ERISA COMPLIANCE AND ERRORS
Top Ten Mistakes
Marcia S. Wagner, Esq. - President/Founder
The Wagner Law Group
Boston, MA
Marilee P. Lau, CPA
Retired Partner KPMG LLP
San Francisco, CA
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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 twentyseven 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.
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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 2004. 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.
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Introduction
Auditors 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.
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Top Ten Problems
1.
2.
3.
4.
5.
6.
7.
Automatic Enrollment & Automatic Escalation
403(b) Plan Universal Availability
Problem Shared and Leased Employees
Compensation Done Incorrectly
Controlled Group Issues
Bad Plan Documentation
Prohibited Transactions
A. Plan Services
B. Bad 408(b)(2) Disclosure
8. Illiquid Plan Assets
9. Late Elective Deferrals
10. Bad Administration
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1. Automatic Enrollment &
Automatic Escalation
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Automatic Enrollment & Automatic Escalation
Applies to any plan allowing elective salary deferrals
Employees enrolled in plan unless elect otherwise
• Plan document specifies percentage
• Employees can opt out or elect different percent
• Default percentage must be uniformly applied
Qualified 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
Contribution
- 100% vesting in matching or nonelective contribution after 2 YOS
- No hardship distributions for required employer contributions
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Automatic Enrollment & Automatic Escalation
Eligible Automatic Contribution Arrangement (EACA)
• Withdrawals allowed within 90 days of first auto contribution
Notice Requirements for QACA and EACA
• Written explanation of rights not to have auto contributions or to elect
deferral percentage other than default percentage
• Timing: reasonable period before beginning of each plan year
• Must give reasonable period of time after receipt to make alternative
election and, in the case of a QACA, to make investment elections
Excess Deferrals
• Participant must notify plan by April 15 of following year
• Corrective distributions of excess deferrals to be reported on Form
1099
• Potential double tax if excess not withdrawn by April 15
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Audit Implications
Understand the nature of the enrollment process
Test that employees have been properly enrolled
when plan provides for auto-enrollment
• Opt out election
• Specified deferral percentage
• Proper refund if participant withdraws
Understanding regulatory requirements, correction
process and accounting implications for the
operational failure
• Determine if amount is material
• Book an employer contribution receivable
• Amend tax status footnote
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Automatic Enrollment & Automatic Escalation
Failure 1
• Plan sponsor fails to implement plan’s auto enrollment provisions by not
deferring salary of an employee who did not make an election
• Corrected 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 deferral
Failure 2
•
•
Employee never receives enrollment materials and is, therefore
treated as an excluded participant rather than a participant whose
deemed 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 (NHCE
or HCE) multiplied by employee’s annual compensation
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2. 403(b) Plan Universal
Availability Problem
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403(b) Plan Universal Availability Problem
Elective salary deferrals must be available to any employee
• Exceptions
- Employee who will contribute $200 or less annually
- Employee eligible to make elective deferrals to 457(b) or 401(k)
plan or another 403(b) plan
- Nonresident aliens
- Students performing certain services and certain employees not
meeting minimum age and service requirements
- Employees normally working fewer than 20 hours per week
- Exception conditioned on working less than 1,000 hours in a
12-month period and subsequent 12-month periods
- No part-time exception
• Universal availability applies separately to each 501(c)(3) entity even if
multiple entities participate in same plan
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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 election
• Universal availability requires meaningful notice of right to defer
Rule only applies to elective deferrals, not employer
match or discretionary or mandatory employer
contributions
• Some 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.
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Audit Implications
Understand who is eligible and who isn’t
Test for proper inclusion/exclusion
Understanding correction process and accounting
implications for the operational failure
• Determine if amount is material
• Book an employer contribution receivable
• Amend tax status footnote
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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
workers
• Corrected by making employer contribution under IRS VCP program of
missed deferral Rev Proc 2013-12 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 place
Failure 2
• Failure to properly notify a group of employees of their right to make
deferrals
• Corrected by making employer contribution under same methodology as
Failure 1.
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3. Shared and Leased
Employees
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Shared and Leased Employees
Employee status controls application of plan rules
• Control (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 87-41
Shared employee definition: a person working for ( and under
control of) more than one business at a time
• Example: staff nurse working for several medical practices
- Each practice is the employer simultaneously and credits all hours of
service for purposes of plan eligibility
- Pro rata share of shared employee’s compensation from each
employer is allocated to the separate plans maintained by each
employer
Failure:
• 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 overall
• Correction: require each plan to include nurse as participant
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Shared and Leased Employees
Leased employee definition: a person on the payroll of one
company but working for another company
• Example: 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. 2002-21)
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 employee
- Full time – 1 year
- Contract between client organization and PEO for employee
services
- “Primary” control by client organization
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Shared and Leased Employees
Safe Harbor exception to treatment of leased employee as
employee of client if employee is covered by PEO plan,
subject to
•
•
•
•
•
Leased employees no more than 20% of client’s NHCE workforce
Money purchase plan
Minimum contribution(nonintegrated) - 10% of compensation
Full vesting
Immediate participation by the leased employees
Failure
•
•
IRS takes position that if leased employee is effectively a common law
employee of client, covering this employee under PEO plan violates exclusive
benefit rule
Correction: 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
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Audit Implications
Hum!!!!!!!!!!!!!!!
Auditors need to be aware of the possibility that
plans have improperly excluded “leased or
shared”employees
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4. Compensation Done
Incorrectly
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Compensation Done Incorrectly
Amount of plan benefits or contributions frequently expressed as percent
of compensation
•
Code §401(a)(17) limits annual compensation that can be taken into account
- Limit in 2014 will be $260,000
Plan definition of compensation must be nondiscriminatory under Code
§414(s)
•
•
Designed based safe harbors
- Include regular or base salary or wages and commissions, tips, overtime,
premium pay and bonuses
- Exclude reimbursements, expense allowances, fringe benefits, moving expenses
and deferred compensation
Reasonable formula not favoring HCEs
- Examples: Rate of pay vs. actual pay
Pay only while plan participant vs. pay for entire plan year
- Plan that includes bonuses but excludes overtime might be treated as
discriminatory
- Test 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
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Audit Implications
Probably No. 1 issue detected by the auditor—wrong
definition of compensation
Usually found in contribution test work
Could result in a material impact on the financial
statements
FinRec Recommendations on booking excess and
corrective contributions
Determination of correction amount can be very
time consuming
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Compensation Done Incorrectly
Failure 1: Plan allocation is based on compensation that
exceeds the limit
•
Correction (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 earnings
- Alternative fix: adopt plan amendment increasing maximum percentage of
compensation and contribute additional amount for each other employee
who received an allocation in failure year
- Example: plan contribution rate equals 5% of compensation
- 5% applied to Employee X’s $300K comp. In 2012 when limit was
$250,000 - reduce X’s account by $2,500 excess and reallocate
- Alternatively, retroactively amend plan to raise rate to 6%
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Compensation Done Incorrectly
Failure 2: improper exclusion of bonuses, overtime,
commissions or another element of compensation from base
on which employees may make elective deferrals
• Correction: 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
earnings
Failure 3: Improper deferral on items not included in plan
definition of compensation
• Correction: Distribute excess elective deferrals plus earnings to
participant. Forfeit match related to excess deferrals and either
reallocate or use to offset future employer contributions
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5. Controlled Group Issues
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Controlled Group Issues
Rules apply as if all controlled group employees worked for
employer adopting the plan
•
Applies to eligibility, vesting, minimum participation, determining contributions
and benefits, nondiscrimination, compensation limits, top heavy rules and
simplified employee pension and simple retirement accounts
Minimum Participation Example
•
•
Failure: 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 Example
•
•
Failure: 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.
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Controlled Group Issues
Discrimination Testing Example
•
•
Failure: 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 test
SIMPLE IRA Example
•
•
Failure: 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.
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Audit Implications
Understand what other plans a company has
• Parent-subsidiary
• Brother/sister companies
Compliance issues
• Book receivable for QNEC contribution
• Inquire or test correction for other issues
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6. Bad Plan Documentation
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Bad Plan Documentation
IRS definition of “plan document failure”
• A plan provision (or absence of a plan provision) that violates Code
qualification requirements
• Arises under 2 scenarios:
- New law passes or regulations issued and plan not timely amended
to meet new rules
- Plan not timely amended during remedial amendment period for
adopting good faith or interim amendments
- Interim amendments are required to keep a plan up to date
between remedial amendment cycles
Examples of recent law changes with expired deadline:
-
Conversion of 401(k) accounts to Roth without distribution
Allowing nonspouse beneficiary distributions via rollover
Allowing suspension of required distributions for 2009
Special benefits for participants w/qualified military service
Faster vesting of employer contributions under PPA 2006
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Bad Plan Documentation
Correcting Amendment Failures
• Adopt amendments for missed tax law changes
- Look for IRS sample language in model amendments and List of
Required Modifications
- Effective date of amendment should be retroactive to conform plan
terms to legislative requirement
- File VCP submission with IRS
- Submission is expected to include the executed amendments
that will correct the failure
- Issuance of compliance statement by IRS results in
amendments being treated as if they had been adopted timely
Avoiding Future Failures
• Do annual review of plan document
• Designate person responsible for identifying time-sensitive amendments
• Use annual cumulative list published by IRS (e.g., see Notice 2012-76)
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Audit Implications
Determine whether plan amendments have been made
that are required as a result of changes in the laws and
regulations
Inquire of the plan administrator whether plan operations
have been revised to comply with current law changes,
even if plan amendments are not yet required
Review correspondence from plan’s legal counsel, third
party administrator, or other ERISA or tax advisor
Review corrective action to determine if compliance
issues were corrected in accordance with prescribed
procedures and properly recorded and disclosed in the
financial statements.
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7. Prohibited Transactions
A. Plan Services
B. Bad 408(b)(2) Disclosure
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Prohibited Transaction and Plan Services
Furnishing goods, services or facilities to plan is a prohibited
transaction unless arrangement qualifies for exemption
Violation results in 15% excise tax and100% tax if not corrected
Four requirements for exemption
•
•
•
•
Service must be necessary to establish or operate plan
- Necessary means appropriate or helpful
Service contract must be reasonable
- Plan must be able to terminate contract without penalty on short notice
- Plan should not be locked into an arrangement that becomes unfavorable
- Long-term lease is acceptable only if it can be terminated before expiration
- Minimal early termination fee to allow recoupment of start-up costs is
acceptable
Plan should pay no more than reasonable compensation
- Management Evaluates reasonableness of fees by market rate for
comparable services
Disclosure by service provider
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Bad 408(b)(2) Disclosure
Regulation effective in 2012 requires plan service provider to
make written disclosures to plan:
• Description of services
• Whether services to be performed as fiduciary
• Compensation to be received from plan and from third parties
Bad disclosure makes service arrangement a prohibited
transaction by plan fiduciary and service provider
• Failures can be cured
• Plan must make written request for information and provider must
respond within 90 days
• Service provider refusal or inability to comply with request for
information requires plan fiduciary to notify DOL
- Plan fiduciary must decide whether to terminate services
- Presumption is termination
- Services to be continued only if prudent
- Good faith mistakes must be corrected no more than 30 days after
provider knows of error or omission
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Audit Implications
AU-C 250 Consideration of Laws and Regulations in
an Audit of Financial Statements applies to
prohibited transactions
Inquire whether plan is in compliance with laws and
regulations
Understand who are parties in interest and what is
deemed a prohibited transaction
Understand plan fee arrangements
Inquire as to compliance with applicable reporting
and disclosure requirements for fees.
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8. Illiquid Plan Assets
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Illiquid Plan Assets
Holding illiquid assets is problematic for an ERISA plan if
•
•
•
Purchased in non-exempt prohibited transaction involving party in interest
Purchase was an imprudent decision or
It is imprudent for plan to continue to hold the asset
Examples of illiquid assets
•
•
•
•
Restricted and thinly traded stock
Limited partnership interest
Real estate
Collectibles
Plan fiduciary must determine that asset is illiquid because:
•
•
•
Asset failed to appreciate, provide reasonable rate of return or caused loss
Sale is in plan’s best interest
Asset 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 plan
May correct by selling to related party subject to conditions
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Illiquid Plan Assets
Conditions of correction by selling to party in interest
• Purchase price on sale to party in interest must be greater of
- FMV of asset at time of resale (unreduced by sale costs)
- Original purchase price plus lost earnings under DOL calculator
• Qualified independent appraiser must report on Asset’s FMV
• Application to DOL
- Documentation of original purchase price to be included in
submission
DOL no action letter
• Allows correction or asset’s original acquisition
• Permits sale of asset in transaction that otherwise might be prohibited
Example
• Plan buys real property from party in interest in 1999 for $60,000. Plan
official makes illiquid asset determination in 2004. 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.
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Audit Implications
Review any plan assets purchased from a related
party
If determined that asset is illiquid
• Perform appropriate audit procedures
• Record and disclose “fix” in financial statements
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9. Late Elective Deferrals
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Late Elective Deferrals
When participant funds become plan assets
• Amounts 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 assets
• Safe 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
cash
IRS Failure
•
•
Employer 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.
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Late Elective Deferrals
DOL Failure
• Regardless 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 or
- Restoration of profits resulting from employer’s use of the
delinquent funds prior to making contribution
• DOL Voluntary Fiduciary Correction Program requires extensive
documentation:
- Narrative of remittance practices and certification by plan official of
earliest date when remittance possible
- Copy of payroll documents showing date / amount of each
withholding
- Relief from submission of documentary evidence if amount is below
$50,000 or delinquency is less than 180 days
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Audit Implications
Inquire of plan sponsor what their normal timeframe
is from paycheck to remittance date
Obtain contribution remittance schedule from plan
sponsor detailing dates withheld, date deposited,
and date received by trustee
Test schedule and inquire about contributions
remitted outside the normal timeframe
Late deposits are a legal determination
Disclose on supplemental schedule
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10. Bad Administration
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Bad Administration – Loans
Loans - In order for a plan loan to not be considered a taxable
distribution, it must meet certain IRC requirements
•
•
•
Maximum amount of loan
Repayable within 5 years with exception for certain home loans
Level amortization and not less than quarterly payments
Failure 1 - Plan sponsor permits loan in excess of Code limit
•
•
Failure - 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 period
Correction – Participant repays excess amount to plan. Principal balance of
loan reamortized over 5 years from date of original loan
Failure 2 – Loan repayment period more than 5 years
•
•
Failure – Loan provides 6-year term
Correction – 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.
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Bad Administration – Loans & Hardship
Withdrawals
Loan Failure 3 – Repayment Failure
•
•
•
Failure – 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 or
- Loan may be reamortized over remaining term
If 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
consequences
Failure 1 Due to Financial Hardship Withdrawal
•
•
Failure - Elective deferrals not suspended for 6-month period following financial
hardship withdrawal, as required by the Code and plan terms
Correction – 6 months of improper deferrals treated as current taxable
distribution. File VCP application and distribute deferrals plus earnings.
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Bad Administration – Hardship Withdrawals
& Eligibility
Failure 2 Due to Financial Hardship Withdrawal
•
•
Failure – Employer permits participant to take hardship withdrawal from a 401(k)
plan that does not provide for such withdrawals
Correction – File VCP application requesting authorization to amend plan
retroactively to permit hardship distributions
Eligibility Failures
•
•
•
In general, employees must be allowed to participate in a qualified plan if:
- They have attained age 21 and
- They have at least 1 year of service
Failure - Employer permits employees who have not met its 401(k) plan’s
eligibility conditions to become participants
Correction – Two alternatives
- If 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 discriminatory
- Distribute improper employee deferrals and notify them of their taxability
A107290.pptx
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Audit Implications
Testing of participant loans receivable and hardship
withdrawals
When transactions are not administered in
accordance with the plan document or IRC
requirements
• Book repayment to participant
• Book receivable for participant catch up loan repayments
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Questions
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