The U.S. Department of Labor (“DOL”) and the Internal Revenue Service (“IRS”) routinely report common operational failures that such agencies detect in the context of retirement plan audits and investigations.  One of the operational failures that is always at or near the top of that list concerns plan sponsors failing to employ the correct definition of compensation for purposes of performing necessary compliance testing and/or determining benefit allocations.  The following article is intended to briefly highlight some of the issues that can occur when the incorrect definition of compensation is employed as well as to provide an explanation of some of the differences between the most commonly employed definitions of compensation.

Impact of Employing the Incorrect Definition of Compensation

As suggested above, utilizing the correct compensation for each retirement plan participant is very important.  This is because compensation is a critical data point which is necessary in order to accurately calculate many different plan limits and make proper benefit calculations.  Sometimes problems occur if a plan sponsor fails to limit compensation to the maximum amount which may be considered for tax-qualified retirement plan purposes under the Internal Revenue Code.  In other situations, a plan sponsor may not understand what types of income are included within the definition of compensation.  In still other circumstances, a plan sponsor may not realize that different definitions of compensation are employed for different plan purposes.  When mistakes such as these occur, tax-qualification defects often result.

As a more specific example, compensation is employed to calculate the Average Deferral Percentage (“ADP”) and Actual Contribution Percentage (“ACP”) tests (the tests that limit the amount of “elective deferrals” and “employer matching” contribution that can be received by plan participants during a plan year).  If such tests are not performed accurately, a failing test may appear to be passing or an incorrect distributable amount may be calculated to “correct” a failing test.  Inaccurate compensation data would also result in the inaccurate calculation of salary deferral, employer matching and employer profit sharing contribution amounts.

As a result of these concerns, plan sponsors should be familiar with the terms of the plan document to ensure that they use the proper definition of compensation for nondiscrimination testing, deferral and contribution calculations and limitation purposes. It is important to recognize whether: 1) certain types of compensation are excluded for specific plan purposes; 2) compensation is limited for specific plan purposes; and/or 3) compensation is determined using different computation periods (i.e., plan year vs. calendar year).

Failure to follow the terms of the plan document, properly limit the maximum considerable compensation under the Code or satisfy the ADP and/or ACP tests are problematic and, if possible, should be corrected as soon as possible under the “Employee Plans Compliance Resolution System” (“EPCRS”) as sponsored by the IRS.  Failure to do so can result in severe consequences which, in extreme circumstances, can lead to significant penalties up to and including plan “disqualification” (the immediate taxation of the trust of the plan at issue, the immediate taxation of the participants on their assets held by such plan and the loss of the employer’s tax deduction on contributions to such plan for all “open” plan years).

Differences Between Commonly Employed Definitions of Compensation

In order to assist in illustrating some of the differences between commonly employed definitions of compensation, we have created the following chart.  However, please be aware that this chart is only a brief summary of some of the differences between the most commonly employed definitions of compensation and is by no means complete.

As much as we hope this article helped you to better understand this topic, it is not to be construed as financial, tax or legal advice.  Therefore, if you believe that the issues discussed herein may apply to your (or your client’s) company, be sure to further discuss it with a qualified retirement plan professional; more specifically, your tax and/or accounting professional.  For more information about this topic, please contact our marketing department at 484-483-1044 or your administrator at Legacy.

Each year qualified retirement plans must successfully navigate through a myriad of deadlines and due dates.  One of the most important deadlines for most plan types relates to the Department of Labor’s annual filing of the Form 5500.  Each Form 5500 must accurately reflect the characteristics and operations of the plan or arrangement being reported. The requirements for completing the Form 5500 will vary according to the type of plan or arrangement. This filing is due by the end of the 7th month following the end of the plan year; for calendar plan years this is July 31st.  A plan may obtain a one-time extension of time to file a Form 5500 annual return/report (up to 2½ months) by filing IRS Form 5558, Application for Extension of Time To File Certain Employee Plan Returns, on or before the normal due date, thereby making the extended due date October 15th for calendar year plans.

As a plan sponsor or financial advisor, it is paramount that you maintain an open line of communication with your TPA or recordkeeper responsible for preparing this filing in order to avoid potential penalties and fines from both the Internal Revenue Service (IRS) and the Department of Labor (DOL).  In order to avoid delays in the preparation and filing of the form, here are some things you can do as the plan sponsor to assist your service provider.

• Return your census and annual questionnaire to your TPA in a timely manner.
• Evaluate and amend your plan’s Fidelity bond requirements with your insurance provider and share any changes in coverage with your TPA.
• If you are a large plan requiring an audit, engage an independent auditing firm early in the year and schedule the audit to occur at least two months prior to the deadline or extended deadline to file the 5500.
• Make sure that you know your DOL assigned UserID and PIN number when the filing is ready to be signed and electronically submitted.

  Administrative Penalties:

1. A penalty of up to $2,586 a day (or higher amount if adjusted pursuant to the Federal Civil Penalties Inflation Adjustment Act of 1990, as amended) for each day a plan administrator fails or refuses to file a complete report. See ERISA section 502(c)(2) and 29 CFR 2560.502c-2.
2. A penalty of $250 a day (up to $150,000) for not filing returns for certain plans of deferred compensation, trusts and annuities, and bond purchase plans by the due date(s). See Code section 6652(e).
3. A penalty of $1,000 for not filing an actuarial statement (Schedule MB (Form 5500) or Schedule SB (Form 5500)) required by the applicable instructions. See Code section 6692.

Other Penalties:

1. Any individual who willfully violates any provision of Part 1 of Title I of ERISA shall on conviction be fined not more than $100,000 or imprisoned not more than 10 years, or both. See ERISA section 501.
2. A penalty up to $10,000, five (5) years imprisonment, or both, may be imposed for making any false statement or representation of fact, knowing it to be false, or for knowingly concealing or not disclosing any fact required by ERISA. See section 1027, Title 18, U.S. Code, as amended by section 111 of ERISA.

Failure to file your Form 5500 in a timely manner can be costly if not handled properly.  The fines and penalties can be mitigated through the Delinquent Filers Voluntary Correction (DFVC) program at a reduced rate in most circumstances.  Legacy Retirement Solutions specializes in assisting plans who have failed to timely file their Form 5500, call us for assistance today.

With the ever increasing need for complete disclosure; managing and maintaining all of the documents, forms, testing results, tax filings, etc. has become a daunting and exhaustive task.  In addition, the regulatory agencies charged with auditing and investigating retirement plans continue to raise their expectations with respect to the formal policies and procedures implemented and maintained by retirement Plan Sponsors in order to facilitate the compliant operation of their plan.

Legacy is here to help your Company satisfy these requirements and expectations by offering 3 different levels of Plan Year Compliance reporting for the Defined Contribution plans from our Standard and our Plus, right up to our Premium.  Each Plan Year report is designed to help your Company maintain a “single source” organized and streamlined record of a prior Plan Year’s operation.  We also have a compliance package for our Defined Benefit/Cash Balance Plans. Below is a listing of each Plan Year Compliance package offered along with a list of included reports and pricing.  Please contact us for more information.

 *If applicable and subject to third-party provision of such documents, if necessary