Complying with Your Plan Document, Part 3 ||

April 26, 2011

We've reviewed seven questions the IRS recommends you ask yourself to help reduce the time it takes to complete your plan audit and may help lower some of your compliance fees. (Part 1, Part 2) Here are the final three questions.

1.     Have you timely deposited employee elective deferrals?

Department of Labor requires employers to make elective deferrals to the trust the amounts of the elective deferrals made by plan participants on the earliest date that the employer can reasonably segregate the amount from the employer’s general assets. However, under no circumstances can the employer deposit the amount later than the 15^th business day of the following month. This is the maximum deadline for deposit.

Failure to deposit employee elective deferrals in a timely manner may be considered an operational mistake resulting in plan disqualification and a prohibited transaction, which could impose an excise tax. The initial tax is 15% of the amount involved for each year in the taxable period. If uncorrected, an additional tax of 100% of the amount involved may be imposed. An operational mistake can be corrected under EPCRS but a prohibited transaction is not one of the correctable mistakes under EPCRS. However, the DOL’s Employee Benefits Security Administration maintains a Voluntary Fiduciary Correction Program (VFCP) that may be able to resolve a prohibited transaction.

2.     Do participant loans conform to the requirements of the plan document and IRC 72(p)?

Participant loans must meet the rules under Code 72(p) so the law does not treat them as a taxable distribution to the participant. Here are the rules:

• The loan must be a legally enforceable agreement, a paper or electronic written document stating the date and amount of the loan and binding the participant to a repayment schedule.
• The amount of the loan cannot exceed $50,000 or 50% of the participant’s vested account balance, whichever is less.
• The terms of the loan should require the participant to make level amortized repayments at least quarterly and be repaid within five years.
• Special exception: A play may permit a participant to suspend repayments for no longer than a year while he or she is on a leave of absence. Upon return from leave of absence, the participant must make additional payments on the loan in order to ensure that he or she fully repays it within the five year period.

o Note: A plan may suspend loan payments for more than one year for an employee performing military service. In this case, the employee must repay the loan within five years from the date of the loan, plus the period of military service.

3.     Were hardship distributions made properly?

Hardship distributions may be made to employees because of an immediate and heavy financial need. They are limited to the amount of the employee’s elective deferrals and don’t include any income earned on the deferred amounts. Hardship distributions cannot be rolled over to another plan or IRA. It is the responsibility of the employer to determine whether an employee has an immediate and heavy financial need. The definition of a hardship should be included in the plan document.

Common reasons for a hardship distribution include the following:

• Medical care for the employee, employee’s spouse or any dependents
• Costs directly related to the purchase of an employee’s principal residence, excluding mortgage payments
• Post-secondary education costs (tuition, fees, room and board expenses) for the next year for the employee, employee’s spouse or dependents
• Funeral expenses for the employee’s parent, spouse, etc.
• Certain repair expenses for damage to the employee’s principal residence

You can read more about these questions from the IRS, how to find the mistake and how to fix it at http://www.irs.gov/pub/irs-tege/401k_mistakes.pdf.