A business owner’s resolution worth keeping - 401(k) compliance

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Business owners face a number of regulatory and compliance requirements that add to the difficulty of operating a profitable business.  Although these requirements do not necessarily contribute to the bottom line, to ignore them or, not be aware of them, puts the business in as much peril as insufficient revenue.

An example of a burdensome but important IRS requirement pertains to qualified retirement plans.  When a company sponsors a plan, such as a 401(k), it must do annual maintenance to ensure it remains compliant with the IRS rules and regulations.  Often clients and business owners struggle to keep up with the IRS rules in two primary plan areas:
1) timely adoption of IRS-required amendments; and 2) operational failures, such as when elective deferrals and matching contributions are neglected on bonus payments as may be required by the plan document.

Issue 1) arises when the business owner fails to implement IRS-required Plan amendments or restatements.  Business owners often ignore plan documentation provided by the document provider.  The consequence is the plan is not timely amended and no longer qualified.

This is corrected by adopting the applicable amendment or restatement and submitting an application with payment of the IRS compliance fee to the IRS under its voluntary correction program.  Failure to submit under the IRS voluntary correction program subjects the employer to greater penalties if noncompliant issues are identified in an IRS audit.

Issue 2) arises where the plan is required to, but does not, account for an employee’s voluntary or elective deferrals and employer matching contributions on bonus payments.  Often the Plan document is not properly written to reflect the employer’s intentions.  Other times the Plan document is not being properly interpreted by the employer’s HR personnel, payroll/third party administrators or accounting service providers.

The consequence is that deferrals and matching contributions are not being made on bonus payments when they should be.  Generally, this is corrected, at the employer’s expense, by making restorative deferrals and matching contributions for years of omission, plus earnings and interest.  A submission to the IRS is also required under its voluntary correction program if the failure is significant.  As with Issue 1), failure to file under the IRS voluntary correction program may subject the employer to greater penalties if these type of operational failures are identified in an IRS audit.

The IRS is improving its identification of noncompliant plans. Over the past five years, a whopping 64 percent of audits have resulted in IRS required changes at the employer’s expense. Given these rates of success, you can expect that the IRS will continue to monitor plans for compliance issues.

Consider this example:

ABC Security Company provides security services to the public and private sector.  It is a family business owned by dad, mom and their two children, and generates annual revenue of $100 million.  The four family members also comprise the Board of Directors.  Because of a proliferation of government spending, ABC Consulting Company has been extremely profitable since 2002, earning the four family members and 20 other employees significant bonuses.  The Company’s Plan calls for matching contributions on the bonuses.  However, nobody with ongoing monitoring responsibility - neither the internal human resources department, the outside company that administers the plan; nor the CPA firm that audits the company’s returns - discovers the oversight until 2011.

At the least, ABC Consulting Company must “make-up” for the missed deferrals.  But the company’s analysis of what it means to make-up for past deferrals is only starting.  Among the considerations are the following: 

1)  There is no statute of limitations, thus the liability is not necessarily limited to the past three years, as with an income tax liability.  Does ABC Consulting Company’s ‘lan liability stretch back to 2002; is it limited to just the past three years open under the income tax statute of limitations; or is it limited just to 2011, the year the CPAs discovered the oversight?

2)  Once the company and its advisoes agree on a corrective action, the company must confess to the IRS before the IRS discovers the problem, thereby hoping to avoid IRS sanctions, which could include loss of income tax deductions for contributions and income tax free accumulations.
3)  There is a third issue extending beyond the IRS and the company, which is potential personal liability against the directors personally - the four family members.  An individual plan participant could assert a claim against the directors for failure to properly oversee the plan. This potential claim raises a related issue; namely, whether it is prudent to have members of the same family serving on the board.     

Law firms are often involved when the non-compliance issues rise to legal concerns.  The legal presentation involves assisting employers with the IRS submissions under the Employee Plans Compliance Resolutions System, which covers self-correction, voluntary correction and audit corrections initiated by the IRS.  Because of the significance of these Plan issues, often times law firms are invited to independently audit the Plans to discover potential problems before they proliferate.

Besides the need to timely adopt plan amendments and avoid operational failures as described above, there is a third area of risk, which pertains to the fiduciary duty plan administers owe the participants regarding the plan’s investment policy.  ABC Consulting Company should be working with a plan administrator or an accredited investment fiduciary, whose investment policy is compliant with Department of Labor regulations.  The investment issues to cover include developing an investment policy statement and monitoring to ensure the portfolio does not deviate from its investment model yet can remove underperforming fund managers.  The bench working of fees paid by plan participants is also a big issue in the Department of Labor’s eyes.   

One New Year’s Resolution critically important for business owners is to review their company’s plan to ensure compliance.  Failure to do so creates financial danger for the company and personal liability for board members.

John P. Dedon is a principal in the firm with the Trust, Estate & Tax Planning practice group of Odin, Feldman & Pittleman. Dedon blogs about estate planning issues for Virginians and U.S. citizens at http://www.dedononestateplanning.typepad.com


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