RSM McGladrey ESOP Blog

An expected but still sad development for the Antioch ESOP

Of course we knew this was coming - Workers sue top leaders at Antioch

It is just the latest chapter in what may have started as a happy employee ownership story but turned into a very sad story.

But what always frustrates me is the tone of these articles. I know that this is the plaintiffs making their case in public. And of course the defendants are not going to comment. But because of that, this manner of reporting these types of lawsuits comes across as so one-sided and unfair to ESOPs in general.

On this relatively unhappy note, I am taking off for the July 4th holiday and then a week of vacation. I will return later in July to continue the discussion of how to correct any operational errors relating to your ESOP.

Have a great 4th!

How to fix an error relating to the compensation definition

So now that you realize how precise and important the definition of compensation included in your ESOP document is to the qualification of your ESOP, what do you do if you find that the compensation actually used does not match the document’s definition?

As noted in prior posts, the IRS is definitely encouraging voluntary correction. So how would you correct an error like this? It depends upon the extent and nature of the error. Maybe it is isolated to an inadvertent omission of some bonus information for one year for a small group of participants. Or maybe it involves more participants and more years.

The first instance where the error is limited may be able to be fixed without even notifying the IRS.

The Self Correction Program (SCP) allows the employer to fix the failures without involving the IRS. There are no fees or penalties, and you are not required to submit anything to the IRS. 
• Only operational errors can be fixed under SCP. These are errors that happen because of how the plan was run in operation. In other words, the document itself meets the requirements, but there was an error in operating the plan (i.e., operations inconsistent with the plan terms).
• Practices and procedures must have been established and followed, and the failure arose due to an oversight or a mistake in applying them, or due to an inadequacy in the procedures.
• If the error is "significant" the Plan Sponsor must have received a favorable IRS determination letter with respect to the plan's tax qualified status.  Significant operational errors must be fixed within two years after the end of the plan year in which the operational failure occurred.
• Insignificant operational errors can be fixed at anytime, no matter how old. Insignificant operation errors can even be fixed during an IRS examination.
• The IRS uses a list of factors to determine if an error is considered significant or insignificant (e.g., whether other errors have occurred, number of years involved, number of participants involved and percentage of plan assets involved, etc.).

If the error is a failure to include some compensation for a few participants, the fix may be to make additional contributions on behalf of theses participants based on that inappropriately excluded compensation. That fix would meet the IRS’s general principles of putting the plan into the position that it would have been had the error not occurred and keeping assets in the plan.

More on your ESOP’s definition of compensation

On Monday, I indicated that there were 3 definitions of compensation that were considered to be nondiscriminatory. Isn’t that amazing? Isn’t compensation the same for all plans and all participants? Well, welcome to the complexity of our Internal Revenue Code!

So what are the basic differences between those three definitions?

The definition of W-2 compensation is exactly what you would expect – it is the compensation that must be reported on the annual Form W-2. (Note, as mentioned previously, most plans typically adjust all three definitions to add back the pre-tax contributions to 401(k) plans, cafeteria plans, etc. )

The federal income tax withholding definition would include all types of payments upon which the employer must withhold federal income taxes. In general, these would be the same items of compensation as in the W-2 definition. One difference would be group term life insurance premiums that are taxable to the employee. These must be included on the Form W-2 but are not subject to income tax withholding.

The current income definition under Code Section 415 is again substantially similar as it includes the most obvious components of compensation such as salary, bonuses etc. One difference here would be a distribution from a nonqualified deferred compensation plan. These amounts would be included in the first two definitions but could be excluded in the current income definition.

So you can see that the definition of compensation can be pretty precise. And it is important that you follow the definition of compensation provided for in your plan document down to each nitty gritty detail.

Grrrrrrr!

I saw this late yesterday - Owning too much company stock puts workers' retirement at risk

I chose not to post it right away because I was struggling with whether to distribute it further.

However, those of us in the ESOP community need to know that there are these opinions out there so we can rally together to fight such perceptions.

We know that there is evidence that employee ownership increases employee productivity, that companies that sponsor ESOPs typically have much richer benefit programs for their employees than non ESOP companies and on and on.

And thanks to The Employee Ownership Foundation, the NCEO and others, there will be more research coming that will likely support what we already know – ESOPs are generally good for companies and employees alike.

I will say that reading this article will be good to maintain the intensity level of my work outs in the near future.

Do you know your ESOP’s definition of compensation?

If you are like many ESOP sponsors, you get a request at the end of each year from your third party administrator (TPA) that asks for an employee census file that shows the compensation paid to each employee during such year. So you download a file from your payroll system and sent it off to the TPA. But did the compensation information that you just sent match the definition of compensation in your ESOP document?  For example, what if the definition in your ESOP document excludes bonuses? Did you remember to back those out of the file that you sent to the TPA?

If the information submitted to the TPA does not match the definition in your ESOP document, you have just committed one of the most common operational errors of retirement plan sponsors. Well, how hard can that be? Compensation is compensation right?

The good news is that a plan sponsor is afforded some flexibility in choosing a definition of compensation for purposes of the ESOP. But that can also be the bad news because once a definition is chosen, then that is the definition that must be used every year or you will be violating the terms of your plan document.

To start with, the following three definitions of compensation are deemed to be nondiscriminatory:
1. W-2 definition
2. federal income tax withholding definition, and
3. the current income definition under Code §415.

I will provide more information on the above definitions later.

Another definition can be used if can pass a special nondiscrimination test. So for example, your ESOP’s definition could possibly exclude bonuses as long as this special nondiscrimination test is satisfied.

Also, it is fairly common to for a plan document to specify that only compensation paid after a new participant actually enters the plan will be considered.  So you need to know your ESOP’s eligibility provisions and entry dates to be able to accurately determine the compensation to be used for ESOP allocations.

Just imagine that you have new staff in your HR department and they get the request from the ESOP TPA for an employee census file. Will they know to read the ESOP document to determine exactly what information to send to the TPA?

IRS To Focus on Qualified Retirement Plan Failures

Here is a piece that is very much related to the discussion that I have just started - IRS To Focus on Qualified Retirement Plan Failures.

It includes the following which clearly illustrates the value of finding and correcting any operational failures on your own.

"Because the failures were uncovered during an IRS audit, in addition to making the required correction the plan sponsor was required to pay a penalty that was 8 times higher than the fee which would have applied for a voluntary compliance prior to notice of the IRS audit. The pre-negotiation penalty asserted by the IRS was about 16 times the voluntary compliance fee."

I plan to discuss some of the common operational failures in future posts.

So how do I fix a plan amendment failure?

Let’s say that you discover that your ESOP is missing one of the amendments that I mentioned in yesterday’s post. Now what? This is where that IRS voluntary correction program comes in. And the good news is that the IRS realizes that these failures do occur. In fact, the following is from their website:

“One of the most common qualification failures currently resolved under the Voluntary Correction Program (VCP) is the nonamender failure occurring in individually designed plans. The term “nonamender failure” includes a failure to adopt timely required good faith plan amendments under the Economic Growth and Tax Relief Reconciliation Act of 2001, Pub. L. 107-16 (EGTRRA good faith amendments), interim, and certain other plan amendments.”

The correction is pretty easy if the failure relates to an EGTRRA good faith, interim or optional amendment. The IRS has a streamlined application for these types of failures.

On the other hand, if the failure relates to the GUST restatement due back in 2002 or a failure to amend within your designated Cycle (see yesterday’s post), the process is more involved.

Still the best course of action if you find that your ESOP has not had one of the necessary amendments is to get the problem fixed by using the IRS’s voluntary correction program as soon as possible.

Required amendments to your ESOP document

I want to start our discussion of common operational errors with a common error that is not really operational in nature.  Sorry for the confusion but it seems like a logical starting place in this discussion is the ESOP plan document.

The importance of your ESOP document can not be overstated. And it is equally important that you maintain the qualified status of your ESOP by adopting all amendments required by legislative or regulatory changes on a timely basis. Failure to do so could disqualify your ESOP.

Here is a list of the amendments that have been required over the past several years:
 GUST Restatement and Good Faith EGTRRA amendment – must have been adopted by February 28, 2002
 Required Minimum Distributions amendment – must have been adopted by the last day of plan year ending on or after December 31, 2003. 
 Mandatory distributions (a.k.a. Automatic Rollover amendment) required for plans containing automatic cash-out provisions– must have been adopted by the later of the last day of first plan year ending on or after 3/28/05, December 31, 2005, or the plan sponsor’s tax filing due date (including extensions) for the first tax year that ends on or after March 28, 2005.
 Final 415 Regulation Amendment - must have been adopted by the later of the last day of the plan’s “Limitation Year” (see plan document to determine limitation year) ending on or after July 1, 2007; or the plan sponsor’s tax filing due date, including extensions, for the first tax year that begins after June 30, 2007.   For corporate employer’s with calendar tax years, due date is March 15, 2009, or if corporate tax return is extended, September 15, 2009.

Note, there are some additional amendments that would have been applicable for your 401(k) plan and any defined benefit plan.

Also, if you prepare an amendment to your ESOP that is not required but rather is a discretionary change to the design of the ESOP, please make sure that these amendments are also signed on a timely basis. If you inadvertently forget to have these amendments approved and signed but begin to operate the ESOP in accordance with such amendment, your ESOP could now be disqualified for the failure to follow the terms of the plan document.

The timing of the entire restatement of your ESOP document is now based on the last digit of your company's EIN as follows:

Extension of the EGTRRA Remedial Amendment Period and Schedule of Next Five-Year Remedial Amendment Cycle
If the EIN of the employer ends in —	The plan’s cycle is —	The last day of the initial cycle (i.e., EGTRRA remedial amendment period) is —	The next five-year remedial amendment cycle ends on —
1 or 6	Cycle A	January 31, 2007	January 31, 2012
2 or 7	Cycle B	January 31, 2008	January 31, 2013
3 or 8	Cycle C	January 31, 2009	January 31, 2014
4 or 9	Cycle D	January 31, 2010	January 31, 2015
5 or 0	Cycle E	January 31, 2011	January 31, 2016