Is Your Retirement Plan In Jeopardy of Losing Prior Years Tax Deductions?
The word “prior” is not a typo. Prior years’ tax deductions can indeed be in jeopardy. In fact, given the amount of company contributions and employee deferrals that get deposited into companies’ retirement plans each year, you could argue that the danger of the retirement plan losing its special tax benefits represents one of the greatest threats facing your company. Why your company and not the plan? Because if issues arise surrounding the qualification of a retirement plan, it is the company and not the plan that will need to pay any additional income taxes, penalties and interest. Previous articles that I have written have focused on things that you and your professional advisors can do to avoid or reduce a liability precipitated by their qualified retirement plan that might exist out in the future. One of our articles discussed the Plan Sponsor’s personal or company liability that is tied to their fiduciary obligation to properly monitor the investment choices in your company’s 401(k) plan. Another talked about the need to remit all employee deferrals within 7 business days of separating that money from their employees’ paycheck and the penalties associated with not doing that. In all instances, we recommended policies and/or procedures that could be put into place that would protect your company and you personally on a going forward basis. That is excellent advice and I still stand by that advice.
But what about prior tax years? If those tax years are exposed, in a very real sense, they can represent a larger liability to your retirement plan than anything that might occur out in the future.
What exactly could ever occur to put these prior years in jeopardy and how many open years might there be? It is the qualified status of your retirement plan that could be at risk. Remember that it is the retirement plan’s qualified status that allows for all of the following special tax benefits:
1. Contributions from either the employer or the employee are tax deductible
2. Contributions to the retirement plan do not get included in the current income of either the employer or the employee
3. No current income tax is due on interest, dividends or any realized gains from any security transactions that the retirement plan engaged in
One of two things can cause a retirement plan to lose its qualified status. The plan can experience an operational failure or there may be a disqualifying defect in the plan document and/or amendments.
Operational Failures:
Think that an operational failure needs to be pretty serious to cause the plan to lose its qualified status? Think again! One operational failure that will automatically disqualify the plan is failing to operate the plan in accordance with its terms. So let’s say that at one time your company’s 401(k) plan had a one year wait to enter the plan. At some point, it was determined that you wanted to let folks in much sooner than that. So you switched the eligibility to let your employees enter the plan on the first day of the month following their date of hire. Simple right? Well, if the plan had not been amended to change the eligibility, and if that amendment was never signed and/or dated then you are running the plan contrary to its terms.
If the way that you operate your plan is not supported by language in the plan document, then you have inadvertently disqualified the plan. So if making the plan more liberal puts you at risk, imagine how making the plan provisions stricter might be viewed?
Document Related Defects:
The second and by far the majority of plan disqualification defects that we see are deficiencies in the plan document. These defects almost always take the form of a failure to properly sign and date the original plan and trust, a failure to timely restate the plan for new tax laws or (and this is the one we see most often) a failure to timely execute one of the many amendments that the IRS mandated be adopted as each year passed by. I would say that 75% – 80% of all of the retirement plans that we take over have some sort of document or amendment related defects. These defects cause the plan to lose its special tax treatment. Also, remember that your company is the Plan Sponsor. It is your responsibility to have all of the properly dated documents and/or amendments available at all times. How many of you actually know where these documents live in your office and whether they are properly signed and dated?
The Closing Agreement Program (CAP):
If an operational failure and/or a document related defect is discovered upon audit, the IRS will put you into something called the Closing Agreement Program (CAP) and they will:
1. Assess additional income tax resulting from the loss of employer deductions for possibly as many as 3 preceding tax years. Think about it. If you filed your retirement plan’s Form 5500 for the 2006 plan year on October 15, 2007, then by simply counting back 3 years 2008, 2007 and 2006 are all open years!
2. The trust would owe income tax on any interest, dividends or realized gains that the plan may have received during the course of these open tax years.
Under CAP, the IRS will then calculate the “Maximum Payment Amount.” The Maximum Payment Amount is basically the additional taxable revenue that (1) and (2) above would generate. At that point, they will apply a discount of about 30% to that amount and request that the plan sponsor write a check to the IRS for the remaining 70%
.
Example: Company A’s retirement plan has 25 participants, wins the IRS “audit lottery” and is examined for the 2006 plan year. The client failed to timely adopt the final 401(k)/ (m) amendment, which needed to have been executed no later than December 31, 2006. Let’s further say that the company put $100,000 per annum into the plan for 2006, 2007 and 2008. Also, while 2008 was not a good year for the market, 2007 and 2006 were. So let’s also say that for those 3 years, the plan had, in the aggregate, interest, dividends and realized gains from the sale of securities of $50,000. The Maximum Payment Amount would therefore constitute income tax on:
1. ($100,000 X 3) + $50,000 = $350,000
2. Discount by 30%: $350,000 X 70% = $245,000
3. Estimated income tax on $245,000 = $73,500*
*assumes a melded corporate rate of 30%
Late payment penalties and/or interest would also apply.
Of course, you still need to correct any and all of the defects that have been identified by the IRS, which may include making additional contributions for employees that terminated years ago and/or adopting any amendments which cannot be located or were never adopted in the first place.
The Voluntary Corrections Program (VCP):
VCP is an extremely valuable IRS program that is little known outside of the pension community. It was the result of a joint effort between various pension organizations and the IRS to find a way to have retirement plans that had inadvertently wandered “off the reservation” recapture their qualified status and retain their special tax benefits. Since the pension division of the IRS is primarily compliance driven, they welcomed the opportunity to find a solution that would allow plans to self-correct themselves. Thus was born VCP.
The first thing you need to know about VCP is that the operative word here is voluntary. The decision to avail yourself of VCP must come from the client or be given to the client as an option by one of their professional advisors. Once the audit notice from the IRS shows up, your ability to use VCP is gone. The process of utilizing VCP is fairly simple. The defect is identified, corrective action is taken and the package with the proposed corrective action is submitted to the IRS, along with a check that corresponds to an IRS schedule based on the number of participants in the plan. Normally, failure to adopt an amendment for a 25 participant plan carries with it compliance/fee is $1,000. However, because in this particular case the defect was caused by a failure to timely adopt an interim amendment, the IRS compliance/filing fee would only be $375.
It can be quite a while from the time you make your VCP submission to the IRS to the time you hear back from them that your correction has been accepted. However, once you place the plan into VCP, you have now walled off the plan from CAP. If you were to receive an audit notice the day after your submission to VCP, the IRS auditor would need to back off, even though your correction had not yet been formally accepted.
Note that it is important to identify and correct all plan defects. VCP will only protect you for the defects that you identify and submit for. If the IRS finds another defect that you did not correct, they can still put you into CAP, where the financial sanctions are clearly much harsher.
For 401(k) plans, the following is a list of the documents that should have been adopted at various times prior to the current round of restatements:
• The GUST Restatement
The following are all of the interim amendments that should have been adopted between GUST (the last full restatement of your retirement plan) and EGTRRA (the current restatement of your retirement plan):
• The EGTRRA Amendment*
• The Automatic Rollover Amendment
• The Final 401(k)/(m) Amendment
• The 415 Final Regulations Amendment
*This is not the EGTRRA restatement. The EGTRRA restatement is something that needs to be signed and dated no later than April 30, 2010
By the way, curing this is not as simple as “finding” and dating the missing interim amendment(s). Many of these amendments had different adoption dates. Make a mistake on dating the amendment (and that has happened) and the “f” word (fraud) starts to get used by the IRS. They take back dating (that is term used by the IRS) very seriously.
If you would like to have your plan reviewed to ensure that you are not exposed, or if you would like to discuss these or any other issues that might concern you in confidence, please contact David I. Gensler, MSPA, MAAA, EA, President of Madison Pension Services and author of this article, at 914-251-0099 Ext. 202.
2009 Required Minimum Distributions
It is again important to focus on the issue of Required Minimum distributions (RMD’s) from Qualified Retirement Plans and Individual Retirement Accounts.
Who is Affected?
Anyone who was ever covered by a qualified retirement plan, a regular or rollover IRA, SEP, and/or SIMPLE, who has attained age 70&1/2. These individuals must begin taking distributions from their plans or accounts, unless they qualify for any of the following exemptions:
New Exemptions for 2009 only:
1. Any participant in a qualified defined contribution plan does not have to take a RMD for 2009 from such plans; such a participant nevertheless can elect to take the 2009 RMD by executing the attached exhibit, in which case the 2009 RMD calculation must be completed by the applicable deadline; absent such an election, no RMD for 2009 will be required or taken.
2. Any participant with a 414(k) account in a qualified defined benefit plan does not have to take a RMD for 2009 from such accounts ; such a participant nevertheless can elect to take the 2009 RMD by executing the attached exhibit, in which case the 2009 RMD calculation must be completed by the applicable deadline; absent such an election, no RMD for 2009 will be required or taken; most participants in a qualified defined benefit plan do not have a 414(k) account, so this exemption will rarely apply
3. Individuals with an IRA do not have to take the 2009 RMD from their IRAs.
Pre-2009 Exemption remains in effect:
Participants in qualified plans who are not 5% owners are permitted to defer their RMD until their actual retirement; Note that this exemption does not apply to RMD’s from any IRA’s.
When Must The 2009 Required Minimum Distribution Be Made?
For those non-exempt individuals who have attained age 70&1/2 in 2008 or earlier, the required minimum distribution must be taken by 12/31/09. For those individuals who have attained age 70&1/2 in 2009, the required minimum distribution must be taken by 4/1/10, but can be taken earlier in 2009. Note that if the initial required minimum distribution is deferred to 4/1/10, a second distribution will need to be taken by 12/31/10.
How Much Must Be Taken?
The IRS has issued regulations specifying how the required minimum distribution is to be calculated under defined contribution or defined benefit plans and IRA’s. Some of the factors which go into the calculation are the size of your account, your life expectancy and who you have named as your beneficiary. We will calculate the required minimum distribution based upon the plans and accounts we know of. If you maintain an individual IRA or have ever rolled over a distribution from another plan into an IRA rollover, the institution holding the money should be responsible to advise you of your required minimum distribution. If you have not heard from them by 12/15/09, we urge you to contact them for this information.
What If I Fail To Take My Required Minimum Distribution?
If you fail to take your required minimum distribution within the prescribed time frame, 50% of the amount of your required minimum distribution that you have not taken will be assessed as a penalty. For example, if your required minimum distribution for 2009 is $20,000 and you only take $8,000, $6,000 [(20,000 - 8,000) x 50%] will be assessed as a penalty. Therefore, it is critical that you take your required minimum distribution timely.
What to Do? If you maintain a qualified plan and Madison Pension is the TPA, please search your files and submit to us in writing any individual who you feel is or may be subject to these minimum distribution requirements. Also, your letter to us should include the plan name, the designated beneficiary, and birth dates of the employee and the beneficiary. Finally, if there were any distributions previously made, please indicate the dates and amounts. This information should be sent directly to your Plan Consultant at Madison. For those individuals who became subject to the required minimum distribution rules in prior years and all applicable information was previously submitted to our office, no further information needs to be submitted at this time, unless such individuals and/or their beneficiaries died or separated from service during the past year. Any deaths or separations from service may impact the required minimum distribution. Accordingly, it is critical that we be advised of any changes in status.
Responsibilities of the Plan Administrator
Madison Pension Services, Inc. designs, implements and helps run successful retirement programs. As your Third Party Administrator (TPA), we also assist with the administration and compliance aspects of your retirement plan. Madison has a long history of customized plan design solutions that are tailored to meet your company’s business needs and strategic plans.
Important Definitions:
Plan Sponsor: The Plan Sponsor is the person or entity (generally the employer) who makes the plan available to its employees.
TPA (Third Party Administrator): A firm engaged by the Plan Administrator to perform the ministerial administrative responsibilities of the plan.
Plan Administrator: The person who is identified in the plan document as having responsibility for running the plan. It could be the employer, a committee of employees, a company executive, or someone hired for that purpose. If the name of the Administrator is not in the plan document, the employer is considered to be the Plan Administrator.
It is important to note that the Plan Administrator has key roles and responsibilities in order to successfully run a retirement plan. The Plan Administrator must:
- Determine who is eligible for the plan and what benefits are due or provide accurate data to the TPA firm in order to accomplish this.
- Distribute summary plan descriptions, summary annual reports, and statements of vested benefits to participants and beneficiaries.
- Maintain proper plan records.
- Review, sign and mail a completed Annual Form 5500 to the EBSA. For plans with over 100 participants, engage an in-dependent qualified public accountant to audit the plan’s financial records.
As your TPA, we can provide assistance in these areas, but that does not relinquish your responsibilities. Ultimately, you, the plan ad-ministrator, are responsible for your plan. This is why at Madison, we think of the TPA relationship as a partnership. We’ve success-fully managed retirement plans with thousands of companies for over thirty years, and we look forward to continuing our relationship with you. Do not hesitate to call your Madison Pension Consultant with any questions.
EBSA criminal project to prosecute egregious violations of ERISA
In a September 14, 2009 speech, Assistant Secretary of Labor Phyllis C. Borzi announced that EBSA has initiated a criminal project to prosecute what she referred to as ‘the most egregious and persistent violations’ of ERISA, and also plans to focus enforcement efforts on several key civil areas. All plan sponsors, administrators and other fiduciaries should be aware of these enforcement priorities. Link to full article: http://www.arentfox.com/publications/index.cfm?fa=legalUpdateDisp&content_id=2144
Compliance on Several PPA Imposed Requirements and Deadlines between now and the end of the year
Between now and the end of 2009, pension plan sponsors of calendar-year plans will need to attend to a host of PPA compliance matters, including final 2008 plan year funding decisions, 2009 AFTAP certifications, PBGC filings and premium payments, 2008 Form 5500 filings (including elections related to yield curves, asset valuation, and credit balances), required benefit statements to participants, and updating of plan documents to reflect changes due to PPA. The chart should aid sponsors in ensuring upcoming compliance requirements are satisfied.
http://www.jpmorgan.com/pages/jpmorgan/am/cbs/insight/retirement_plans/PPA_Compliance_September_2009
New York Local Government Pension Woes Worsen
The financial troubles for local governments worsened when Comptroller Thomas DiNapoli announced they will need to pay 61 percent more in pension costs in 2011. Although anticipated, the announcement did little to quell concerns of town, village and county governments, which are already grappling with declining sales-tax revenue and higher costs for health insurance and state-mandated programs. The pension fund for public workers will increase in 2011 from 7.4 percent of payroll to about 12 percent, slightly higher than projections a few months ago, DiNapoli said. See attached link for full article.
http://www.democratandchronicle.com/article/20090904/NEWS01/909040343/1002/RSS01
Pension Deadlines for the remainder of 2009
09/15/09 – 2008 Minimum Funding deadline for defined benefit, money purchase and target benefit plan contributions to avoid a funding deficiency and excise taxes.
09/15/09 – 2008 Employer tax filing due date with extension for Corporations (C or S) and Partnerships, which may include LLPs and LLCs. Contributions must be made by this date to claim a timely deduction
09/30/09 – 2008 Summary Annual Report (SAR) due date (without 2008 Form 5500 extension) for Non-PBGC covered plans
09/30/09 – Implementation Deadline for new 2009 401(k) Safe Harbor Plan (i.e. must be in effect and operational for at least 3 months)
10/01/09 – 2009 AFTAP deadline. Any plans that have a 2009 AFTAP percentage under 80% will also have to hand out a benefit restriction notice to all of their employees by October 31, 2009, unless same benefit restriction notice was previously handed out.
10/15/09- 2008 Form 5500 filing due date (with extension)
10/15/09 – 2008 Employer tax filing due date with extension for Sole Proprietors. Profit Sharing contributions to Sole proprietor plans must be made by this date to claim a timely deduction.
10/15/09 – 2008 Corrective Amendment adoption date deadline
12/01/09 – 2009 401(k) safe harbor plan notices will need to be distributed to all participants.
12/01/09 – 2009 Qualified Default Investment Alternative (QDIA) notices to be handed out to all plan participants for plans which have a QDIA.
12/01/09 – 2009 Automatic Enrollment notices to be handed out to participants in plans which have an automatic enrollment feature
12/15/09 – 2008 Summary Annual Report (SAR) due date (with 2008 Form 5500 extension) for Non-PBGC covered plans
12/31/09 – DC and DB PPA (includes Heart, WRERA, etc.) amendments need to be executed by this date.
12/31/09 – Deadline for making QNEC/QMAC contributions to correct a failed 2008 ADP and/or ACP test; Also, deadline for making any 2008 401(k) safe harbor contributions (either non-elective or match)
12/31/09 – Adoption Date deadline for new 2009 DC or DB plan documents
Note: For PBGC covered plans, the new Annual Funding Notice replaces the SAR, and must be released to plan participants not later than the earlier of:
a) the actual filing date of the Form 5500, or
b) the latest filing date of the Form 5500, including any extensions
Workplace Balance
An interesting blog post on the Harvard Business site yesterday stated that if you slow down you can do more. I of course got to thinking about this statement and decided to post my own perspective on this issue. The article extended the claim from a business setting to marathon running. There have actually been studies done that show that marathon runners can beat their race times if they actually stop and walk part of the race instead of running the entire race from start to finish. This is a pretty incredible claim that is counter intuitive to many.
I think that the idea of doing less to achieve more speaks directly to the idea of balance in anything we do. As part of my martial arts training balance is a key factor, both physically (for those high round house kicks or spinning wheel kicks) but also for the training methodology and interaction with self and others. The way that most of us start to understand balance is through imbalance. For those of us that are athletes, this is obviously the case as the body adapts to moments of imbalance by correcting itself and learning the correct placement or the body etc. This is also very applicable to work life and life in general. If we have moments of imbalance in our workplace or private lives that create problems or issues (physically, relationships or work product wise etc.) we learn to adapt and to move back towards a more balanced approach that achieves greater results or suffer the consequences or remaining out of balance. Sometimes it may not even be a noticeable or conscious change or decision. A decision can occur by merely not making a decision in some cases. Injuries or illness often provide us with this feeling of imbalance and allow us time to reflect and readjust our schedules and actions.
Madison Pension strives to create a balanced workplace. Employees are given the ability to work from home if needed via state of the art secure remote login access. Our company’s visionary approach to harnessing current technology (paperless office, salesforce, twitter, e-fax etc.) allows our employees to have all their work papers and tools at hand from wherever they may be. We provide summer hours which provide free Friday afternoons to all employees. Longer weekends tend to reset our staff and everyone is much more focused and relaxed when returning to work on Monday, which is passed along to our clients in increased efficiencies and friendly, happy, approachable consultants and staff. We sponsor company outings, like the Yankee game that we went to in June. We closed the office and spent the day as a team enjoying a Yankee game in the new stadium. Employees are encouraged to bring their dogs to work from time to time and employee’s kids and family stop by to say hello and grab lunch with mom or dad. The daughter of one of our partners is currently coming in on Fridays to help out around the office while on summer vacation from high school. All in all, we have a very family oriented and balanced work life here at Madison Pension.
For those interested in the Harvard Business article, please click on the following link: http://bit.ly/N6YZe
Zen and the art of being a CEO
My monthly Vistage meeting today was focused around making your company remarkable. There was a great video clip that the speaker showed us of John Edwardson of CDW speaking about the topic of CEO required traits. A few things that resonated with me from that video clip were: 1. teams make better decisions than individuals and 2. get ideas from others without smothering them with your ideas.
I tend to fall back to my martial arts training and philosophy on a lot of business questions I pose to myself or others pose.
One thing that I always live by is the idea that a great leader (or sensei, teacher, CEO etc.) should welcome the day his student/employee was able to out perform him/her. I try to take this philosophy and apply it to business and how I mentor my staff. I try not to just train a successor to take over my position, but I try to train them (or inspire them) with the expectation and hope that they will take what I have created and make it better and exceed what I have been able to achieve or create. Having the ability to do that and not let ego or other stuff get in the way is a wonderful/magical thing. I think that only someone who has a strong character, self confidence and a non-defeatist attitude can achieve such a goal.
I have also learnt via Cuong Nhu (the martial art I train in and teach) that the following 10 leadership attributes are key: fitness, wellness, assertiveness, openness, fairness, directness, oneness, togetherness, forgiveness and creativeness.
It’s great to think about all this stuff when one is cycling. I am an avid cyclist as well as martial artist. I cycle to work daily and I find it allows my mind to be free to flow (no interruptions etc.). Old zen stories say that the body (like the mind) is also best equipped to perform when the fighting techniques are no longer required to be first thought before executed (ie. the body is flowing and not thinking about the next move). The moves just come out automatically without thoughts preceding them. There was an old zen story about a zen master who kept asking his best student how many movements of a kata (he was practicing) that he could remember. This student had been chosen to defend them against a pending attack on the kingdom. After lots of training, the student finally said he remember none of the movements – the zen master told him he was now ready to go out and protect the kingdom. Takuan said “The mind should be nowhere in particular” and I think this is accomplished when cycling (and other sports too) as it helps the mind to flow and great ideas are borne (just like in the zen story the body flows and great physical feats are accomplished). If you are interested in a quick read “Zen in the Martial Arts” by Joe Hyams is excellent (only 140 pgs!) and its not just about Martial Arts, the lessons are far reaching in my opinion and very applicable to the business world.
Defined Benefit Plans – Form 5500: not business as usual
There are a lot of new requirement this year with respect to Defined Benefit Plan Form 5500s and related schedules. One thing to be aware of is the requirement to post your Schedule SB (Actuarial schedule) to your intRAnet, if your company maintains one. This must be posted on or before the 5500 package (which includes the Schedule SB) is filed with the EBSA, as per the instructions you will probably receive from your TPA firm.
There is a very important side effect of all the new regulations and requirements for Defined Benefit Plan reporting, required calculations and election forms. It has to do with how you have interfaced with your actuarial or TPA firm in the past with respect to getting them the data and contribution deposit information. Are you usually gathering and submitting the information that they have requested at the last minute – i.e. close to the Form 5500 extension due date (October 15th for calendar year plans). If so, it isn’t business as usual this year. The forms are more complicated (and take longer to prepare) and there are more calculations, elections etc. than ever before! Make sure that you provide all the information to your consultants as soon as possible so that they can ensure that you meet this very important filing deadline. Penalties do apply for late filers and in this economy no one wants to throw money out the window on late penalty payments to the IRS!
