Since March 27, 2020 when the CARES Act was signed into law, many questions have mounted related to implementing the retirement plan provisions.  Now, with roughly 3 months under our belts since the issuance of the Act and countless CARES Act distributions and loan suspensions processed, the IRS clarified several eligibility, administrative, and taxation reporting rules by issuing IRS Notice 2020-50.  The Notice provides safe harbors, a model certification, and information reporting codes.  It is a must-read for those responsible for administering employer-sponsored retirement plans.  We discuss the basics of the CARES Act in an earlier article.

Coronavirus-Related Distributions

The CARES Act authorized eligible retirement plans to offer for a limited time a new type of distribution, a Coronavirus-Related Distribution (CRD), which is afforded special tax treatment.  Only Qualified Individuals (QI) are eligible for a CRD.  Significantly, the Notice expands the definition of a QI under Section 2202 of the CARES Act to include individuals whose:

  • Pay was reduced because of COVID-19, including self-employment income;
  • Job offer was rescinded or postponed;
  • Spouses’ or other household members (someone who shares the individual’s principal residence) experience a COVID-19 related adverse financial consequence, including the closing or reducing of hours of a business they own and operate.

The CARES Act allows employers to rely on an employee’s certification, barring any actual knowledge to the contrary, of being a QI when requesting a CRD.  Administrators do not have a duty to investigate.  Instead, actual knowledge is present only when the administrator already knows facts to determine the truthfulness of the certification.  The Notice provides sample language of an acceptable certification for employers and individuals to use for documentation.

The Notice clarifies the types of distributions that qualify as CRD, noting that even distributions to beneficiaries, required minimum distributions, and plan loan offset amounts can qualify.  A QI may consider a distribution to be a CRD for personal tax reporting even if the plan does not.  But the Notice explicitly excludes certain distributions from designation as a CRD, including:

  • Corrective distributions of elective deferrals;
  • Loans treated as deemed distributions;
  • Dividends on employer securities;
  • Distributions from an eligible automatic contribution arrangement.

The Notice also clarifies that an employer may expand options for CRDs to include sources that ordinarily are not permitted without a distributable event or reaching age 59 ½.  Examples of these sources include qualified nonelective or qualified matching contributions.  However, the Notice reminds employers that the CARES Act does not change the distribution rules normally applicable to plans, noting for example that pension plans and money purchase pension plans cannot permit distributions before a permissible distribution event, even if it would qualify as a CRD.

Unlike other need-based distributions, e.g., hardship distributions, the amount a QI requests as a CRD need not correspond to an actual amount of need.  But the eligible retirement plan and any related plans are limited to an aggregate amount of $100,000 for a CRD to anyone QI.

CRDs are not subject to the 10% early withdrawal penalty, reportable as gross income over 3 years and most may be recontributed and treated as a rollover contribution over a 3-year period to an eligible retirement plan that accepts rollovers.  Notice 2020-50 clarifies how to treat a CRD for tax purposes and provides specific codes an administrator should use in box 7 of the Form 1099-R.

Recontributions of CRD

A QI may recontribute a CRD as a rollover contribution over 3 years to an eligible retirement plan that accepts rollovers.  The Notice explains how a CRD may be recontributed, even for distributions not normally eligible for rollover.  The Notice identifies one situation, any CRD paid to a QI as a beneficiary of an employee, where a QI may not recontribute a CRD.  The employer may also rely on the individual’s certification of satisfaction of the QI requirements when determining the status of a CRD as eligible for recontribution.

A plan that does not accept rollovers need not accept recontributions of CRDs.  Instead, the decision of whether to amend a retirement plan to implement these CARES Act provisions is at the discretion of the employer.

Loans

Among other plan loan changes, the CARES Act allows certain loan repayments due by QI to be suspended.  The Notice provides a safe harbor for implementing these plan loan suspension rules.  The safe harbor applies if the loan is re-amortized after the suspension period (which must not end later than December 31, 2020) over the remaining period of the loan plus 1 year.  Interest accruing during the suspension period must be included in the re-amortized payments.

The Notice acknowledges there are other reasonable, and perhaps more complicated, ways to implement the CARES Act plan loan suspension provisions.  The safe harbor is not the only option available.

Required Minimum Distributions

The SECURE Act raised the beginning age for Required Minimum Distributions from 70 ½ to 72.  The CARES Act waived the requirement that an individual receive the distribution in 2020.  Individuals may elect to not receive their Required Minimum Distribution in 2020.  The Notice provides that a QI eligible to receive a Required Minimum Distribution may elect to receive the distribution and consider it a CRD on their individual tax return, which would allow the individual to include the amount in gross income over 3 years.  But these distributions are not eligible for recontribution into an eligible retirement plan.

Cancellation of 409A Deferral Elections

The adverse financial effects of the COVID-19 pandemic have not been limited to only certain factions of the workforce.  The Notice acknowledges that those participating in nonqualified deferred compensation plans also may experience financial challenges.  It provides that an individual qualifying for a CRD will be treated as having received a hardship distribution for purposes of the regulations implementing Section 409A of the tax code, enabling service providers to cancel nonqualified deferred compensation plan deferral elections if the plan so permits.

We are available to help plan administrators understand the new guidance.  Please contact a team member or the Jackson Lewis attorney with whom you regularly work if you have questions or need assistance.

With the combination of our nation’s response to COVID-19 and the resultant economic downturn, employers of all sizes face the moral and financial dilemma of evaluating employee headcounts while businesses are grappling with the reality of the current situation.  Many employers are considering furloughs, or other types of approved leaves of absences, to reduce immediate payroll, hoping the downturn lasts for a period of a few weeks instead of months. Other employers are opting to implement systemic reductions in the workforce and let employees go.  The focus of this article is to highlight that different employment actions produce different employee benefits consequences that must also be part of any employment decision.

No general rules apply to every situation, as all circumstances are somewhat unique.  Below is a list of several key issues employers must consider as they evaluate their employee benefits programs with an eye toward reducing payroll costs:

  • Don’t assume coverage continues during leaves or furloughs or automatically ends immediately upon termination of employment. Plan terms typically dictate whether active coverage can continue during short-term leaves of absence, whether paid or unpaid, and many plans have minimum hour requirements to maintain active coverage.  Employers that expand coverage for ineligible employees outside the terms of the plan or policy without consent from the insurer or stop loss carrier face significant financial exposure.
  • COBRA continuation coverage (or state continuation coverage, if applicable) generally must be offered for all group health plans when there is a loss of coverage because of a termination of employment or reduction in hours. An increase in the employee’s share of the premium because of his or her reduction in hours (including to zero, as in a furlough) is a loss of coverage for this purpose.
  • The Affordable Care Act employer penalty should be considered. Terminating the group health plan coverage for an employee when a leave or furlough begins may cause an ACA penalty for failing to offer coverage to 95% of full-time employees.  And the coverage offered must remain affordable to avoid an ACA penalty, which may require a continued or increased employer subsidy, whether on active or COBRA coverage.
  • Plan for how employees will keep paying monthly premiums/contributions to maintain coverage during any leave period. Failure to pay monthly premiums could cause coverage to lapse without COBRA protections for health, dental and vision plans, invalidate future Health FSA and Dependent Care FSA claim reimbursements and could also trigger obligations to reinstate life and other disability plan arrangements only through evidence of insurability.  Arrangements should be made in advance with employees about how they will keep contributing to any allowable coverage during leave, whether through a COBRA vendor, ACH payment from a personal checking account or by mail.
  • Before taking any employment actions, the employer should first determine whether it maintains or maintained any formal or informal severance plan or policy that provides a precedent for what benefits may be offered to terminated employees.
  • 401(k) and other retirement plan implications must be considered. A reduction in force, layoff or furlough could cause a “partial termination” under a 401(k) or other retirement plan rules, which triggers 100% vesting for affected participants.   Review hardship and other distribution provisions, and make sure plan loan provisions are reviewed and followed so that “deemed distribution” consequences may be avoided.  Service credit for vesting and employer contributions can also still be required during leaves or breaks in service.  “Safe harbor” match or other fixed contribution provisions should be suspended only after considering the potential ramifications and taking the required implementation measures. Employers should be vigilant in maintaining the same payroll deposit schedule for employee salary deferrals.
  • Employers should review all deferred compensation agreements and other employment agreements for any leave or termination impact. Such agreements may have short-term bonus payouts or other incentive payment obligations due to any “termination without cause” or other “separation from service” that cannot be altered without a review of all implications of Section 409A of the Tax Code. These rules generally prohibit employees from making salary deferral election changes mid-year (including canceling elections) and/or changing the timing of payments.

This is by no means an exhaustive list of all issues to consider before final decisions are made related to any short-term or long-term reduction in employee payroll.  Each employer must evaluate the issues to find the best options during these challenging times.  Please contact any of our Employee Benefit attorneys to help evaluate the issues based on your specific factual circumstances and plan designs.

The IRS has issued specific guidance for the tax treatment of a leave-sharing arrangement that permits employees to donate PTO/ leave/vacation time in an employer-sponsored leave bank for use by other employees adversely affected by an event declared a major disaster or emergency by the President.  See IRS Notice 2006-59.

TAX TREATMENT OF DONATING EMPLOYEE

General Tax Rule

Generally, the employee who donates PTO/leave/vacation time will be treated as having W-2 compensation for the donated time (based on his or her rate of pay at the time of the donation).  This rule is based on the long-standing “assignment of income” tax law doctrine.

IRS Exceptions

The IRS has created several limited exceptions to the general rule:

  1. Medical leave-sharing plans.  See IRS Revenue Ruling 90-29.
  2. Major disaster leave-sharing plans.  See IRS Notice 2006-59.
  3. Leave-based donations of cash to charitable organizations in the case of qualified disasters, including:

Exception for Major Disaster Leave-Sharing Arrangement [IRS Notice 2006-59]

If an employer sponsors a “major disaster leave-sharing plan” that meets the requirements listed below:

  • Employees who donate leave will NOT be taxed on the donated leave time.
  • Employees who use donated leave will be taxed on the donated leave time used — e.g., the donated leave time used is treated as W-2 wages for all income and employment tax withholding purposes.

Major Disaster Leave-Sharing Plan” Requirements

A “major disaster leave-sharing plan” is a written plan that meets these requirements:

  • The plan allows a leave donor to donate accrued leave to an employer-sponsored leave bank for use by other employees adversely affected by a major disaster or emergency (as declared by the President).  An employee is considered “adversely affected” by a major disaster if it has caused severe hardship to the employee or a family member of the employee that requires the employee to be absent from work.
  • The plan does not allow a leave donor to donate leave to a specific leave recipient.
  • The amount of leave that a leave donor may donate in any year generally may not exceed the maximum amount of leave that he or she normally accrues during the year.
  • A leave recipient may receive paid leave (at his or her normal rate of compensation) from the donated leave bank.  Each leave recipient must use this leave for purposes related to the major disaster.
  • The plan adopts a reasonable limit, based on the severity of the disaster, on the period of time after the major disaster occurs during which a leave donor may donate, and a leave recipient must use, the donated leave.
  • A leave recipient may not convert leave received under the plan into cash in lieu of using the leave.

However, a leave recipient may use leave received under the plan to eliminate a negative leave balance that arose from leave advanced to the leave recipient because of the effects of the major disaster.  A leave recipient also may substitute leave received under the plan for leave without pay used because of the major disaster.

  • The employer must make a reasonable determination, based on need, as to how much leave each approved leave recipient may receive under the plan.
  • Leave donated due to one major disaster may be used only for employees affected by that disaster.

Except for an amount so small as to make accounting for it unreasonable or administratively impracticable, any leave donated under a major disaster leave-sharing plan not used by leave recipients by the end of the period specified in the plan must be returned within a reasonable period of time to the leave donors (or, at the employer’s option, to those leave donors still employed by the employer) so the donor can use the leave.

  • The leave returned to each leave donor must be in the same proportion as (1) the leave donated by each leave donor bears to (2) the total leave donated because of that major disaster.

If a leave-sharing arrangement does not meet these specific requirements, then the donating employee MUST be treated as having W-2 compensation for the donated time (based on his or her rate of pay at the time of the donation).  See, IRS Letter Ruling 200720017.

TAX TREATMENT OF EMPLOYEE RECEIVING DONATED PTO/LEAVE/VACATION TIME

Any payments received by an employee using donated PTO/leave/vacation time under the program must be treated as W-2 wages for all income and employment tax withholding purposes.

WHAT AN EMPLOYER HAS TO DO

  • In order to use either of the two tax exceptions described above, the employer must have a formal written leave-sharing program.
  • The IRS does NOT require an employer to obtain any pre-approval of a leave-sharing program nor does the IRS require an employer to file any subsequent reports about the program.  Also, since a leave-sharing plan is NOT subject to ERISA, there are no filings or other actions required by the DOL   In short, the only employer reporting obligation is to properly report W-2 wages and withhold taxes.

CASH PAYMENTS TO AFFECTED EMPLOYEES

Note that separate from a major disaster leave-sharing program, Section 139 of the Internal Revenue Code provides that a tax-free disaster relief payment can be made in cash to any individual if the payment is a “qualified disaster relief payment.”  Both the Congressional report for Section 139 and the IRS have made clear that the requirements for making tax-free disaster relief payments are very simple and easy to meet.

The Congressional report and Section 139 specifically provide that qualified disaster relief payments are excluded from gross income and from wages and compensation for employment taxes.  As a result, an employer can make tax-free disaster relief payments to its employees.

  • Section 139 applies only to the federal tax treatment of the payments.  State tax laws may or may not be the same.

Note that an employee who donates cash to another employee can make the donation only out of after-tax income.

Jackson Lewis can help you with your leave sharing/donation plan.

If your Company leadership is looking for an innovative employee benefit – something outside the standard employee benefit package of retirement, health, and welfare benefits, a Company-sponsored charitable foundation might be your answer.   A charitable foundation not only can further your Company culture while serving the community, but it also has tax benefits to boot.

A Company’s culture is the tie that binds.  No matter how much pay or how lucrative the benefits package, if the employee feels like just a number or that the employee’s opinion does not matter, that employee will forever be on the lookout for a better fit.  The world is changing, and social causes are all over the news.  Imagine the impact it would have if you could put your employees in the driver’s seat of choosing from a litany of social causes that matter most to them.  Imagine the positive public relations that would come from the Company’s foundation making sizable gifts of support in the community.

What does a Company-Sponsored Charitable Foundation Do?

Most are designed as grant-making organizations, as opposed to operational entities.  The purpose of the charitable foundation could be:

  • To make grants to other 501(c)(3) charities or governmental entities in the community who are furthering causes that are important to the Company. For example, a manufacturing company might choose to focus on environmental causes.  A company in the healthcare field might choose to focus on healthcare education or support causes combatting the opioid crisis.
  • To make grants to individuals in the community who have experienced a severe financial hardship. For example, if a family in the community loses their home to a fire or a flood, or the breadwinner in the family dies unexpectedly while in the line of duty leaving behind 4 little hungry mouths to feed, the Company’s foundation could be there to provide financial support.
  • To provide educational scholarships to employees and their family members. Note that, unlike the two foregoing, there are additional, rigid tax law requirements in IRS Revenue Procedure 76-47 with which the charitable foundation must comply to get this type of entity to work.  For example, the selection committee must be unrelated to the employer and foundation (e.g., no employees, former employees, officers, directors may serve on it).

How Could Employees Be Involved?

Absent a foundation, when the Company wants to support an identified cause, funds are raised and provided directly to that charity.  Once given, control over the ultimate expenditure of the funds is ceded to the charitable organization.

With a Company-sponsored charitable foundation, your employees can be more involved in the promotion of the foundation and have more say in how and when the charitable funds are used.

For example, the Board of Directors of the non-profit corporation could consist of your employees.  They could have oversight responsibility over the foundation and have the ultimate say in which charities or individuals are chosen for support.  Employees could serve on a selection or nominating committee or simply promote the foundation in its giving efforts.

How Is the Foundation Funded?

Employees also can be involved by providing financial support to the foundation.  For example, the Company could do one or more of the following:

  • Allow employees to have a percentage of their after-tax pay payroll deducted and contributed to the foundation;
  • Offer to match employee contributions according to a specified formula or up to a certain amount;
  • Have all unused paid time off that normally would be forfeited at year-end converted to a charitable contribution to the foundation, giving employees the feel-good knowledge that if they work more, they also will do more for the community.

Amounts contributed to the foundation would be tax-deductible up to the legal limits allowed under Section 170 of the Internal Revenue Code.  Company-sponsored charitable foundations often are classified as “private foundations,” rather than “public charities,” which simply means additional tax rules apply, and the deduction limit is reduced.  Even so, this reduced deduction limit applies only with those giving substantial amounts to charity.

Unlike your normal charitable giving, a Company-sponsored foundation is different.  Here, funds can be raised, but do not all need to be expended each year.  Some distributions will have to comply with applicable tax law.  However, the foundation could serve as a charitable endowment that grows over time so that when the right cause comes your way, the foundation will have the resources to make a substantial impact.

What is Involved in Setting One Up?

Charitable foundations are like most corporate entities.  First, the separate legal entity would need to be formed under applicable state law.  Typically, non-profit corporations are the best fit for the entity form.  The charitable foundation would need to abide by all the requirements under state law to be a viable entity and for its corporate separateness to be respected.  This means that the foundation should have bylaws, regular board meetings with minutes, and separate bank accounts, to name a few.

The foundation also would file an exemption application with the Internal Revenue Service using the Form 1023 series to seek a determination that the foundation is exempt from taxation under Section 501(c)(3).

And the foundation may be subject to state charitable registration requirements if it will be soliciting charitable donations.   It also may need to register in other states if its activities will be crossing state lines.  Foundations, like other corporate entities, are subject to annual filing and reporting requirements with the state and federal governments.

Thus, like all other employee benefits that require on-going maintenance and attention, a charitable foundation is no different.  There are start-up costs, and on-going costs.  But, for your employees, this atypical “benefit” really could make a difference both inside and outside your Company.

We recently informed you that the IRS reduced the 2018 health savings account (“HSA”) contribution limit for individuals with family coverage to $6,850.00 despite having previously announced that such limit was $6,900.  Because of compelling comments from stakeholders, the IRS reversed this decision in Revenue Procedure 2018-27 and the contribution limit for individuals with family coverage has reverted back to $6,900 for 2018.  The Revenue Procedure contains helpful guidance regarding how any distributions made in response to the reduced limit published in Revenue Procedure 2018-18 can be undone.

Ultimately, the IRS acknowledged the hardship and cost associated with the lower limit and reasonably reverted to the higher, previously announced, limit.

This is the seventh article in our series covering various tax and employee benefits-related changes contained in the Tax Cuts and Jobs Act signed by the President on December 22, 2017.

Once significant change made by the Act, summarized below, is the elimination of the Affordable Care Act’s individual mandate, effective 2019.

Background

Long an unpopular feature of the ACA, the individual mandate requires most Americans (other than those who qualify for a hardship exemption) to purchase a minimum level of health coverage. Those who fail to do so are liable for a penalty of $695 for an adult or 2.5 percent of household income, whichever is greater.

The Act accomplished the elimination of the individual mandated by reducing the penalty amounts to $0 and zero percent, respectively.

Although often cited as an egregious example of government over-reach, the individual mandate does not impact the majority of Americans, specifically those who receive their health coverage through their employers or through public programs such as Medicare and Medicaid.

Impact of Elimination

The nonpartisan Congressional Budget Office (“CBO”) projects that the elimination of the individual mandate will spare taxpayers $43 billion in penalties that they would otherwise have paid through 2027. The CBO also projects that the elimination will result in 4 million people dropping health insurance coverage in 2019, with 13 million more becoming uninsured by 2027.

The elimination is expected to save the government $300 billion over the next ten years, in the form of fewer people receiving insurance subsidies or Medicaid, according to the CBO.

The CBO estimates that marketplace premiums will rise 10 percent without the individual mandate.

Employer Mandate and Other ACA Features Still in Place

The Act leaves many aspects of the ACA intact, including the individual marketplace, premium subsidies for those earning between 100% and 400% of the federal poverty rate, the ban on insurers charging more or denying coverage based on health factors, and Medicaid expansion.

Most significantly for employers, however, is the employer mandate and reporting requirements, which remain in force. Accordingly, applicable large employers will need to plan around the Code section 4980H(a) (“A”) penalty — which can apply if an employer does not offer minimum essential coverage to at least 95% of its full-time employees and at least one full-time employee buys subsidized marketplace coverage — and the Code section 4980H(b) (“B”) penalty — which can apply if an employer offers full-time employees coverage that is not affordable or does not meet minimum value requirements.

In 2018, A penalty is $2,320 (or $193.33 per month) multiplied by the total number of full-time employees (minus 30). The B penalty is $3,480 (or $290 per month) for each full-time employee who buys subsidized marketplace coverage (capped by the amount of the A penalty).

On November 2, 2017, the U.S. House of Representatives unveiled the Tax Cuts and Jobs Act (H.R. 1) (the “Bill”) as part of proposed tax reform legislation. The Bill is sweeping in scope and provides for significant changes to the U.S. Internal Revenue Code (the “Code”), including in the area of executive compensation and employee benefits.

Executive Compensation

The Bill makes far-reaching changes in the executive compensation arena, which would curtail employees’ ability to defer taxation of compensation and incentive awards (other than under a tax-qualified retirement plan) and employers’ ability to provide fully tax-deductible compensation to their executives. If enacted in its current form, it will require fundamental rethinking and restructuring of many present-day incentive compensation packages.  Some highlights of the Bill are as follows:

  1. The Bill requires that nonqualified deferred compensation (which under the Bill includes stock options and stock appreciation rights which are generally excluded from such definition under current guidance) attributable to services performed after 2017 be subject to income tax when it is no longer subject to a substantial risk of forfeiture (i.e., when it vests, rather than when it is subsequently paid, as is currently permitted under Code Section 409A). For this purpose, only a condition requiring the future performance of substantial services will generally constitute a substantial risk of forfeiture. The Bill “grandfathers” existing nonqualified deferred compensation arrangements until 2025, at which time they will also become subject to the foregoing rules. Note that an amendment to the Bill released by the House Ways and Means Chairman Kevin Brady includes a watering-down of some of these requirements as it provides that certain employees of non-public companies who receive stock options or restricted stock units as compensation for the performance of services may elect to defer recognition of income for up to 5 years.
  2. The Bill greatly expands the reach of Code Section 162(m) (which denies a corporate deduction for compensation in excess of $1 million paid to certain top executives of publicly traded companies) by eliminating current exceptions from this rule for performance-based compensation and broadening its application in various other respects.
  3. The Bill also imposes an excise tax on compensation in excess of $1 million paid by tax-exempt employers to their five highest paid employees, as well as on certain payments contingent on separation from employment paid to such employees.

Employee Benefits

Though relatively less sweeping, the Bill also makes various changes to the current tax rules governing various employee benefit arrangements (and a number of these changes are beneficial to employees):

  1. The Bill removes taxpayers’ ability to change the tax characterization (Roth or traditional) of their contributions to individual retirement accounts (IRAs).
  2. The Bill reduces the age at which in-service distributions are permitted under defined benefit plans (as well as certain state and local government plans) from age 62 to age 59 ½.
  3. The Bill makes various changes to the rules governing participant hardship distributions under retirement plans, which would likely have the effect of facilitating larger and more frequent hardship distributions.
  4. The Bill extends the deadline for individuals who leave employment, or whose plan terminates while they are employed, to roll over their outstanding plan loan balances to an IRA in order to avoid adverse tax treatment.
  5. The Bill grants relief from nondiscrimination testing and certain other qualification requirements for some defined benefit retirement plans.
  6. The Bill limits the deductibility or exclusion of certain employer-provided fringe benefits.
  7. The Bill eliminates dependent care assistance programs, although a recent amendment to the Bill would continue the exclusion for up to $5,000 of employer-provided dependent-care assistance through Dec. 31, 2022.

If the Bill were to be passed in current form, the foregoing changes would generally apply to taxpayers beginning in 2018. However, as the Bill progresses through Congress, we expect that these provisions will undergo further revision and evolution.  Although it is too early to speculate about the final form of the Bill, it could ultimately require employers to perform a comprehensive review and restructuring of their executive compensation practices and benefit plans.

We will provide further updates as this legislation develops.

Frequently a plan sponsor’s operational failure to follow the terms of its 401(k) or other qualified plan can be corrected under the IRS’s Employee Plans Compliance Resolution System (“EPCRS”) (described at http://www.irs.gov/Retirement-Plans/EPCRS-Overview) with a retroactive amendment instead of a sometimes expensive financial correction. This possibility should not be surprising, given that the maintenance of qualified plans depends heavily on IRS rules and procedures that permit plan sponsors to keep plan documents in compliance with all legally required written provisions by retroactively adopting required restatements and amendments. Apart from what the plan document states, however, the IRS also considers any uncorrected failure to follow the terms of the plan to constitute a qualification defect that threatens the current income exemption and other tax benefits of the plan.

Under EPCRS, a few operational failures, such as making hardship distributions or plan loans from a plan that has no plan terms allowing such distributions or loans, may be self-corrected by the plan sponsor with a retroactive amendment. In general, however, a retroactive amendment fix will require the employer or other sponsor to submit an application to the IRS under the Voluntary Correction Program (“VCP”) to get IRS approval.

As a threshold requirement, the way the plan was actually operated must have been permissible under the law and regulations in order to obtain approval for a retroactive amendment conforming the plan terms to that operation. For example, a retroactive amendment can be considered if a 401(k) plan actually allowed deferrals on bonuses even though the plan’s definition of compensation did not include bonuses, because the plan could have so provided under the law. If the plan was a prototype or volume submitter, then the amendment must also be permitted under the vendor’s pre-approved document.

IRS standards for approving a retroactive amendment fix are not formally set out anywhere. In practice, however, the IRS normally needs to see some convincing documentary evidence indicating that the way the plan was actually operated was the way the sponsor, participants and any relevant TPAs or vendors assumed the plan was written. A summary plan description (“SPD”) that provides for the particular event or practice that occurred is usually considered the best evidence. However, other good evidence might be emails, internal memoranda or correspondence that reflect the way some or all parties thought the plan actually read.

A retroactive amendment is often appropriate to correct a failure to follow plan terms that occurs after a sponsor restates its plan on the pre-approved form of a new vendor as part of a change in plan investments and/or administrative services. In such cases, even though it is clear from the record that no plan design change was intended in conjunction with the vendor change, the plan is sometimes incorrectly mapped over to the new document. The IRS frequently approves a retroactive amendment in such cases as long as the amendment is permissible under the vendor’s document.

The Internal Revenue Service encourages employers and other retirement plan sponsors to voluntarily and timely correct plan failures to help ensure the plans’ ongoing tax-qualified status (and tax-favored treatment). However, in some cases, the IRS’ Employee Plans Compliance Resolution System (“EPCRS” – most recently restated in Revenue Procedure 2013-12) correction method for minor errors results in substantial costs to employers relative to the errors being fixed and a windfall to affected participants.

As discussed below, the IRS provides employers with new (and less costly) options for correcting certain elective deferral failures in Revenue Procedure 2015-28. In addition, in Revenue Procedure 2015-27, the IRS modifies and clarifies certain guidance for correcting retirement plan qualification failures. Instead of entirely replacing the current EPCRS program, this new revenue procedure clarifies overpayment recoupment rules, modifies the self-correction rules regarding certain annual addition failures, and lowers the fees for certain voluntary correction submissions, among other things.

Failure Related to Automatic Contribution Features.  When an employer fails to implement an automatic deferral (including elective deferrals made in lieu of automatic deferrals which were not implemented properly) under the EPCRS, the employer generally is required to make a qualified nonelective contribution to make up for the missed deferral opportunity by contributing 50% of the missed deferral amount. The employer is also required to make up any missed matching contributions and missed earnings. In RP 2015-28, the IRS appears to acknowledge the inequity of this provision and provides an alternative correction method which eliminates the requirement for employers to make this 50% of the missed deferral contribution as long as certain correction timing and notice requirements are satisfied. RP 2015-28 also allows the employer to use the plan’s default investment alternative’s performance to determine lost earnings on missed matching contributions, if any, significantly simplifying this calculation.

Brief Failures. The modification to the EPCRS also allows employers to correct brief (up to 3 months) elective deferral failures without making a contribution for the lost deferral opportunity, subject to correction timing and notice requirements. Similarly, the modification to the EPCRS provides for a reduced employer contribution (25% of the affected employee’s missed deferral) if the elective deferral failure is not “brief”, but is timely corrected within a limited period in accordance with the EPCRS and the notice requirements are met.

 Plan Overpayment Failures. When a plan participant receives a greater benefit than the benefit to which he or she is entitled under the plan terms, the overpayment may be corrected by having the participant repay the plan or by reducing future benefit payments to the participant. Large overpayment recoupments have resulted in financial hardships – particularly in cases where periodic pension overpayments continued for many years. RP 2015-27 clarifies the existing rules for overpayments paid to plan participants by stating that plan sponsors have some flexibility to correct overpayments and that plans aren’t required to recoup overpayments in every situation. Depending on the facts and circumstances, it may be appropriate for the employer itself (or another party, if at fault) to restore the overpayment amount to the plan or to retroactively amend the plan to conform with the overpayment (which still would require submission to the IRS under the Voluntary Correction Program). The IRS seeks public comments on the circumstances in which employers should be required to restore the overpayment amount.

Excess Annual Addition Failures. The annual addition (the amount that may be contributed by the employer and employee to an employee’s 401(k) or 403(b) plan account) is limited by Internal Revenue Code section 415(c). RP 2015-27 modifies RP 2013-12 to permit plan sponsors to use the Self Correction Program to correct excess annual additions – even recurring excess annual additions – if the plan only has elective deferrals and nonelective contributions (but not plans that have matching contributions). The timeframe for distributing excess annual additions is increased to 9 ½ months (instead of 2 ½ months).

Fees For Correcting Minimum Distribution and Loan Failures. Generally, the Voluntary Correction Program fee is based on the number of participants such that, depending on the number of participants, an employer would have to pay a VCP fee of anywhere from $750 (plans with no more than 20 participants) to $25,000 (plans with over 10,000 participants). RP 2015-27 lowers the VCP fee where the sole failure being corrected under VCP is late payment of required minimum distributions and affects no more than 300 plan participants.   If the employer meets the conditions for the reduced VCP fees, the fee would be $1,500 for minimum distribution failures involving 151 to 300 participants and only $500 for minimum distribution failures involving no more than 150 participants.

If the only failure involves loan failures that affect no more than 25% of participants, the general VCP fee – based on the number of participants as set forth in RP 2013-12 – is reduced by 50%. RP 2015-27 sets the VCP fee at $3,000 where over 150 loan failures are being corrected and at $300 where no more than 13 loan failures are being corrected.   (Self correction, without a VCP filing, still is not available for loan failures.)

Conclusion.

While RP 2015-27 and RP 2015-28 make the IRS’ correction program easier to use and less costly in certain ways, additional flexibility and fee relief would be welcome for employers seeking to ensure continuation of employee retirement benefit programs.

Especially during the holidays, but also throughout the year, both employers and employees often seek a means of financially assisting distressed coworkers and their families. The various methods of targeting relief to employees are summarized in IRS Publication 3833, DISASTER RELIEF, PROVIDING ASSISTANCE THROUGH CHARITABLE ORGANIZATIONS at http://www.irs.gov/pub/irs-pdf/p3833.pdf.  Some employers establish a “donor-advised fund” or other similar account at a local “community foundation” in order to target assistance to members of the company “family” who are in need due to some financial or medical setback or circumstance. Many moderate to large-sized companies, however, have established their own charitable employee relief organizations to perform this function.

A Company Workforce as a “Charitable Class”

Since Hurricane Katrina, the IRS has recognized significantly smaller employee populations than previously as a qualifying “charitable class” that can be benefited by a 501(c)(3) company-sponsored organization.  The benefited class must be the indefinite open-ended group of current and future employees, rather than a specific group of existing employees.

The Benefits of Public Charity Status

A 501(c)(3) employee relief charity will be classified as a “private foundation” unless it meets the requirements to qualify as the generally more tax-favored and flexible “public charity.”  Deductible contributions to a public charity are capped at a higher limit than those for private foundations. Private foundations must also comply with more burdensome regulations and restrictions on their investments and grants than do public charities.

Company private foundations can provide employee financial relief only in the case of “qualified disasters” designated under federal law, but if an organization qualifies as a public charity it can provide such relief in virtually any kind of disaster or personal emergency hardship situation.  Recipients must be selected based on objective determinations of need or distress by an independent selection committee or some other procedure that ensures any benefit to the employer is incidental.  In short, the relief granted cannot be a disguised “employee benefit” or entitlement even though it may, and should, cause the company to be deemed a more desirable place to work.

Establishing “Public Support”

To establish public charity status, the organization must normally not receive more than one-third of its support from gross investment income and must normally receive more than one-third of its support from contributions by employees (through payroll deduction or otherwise), other public charities, governmental units and/or the general public.  Generous employer contributions may need to qualify as isolated or “unusual” grants in order to meet this one-third test.   Fundraising activities for an employee relief charity can include golf tournaments or other similar events.  Employees may make payroll deduction contributions or donate unused PTO dollars. The employee may deduct these just like contributions to the United Way.

A company employee relief charity can build workforce morale in a way that complements other employee benefits offerings.  The unbenefit can be a real continuing benefit for both employees and employers.  Happy Holidays!