notice )
33 Audit ImplicationsDetermine whether plan amendments have been made that are required as a result of changes in the laws and regulationsInquire of the plan administrator whether plan operations have been revised to comply with current law changes, even if plan amendments are not yet requiredReview correspondence from plan’s legal counsel, third party administrator, or other ERISA or tax advisorReview corrective action to determine if compliance issues were corrected in accordance with prescribed procedures and properly recorded and disclosed in the financial statements.
34 7. Prohibited Transactions A. Plan Services B. Bad 408(b)(2) Disclosure
35 Prohibited Transaction and Plan Services Furnishing goods, services or facilities to plan is a prohibited transaction unless arrangement qualifies for exemptionViolation results in 15% excise tax and100% tax if not correctedFour requirements for exemptionService must be necessary to establish or operate planNecessary means appropriate or helpfulService contract must be reasonablePlan must be able to terminate contract without penalty on short noticePlan should not be locked into an arrangement that becomes unfavorableLong-term lease is acceptable only if it can be terminated before expirationMinimal early termination fee to allow recoupment of start-up costs is acceptablePlan should pay no more than reasonable compensationManagement Evaluates reasonableness of fees by market rate for comparable servicesDisclosure by service provider
36 Bad 408(b)(2) DisclosureRegulation effective in 2012 requires plan service provider to make written disclosures to plan:Description of servicesWhether services to be performed as fiduciaryCompensation to be received from plan and from third partiesBad disclosure makes service arrangement a prohibited transaction by plan fiduciary and service providerFailures can be curedPlan must make written request for information and provider must respond within 90 daysService provider refusal or inability to comply with request for information requires plan fiduciary to notify DOLPlan fiduciary must decide whether to terminate servicesPresumption is terminationServices to be continued only if prudentGood faith mistakes must be corrected no more than 30 days after provider knows of error or omission
37 Audit ImplicationsAU-C 250 Consideration of Laws and Regulations in an Audit of Financial Statements applies to prohibited transactionsInquire whether plan is in compliance with laws and regulationsUnderstand who are parties in interest and what is deemed a prohibited transactionUnderstand plan fee arrangementsInquire as to compliance with applicable reporting and disclosure requirements for fees.
39 Illiquid Plan AssetsHolding illiquid assets is problematic for an ERISA plan ifPurchased in non-exempt prohibited transaction involving party in interestPurchase was an imprudent decision orIt is imprudent for plan to continue to hold the assetExamples of illiquid assetsRestricted and thinly traded stockLimited partnership interestReal estateCollectiblesPlan fiduciary must determine that asset is illiquid because:Asset failed to appreciate, provide reasonable rate of return or caused lossSale is in plan’s best interestAsset cannot be sold for its original purchase price or FMV (if greater) to a person other than person who is a party in interest to the planMay correct by selling to related party subject to conditions
40 Illiquid Plan AssetsConditions of correction by selling to party in interestPurchase price on sale to party in interest must be greater ofFMV of asset at time of resale (unreduced by sale costs)Original purchase price plus lost earnings under DOL calculatorQualified independent appraiser must report on Asset’s FMVApplication to DOLDocumentation of original purchase price to be included in submissionDOL no action letterAllows correction or asset’s original acquisitionPermits sale of asset in transaction that otherwise might be prohibitedExamplePlan buys real property from party in interest in 1999 for $60,000. Plan official makes illiquid asset determination in In 2004, appraiser values property at $20,000. Plan sponsor pays plan $60,000 plus lost earnings and plan transfers real estate to plan sponsor.
41 Audit ImplicationsReview any plan assets purchased from a related partyIf determined that asset is illiquidPerform appropriate audit proceduresRecord and disclose “fix” in financial statements
43 Late Elective Deferrals When participant funds become plan assetsAmounts that a participant pays to an employer or amounts that a participant has withheld from wages must be paid to the plan trust on earliest date they can be segregated from employer’s general assetsSafe harbor for plans with fewer than 100 participants: deadline for remittance to trust is 7th business day following day on which the amount is received by the employer or would have been payable to the participant in cashIRS FailureEmployer fails to remit participant elective deferrals by the earliest date employer can reasonably segregate deferral deposits from general assets. This will not be an operational failure for VCP purposes if plan does not have language relating to time contributions are deposited. If plan has timing language, there will be a qualification failure for failing to follow plan terms.Correction: Employer makes contributions with earnings up to date of correction. VCP submission should describe new procedural safeguards adopted to ensure that deposits will be timely made.
44 Late Elective Deferrals DOL FailureRegardless of plan language, failure to make timely remittance will be a prohibited transaction for DOL purposes.Correction: employer required to make delinquent contributions plus greater of:Lost earnings orRestoration of profits resulting from employer’s use of the delinquent funds prior to making contributionDOL Voluntary Fiduciary Correction Program requires extensive documentation:Narrative of remittance practices and certification by plan official of earliest date when remittance possibleCopy of payroll documents showing date / amount of each withholdingRelief from submission of documentary evidence if amount is below $50,000 or delinquency is less than 180 days
45 Audit ImplicationsInquire of plan sponsor what their normal timeframe is from paycheck to remittance dateObtain contribution remittance schedule from plan sponsor detailing dates withheld, date deposited, and date received by trusteeTest schedule and inquire about contributions remitted outside the normal timeframeLate deposits are a legal determinationDisclose on supplemental schedule
47 Bad Administration – Loans Loans - In order for a plan loan to not be considered a taxable distribution, it must meet certain IRC requirementsMaximum amount of loanRepayable within 5 years with exception for certain home loansLevel amortization and not less than quarterly paymentsFailure 1 - Plan sponsor permits loan in excess of Code limitFailure - Loan is more than lesser of (a) 50% of vested account balance (but not less than $10,000) or (b) $50,000 reduced by highest amount owed on other loans by the participant during prior one-year periodCorrection – Participant repays excess amount to plan. Principal balance of loan reamortized over 5 years from date of original loanFailure 2 – Loan repayment period more than 5 yearsFailure – Loan provides 6-year termCorrection – Plan sponsor can avoid treating loan as taxable distribution by filing VCP application. Remaining balance of loan at time of submission would be reamortized so that loan is fully paid by end of 5 years measured from loan date.
48 Bad Administration – Loans & Hardship Withdrawals Loan Failure 3 – Repayment FailureFailure – Employee fails to make loan repayments according to repayment schedule (e.g., employee’s loan information not forwarded to payroll dept. which would have implemented repayment by payroll deductions.Correction - Two alternatives under VCP provide relief from reporting loan as distribution:Participant to repay missed payments plus accrued interest in lump sum and repay loan balance over remaining loan term orLoan may be reamortized over remaining termIf plan provides that a loan does not become deemed distribution until end of calendar quarter following quarter in which payment was missed, the cure period may allow administrator to fix problem without VCP or other negative consequencesFailure 1 Due to Financial Hardship WithdrawalFailure - Elective deferrals not suspended for 6-month period following financial hardship withdrawal, as required by the Code and plan termsCorrection – 6 months of improper deferrals treated as current taxable distribution. File VCP application and distribute deferrals plus earnings.
49 Bad Administration – Hardship Withdrawals & Eligibility Failure 2 Due to Financial Hardship WithdrawalFailure – Employer permits participant to take hardship withdrawal from a 401(k) plan that does not provide for such withdrawalsCorrection – File VCP application requesting authorization to amend plan retroactively to permit hardship distributionsEligibility FailuresIn general, employees must be allowed to participate in a qualified plan if:They have attained age 21 andThey have at least 1 year of serviceFailure - Employer permits employees who have not met its 401(k) plan’s eligibility conditions to become participantsCorrection – Two alternativesIf prematurely included employees are primarily NHCE, employer may file VCP submission requesting that plan be retroactively amended to permit their participation. Impact of amendment must not be discriminatoryDistribute improper employee deferrals and notify them of their taxabilityA pptx
50 Audit ImplicationsTesting of participant loans receivable and hardship withdrawalsWhen transactions are not administered in accordance with the plan document or IRC requirementsBook repayment to participantBook receivable for participant catch up loan repayments