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ERISA COMPLIANCE AND ERRORSTop Ten Mistakes

Marcia S. Wagner, Esq. - President/FounderThe Wagner Law GroupBoston, MA

Marilee P. Lau, CPARetired Partner KPMG LLPSan Francisco, CA

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Speaker Biography – Marcia S. Wagner

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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.

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Speaker Biography - Marilee P. LauMarilee 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. Automatic Enrollment & Automatic Escalation

2. 403(b) Plan Universal Availability

3. Problem Shared and Leased Employees

4. Compensation Done Incorrectly

5. Controlled Group Issues

6. Bad Plan Documentation

7. Prohibited Transactions A. Plan Services B. Bad 408(b)(2) Disclosure 8. Illiquid Plan Assets 9. Late Elective Deferrals10. 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 UniversalAvailability 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 ProblemFailure 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 EmployeesEmployee 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 IncorrectlyAmount 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 IssuesRules 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 IssuesDiscrimination 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 DocumentationIRS 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 ServicesB. 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) DisclosureRegulation 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 AssetsConditions 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 & HardshipWithdrawals

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