United States: Prohibited Transactions 101 - Avoiding Late Remittances

Department of Labor (DOL) regulations related to pension plans are aimed primarily at protecting employees and their retirement savings. The regulations restrict who can do business with a pension plan and which types of transactions are allowed. Prohibited parties (also called parties in interest) include the employer, the union, plan fiduciaries and service providers, as well as owners, officers and the relatives of parties in interest. Prohibited transactions include a sale or lease between the plan and a party in interest, loans of money between the plan and a party in interest, and the furnishing of goods or services between the plan and a party in interest.

The DOL continues to audit pension plans and can impose civil penalties (including excise taxes payable to the IRS) on prohibited transactions related to late remittance of employee contributions to retirement plans. Through its regulations, the DOL defines not only plan assets but also when contributions are considered plan assets.

The general rule is that the "assets of a plan include amounts that a participant pays to an employer, or amounts that a participant has withheld from his wages by an employer, for contribution to the plan as of the earliest date on which such contributions can reasonably be segregated from the employer's general assets." This earliest date may be no later than the 15th business day of the month following the month in which the employer withholds or receives participant contributions.

When an employee's deferrals (and where applicable, loan repayments) are not transmitted on time to the plan in accordance with these rules, the employer is deemed to have temporarily used plan assets for its own business purposes. In essence, the employer is viewed as having taken a loan from the plan — a prohibited transaction.

Despite DOL outreach efforts and observations from plan auditors, many plan sponsors still have questions related to timely deposits of employees' contributions to pension plans (primarily to 401(k) and 403(b) plans). In particular, sponsors continue to mistakenly treat the "15th business day" rule as a safe harbor and to believe that errors relating to a small amount of employee contributions do not need to be corrected.

Required time to deposit employee contributions

The date when participant contributions can reasonably be segregated from the employer's general assets is usually earlier than the maximum time period under the rules. The DOL warns that when contributions can reasonably be segregated from the employer's general assets in a shorter time period, a delay in forwarding the contributions — even a delay that does not exceed the maximum time period under the regulation — may result in a prohibited transaction.

To make the plan whole, employers who fail to deposit contributions in a timely way are required first to deposit all employee contributions and then make a payment to the plan that equals a defined amount of interest the plan would have earned if the late remittance had actually been a loan. The interest amount is computed using an online calculator provided on the DOL's website and is calculated from the date the contribution could have reasonably been remitted to the plan, to the date the contribution actually was remitted.

To manage the remittance process effectively and avoid the correction process, plan sponsors should document the earliest date on which the contributions could have reasonably been segregated from the general assets. This documentation may consist of a withholding and remittance history, a description of the withholding and remittance process, and a notation regarding the minimum time between withholding and remittance. The process can then be managed proactively within timing perimeters.

De minimis amount for correction

There is no material or minimum amount of late contributions or lost earnings that requires a correction. The DOL has exercised its discretion on an ad hoc basis and has not required the correction process after it is contacted by plan sponsors who have had very small errors. However, there is no dollar or percentage amount established as a correction threshold. Correcting late remittances may be an administrative burden — or just inconvenient. Neither is a defense for failure to correct delinquent deposits.

VFCP or IRS Form 5330

Failure to remit employee contributions in a timely way may be voluntarily corrected under the DOL's Voluntary Fiduciary Correction Program (VFCP). Because this failure also violates Section 4975 of the Internal Revenue Code, an excise tax return is generally required, on Form 5330, "Return of Excise Taxes Related to Employee Benefit Plans." The excise tax is computed as 15% of the "amount involved," generally the amount of interest owed by the plan sponsor.

If sponsors elect to file the correction under the VFCP, the DOL may waive the requirement that the sponsor pay the excise tax. To obtain this waiver, the sponsor generally must notify plan participants of the failure and its correction. For excise tax amounts of less than $100, sponsors may obtain the waiver by documenting the amount to the DOL and contributing the amount to the plan. If the excise tax is very small, the DOL may waive the tax entirely.

Although some parties have asked the DOL for a simplified self-correction process for late remittances, the DOL has not approved any such simplification at this time.

Plan sponsors who face this issue regularly should consider implementing procedures to streamline the remittance process so that employee contributions and loan repayments can be deposited within an acceptable time. This is a best practice recommendation that requires dedicated internal resources. Yet that commitment is less burdensome than complying with the administrative requirements of the correction process.

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This document was written to support the promotion or marketing of professional services by Grant Thornton LLP, and is not written tax advice directed at the particular facts and circumstances of any person. Persons interested in the subject matter of this promotion or marketing document are encouraged to contact Grant Thornton to discuss the potential application of the subject matter herein to their particular facts and circumstances or seek advice from an independent tax advisor. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed herein. To the extent this document may be considered to contain written tax advice, in accordance with applicable professional regulations, please understand that, unless expressly stated otherwise, any written advice contained in, forwarded with, or attached to this document is not intended or written by Grant Thornton LLP to be used, and cannot be used, by any person for the purpose of avoiding any penalties that may be imposed under the Internal Revenue Code.

The information contained herein is general in nature and is based on authorities that are subject to change. It is not, and should not be construed as, accounting, legal or tax advice or opinion provided by Grant Thornton LLP to the reader. This material may not be applicable to, or suitable for, specific circumstances or needs, and may require consideration of non-tax factors and tax factors not described herein. Contact Grant Thornton LLP or other tax professionals prior to taking any action based upon this information. Changes in tax laws or other factors could affect, on a prospective or retroactive basis, the information contained herein; Grant Thornton LLP assumes no obligation to inform the reader of any such changes. All references to Section, Sec., or § refer to the Internal Revenue Code of 1986, as amended.

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