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Faulty Form 5500 Filings and “Reasonable Cause”

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“My client who sponsors a 401(k) plan received a notice from the Department of Labor (DOL) that the DOL rejected the plan’s Form 5500 filing because it lacked certain required information. My client is now facing a $75,000 penalty.  Is there any way to correct this error and reduce the penalty?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare.  We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with an advisor in Illinois is representative of a common inquiry regarding faulty Form 5500 filings.

Highlights of Discussion

Unfortunately, since the plan sponsor has already received a formal notice from the DOL, the DOL’s Delinquent Filer Voluntary Correction Program (DFVCP) is not available to the sponsor to correct the failure with a minimal penalty. But—there still may be an option to correct the error and pay a lesser penalty using the “reasonable cause” argument.

The DOL is authorized to waive all or part of the civil penalty for a faulty Form 5500 filing if the plan sponsor demonstrates reasonable cause for its failure. The IRS has a similar waiver provision. Reasonable cause is based on all the facts and circumstances in the situation. The plan sponsor must establish it exercised all ordinary business care and prudence to meet the annual filing obligations but, nevertheless, was unable to comply with the duty within the prescribed time.

According to the IRS’s Delinquent Filing Penalty Relief Frequently Asked Questions, reasonable cause may include the following:

  • Fire, casualty, natural disaster, or other disturbances,
  • Inability to obtain records,
  • Death, serious illness, incapacitation or unavoidable absence of the taxpayer or a member of the taxpayer’s immediate family,
  • Other reasons that establish the plan sponsor used all ordinary business care and prudence to meet its filing obligations but, despite its best efforts, failed to meet the file standards.

RLC regularly works with a plan service provider who has had success using the reasonable cause argument when applicable. One example involved a plan sponsor that received a DOL notice rejecting its Form 5500 filing because the plan sponsor had not included the necessary audit report. According to the notice, the DOL was going to assess a $50,000 penalty. The plan service provider helped the plan sponsor draft a letter of reasonable cause, assisted with getting the audit done and refiled the Form 5500 within the prescribed 45-day correction window. As a result, the DOL lowered its penalty to $5,000.

Conclusion

Even in situations where the DFVCP can no longer be used because the plan sponsor has already received a DOL notice regarding a faulty Form 5500 filing, there still may be ways to lessen the penalty assessment by utilizing the reasonable cause argument.

© Copyright 2024 Retirement Learning Center, all rights reserved
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The New Way to Count Participants for Form 5500 Audits

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“I attended a conference where there seemed to be a great deal of confusion regarding the Department of Labor’s (DOL’s) newly released Form 5500 filing rules. One change relates to how plans count participants for the independent audit requirement. Can you clarify, please?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare.  We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with an advisor in Colorado is representative of a common inquiry regarding Form 5500 filing rules for defined contribution plans.

Highlights of Discussion

Perhaps the most important detail about the new Form 5500 filing rules is that they pertain to the 2023 plan year filing, which will be done in 2024. Plan sponsors must follow the current rules for the 2022 plan year filing.

The DOL requires sponsors of employee benefit plans subject to the annual Form 5500 series of returns and schedules to include an audit report from an independent qualified public accountant (IQPA). There is an exception to this requirement for “small plans” (i.e., those with fewer than 100 participants at the beginning of the plan year) (DOL Reg. 2520.104-46).  The current rules count individuals who are eligible to participate even if they have not elected to participate and do not have an account in the plan.

For plan years beginning on or after January 1, 2023, participant count for the audit waiver will be based on the number of participants with account balances at the beginning of the plan year. This change is intended to reduce the number of plans that need to have an audit, lower expenses for small plans and encourage more small employers to offer workplace retirement savings plans to their employees.

For both 2022 and 2023, a plan may qualify for the audit waiver even if there are more than 100 participants. Under the “80 to 120 Participant Rule,” if the number of participants covered under the plan as of the beginning of the plan year is between 80 and 120, and a small plan annual report was filed for the prior year, the plan administrator may elect to continue to file as a small plan and, therefore, qualify for the audit waiver.

For more information, please see the final regulations for Annual Reporting and Disclosure.

Conclusion

The Form 5500 filing regulations, among other things, change the method of counting participants for purposes of determining when a defined contribution plan must file as a small plan, which also factors into whether the plan may be exempt from the IQPA audit requirement. Specifically, for 2023 and later plan years, plans are directed to count only the number of participants/beneficiaries with account balances as of the beginning of the plan year, as compared to the current rule that counts all the employees eligible to participate in the plan.

 

 

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Distributions Affect Saver’s Tax Credit

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“My client wants to claim a Saver’s Tax Credit for 2022 but has taken some distributions in the past. Will those withdrawals affect the amount of credit for which he will qualify?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare.  We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with an advisor in Rhode Island is representative of a common inquiry regarding available tax credits for personal contributions to eligible plans.

Highlights of Discussion

This is a very important tax question for which your client should seek specific tax advice. Generally, yes, the amount of any contribution eligible for the Saver’s Credit is reduced by certain withdrawals taken for the last three years (See IRS Announcement 2001-106, Q&As 4 and 5). For example, for 2022 tax filings, distributions your client (and his spouse, if filing jointly) took after 2019 and before the due date of their 2022 tax return (including extensions) from the following types of plans will lower the credit amount:

  • Traditional IRAs,
  • Roth IRAs,
  • Achieving a Better Life Experience (ABLE) accounts,
  • 401(k) plans,
  • 403(b) plans,
  • Governmental 457(b) plans,
  • IRS Sec. 501(c)(18)(D) trusts created before June 25, 1959, to pay pension benefits,
  • Qualified plans under IRC Sec. 401(a),
  • Qualified annuities under IRC Sec. 403(a),
  • Simplified Employee Pension (SEP) IRA plans,
  • Savings Incentive Match Plans for Employees (SIMPLE) IRA plans,
  • the Federal Thrift Savings Plan (Federal TSP).

However, they should not count distributions

  • That are not taxable as the result of a rollover or a trustee-to-trustee transfer,
  • That are taxable as the result of an in-plan rollover to a designated Roth account,
  • From an eligible retirement plan (other than a Roth IRA) rolled over or converted to a Roth IRA,
  • That are loans from a qualified employer plan treated as a distribution,
  • Of excess contributions or deferrals (and income allocable to such contributions or deferrals),
  • Of contributions made to an IRA during a tax year and returned (with any income allocable to such contributions) on or before the due date (including extensions) for that tax year,
  • Of dividends paid on stock held by an employee stock ownership plan,
  • From a military retirement plan (other than the Federal TSP) or
  • From an inherited IRA by a nonspousal beneficiary.

Your client and his tax advisor can read details of the credit in IRS Form 8880, Credit for Qualified Retirement Savings Contributions instructions and here Saver’s Credit.

Currently, the credit

  • Equals an amount up to 50%, 20% or 10% of eligible taxpayer contributions capped at $2,000 ($4,000 if married filing jointly), depending on adjusted gross income (as reported on Form 1040, 1040SR or 1040N (making the maximum credit $1,000 or $2,000 if married filing jointly);
  • Relates to contributions taxpayers make to their traditional and/or Roth IRAs, or elective deferrals to a 401(k) or similar workplace retirement plan (other plans qualify so see full list below); and
  • Is claimed by a taxpayer on Form 8880, Credit for Qualified Retirement Savings Contributions.

Contributors can claim the Saver’s Credit for personal contributions (including voluntary after-tax contributions) made to

  • A traditional or Roth IRA;
  • 401(k),
  • SIMPLE IRA,
  • SARSEP,
  • 403(b),
  • Governmental 457(b),
  • Federal Thrift Savings Plan,
  • ABLE account* or
  • Tax-exempt, union pension benefit plan under IRC Sec. 501(c)(18)(D).

In general, the contribution tax credit is available to individuals who

  1. Are age 18 or older;
  2. Not a full-time student;
  3. Not claimed as a dependent on another person’s return; and
  4. Have income below a certain level (i.e., for 2022 tax filings, the amount on Form 1040, 1040-SR, or 1040-NR, line 11, is $34,000 or less ($51,000 if head of household, or $68,000 if married filing jointly).

2022 Saver’s Credit Income Levels

Credit Rate Married Filing Jointly Head of Household All Other Filers*
50% of your contribution AGI not more than $41,000 AGI not more than $30,750 AGI not more than $20,500
20% of your contribution $41,001- $44,000 $30,751 – $33,000 $20,501 – $22,000
10% of your contribution $44,001 – $68,000 $33,001 – $51,000 $22,001 – $34,000
0% of your contribution more than $68,000 more than $51,000 more than $34,000

*Single, married filing separately, or qualifying widow(er)

The IRS has a handy on-line “interview” that taxpayers may use to determine whether they are eligible for the credit.

Conclusion

Every deduction and tax credit counts these days. Many IRA owners and plan participants may be unaware of the retirement plan-related tax credits for which they may qualify. Seeking qualified tax advice is essential to ensure accurate calculations.

 

 

 

 

 

© Copyright 2024 Retirement Learning Center, all rights reserved
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A SIMPLE Switch

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“Can I terminate my SIMPLE IRA plan and start a 401(k) plan mid-year?”

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with a financial advisor from Minnesota is representative of a common inquiry related to SECURE Act 2.0 of 2022 (SECURE 2.0).

Highlights of the Discussion

That’s a straightforward question that, currently, has a problematic answer due to the “exclusive plan rule,” which says the SIMPLE must be the only plan the business maintains for the year. Problem solved—thanks to SECURE 2.0 for plan years beginning after December 31, 2023.

For the 2024 plan year and later plan years, employers may replace their SIMPLE IRA plans mid-year with what we will call an “eligible 401(k) replacement plan.” The annual deferral limits are different for the two plan types. Therefore, under the new rules, the participant’s annual deferral limit will be prorated (by day) between the SIMPLE IRA plan and the eligible 401(k) replacement plan for the year.

An eligible 401(k) replacement plan, for this purpose, is a

  • SIMPLE 401(k),
  • Safe Harbor 401(k),
  • 401(k) with a qualified automatic contribution arrangement (QACA), or
  • Starter 401(k) (new under SECURE 2.0).

 

Eligible 401(k) Replacement Plan Key Characteristics
A SIMPLE 401(k)
  • Employer has 100 or fewer employees
  • Must be the only plan maintained by the employer
  • Must file a Form 5500 annually
  • Voluntary employee deferrals
  • Mandatory employer contributions (generally, 3% match or 2% nonelective)
  • Immediate vesting for contribution types
  • Additional information at IRS SIMPLE 401k facts
Safe Harbor 401(k)
  • No limit on number of employees
  • Voluntary employee deferrals
  • Mandatory employer contributions—3 options
  1. Basic match: 100% percent match on deferrals up to 3% of compensation and a 50% match on deferrals between 3% and 5%
  2. Enhanced match:  At least equal to the aggregate match under the basic match formula (e.g., 100% match on deferrals of 4% compensation) or
  3. A 3% nonelective contribution
QACA 401(k)
  • No limit on number of employees
  • Automatic enrollment of at least 3% with automatic escalation of at least 1% annually after the initial period, to at least 6% up to a maximum of 15%
  • Mandatory employer contributions—2 options
  1. Matching contribution: 100% match on deferrals up to 1% of compensation and a 50% match on deferrals between 1% to 6% of compensation; or
  2. A 3% nonelective contribution
  • Two-year vesting schedule could apply to employer contributions
  • Standard Form 5500 filing rules apply
  • Additional information IRS QACA facts
Starter 401(k)

Available for plan years after December 31, 2023
  • For employers without a qualified plan
  • Must be the only plan maintained by the employer
  • No limit on the number of employees
  • Automatic enrollment at 3% up to 15% of compensation
  • Deferrals limited to the annual IRA contribution limit (i.e., $6,000 indexed, plus $1,000 in catch-up indexed)
  • No employer contributions
  • Standard Form 5500 filing rules apply

What’s more, SECURE 2.0 will help SIMPLE IRA plan participants who are experiencing a mid-year plan switch, overcome another, potentially expensive, hurdle. Currently, SIMPLE IRA participants cannot roll over the assets from their SIMPLE IRAs to another plan within the first two years of participation without incurring a 25 percent penalty, unless they have a penalty exception (e.g., age 59 ½). During the initial two-year participation period participants can only transfer money to another SIMPLE IRA. SECURE 2.0 will waive that penalty starting with the 2024 plan year in certain circumstances. If an employer terminates a SIMPLE IRA plan and establishes a 401(k) plan (or, for rollover purposes, a 403(b) plan), rollovers between the SIMPLE IRAs to the new 401(k) plan are allowed if the rolled amount is subject to 401(k) distribution restrictions (e.g., age 59 ½, death, severance of employment, hardship, etc.).

Through the 2023 plan year, however, the current SIMPLE IRA rules are in place. Consequently, if an employer maintains another plan during the same year it has a SIMPLE IRA plan, the employer violates the exclusive plan rule and invalidates the SIMPLE IRA plan, technically, making all contributions to the SIMPLE IRA excess contributions. According to the IRS’s, SIMPLE IRA Plan Fix-It Guide, which is based on its Employee Plans Compliance Resolution System (EPCRS), the business owner may be able to file a Voluntary Correction Program (VCP) submission requesting that contributions made for previous years in which more than one plan was maintained remain in the employees’ SIMPLE IRAs. User fees for VCP submissions are generally based upon the current value of all SIMPLE IRAs that are associated with the SIMPLE plan. Self-correction is not available for this type of error. Further correction information is available here.

Options for 2023 when considering a mid-year plan switch from a SIMPLE IRA plan

  • Wait to start a new 401(k) plan until January 1, 2024, providing required notices prior.
  • If a switch to a 401(k) plan is made mid-year 2023, contemplate a VCP filing.

Options for 2024 when considering a mid-year plan switch from a SIMPLE IRA plan

  • Wait to start a new 401(k) plan until January 1, 2025, providing required notices prior.
  • Take advantage of the SECURE 2.0 change and adopt one of the eligible 401(k) replacement plans.

Conclusion

For 2023, switching from a SIMPLE IRA plan to another plan type mid-year is problematic, and may involve an IRS VCP filing (with fees). SECURE 2.0 provides relief for 2024 and later years for this scenario when adopting an eligible 401(k) replacement plan.

 

 

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Sweeter Deal Awaits Small Businesses When Starting a Workplace Retirement Plan

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“What are the changes to the small plan startup tax credits for 2023 and could you walk me through an example, please?”

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with a financial advisor from Florida dealt with a question on the SECURE Act 2.0 of 2022 (SECURE 2.0).

Highlights of Discussion

First, for businesses with up to 50 employees without a retirement plan that establish a SEP, SIMPLE IRA or 401(k) plan, Section 102 of SECURE 2.0 increases the small plan startup tax credit from 50 percent to 100 percent of eligible costs (capped at $5,000 per year) for the first three years the plan exists. (Prior rules still apply for those with 51-100 employees.)

More precisely, the enhanced credit is 100 percent of the eligible startup costs, up to the greater of

$500; or

The lesser of

  • $250 multiplied by the number of nonhighly compensated employees (nonHCEs) who are eligible to participate in the plan, or
  • $5,000.

Other eligibility rules include

  • The business had at least one plan participant who was a nonHCE; and
  • In the three tax years before the first year the business is eligible for the credit, the covered employees were not substantially the same employees who received contributions or accrued benefits in another plan sponsored by the business.

Second, the new law also added an additional credit exclusively for defined contribution plans with 50 or fewer employees. The credit is equal to a percentage of the amount contributed by the employer on behalf of employees, up to a per-employee cap of $1,000. Employees with compensation in excess of $100,000 are excluded from the calculation. This credit applies for five years and is phased out for employers with between 51 and 100 employees.

Year % of Contribution up to $1,000
1 and 2 100%
3 75%
4 50%
5 25%

 

But don’t forget about the third potential plan startup credit that still exists under the old rules. An eligible employer that adds an auto-enrollment feature to its plan can claim a tax credit of $500 per year for a three-year period beginning with the first taxable year the employer includes an auto-enrollment feature.

EXAMPLE:

  1. Newbie Inc., sets up a new auto-enroll 401(k) plan with a 100% match up to 4% of compensation
  2. The company has 19 employees: 17 nonHCEs and 2 HCEs,
  3. There are 8 employees with compensation over $100,000 and 11 employees each with compensation of between $25,000-$100,000.
  4. Total startup costs for Year 1 = $7,500

Credit #1 Startup Credit

Dollar Limitation (The greater of $500 OR the lesser of A or B)

  1. $4,250 (i.e., $250 x 17 nonHCE participants)*
  2. $5,000

Result= $4,250

*20-50 nonHCEs would impose the $5,000 yearly cap

Credit #2 Auto Enrollment

Credit for auto enrollment feature = $ 500

Credit #3 Employer Contributions

11 employees with comp < $100K x $1,000= $11,000

Year 1 Startup Credits
100% of costs up to dollar limitation $4,250
Plus credit for auto enrollment feature $   500
Plus credit for employer contribution $11,000
Total Year 1 Credits $15,750

 

Businesses will likely use an updated version of Form 8881, Credit for Small Employer Pension Plan Startup Costs and Auto-Enrollment to claim the credits.

Conclusion

A sweeter tax deal may await small businesses that do not currently offer workplace retirement plans. SECURE 2.0 enhances current plan startup tax credit rules and adds a new tax credit for employer-provided contributions. Plus, the $500 spiff for adding an auto-enroll feature may apply.

 

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How SECURE 2.0 Effects Plan Establishment Deadlines

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“Did SECURE 2.0 affect the deadline for establishing retirement plans?”

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with a financial advisor from Texas is representative of a common inquiry related to setting up qualified retirement plans.

Highlights of the Discussion

Two provisions in SECURE 2.0 affect plan establishment deadlines. First, Section 317 of the new law added retroactive first year elective deferrals for sole proprietors and single member LLCs. Effective for plan years beginning after December 29, 2022, sole proprietors and single member LLCs can make employee contributions (pre-tax deferrals, Roth or after-tax contributions) up to the employee’s tax return filing due date, determined without regard to any extensions, for the initial year.

Second, pursuant to Section 332 of SECURE 2.0, employers may replace a savings incentive match plan for employees (SIMPLE) IRA plan mid-year with a SIMPLE 401(k) plan or other 401(k) plan that requires mandatory employer contributions. This provision takes effect for plan years beginning after December 31, 2023. Currently, discontinuing a SIMPLE IRA plan mid-year is problematic because of the exclusive plan rule that requires a SIMPLE IRA be the only retirement plan maintained by the sponsoring employer during the plan year.

And don’t forget “SECURE Act 1.0” (i.e., Setting Every Community Up for Retirement Enhancement Act, 2019) affected plan establishment deadlines, too, by giving businesses more time to set up plans. Under  SECURE 1.0, for 2020 and later tax years, a business has until its tax filing deadline, plus extensions for a particular tax year to set up a plan. The plan establishment deadline is tied to the type of business entity and its associated tax filing deadline as illustrated below.

Tax Status Filing Deadline Extended Deadline
S-Corporation (or LLC taxed as S-Corp) March 15 September 15
Partnership (or LLC taxed as a partnership) March 15 September 15
C-Corporation (or LLC taxed as C-Corp) April 15 October 15
Sole Proprietorship (or LLC taxed as sole prop) April 15 October 15

[Note: Simplified employee pension (SEP) plans have historically followed the above schedule; and special set-up rules apply for safe harbor 401(k) plans.]

Prior to SECURE 1.0, a business that wanted a qualified retirement plan (e.g., 401(k), profit sharing, money purchase pension, defined benefit pension plan, etc.) for a particular tax year had to establish it by the last day of the business’s tax year. For example, a calendar year business had to sign documents to set up the plan by December 31 of the tax year in order to be able to contribute to and take a deduction for contributions.

Conclusion

From a timing perspective, both SECURE 1.0 and 2.0 have made it easier for business owners to set up retirement plans. This is in keeping with Congress’s goal to facilitate plan establishment with the end result being increasing employee coverage by workplace retirement plans.

 

© Copyright 2024 Retirement Learning Center, all rights reserved