“One of my clients has employees who are subject to a prevailing wage determination. The employer has a QACA 401(k) plan. Could the plan sponsor use deferrals and matching QACA contributions to satisfy the fringe benefit portion of the prevailing wage determination?”
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 plans, including nonqualified plans. 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 California involved a qualified automatic contribution arrangement (QACA) covering participants doing covered employment under the Davis-Bacon Act (also known as prevailing wage).
Highlights of Discussion
Before answering the question, let us lay a bit of a foundation. The Davis-Bacon and Related Acts and Reorganization Plan No. 14 of 1950 (DBRA) requires contractors and subcontractors to pay laborers and mechanics employed on a covered project jobsite not less than the prevailing wage rates (including fringe benefits) listed in the contract’s Davis-Bacon wage. The purpose of the DBRA is to protect communities and workers from competition from nonlocal contractors who might obtain federal construction contracts in the area by underbidding local wage levels. Prevailing wage amounts for both wages and fringe benefits are determined by the Wage and Hours Division of the Department of Labor, however, the Employee Benefits Security Administration (EBSA) is responsible for regulating the application of the fringe benefits under DBRA.
The prevailing wage determination consists of two components: The basic hourly rate and the basic fringe benefit rate. For the purposes of satisfying the wage determination, employers may pay any combination of the basic hourly rate and the fringe benefit amount, so long as the total amount paid equals the total of the basic hourly rate plus fringe benefit in the determination. In other words, the plan sponsor may pay more in cash, and less in fringe benefits than the determination specifies, or vice versa. For a fringe benefit to satisfy the prevailing wage determination, it must be made to a bona fide prevailing wage plan.
With that background out of the way, let us get back to the original question. Elective deferrals made by an employee covered under the DBRA cannot satisfy the fringe benefit portion of the prevailing age determination, because the employer does not make them. Elective deferrals under the DBRA are considered employee contributions subject to the same taxation, testing and regulatory rules applicable to all 401(k) deferrals. As an aside, all contributions made by employees that are paid by employees for fringe benefits must be voluntary under the prevailing wage rules.
However, a plan sponsor can take credit for employer contributions made to a bona fide fringe benefit plan, and a QACA qualifies as such, but there is a catch. For an employer to take full credit for contributions to a bona fide fringe benefit plan, they must be fully vested, or they become subject to a process called “annualization.” A full explanation of annualization is beyond the scope of this discussion, but annualization basically requires a plan sponsor to spread any unvested contributions made to a fringe benefit plan over all the hours worked by a participant doing covered work under DBRA, as well as work that is not covered under DBRA, and it is very common that employees perform work under both DBRA and nonDBRA assignments. Because the employer must spread unvested contributions it makes related to DBRA covered work, over all hours worked by a participant, this typically serves to dilute the value of the contributions that can be used to satisfy the fringe benefit portion of the prevailing wage determination. With QACA plans, when a match is used to satisfy the safe harbor requirement, the match may be subject to a two-year vesting schedule, so there is a possibility that some DBRA-covered participants receiving the match will have their match annualized. Consequently, most Davis-Bacon plans provide for immediate eligibility and full vesting for contributions in order to avoid annualization [(29 C.F.R. § 5.5(a)(1)].
Although QACA matches can be used to satisfy the fringe benefit determination under work covered by the DBRA, an employer may not get full credit for a matching contribution if it is not fully vested. In addition, not all participants will receive the match if they elect not to defer into the plan, so the employer will have to provide those individuals who did not receive the match with an amount in cash commensurate to what the match recipients received. This would complicate the prevailing wage reporting and cost more, because whenever an amount is paid in cash rather than as a fringe benefit, it is subject to Federal Insurance Contributions Act (FICA) and other employment taxes, and these taxes cannot be used to satisfy the DBRA fringe benefit requirements.
Employers may want to consider satisfying their safe harbor requirements and their DBRA fringe benefit obligations by providing a fully vested nonelective safe harbor contribution rather than a nonvested contribution. This approach would be beneficial for several reasons, including,
1. Satisfying the safe harbor requirement for testing;
2. Avoiding annualization since safe harbor nonelective contributions are fully vested;
3. Simplifying the tracking of DBRA fringe benefits because all participants will get the same fringe benefit to the plan;
4. Cost savings on employment taxes since there would be no cash payments made to participants who did not receive a match; and
5. Using the contribution to satisfy the gateway test pursuant to Treasury Regulation 1.401(a)(4)-8(b)(1) if the plan also uses a new comparability profit sharing formula.