Tag Archives: Suzanne Smith

New IRS form requests supplemental information from plan sponsors

Smith-SuzanneIf you sponsor a calendar year retirement plan, you are likely in the process of completing your Form 5500 for the 2014 plan year. Thus, it seems like a good time to let you know that, unfortunately, new information may be required next year on your Form 5500.

The Internal Revenue Service (IRS) has proposed a new Form 5500-SUP for the 2015 plan year. SUP stands for “supplemental information.” Essentially, the IRS is adding some new questions to the annual filing to gather certain plan compliance information.

Each year, the U.S. Department of Labor (DOL) uses the information on Form 5500 to identify plans for further questioning and auditing. With the addition of these new questions proposed by the IRS, the IRS will have a similar ability to use the Form 5500 responses to target plans for IRS examination or perhaps a compliance questionnaire. As a result, it’s crucial to answer all Form 5500 questions, including these new questions, with care.

Some of the new information that may be required is pretty basic, such as the name of the trust, the trust identification number, and the name and telephone number of the trustee or custodian.

But other items will require more effort to answer. These items include:

• How does the plan satisfy nondiscrimination testing and coverage testing?
• Which testing method is used for the actual deferral percentage (ADP)/actual contribution percentage (ACP) test?
• Has the plan been amended in time for all tax law changes?
• What is the date of the last amendment/restatement?
• What is the date of the IRS opinion or advisory letter (for preapproved plans) or favorable determination letter (for individually designed plans)?
• Is the plan maintained in a U.S. territory?
• Did the plan trust incur unrelated business taxable income?
• Were in-service distributions made during the plan year and, if so, what was the amount?

Most employers will be able to answer these new IRS questions electronically on Form 5500 and 5500-SF. Plan sponsors that do not file electronically will need to use the paper Form 5500-SUP.

Although these questions are still in proposed form, as you administer your retirement plan through the 2015 plan year, you will want to keep in mind that you may need to be prepared to answer these new questions next year.

Will the proposed overtime pay changes affect your retirement plan compensation?

Smith-SuzanneThe U.S. Department of Labor (DOL) announced a proposed rule on July 6, 2015, that would change who qualifies for overtime pay.

Today, only 8% of salaried workers qualify for overtime pay—those workers who earn less than $23,660. The proposed rule will extend overtime pay to salaried workers who earn less than about $50,440 next year. The proposed change is estimated to cover 4.6 million workers, more than the current regulations.

What does this mean for the retirement plans of employers that will be affected by this proposed rule?

While many employers use gross compensation or total pay for retirement plan purposes, some employers provide retirement benefits only on base pay, excluding additional pay such as overtime, bonuses, or premiums for shift differentials.

Generally, excluding overtime pay for retirement plan purposes is OK if the plan’s definition of compensation passes nondiscrimination testing.

Nondiscrimination testing on compensation is done by comparing the average includable compensation for highly compensated employees (HCEs) to the average includable compensation for non-highly compensated employees (NHCEs). If the HCE average percentage exceeds the NHCE average percentage by more than a de minimis amount, the plan will fail the test. A de minimis amount is generally thought to be no more than 3%, but there is no formal guidance so plan counsel should be involved.

2015 example: Plan excludes overtime pay and bonuses from plan compensation

HCE Average Includable Compensation 95%
NHCE Average Includable Compensation 93%
PASS

Because the HCE average inclusion percentage exceeds the NHCE average inclusion percentage by no more than 3%, the plan passes the test.

But what happens next year if many of the NHCE participants are suddenly eligible for overtime pay? The increase in excludable overtime pay will cause the NHCE inclusion ratio to drop, and the disparity between HCE and NHCE includable compensation will exceed 3%—and thus fail the test.

2016 example: Plan excludes overtime pay and bonuses from plan compensation

HCE Includable Compensation 95%
NHCE Includable Compensation 86%
FAIL

Because the HCE average inclusion percentage exceeds the NHCE average inclusion percentage by more than 3%, the plan fails the test.

Failed testing is never good. More complex testing would have to be done, and the plan may have to take corrective action if the complex testing doesn’t pass.

Employers with salaried workers who would qualify for overtime under the proposed changes will want to check their retirement plan compensation definitions and keep an eye on what happens with the proposed overtime regulations.

Interested parties can submit comments on the proposed rule at www.regulations.gov (RIN: 1235-AA11) on or before September 4, 2015. The DOL is expected to make a final rule next year.

IRS guidance on favorable determination letters for individually designed plans expected this summer

Smith-SuzanneEvery summer we look forward to nice weather, vacations, picnics, and barbecue. And Internal Revenue Service (IRS) guidance.

Yes, this summer we are expecting IRS guidance relating to changes in the determination letter program. The IRS has informally communicated a possible halt, beginning in 2016, to the issuance of IRS determination letters for individually designed retirement plans except for new plans or terminating plans. A formal announcement with details and an opportunity for comment is expected this summer.

Initially, this may sound like a beneficial change for employers because it eliminates a burdensome and costly process that individually designed retirement plans must generally undertake every five years.

But the potential negative impact of such a change is very concerning. While there is no federally regulated requirement to have favorable determination letters for each retirement plan, there are many good reasons for employers to seek them:

Reliance on audit: By having a current determination letter, an employer has assurance that its plan language is tax-qualified. If a plan is audited, the employer can rely on the determination letter to prove the plan’s tax-qualified status.
Approval of amendments to plan: Most plans are amended from time to time to incorporate new laws and optional plan provisions. A determination letter is important to demonstrate that the amended plan language meets the tax-qualified rules.
Due diligence for corporate restructuring transactions: When corporate restructuring transactions such as mergers, acquisitions, or divestitures occur, it is prudent to obtain current determination letters to review the tax qualifications of the plans involved in the transaction.

Without the ability to secure a current determination letter, plan sponsors would not be able to confirm the tax-qualified status of their plans, thereby leaving them unprotected in the event the IRS finds the plan language to be noncompliant during a future audit. Such a finding could result in severe penalties.

Two types of plans that have been considered individually designed and for which an employer would generally seek a favorable determination letter are employee stock ownership plans (ESOPs) and cash balance plans.

Perhaps recognizing that it will be limiting the availability of determination letters for individually designed plans, the IRS has recently released guidance that would expand the preapproved plan document program to include ESOPs and cash balance plans. If an employer uses preapproved language without modifications, an employer would have reliance on the IRS opinion/advisory letter without the need for a favorable determination letter. Thus, employers with individually designed ESOPs and cash balance plans may want to consider converting their plans to preapproved plan documents in the future.

So, as we kick off summer, we are anxiously awaiting IRS guidance on the future of the determination letter program as well as watermelon, fireworks, and pool parties.

The Supreme Court, Tibble, fees, and the statute of limitations

Smith-SuzanneEarlier this month, the U. S. Supreme Court decided that it will review a case relating to retirement plan fees. Although it is a case about fees, the issue before the Supreme Court is really about ERISA’s six-year statute of limitations.

Background about the case. Plan participant Glenn Tibble brought a lawsuit against his employer, Edison International, and the company’s benefits and investment committees as fiduciaries and administrators of his defined contribution (DC) plan. Tibble claims the plan fiduciaries managed the plan imprudently by selecting retail mutual funds as retirement plan investments when institutional shares were available at a much lower cost to participants.

The lower courts found that the fiduciaries were imprudent in selecting retail-class shares and failing to investigate alternative institutional-class mutual funds.

The problem for Tibble is that some of the retail-class funds were added to the retirement plan more than six years before Tibble filed the lawsuit.

The courts have held that although the fiduciaries were imprudent with the selection of the retail-class shares, Tibble’s claim with respect to funds selected more than six years before the lawsuit is barred by ERISA’s six-year statute of limitations.

Current issue for the Supreme Court review. Now the Supreme Court has agreed to review the statute of limitations issue.

Tibble’s argument, which is supported by the U.S. Department of Labor, is that there is a continuing duty to monitor the plan investments. As a result, Tibble thinks his claim should not be time-barred under the theory that there is a restart of the six-year period with the ongoing failure to monitor the plan’s investments. This is a frightening thought for employers!

Prior court decisions have sided with the fiduciaries and found that the six-year period runs from the initial selection of the investment. While there is a duty to monitor the plan’s investments, the courts have been reluctant to permit a new limitations period for a continuing violation. The Ninth Circuit said it would lead to an “unworkable result” where present fiduciaries could be liable for decisions made by their predecessors decades before.

So what are the takeaways for plan fiduciaries? On the fee issues, if you are selecting retail type mutual funds, you need to consider alternative institutional-class mutual funds and document your decision.

With respect to the statute of limitations, we should have the Supreme Court decision by the end of June 2015. For plan fiduciaries, the decision will be an important ruling on the meaning of ERISA’s six-year statute of limitations and the future liability for plan sponsors.

Recent guidance relating to pretax and after-tax distributions

Smith-SuzanneRecent guidance from the IRS (Notice 2014-54) is good news that should make it easier for defined contribution plan participants with pretax and after-tax amounts to split their accounts when taking distributions. The guidance makes Roth 401(k) accounts more attractive for participants and, as a result, employers who have not yet added Roth deferrals to their 401(k) plans may want to re-consider adding the Roth feature to their plans.

With an increase in the number of retirement plans that offer Roth after-tax contributions, more participants may be retiring with pretax and after-tax amounts in their plan accounts.

At distribution time, it is common for participants who have both pretax and after-tax amounts in their plan accounts to want to continue to defer tax on the pretax amount by directly rolling the pretax amount over to an individual retirement account (IRA) or other employer plan. At the same time, participants often want to receive the after-tax amounts in cash with no tax consequences.

In the past, the rules required that each distribution from a plan account had to include a pro rata share of both pretax and after-tax amounts. This made it hard for a plan participant to directly roll over the pretax portion and take the after-tax portion in cash.

There was a work-around solution, but it wasn’t easy. If a participant took an indirect rollover, instead of a direct rollover, that participant could accomplish the goal of rolling over the pretax amount. With an indirect rollover, distribution amounts are treated as consisting of pretax amounts first, rather than a pro rata share. But 20% withholding would apply, which means the participant would have to come up with money outside the plan account to make up for the withholding. Thus, while this approach was doable, it was not convenient.

Now, the IRS has changed the rules. The new rules assign the pretax amount to the direct rollover portion first. This allows participants to directly roll over the pretax portions. Any excess pretax amount is next assigned to any indirect rollover and remaining pretax amounts are taxable.

This is great! We love it when the IRS guidance is helpful for plan administrators and participants! Industry organizations had requested these changes and the IRS listened, understood, and made the change.

With this guidance and the earlier expansion of Roth in-plan rollovers, employers who permit pretax salary deferrals only may want to take another look at adding Roth deferrals to their plans. And let’s hope for more beneficial guidance like this from the IRS in the future!