Every qualified
retirement plan has a specific deadline by which employer
contributions must be deposited to the plan for each plan
year. However, the rules concerning participants'
contributions have not been as clear. For example, in 401(k)
plans, employees typically defer a portion of their weekly
or biweekly paychecks. How soon should these contributions
be deposited into the plan?
The question of when participant salary deferrals must be
deposited into the plan is a long-standing issue and one
about which the Department of Labor (DOL) has been quite
vocal. The DOL has also been very active and aggressive in
its enforcement in this area. Fortunately, final regulations
issued earlier this year have provided welcome guidance for
plans sponsored by small employers.
Plan Asset Rule
The regulation describing the deposit requirement is
sometimes referred to as the "plan asset rule" since it
actually specifies the timing within which participant
contributions are deemed to become assets of the plan. This
translates into a deposit deadline because it is considered
an illegal loan from the plan if an employer is still
holding those amounts on or after the date they are deemed
to be plan assets. Pre-tax salary deferrals and after-tax
employee contributions withheld from payroll as well as loan
repayments are considered participant contributions for
purposes of the rule.
General Deposit Timing Rule
There are two tests to determine when deferrals have
become plan assets and, thus, whether they have been timely
deposited. The better known of the two specifies that
deferrals become plan assets, at the latest, on the 15th
business day of the month following the month in which they
were withheld from employees' paychecks. For example, any
deferrals withheld during the month of May become plan
assets, at the latest, as of the 15th business day of June.
The second test provides that, if it is possible for a
plan sponsor to segregate deferrals from its general assets
earlier than the 15th business day of the following month,
then those deferrals become plan assets as soon as it is
reasonably possible to segregate such amounts. This rule
presents several operational issues to consider.
It is not uncommon for an employer to have several
payroll periods in a month but to wait to deposit salary
deferrals until after the final payroll of that month.
However, the DOL has indicated that, if it is
administratively possible to make a deposit within a certain
number of days following the final payroll of the month, it
should also be possible to make a deposit within the same
number of days after each mid-month payroll. Therefore, any
mid-month salary deferrals and loan repayments held and
deposited with the final monthly payroll would be considered
delinquent.
Example
ABC Company, Inc. has biweekly payroll with pay dates of
Friday, April 16 and Friday, April 30, 2010. Salary
deferrals for both pay periods are deposited on Wednesday,
May 5th. Since the date of deposit is only 3 business days
following the last pay date in April, the DOL would likely
assert that deferrals from the April 16th payroll should
have been deposited no later than April 21st and treat them
as 14 days delinquent.
The Confusion
Since what is "reasonably possible" is open to
interpretation, there has been a great deal of confusion in
the industry as to how to appropriately determine when
deferrals become plan assets. This confusion has been fueled
by inconsistent DOL enforcement of the issue. For example,
in some regions of the country, DOL investigators have
treated 10 to 12 calendar days following payroll as timely
while other regions have enforced a 3 to 5 calendar day
standard. They set the standard and require plan sponsors to
present evidence that a longer timeframe should be allowed.
To make matters more challenging, some DOL investigators
have claimed the rule requires that deferrals not only be
deposited within the requisite timeframe but also allocated
to participant accounts and invested. In an effort to comply
with such an ambiguous rule, some employers have gone to the
other extreme and deposited deferrals as soon as they knew
the amounts, even if prior to the actual payroll date.
While such an approach solves the DOL issue, it creates
another problem in that IRS regulations prohibit depositing
deferrals prior to the pay date to which they relate.
Safe Harbor Deadline Offers Welcome
Guidance for Small Plans
Earlier this year, the DOL finalized new regulations that
provide much needed clarity to this rule. In short, the new
regulations create a safe harbor timeframe in which to
deposit employee contributions and loan repayments. As long
as those amounts are deposited into the plan no later than
the 7th business day following payroll, they are deemed to
be timely, even if the employer is able to make the deposit
earlier.
The regulations also clarify that it is only the deposit,
not the allocation or investment, that must occur within the
requisite window.
While the new guidance removes much of the ambiguity,
there are several important points to note. First, as with
other plan-related safe harbors, the 7-day safe harbor is
optional. Employers who choose to make deposits outside of
this window or do so inadvertently lose reliance on the safe
harbor and are judged by the "as soon as reasonably
possible" standard which may call for a 3 to 5 day deposit
window. Thus, a deposit on the 8th day will not be
considered one day late—it will be 3 to 5 days late.
Second, the safe harbor is only available to plans with
fewer than 100 participants as of the first day of a given
plan year. While many plan sponsors may define a participant
as someone who is actively contributing to the plan, the DOL
considers anyone eligible to make contributions to be a
participant in addition to terminated employees who still
have plan balances. This means that larger plans cannot
assume that the DOL will consider deposits made within 7
business days to be timely.
What's the Worst that can Happen?
As noted above, the DOL treats late deposits as a loan of
plan assets to the plan sponsor. Such a loan is a
"prohibited transaction" (PT) and a breach of fiduciary
responsibility. As a PT, the delinquency subjects the plan
sponsor to a 15% excise tax. The excise tax is applied again
for each year (or portion of a year) in which the PT remains
uncorrected.
In addition, another PT, subject to its own excise tax,
is deemed to occur each year until correction is made. This
is often referred to as a cascading or pyramiding excise
tax. There is no proration based on the number of days that
elapse, so even though a PT occurs near the end of the year,
the full excise tax applies.
Form 5500 Reporting of Late Deposits
Late deposits are required to be reported each year on
Form 5500 (line 4a of Schedule H or I, whichever is
applicable). New rules imposing penalties on
service-providers who improperly complete Form 5500 make it
unlikely preparers will "look the other way" on this
reporting requirement even if the deposit is only a few days
late. In addition, CPAs who audit large plans are required
to review the timeliness of deferral deposits and note any
delinquencies in their reports.
As if the above isn't enough, the DOL issues monthly
press releases announcing lawsuits it has filed against
large and small companies alike for failure to timely remit
salary deferrals of amounts as low as $5,000.
Further, the DOL recently announced the Contributory Plan
Criminal Project that could result in criminal prosecution
of employers who "may convert employee payroll contributions
for their own personal use or may use employee contributions
to pay business expenses."
The Fix is In
Since there are numerous avenues for the DOL to become
aware of delinquencies, it is in an employer's best interest
to voluntarily take corrective action as soon as possible
before an investigator knocks at the door. The DOL's
Voluntary Fiduciary Correction Program (VFCP) provides
specific guidance on how to correct a late deposit.
Step 1
Deposit all outstanding delinquent amounts as soon as
possible.
Step 2
Provide an additional contribution to participants to
make them whole for any lost investment earnings. This is
required even if the stock market has had negative returns
during the timeframe in question.
The DOL provides an online calculator on its website to
use to determine the lost earnings amount. The following
information is required to use the calculator:
- Amount of late deferrals;
- Loss Date: The date the deferrals should have been
deposited;
- Recovery Date: The date the deferrals were actually
deposited; and
- Final Payment Date: The date the lost earnings amount
will be deposited.
If multiple payrolls are delinquent, each must be entered
separately into the calculator.
Step 3
Submit documentation of the correction to the DOL and
request a no-action letter.
Some employers choose to make the corrective
contributions but forego the formal submission. While that
approach may make the participants whole, the employer does
not have any assurance against DOL action and must still pay
the excise tax. As long as the deferrals in question were
not more than 180 days delinquent and the employer follows
VFCP to apply for a no-action letter, the excise tax is
waived.
Conclusion
The new safe harbor regulation greatly clarifies the
deposit requirement for employers that sponsor smaller
401(k) plans. Those who choose not to avail themselves of
this relief should carefully review their process for
transmitting employee contributions to their plans and
maintain careful documentation describing the amount of time
it takes to complete the process each pay period as well as
an explanation of why it cannot be completed more quickly.
The DOL has made it clear that it plans to continue
actively enforcing the deposit timing rules, to ensure
employee contributions are used for the purpose for which
they were intended. Therefore, it is important for all plan
sponsors to review their deposit procedures to ensure
contributions are being made on a timely basis.
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