403(b) Corrections and Examination Trends Phone Forum - May 23, 2013
Note - Any federal tax advice contained in this transcript is intended to apply to the specific situation described and should not be considered official guidance independent of the presentation. The tax advice and statements contained herein should not be relied upon for retirement planning purposes without first consulting a tax or retirement planning professional. This transcript has been edited for technical accuracy and may differ slightly from the audio recording of the 403(b) Plan, Corrections, and Examinations Trends phone forum. This information is current as of May 23, 2013. Since changes may have occurred, no guarantees are made concerning the technical accuracy after that date.
Mark: Hi, everyone. I'm Mark O'Donnell, Director of IRS Employee Plans, Customer and Education Outreach. Welcome to our 403(b) Plan, Corrections, and Examinations Trends Phone Forum. Today, we'll be hearing from Avaneesh Bhagat, Voluntary Compliance Group Manager, Stephanie Bennett, Voluntary Compliance Program Coordinator, and Bob Cremeens, Employee Plans Program Analyst.
Thank you all for joining us today. Before we start, I'd like to point out a couple of things. Click on slide two for this information. Everyone registered for this phone forum receive a certificate of completion by email in about a week, as long as you attend the entire live phone forum. Enrolled agents, enrolled Retirement Planning Agents, and enrolled actuaries are entitled to continuing education credit for this session. Other types of tax professionals should consult their licensing organization to see if today's session qualifies for contingent education credit.
As with all our presentations, the comments expressed by our speakers should not be construed as formal guidance from the IRS. We have an array of Retirement Plan resources available for you. For more information regarding 403(b) Plans, please visit our Retirement Plans website at www.irs.gov/retirement. You can also get there by going to the main irs.gov landing page. Click on "Information For" in the upper right-hand side of the screen and select "Retirement Plans." Then look to the left-hand navigation bar and select "Type of Retirement Plans" and choose "403(b) Plans."
While you're visiting our website, you might also want to subscribe to our free electronic newsletters. To subscribe, select "Newsletters" on the left-hand navigation bar, choose "Subscribe," and then select "Retirement News for Employers," our newsletter for employers sponsoring retirement plans and "Employee plans news," our newsletter for retirement plans professionals.
Now, let's hear from Avaneesh, Stephanie, and Bob.
Stephanie: Thanks, Mark. What I want to do before we start discussing our topic is to provide a brief bit of background because there may be people listening in who have varying levels of familiarity with the program. With that in mind, there are three programs that form the Employee Plans Compliance Resolution System. The rules for that are covered in Revenue Procedure 2013-12, the current revenue procedure governing the employee plans compliance resolution system.
Those three programs are, first, there's a Self-Correction Program which allows you to correct certain problems on your own without actually getting formal IRS approval for it. Then you have the Voluntary Correction Program or VCP, which we commonly call it, that's the program that I will be focusing on today, and it requires a formal submission, and a payment of a fee to the IRS, where the Plan Sponsor comes in, identifies the problem, and proposes a correction to the IRS. After we review it and if we decide to approve it, the IRS issues a compliance statement.
The advantage of getting a compliance statement is that, if your plan is later audited, assuming the facts presented in the original submission were accurate, that compliance statement protects the plan from disqualification for the particular issues that are covered on to the compliance statement. Finally, there's the last component and that's the Audit Closing Agreement Program, which allows plans to correct problems when the plan is under examination. There's a brief rundown of the basics of the three programs. Although each program is different, the goal of all three programs is to preserve the tax deferred benefits for participants, in other words, to preserve the tax-favored treatments that those plans are able to take advantage of.
Now that we have that brief overview, I'm going to be following the slides in the PowerPoint presentation that are available on the IRS website, and are designated as the hand-out for this session. Once we complete those slides, we will discuss select questions that were submitted prior to this session. If We don't have time to respond to a question that you submitted prior to this session, We will contact you directly after the session and discuss the issues that you have asked about in your questions that you submitted via email prior to this session.
The goal of this session is to provide a summary of the changes made in Revenue Procedure 2013-12 to the corrections for 403(b) Plans. Specifically, what we'll focus on is what 403(b) failures can be corrected under the Voluntary Correction Program. Can we turn next slide --slide four. While the primary focus of this session will be on Corrections under Revenue Procedure 2013-12, we also need to look back to the prior Revenue Procedure, and that's Revenue Procedure 2008-50, because that guidance will be helpful when it comes to analyzing whether a 403(b) operational failure that occurred prior to January 1, 2009, is eligible for correction. Moving to slide five.
Focusing first on 403(b) Correction prior to the issuance of Revenue Procedure 2013-12, we realized that there were limitations regarding what failures were eligible for correction. While the Operational, Demographic, and Employer Eligibility Failures could be corrected, the definition of Operational failure under a 403(b) Plan was limited to specific enumerated failures, and this often results in us treating submissions as ineligible because there was not a broad category to cover operational failures.
One example that we would get submissions where the failure was a failure to operate the plan in accordance with its terms, and that failure cannot be resolved unless it fit into one of the
pre-determined operational failures under 2008-50. In addition, under the prior Revenue Procedure, we were unable to accept plan document failures. Next slide.
Now with Revenue Procedure 2013-12, correction for 403(b) Plans is expected to be the same as the corrections for a qualified plan. In keeping with that framework, plan document failures can now be addressed. In addition, the definition of operational failure now allows us to address the failures to operate in accordance with the 403(b) Plan terms. Remember that the program cannot be used to correct a failure to follow the terms of a 403(b) Plan document that occurred before January 1, 2009. This is because 403(b) Plans were not required to have a written plan before that date.
In order to use the Self-Correction Program to correct operational failures, the Plan Sponsor or administrator of the plan is required to establish practices and procedures that are reasonably designed to promote and facilitate overall compliance with code requirements. For purposes of 403(b) Plans, the revenue procedure recognizes that the written plan requirement is a recent requirement, so the practices and procedures requirement for the use of the Self-Correction Program only applies for failures during periods after December 31, 2009. If you're following along in the slides, we're going to proceed to the next slide, slide seven.
A key modification of the current revenue procedure is that plan document failures are now one of the types of failures that are correctible for a 403(b) Plan. Now that this failure can be addressed, what is a plan document failure for a 403(b) Plan? How do we define that? The plan document failure is a plan provision or the absence of a plan provision that, on its face, violates the requirement of code section 403(b). It also includes the failure of a plan to be adopted in written form, or it be amended to reflect a new requirement within the plan's applicable remedial amendment period.
It includes the failure to timely or properly amend the plan during an applicable remedial amendment period, with respect to provisions required to maintain the status of the plan under code section 403(b). Finally, it includes any 403(b) failure that adversely affects the status of the plan under code section 403(b) that is not an Operational failure, a Demographic failure, or an Employee Eligibility failure. That's how the new revenue procedure defines what a plan document failure is. Under Notice 2009-3, 403(b) Plans are required to adopt a written plan. Now that plan document failures are eligible under the program, how are those failures going to be corrected? It's important to know that the plan document failures can only be corrected using the Voluntary Correction Program and not the Self-Correction Program.
If you have a 403(b) Plan with a plan document failure, you can't self-correct it. You have to come in under VCP, which requires a fee and a submission to the IRS. If you have a plan document failure such as the failure to timely adopt a written plan by January 1, 2009, and you submit that under VCP for correction, by virtue of correction, the late adopted plan will be treated as if it was timely adopted for purposes of the extended remedial amended period provided in Announcement 2009-89. What that means is if you come in, to disclose a failure … you pay a fee, and you correct by adopting the written plan, and we review your submission, we approve it, we issue you a compliance statement. You're going to be treated as if that plan was timely adopted for purposes of the extended remedial amendment period.
Once you get that compliance statement, if the plan sponsor wants to later use the Self-Correction Program, the plan will be treated as if it had a favorable determination letter, for purposes of the Self-Correction Program. This is important because under the Self-Correction Program, Plan Sponsors are eligible to correct significant operational failures only if the plan has a favorable determination letter. Once the plan document is submitted for correction and we review the submission and determine that everything is there to allow the correction of the plan document failure, we issue the compliance statement, as I mentioned before. That compliance statement is not a determination that the written plan meets the requirements of 403(b) or the regulations. It's not a determination that the actual wording of the documents, the language in the document satisfies 403(b).
The compliance statement however, does result in the plan being treated as if it's timely adopted a written plan for purposes of the extended remedial amendment period. Right now, for the plan document failures, there's a 50% fee discount for 403(b) Plans that fail to timely adopt the written plan. If you're a sponsor of a 403(b) Plan that did not timely adopt the written plan by January 1, 2009, if you submit an application to VCP on or before December 31st, 2013, your compliance fee will be half of the fee listed in the general fee schedule. In addition, if you have this failure, we also have incorporated that failure, the failure to timely adopt a 403(b) Plan, as a failure in one of our model forms, Appendix C, Part II, Schedule 2.
You can submit using that schedule, and there's a box, a placeholder right there that says, "Failed to timely adopt the 403(b) plan." You would check that box and submit your VCP submission along with the fee, along with the corrected plan documents. If you need help going through this process because it's rather involved, if you're not familiar with the program, there's a VCP submission kit to assist plan sponsors with this failure, and the kit's going to walk you through the steps of completing the VCP submission for the failure to timely adopt a written 403(b) Plans. Now we're going to move on to slide 10.
This slide is a segue into discussion of operational failures, the new revenue procedure, so it's more properly titled Operational Failure. And the slide makes an important point, and that point is while Operational Failure is broadly defined as a failure to follow a plan's provision, that definition only applies for operational failures that occur on and after January 1st, 2009. The reason behind that date is that plans were not required to have a written plan before that January date. Let's move on to the next slide, slide 11. We're still focusing on Operational Failures.
Now that we understand the effective date of the broader definition of an Operational Failure for a 403(b) Plan, how does the revenue procedure define a 403(b) Operational Failure? What do we deem to be a 403(b) Operational Failure? The short answer to that is, it's defined very similar to the definition of Operational Failure for a qualified plan, and that definition is basically a failure that arises solely from a failure to follow a plan's provision. Basically, your operation of the plan does not reflect the plan's terms. By way of example of an operational failure, the definition provides that a failure to comply with the universal availability rule in Section 403(b)(12), and that rule relates to making elective deferrals available to all employees. That's an operational failure. And the definition also provides by way of example, that a failure to comply with code section 401(m), as it applies to 403(b) Plans, and that's related to the actual contribution percentage test, that's also an operational failure.
In addition, there's a departure from the definition provided for qualified plans, and the definition of a 403(b) operational failure specifically states that a plan will not have an operational failure to the extent the plan sponsor is permitted to retroactively amend the plan to reflect the plan's operation. We're still going to focus on operational failures, but we're going to move to the next slide, slide 12.
Now that we know how the new revenue procedure defines operational failure, it's still important to look back to the prior definition of operational failure in Revenue Procedure 2008-50. With Revenue Procedure 2013-12, we broadly define operational failure, but we had a more finite definition of operational failure in Revenue Procedure 2008-50 where we specifically enumerated what we would consider an operational failure. It's relevant to look back to that prior definition in Revenue Procedure 2008-50 because in order to correct an operational failure that occurs before January 1, 2009, the failure must otherwise be correctible in accordance with 2008-50. What that means is if the failure occurs before January 1st, 2009, it must fall into one of those categories of operational failures in Revenue Procedure 2008-50.
We cannot address the failure to follow the terms of a 403(b) Plan document that occurred before January 1st, 2009, unless that failure meets one of the operational failures outlined in Revenue Procedure 2008-50. I'm not going to list all of those failures that are considered operational failures under the prior revenue procedure, but those are listed in slide 12. You can always take a look at the definition of operational failure provided in Section 5.02 of Revenue Procedure 2008-50. Moving to the next slide.
We're still focusing on operational failures. Slide 13 is the slide I'm on right now. Recognizing that there's a change in the definition of Operational Failure effective January 1st, 2009, how is this failure that spans the period before and after January 1st, 2009 handled under our program? Basically, as I mentioned before, we cannot address the failure to follow the terms of a 403(b) Plan document if the failure occurred before January 1st, 2009. If you come in and the failure occurred before January 1st, 2009 and you said the failure was a failure to follow the plan's terms, we cannot address that failure because the failure was not considered an operational failure as that term was defined for failures occurring before January 1st, 2009. In other words, you'd have to look back to Revenue Procedure 2008-50, and if the failure occurs before January 1, 2009, in order for it to be considered under a program, it would have to fall within one of those specifically enumerated definitions of what is considered an operational failure under a program.
In that situation, we can only address the failure for plan years beginning on and after January 1st, 2009. If you have that situation, one approach is to correct the years you can by defining the failure for the period of time in which it can be addressed under VCP. I'm moving into the next slide, slide 14, and we're moving to Demographic Failures.
Demographic Failures are failures that occurs when a plan fails to satisfy the requirements of code section 401(a)(4), 410(b), and 401(a)(26). That is not an operational failure or an employer eligibility failure. This type of failure typically requires a corrective amendment to the plan, adding more benefits or increasing existing benefits. Now we're going to move to a brief discussion of employer eligibility failures and that's in slide 15.
This type of failure occurs when a plan sponsor adopts the 403(b) plan that was intended to comply with 403(b), but the plan sponsor is not an eligible employer. They're not eligible to sponsor a 403(b) plan. Moving to slide 16, we're going to go through a couple of examples of failures and discuss an approach to correcting those failures. The first example that's provided in slide 16 is it's in a Credit Union, and it's the XYZ Credit Union, and there are 501(c)(14) organization that was sold a 403(b) plan in 2010. They've allowed their employees to participate in the plan and make contributions, so the questions we pose are, is the employer eligible to sponsor the plan? That's the first question, and the second question is, can contributions that are already funded remain in the plan?
If you move to the next slide, slide 17, we're going to get to the answer portion. We're going to address the first question, is the employer eligible to sponsor the plan? The employer, in this situation, the Credit Union is not eligible to sponsor a 403(b) plan because the employer is not a tax-exempt organization described in 501(c)(3), nor are they a public educational organization described in Section 170(b)(1)(A)(ii). Moving to the next slide, slide 18, and focusing on the second question and whether those contributions that were already funded are permitted to remain in the plan?
The answer is, yes, but of course, if you make a submission under VCP and you pay a compliance fee, we can permit the contributions already funded to be treated as if they were made to a valid Section 403(b) plan. What that means is that no new employer or employee contributions will be permitted in the future and the assets of the plan will remain in the trust, annuity contract, or custodial account, and will be distributed no earlier than the occurrence of one of the permitted events, the distributable events in 403(b)(7) or 403(b)(11). That's how we would correct this issue under the VCP program with respect to an employer eligibility issue.
There is an alternative correction and that's discussed in slide 19. The alternative correction is that the contributions can be treated as not being excluded under 403(b), and the contributions can be treated as contributions to a 403(c) annuity contract. That correction is discussed in the revenue procedure. You can take a look at Section 6.03(2) and 6.10(2). Now that we've discussed an employer eligibility failure, we're going to move to slide 20, and there's another example in slide 20 and it involves 501(c)(3) organization, Heart Hospital, and they sponsor a 403(b) plan.
They have employees who work less than 20 hours and those employees are excluded from participation in the plan. The plan provides 100% match up to 3% of participant compensation, and they have several employees who work less than 20 hours and five employees who work less than 20 hours in the billing department. Those employees in the billing department, they've been making deferrals to the 403(b) plan. The first question we pose is, is there a failure? The second question is, if you decide there is a failure, what is the failure? Let's move on to the next slide where we discuss the answers. Slide 21 is the slide we're on.
Addressing the question of whether there's a failure, and the answer is maybe. It is a permissible to include employees who regularly work less than 20 hours per week. You can't exclude those employees from making deferrals under the universal availability rule, you can also include them if you like. But if you do, the plan can include them if all employees of that category are included. That addresses whether or not there's a failure, so it's a maybe issue, so you have to look at the facts in this situation. Addressing what type of failure it would be if all employees of the employer who work less than 20 hours per week and they're not included, then we have a universal availability problem because you these five employees in the billing department who were working less than 20 hours per week and they were allowed to participate and make deferrals.
Alternatively, if the plan terms require exclusion of employee who regularly work less than 20 hours per week, you could have a problem of an erroneous inclusion of those five employees. Let's move to the next slide. We still are focusing on this fact situation and fact pattern presented in slide 22. But in slide 22, the hospital comes in and makes a VCP submission. The same facts as above that were discussed in slide 20 and 21, but we're going to add some additional facts, and now assume that there are 50 other employees and those employees regularly work less than 20 hours per week, and they make $25,000.00 annually and they were not given an opportunity to make deferrals to the 403(b) plan during the 2010 to the 2012 years. Is there a failure? and if so, what is the failure and the correction? Let's move to the next slide, slide 23.
Based on the facts presented, there's a failure and it's a failure to comply with the universal availability rule, and the correction is to make corrective contributions on behalf of those 50 employees. You have to make a corrective contribution, but how do you determine what that corrective contribution is? Let's move to slide 24, and we're going to discuss how you determine that corrective contribution. The total corrective contribution owed to each excluded employee for lost deferral is $750.00. You look at their annual compensation which was $25,000.00, you multiply that by the 3%, and then it's going to be 50% of that, and it works out as $375.00, but then we have two years involved here, so then you multiply that by two, so we have $750.00 for the loss of deferrals.
We have the lost deferral amount, but remember, this employer provided a matching contribution. For the lost deferral amount of $750.00 that the excluded employees could have made to the plan, and a matching contribution owed per year is equal to $750.00. The total matching contributions owed to each excluded employees is $750.00 times the two years excluded, so we're at $1,500.00. The total corrective contribution owed to each excluded employee in this situation is $2,250.00, $750.00 for the deferrals and then the $1,500.00 for the match, and that amount needs to be adjusted for earnings through the date of correction. That finishes my portion and now I'm going to turn it over to Avaneesh Bhagat to discuss the next series of slides.
Avaneesh: Thank you, Stephanie. Now, we are on slide 25, for those who are following the slides. This is a bit of a continuation of the excluded employee thing. Here, we have to address the following question. You have a hospital that sponsors the 403(b) plan and it's a 501(c)(3) organization, so we have an eligible employer sponsoring a 403(b) plan. No problem there. Under the terms of the plan, nurses as a group are excluded from making deferrals to the plan. That's the issue here. Could we have a plan where nurses are excluded and still comply by the rules? What's the first thought that comes to mind?
The first thought is, "Well, is my client in compliance with the universal availability requirement?" which generally says that all employees, except for those who belong in certain categories, such as non-resident aliens, students, employees working less than 20 hours per week, and employees who make deferrals to other plans sponsored by the employer where deferrals are allowed, such as for another 403(b) plan, another 401(k) plan, or where an applicable another 457(b) plan. These are categories of individuals that you can exclude and still meet the universal availability requirement.
When we address the "Nurse" question, could we exclude nurses? The real question is, could these nurses be part of an excludable category? If the answer is yes, then you could probably design a plan that would have the effect of excluding these nurses. If the answer is no, you have a universal availability problem. For example, again, we talked about the various categories. I'm going to repeat two again. Employees who work in only less than 20 hours per week, and employees who make deferrals to other plans sponsored by the employers and those plans to permit elective deferrals. Thinking of those two categories, if all the nurses concerned work less than 20 hours per week or normally work less than 20 hours per week, they could be excluded based on the permission to exclude employees who normally work less than 20 hours per week.
The other requirement is, if these nurses were put into another plan, they were participating in another 403(b) plan, or another 401(k) plan, then in that case, you could certainly exclude nurses since there's another deferral-based plan accommodating the nurses. Those are two examples of requirements where if the nurses fit, then they could be excluded under those
categories and be precluded from participating in the plan. Otherwise, you have the universal availability requirement that comes into play. As a matter of general plan design, you wouldn't be able to just exclude nurses, but if they happen to fall under these excludable categories, then you would be able to exclude them based on those categories, but not based on the mere job classification of nurses alone.
That's the purpose of that question is to caution you to be careful of the universal availability rule. We move to slide 26, there's an answer there that again says, be cautious of the universal availability rule. The general rule would be that if you have a group of employees that don't fall into one of those excludable employee categories, then you couldn't exclude that category of employee, so nurses as a general rule, you couldn't just exclude those employees and pass the universal availability requirement. They would have to fall under one of those excludable employee categories. We'll go to slide 37.
Let's assume now that we decide that the nurses concerns were improperly excluded. They didn't fit in any of the categories, the universal availability requirement was failed, and now we want to correct the problem. Basically, in order to correct the problem, intuitively you would have to make corrective contributions on behalf of these employees to compensate them for two things, one, they missed out on the opportunities to make a deferral, so you have to contribute on the nurses' behalf for the missed deferral opportunity, and two, they missed out on possible employer contributions, so those employer contributions need to be replaced, and all these corrective contributions have to be adjusted for earnings.
Let's address each piece individually. The missed deferral opportunity. The first step is to find out what the missed deferral might have been. We don't know what that number is because the employee involved didn't make the election during that time, wasn't provided the opportunity to do so. We don't know what his or her election would have been. This is also a plan that normally doesn't do an ADP test, so when you look at qualified plan rules, they have an ADP analysis and you could say, "Okay, if the employees are non-highly compensated employee, we could just take the average of what other non-highly compensated employees defer, and use that average as a proxy for figuring out what the missed deferral would be."
In this case the 403(b) plans don't conduct any kind of ADP analysis so what the revenue procedure did is give you a rule to work with where you could just figure out what the missed deferral might have been or come up with a usable estimate without doing that ADP analysis. In that case now, if you look at slide 28, it gives you a flavor of the rules. In general, you assume that the employee would have deferred 3% of compensation, but in certain situations where the employer provides for a generous match such as where the matching contribution would be at least 100% of what was deferred for a higher level of deferral, then you would use the higher level of deferral. By way of example, if let's say, your plan has a formula that says that it will provide for 100% match for deferrals up to 4% of compensation, you will use 4% of compensation instead of 3%. The general rule is 3% of compensation but if the plan provides for 100% or greater match for a deferral level that's more than 3%, you would use that as the proxy for figuring out what the missed deferral might have been. Then once you know what the missed deferral is, you would make a corrective contribution equal to 50% of that missed deferral, which basically is rough justice for figuring out what the missed deferral opportunity was and the employer would have to make a contribution for that piece, that missed deferral opportunity piece.
Also, in terms of for those who don't have background in this, the reason why we do this is because deferrals are a little bit different from employer contributions in that, if I don't have an opportunity to make a deferral of compensation, I still would have received that compensation in cash. What I was deprived of was the opportunity to have a portion of my compensation deferred into a tax-favored vehicle. The missed deferral opportunity refers to the loss of that opportunity, and that's what you're compensating the employee for rather than the dollars themselves.
Related to that, if your plan provides for a matching contribution, these are dollars that are totally missed on. So now the employer has to make the full matching contribution that the employee would have received, had that missed deferral been made. Basically, for employer contributions, it's the full amount that was missed out on, and for missed deferrals, it's the missed deferral opportunity that you're compensating the employee for. Let's go to the next slide, slide 29. We're shifting gears now from who can be in the plan and who can be out and if the person is out, what the correction would look like.
Now, we're going to deal with the separate issue of contribution limits, and we'll talk about first the Section 415 contribution limit. Basically, in general, when we're figuring out what the 415 contribution limit is, and you look at what the rule is, it will say something like, "Your 415 contribution limit cannot be more than the lesser of 100% of includable compensation or the dollar limit which is $51,000.00 in 2013. When we talk about the 415 limit, if you take into account employer contributions, all employer contributions, all elective deferrals or employee contributions, and all employee after-tax contributions, all those things are taken into consideration.
In 403(b) plans, as many of you are aware, there's even an additional catch-up piece that allows you for a higher deferral limit for those who completed more than 15 years of service. That's commonly referred to as the 15-year catch-up under 402(g)(7). Those catch-up contributions, they are made because you completed 15 years of service and now have the ability to make an additional deferral [beyond the normal 402(g) limit] are counted towards the 415 limit. What is not counted however is that your plans could also, in addition to that 15-year catch-up, could provide a catch-up contribution for those who are age 50 or older. Those are described in Section 414(v) of the code.
Those catch-up contributions, the age 50 catch-up contributions, do not count against you in the 415 limit. Basically, when you're figuring out what the limitation is, you would consider all the contributions except those that are relating to catch-up contributions. Just for the sake of
argument, let's assume that my 415 limit is that $51,000.00, that would take into account all of my employer contributions, employee deferrals, and employee after-tax contributions, but however, if I was also catch-up eligible and made some contributions towards the catch-up contribution, up to the age 50 catch-up contribution limit, then I would segregate that, and it doesn't count against me, for the $51,000.00 limitation.
Let's suppose I make $5,000.00 of catch-up contributions and it's within the age 50 catch-up contribution limit, I can add that to my $51,000.00 and actually have $56,000.00 worth of contributions made on my behalf. That's the key thing, is that you know what's included and what's excluded in the limits. Carrying on with 415, sometimes you could deal with issue of multiple accounts, multiple plans. There are certain rules that you need to consider when you have that situation. If the employee contributed to more than one 403(b) account, contributions made to all 403(b) accounts must be combined. If the employee participates in a 403(b) plan and a qualified plan, contributions made to the 403(b) account must be combined to the contributions to a qualified plan if the employee has a controlling interest in [the employer that sponsors] the qualified plan. In essence now, there's an interesting situation that you have for 403(b) plans versus the rules that you would consider for qualified plans.
In general, if let's say, you have an employer that sponsors a 403(b) plan and a 401(a) plan. A qualified plan and a 403(b) plan, so let's just take Heart Hospital 501(c)(3) organization and it's certainly allowed to sponsor a 403(b) plan and a 401(k) plan. Let's say you have a medical professional. Let's say we have a doctor who makes contributions to the 403(b) plan and also has contributions made on his behalf in the qualified plan sponsored by that hospital. Let's also assume the employee does not have a controlling interest in the hospital, but the employee might have another business he moonlights and he's in another business, and that business sponsors another separate qualified plan of its own. You would for 415 limit purposes, aggregate the 403(b) plan with any plan sponsored by a business that the employee controls. If the employee is moonlighting and he has a separate business and has his own qualified plan, that's the plan you would use to aggregate with the 403(b) plan to figure out if 415 limits are exceeded.
The other qualified plan that the hospital sponsors would not be considered for this purpose, especially if the employee does not have a controlling interest in the hospital that employs him. In essence, looking at these rules would be critical for you to determine which plans you want to aggregate for the purposes of figuring out what the applicable 415 limit is. That's the purpose of this slide, I know it's a bunch of rules in one shot, but it's something that at least has as a purpose of alerting you that you should know which groups of plans, or what groupings you need to consider when calculating applicable limits. That's the purpose of this particular slide, and there are other limits that also apply to a 403(b) plan, example would be 402(g) limits for elective deferrals. Also, there's a distinction in rules there for 402(g) versus 415.
When we talk about 415 limits, what we said was we would consider the elective deferrals made to the 403(b) plan or other contributions made to the 403(b) plans plus contributions made on the employee's behalf to a plan that was sponsored by a business that the employee is control of. You would aggregate those things. The 402(g) limits, that's for elective deferrals, you would consider plans sponsored by any employer. It's an individual-based limit, you can have unrelated entity sponsoring deferral-based plans. You can have, now in this particular case, you can have his employer sponsor a 401(k) plan and a 403(b) plan and you could moonlight separately in a totally unrelated organization that has its own deferral plan. All these deferrals have to be added up to figure out whether he's in compliance with the applicable limits for deferrals under 402(g).
The fact that you have unrelated employers does not mean you have separate limits, and when you talk about 402(g) limits, the 402(g) limits is just one limit that applies to the individual regardless of whether he's participating in a plan sponsored by related employers or unrelated employers, there's no constraint, no rule to waive. He's in multiple plans that have deferrals, you have a single limit that applies. Right now, the limit is about $17,500.00, that $17,500.00 would be the single limit that he would have to take into account, regardless of how many plans, or how many employers you may be in.
In demonstrating that, if you take a look at slide 31. Doctor Q, who works for Heart Hospital and moonlights for Mind Hospital. She makes contributions to both the hospitals' 403(b) plan, and Mind Hospital's 401(k) plan. First questions is, are Doctor Q's contributions subject to a single 402(g) limit? The answer is yes, because it doesn't matter which employer's plans he is participating in. You would take into account all plans that provide for elective deferrals and see how much she deferred to each, add them up, and you have that one single $17,500.00 limit to worry about. It could be a higher limit if you have things like the 402(g)(7) special catch-up rule for those with more than 15 years of service. However, regardless of whether you have the higher limit or lower limit, it's a single limit for the individual.
415 on the other hand, you're looking at which employer sponsors that plan and is there are any relationship or not. For example, if she participates in plans sponsored by Heart Hospital and Mind Hospital, let's make it really simple, let's assume she doesn't have controlling interest in either of these organizations, then the contributions made on her behalf to the plan sponsored by Heart Hospital would be subject to a separate 415 limit, then the contributions made on his or her behalf for Mind Hospital. Unrelated employers, employee doesn't have any controlling interest, separate 415 limits, not a single 415 limit like you would have for employee deferrals. That's the purpose of illustrating this, is that you need to consider what rules apply when applying different limits, especially when an individual is participating in multiple plans sponsored by more than one employer.
Now, we're shifting gears from limits, and we're now going to get into the concept of what happens when you actually exceed these limits. Now, in slide 32, it introduces the concept of Excess Amounts. If you have a situation where contributions are made on an employee's behalf that exceeds what's allowed by the terms of the plan or by some statutory limit such as 415 or 402(g), like we talked about, you have an excess amount that was contributed on behalf of that particular employee and the excess amount needs to be fixed. So if we move on to slide 33, we talk about concepts of what can be done to fix an excess amount that's contributed on an employee's behalf.
In the case of a 403(b) plan, one possibility would be that especially if your excess amount is attributable to exceeding 415 limits, you could designate the excess amount that's contributed on an employee's behalf as a 403(c) account which has different characteristics than a 403(b) plan does.
Remember a 403(b) plan, you have pre tax deferral immediately at the time the employee makes an elective contribution to the plan and so, as a result of that, the employee does not have to recognize that amount as income until he actually takes a distribution from that plan. In the 403(c) account, an employee recognizes the amount contributed on his or her behalf as income as soon as there's no substantial risk of forfeiture or just simply put, once he becomes fully vested, he becomes vested in a piece of the contribution, he has to recognize the contribution into income in the year that the he becomes vested in a portion of that contribution. Different tax characteristics, 403(c) is a little bit less favorable than what 403(b) is. If you'd treat the excess as excess 415 contribution as a 403(c) account, then that could be a correction to this particular problem.
The other methods of correction are actually very similar to what you would have for qualified plans, okay? If your excess amount, contribution of excess amount is attributable to employee-based contributions such as elective deferrals or after tax employee contribution, then those amounts can be distributed to the employee, and those are taxable to the employee, all right?
If they are attributable to employer contributions, that these excesses are attributable to employer contributions then, typically, you would forfeit the employer contributions, reallocate those to an unallocated account and then depending on what the plan says, you would either take the amounts from the unallocated account and apply it towards future employer contributions to the plan, or you would reallocate those moneys to other employees, entitled to an allocation of forfeitures.
In essence, the distribution for excess contributions attributable to employee contributions or elective deferrals, forfeitures for employer contributions then generally transfer to unallocated account used towards future employer contributions. Those two things apply both for qualified plans, as well as 403(b) plans and then, for 415 excesses. For example, if you treat the excess as a 403(c) contribution to a 403(c) account, that's a correction that's pretty unique to 403(b) plan corrections.
Moving on to slide 34, we have an example and again here, we're going back to the issue of limits and how you apply them and this kind of example illustrates that. And here you have a situation where an employee made elected deferrals to the plan, he took advantage of all the limits that were available to him, contributed the … this was in 2009. In 2009 the regular 402(g) limit was $16,500. The employee deferred the full $16,500.
In addition to that was the 15 years of service catch up on the 402(g)7, this employee had at least 15 years of service, could have that increase deferral, so he took advantage of that and contributed $3,000 to that and in certain situations, if there's no prior history of the employee taking advantage of these increase deferral limits, he could conceivably contribute up to $3,000 in additional contributions, the initial catch up contributions, because he's eligible for it, yes. 23 years of service and therefore can do that.
Finally, he's over age 50 and the plan has a provision for it so, he took full advantage of the catch up contributions that were available to him which was $5,500 and so, he could make a deferral in this case of up to $25,000 without violating any limits relating to elective deferrals. Again, this is a simply fixed example in the sense that we're assuming there are no other plans, this is a sole plan and here is a case where he met all the eligibility requirements for the applicable limits and so was able to make $25,000 to the different categories of elective deferrals and was able to make $25,000 of elective deferrals in the 2009 plan year.
This illustrates an example, to give you an illustration that you've have to look at the various categories, the limits that apply to various categories and then after that, if all those individual limits are complied with, you could end up with an aggregate that's considerably higher than the plain vanilla 402(g) limit and still comply with the rules for limits on elective deferrals.
Okay, the other thing also that the plan needs to do is consider how to coordinate that with 415(c) limits, okay, which taken to account both employer contributions, as well as elective deferrals and any other employee contributions. In this particular case too, you need to pay attention to categories because now, let's say the, 415(c) limit is $49,000 for the 2009 plan year.
If we go to the next slide, we could see how this is applied to figure out what the maximum possible employer contribution could be on the employee's behalf without violating any 415(c) requirement. The key thing that you need to take into account there is among all these categories of contributions and as we talked very early in the presentation, age 50 catch up contributions does not count against you. Basically, the employee deferred $25,000, made elective deferrals of $25,000, out of which $5,500 consisted of catch up contribution, age 50 catch up contribution. In essence, only $19,500 counts against the individual for purposes of applying the 415 limit.
When I want to figure out what the maximum possible employer contribution could be, while still complying with 415, I would only subtract 19,500 which should be an addition of 16,500 regular 402(g) limit plus the 3,000, 15 years of service addition to the deferral limit, but I won't count the … those two added up become 19,500. I don't count the age 50 catch up contributions. They don't count against me for the age 50 limit.
The maximum possible employer contribution that could be made on my behalf without violating the rules would be $29,500 because my 415 limit in 2009 was 49,000, out of which 19,500 count against me for elective deferrals, so 29,500 could be made on my behalf. The end results were if I was the person in this particular situation in 2009, I could have conceivably made $25,000 of elective deferrals and $29,500 could have been contributed on my behalf by my employer. I could have contributed $54,500 of total contributions could have been made on my behalf without me violating 402(g) or 415.
This kind of coordination is what you would need to take into account in figuring out what the limits are. If the limits are exceeded, then we have to correct and we've talked about how those limits are potentially corrected. As we go to the next slide, it talks about, for example, using the 403(c) route, where you have a situation where the total contribution exceeded the applicable limits by $500 and you could just treat that $500 excess as a 403(c) account. That's one option. The other option would be that if you attribute the $500 of excess to elective deferrals, then that money could be potentially distributed on a taxable basis to the employee and you could correct it this way.
You have different options for correcting an excess amount that's contributed on your behalf. The trick is first to get the calculation right, taking to account all the particular limits in terms of figuring out what your limits are and then after that, figuring out whether you violated anything and if you have an excess, how you fix it. This example illustrates both the limit as well as what you could conceivably do if you exceeded the limits.
Now to the next slide, you have a situation again of deferrals that exceeded the 402(g) limit, so the limit on elective deferrals and we've talked about this in different ways before, but you have a state university that discovered that for 14 participants made elective deferrals that exceeded the 402(g) limit. It's a general statement but, in your case, when you're making that determination, you can make sure what buckets these amounts are contributed to to determine whether you've exceeded the limits in the first place. Because, as we saw in the previous examples, you could have elective deferrals hired in the plain vanilla 402(g) limit and still be in compliance. If you were able to take advantage of the additional deferrals allowed because you had 15 years of service or catch up contributions because you had attained the age 50, you may not actually have an excess of 402(g) limit issue, so check that. Once you've determined that you have an excess 402(g) limit, you have two consequences.
First of all, your excess 402(g) limit has the consequence of dual taxation, it's the excess of tax twice. Once, in the year made and then in the year distributed. Basically, when you're considering your correction, to correct it, you would distribute the excess deferrals to the participant, but in addition to that, also know that you're reporting for tax purposes. It's a dual tax impact, you would report that excess, both in the year in which it occurred and in the year in which that excess was corrected and distributed to the employee. That's the unique aspect of corrections for 402(g) limits, you have a dual tax consequence there.
Now we shift gears to slide 39, we've talked a little bit about hardship distributions and when can you have a hardship distribution in the context of a 403(b) plan? The regulations clarify that 403(b) plan hardship distributions will follow the 401(k) rules. Hardship distributions are considered premature distributions when, adequate documentation of financial hardship was not obtained, other available financial means were not previously exhausted, or total distributions from multiple vendors exceeded the amount needed to relieve the hardship. If you have that situation, you could have a situation where you have an improper in-service distribution.
Here's an example that illustrates that. We're on slide 40 now for those of you who are following the slides. A public university sponsors a 403(b) plan that allows for hardship distributions. The 403(b) vendors make the determination that distribution meets the hardship requirements. Blanca, a professor, receives a hardship distribution without providing any supporting information to verify the hardship and use the amount to make a down payment on a sail boat. Here you have multiple problems, you don't have a valid hardship distribution because you don't have either a hardship purpose and actually you have to stop right there. If you don't have a hardship purpose so investigating financial means is not even necessary here.
The point is now, you have an improper in-service distribution and how should that be corrected? If you look at what the fix is, then in that situation, in essence, you have an improper in-service distribution and you need to basically … the plan needs to make an attempt to recover distributions and if the plan is not successful in the recovering of those distributions, then in general, the employer needs to make up the difference.
However, in this current revenue procedure, there's a unique exception made to the general requirement that where improper distributions are made, and that's where the employer tries to recover. It's not successful in doing so or is only successful in recovering part of the amount, the employer would not be required to contribute the difference if that amount is actually otherwise attributable to the employees proper vested account balance.
In other words the money comes out, it's coming out from his own account balance in which he's vested in. Therefore none of the other employees negatively impacted. The employer then in that situation does not have to make replacement contributions on behalf of the employee for that purpose.
Now basically, the issue is only one of notification. The typical notification when you have an improper in-service distribution is that if the money is not returned, those money is not eligible for any tax favored treatment such as a tax-favored roll over to another qualified plan. Basically, a tax has to be recognized in the year of distribution.
Hardship distributions however, in general, if they were administered properly to begin with would … basically, these employees would have received a notification saying hardship distributions are not eligible for tax pre-roll over. The purpose of that notice there might be moot if originally the improper amounts distributed were hardship distributions and they were characterized correctly to begin with. This gives you a scenario where you have a distribution of improper amount because there was no distributable event and how you would fix that.
As you all noticed, I skipped a couple of slides in between the one. There's a definition on slide 38 that deals with overpayments. Hardship distribution is a subset of the over the overpayment category as a whole. In essence, you would have an overpayment if you have a distribution of excess amounts that we talked about earlier. In the earlier examples where we talked about, you had excess contributions made on employees behalf that you needed to correct, let's assume now those amounts were improperly distributed to the employee and you have to correct after distributions are made.
Now, we're talking about over payment instead of just an excess amount. The excess amount has now been paid to the employee and you have to correct from that point. The other situation up in over payment is the situation that we talked about now, which is the one of timing where a person took a distribution from the plan, either if the amount is the correct amount, but he took it in the absence of distributable event.
In essence, if your excess distribution occurred because the amount is wrong, or because the timing was wrong, that whole thing gets clubbed into a category called overpayment. That's what overpayment does, is it covers this entire situation where you have excess distributions on account of both amounts and timing, and the hardship distribution illustration is one example of that.
We're going to shift gears to something entirely different in the next slide, which is slide 42 for those following and this deals with the issue of information sharing agreement. As you're all aware now, all contracts under our plan, in order to be part of a plan, you need to be subject to information sharing agreement because that facilitates coordination so that whoever is administering the plan knows whether for example applicable limits have been complied with, or whether distributions are being made presumably to proper events, things like that, where you would need to know the whole picture in order to figure out whether you're complying with applicable rules.
If you have a situation where a contract that was issued on behalf of a participant, was not part of the plan because it didn't have an information sharing agreement with the plan, a permitted correction for that would be to basically transfer those assets in that bad contract to a contract sponsored by another vendor where … which has agreed to be part of that information sharing agreement. These are just illustrations of issues where things can go wrong and what possible corrections might be.
Carrying on that same vein, so that you get a flavor of the kinds of issues that we commonly see, Bob will now take over the presentation and he will talk about what trends are seen when … basically, he will share the experience of IRS audits of 403(b) plans and what issues are spotted there and what possible solutions might be. With that, Bob Cremeens, take over.
Bob: Okay, thanks Avaneesh. This is Bob Cremeens. I'm an Employee Plans Analyst. I'm in Dallas and I'm with exam planning and programs. I'd like to go over our current examination trends in 403(b) examinations and these are being reported to us from agents in the field. The trends I'm going to go over are pretty much in the order that we see them, the frequency that we see these failures. These failures talked about, they can be corrected through EPCRS through either SCP or a closing agreement or sometimes, some of the items I'm going to talk about, they may not be considered a plan failure, because they're like a misreporting. All of these are correctable through EPCRS if you choose to do so. The first one and the most frequent failure that we see is the failure of the 15 year of service catch up.
The IRS regulations [1.403(b)-4(c)(3)(ii)] allow 403(b) plans that are eligible to permit employees to make the special section, 403(b) catch up limitation for an employee with 15 years of service. If the plan permits, employees who attain age 50 or more by the end of the calendar year can also make the age 50 catch up under 414(b). We frequently find issues with the coordination of these two catch ups.
After the 15 year issue, the second biggest issue is the coordination of the two catch ups for the 15 year and the age 50. Many public schools have been found to have excess deferrals due to poor tracking of participant's prior compensation and contribution history and the application of the 15 year rule. Individuals who take the special 15 years of service catch up, usually do not realize that this catch up provision is not automatic, but it is subject to three separate calculations.
The contribution is increased by the lesser of $3,000,$5,000 multiplied by the number of years of service less the total amount of your elective deferrals, including Roth deferrals and the 15 year catch up, $15,000 minus the prior 15 year catch-up contribution amount, both pre-taxed and Roth. I'm on to slide 44 and if you'd like more information about this, you can look at publication 571 and our 403(b) Fix It Guide that's been updated on the web. They're really great resources to look at for how to properly calculate the 15 year rule.
The next one is on slide 45, failure of the universal availability non-discrimination requirements in IRC section 403(b) (12)(a) (ii). Usually what we see happens on this is that employers are not giving their employees the effective opportunity to participate and make salary deferrals. Maybe one classification of an employee, one type employee you have in your organization, you're not giving them the effective opportunity to make an elective deferral.
Also, we frequently find the failure with excluding the classification of an employee such as for part-time and the employee worked over 20 hours per week. It's not one of the excludable definitions of employee and it's a classification that the employer has set up and they're working over 20 hours per week. That's probably the most frequent issue we find with the universal availability requirement that maybe in your public school you exclude janitors or some type of classification of employee that works part time, but they're actually working 20 hours per week or more and they should be included.
Then the categories of employees which a 403(b) plan can exclude from elective deferrals are employees who are eligible to defer under another employer plan, like a 457(b) plan or a 401(k) plan or another 403(b) plan of the organization, non-resident aliens, students performing service as described in co-section 3121(b)(10) and employees who normally works fewer than 20 hours per week.
The definition of effective opportunity under the treasury reg. [1.403(b)-5(b)(2)]. A section 403(b) plan satisfies the effective opportunity requirements only if at least once during each plan year, the plan provides an employee with an effective opportunity to make or change a cash or deferred election. You at least have to provide the employee at least once during each plan year an effective opportunity to make (or change) a cash or deferred election. We're on slide 47. Our next examination trend is at RC 401(a) (17), that employers are not limiting the compensation for employer not elective, and for matching contributions. The annual compensation limited under section 401(a)(17), increased in 2013 from 250,000 to 255,000.
Number four, miscoding of W2s for box 12 deferrals. We see that amounts are sometimes reported as 457 deferrals instead of 403(b) and taxpayers are reporting matching contributions in box 12 instead of box 14 and post service contributions are not in box 12 and post service contributions actually shouldn't be reported on the W2 at all. Number four, we wouldn't consider that a plan failure, but it is a reporting failure. That failure wouldn't subject to a sanction or something. If we found that, we would just try to correct your W2s on exam and so you're reporting that correctly to participants.
Slide 48, 403(b), non-elective contribution, it's not uniform and no 401(a) for testing has been done causing a discrimination failure and that's going to be in an exempt organization 501(c) (3) type of organization with a 403(b) plan and not in a government entity. We're seeing poor coordination between vendors that contributes to 402(g) deferrals in excess. We commonly see problems with the vendors that are just not communicating with each other and they don't have a third party administrator coordinating benefits, and therefore they have excess deferrals because they're just not watching what the participants are doing.
Several instances of government entities incorrectly adopting a 403(b) plan as an eligible employer and I believe Stephanie and Avaneesh, they talked about ineligible employers. And we still see these issues with this or probably most common in like a public hospital where the local government organization thinks they can adopt to 403(b) plan and they're not eligible and then the correction is to freeze the deferrals and we allow the plan to then roll over through our EPCRS program.
Also, I would like to talk about Exempt Organizations. They recently had a compliance project where they're trying to clean up a lot of 501(c)(3) organizations that were not active anymore and they weren't filing the 990 return. This came from Code section 6033(a)(1) from PPA in 2006 that came changed to require that if you didn't file the 990 return for three years running, then you lost your exemption and we actually reviewed some plans that had that situation where they are a dual qualified as governmental and IRC 501(c)(3) organizations and they lost their exempt status for non-filing of the 990 return.
Some of those organizations, they're having to come in and request re-exemption [under 501(c)(3) and they are requesting that status retroactively. See the IRS EO website for more details.] Some of these organizations were dual qualified [as both 501(c)(3) and governmental,] but they didn't request the non- filing status [as a governmental organization with their original 1023 application or later with form 8940 with user fee]. It's a situation where if you are dual qualified, you do have to tell the IRS you're governmental [request from the IRS the non-filing status for the 990 return if you're governmental] also, that's something to note, that if you don't tell us you're governmental and so you don't think you have to file the 990 return, you need to tell the determination folks that or file I believe it's an 8940 request, non-filing status.
Also, we're seeing self-certification for hardships and for plan loan limits which are not allowed for. In other words, you're not having your third party administrator coordinate between the vendors and we're seeing that the participants themselves are saying I'm eligible for hardship, but they're not documenting the hardship or plan loan limits and you have three or four different annuity contracts and you don't really realize under all the contracts they are over the loan limitations.
Another failure that we haven't seen a lot of and it came about because of a Supreme Court ruling on the Mayo Clinic Foundation in January of 2011. Medical residents classifying as medical student leftovers, where organizations excluded medical residents but they should not have been excluded them according to the Supreme Court ruling, So the medical residents could be considered employees under the Mayo Clinic foundation ruling and we've seen that in a couple of cases. Right now, our position is that you would have to include those residents as employees for participation.
Just continuing on slide 50, the regulations provided that a school, college or university can exclude from making contributions, any student who was described under 3121(b)(10) but like I said, the medical resident issue is out there as well. A student who is enrolled and regularly attends classes at the school, or college, or university, however Supreme Court has ruled that medical residents are not students as defined in 3121(b)(10).
Another issue that we're seeing is mandatory contributions that are mischaracterized as elective deferrals. Mandatory contributions are not elective employer contributions as far as the plan is concerned, except for church plans and governmental plans. These contributions are subject to non-discrimination testing under code section 401(a)(4) and they're not subject to the universal availability rule and can't be used to satisfy that rule or the 402(g) limit.
Slide 51. We're seeing taxpayers with 403(b)plans and special pay plans for unused sick and vacation leave not properly administrated and the issues are the plan incorrectly allows for either an election to defer to 403(b) benefits or to current income causing taxation to the participant. The issue there is that the plan has allowed for an election. It's then available to the participant in current income, the way that it's set up, or it can go into 403(b) and that's not proper. There's not supposed to be an election feature on the special pay.
13,[ see item 13 slide 51] a misapplication of the five year post retirement contribution rule in 403(b)(3), and we're seeing participants making contributions beyond the 5-year period after separation of employment.
On slide 52, we're just now starting to look at in the last few years of examination about the requirement for the plan document issue and we've seen very few instances where there's a actual employer that doesn't have a plan. We have seen a few [instances where the sponor organization has not had a plan], but most of the errors that we've seen in regards to the plan document are we're finding it is that the plan is not following the actual written terms in operation and that's really an issue if... before 2009, it was not an issue, but after 2009 if you're not following the plan in operation, then that's a failure, or you're choosing inconsistent options in regards to how the plan has run or the terms are inconsistent with an employee handbook. Most of our plan failures we're seeing are just, You're not following the terms of your plan, or You have inconsistent provisions in them and we have to correct those failures through EPCRS and now we are able to with the new Rev Procedure 2013-12.
Slide 53, we're seeing an issue with designated 403(b) Roth account deferrals. Those need to be counted into the 402(g) limits. If you're allowing for 403(b) Roth accounts, you have to look at the Roth and if the employer actually has a 401(k) plan also. Really, you have to aggravate all the deferrals from all plans of the employer, all the regular 403(b) deferrals, if you have a 401(k) plan, those deferrals and both the designated Roth for or 403(b) and 401(k) deferrals. That's something to look out for.
On record retention, the agents are reporting that they see missing source documents to support plan loans and hardships and notification of plan eligibility on their examination of books and records, just that some of the basic documents are not there, that's just something to watch out for.
We're going to go over the pre-submitted questions now and I'm going to hand it back to Stephanie and Avaneesh and they're going to address in the time that we have left some of the pre-submitted questions to us.
Stephanie: Thanks Bob. That was such a great rundown of some of the issues you guys are seeing. I just wanted to point out before we turn to the questions that slide 54 has some links to some helpful websites. If you wanted to find out some more about any of the information we discussed today, you can go ahead and take a look at some of those links and they provide more information about 403(b) plans.
With that, I'm going to turn to the questions. These are question that were submitted prior to this presentation. The first question we have is, it involves an elective deferral only 403(b)(9) plan, and in that plan, the participants submit a salary reduction agreement requesting that their deferrals be stopped. The employer stopped the withholding for the participants within the payroll system but for some reason, for several months, the person handling the monthly remittances continues to send in the same amount to the vendor and is quoted as elective deferrals.
The questioner is asking, since nobody was withheld and the payment actually came from the employer's general operating fund, is this an excess allocation of employer contribution where the money should be placed in an unallocated account and used to reduce future employer contribution, or can it be treated as a mistaken contribution as described in the 403(b) LRMs? I'm going to turnover to Avaneesh for an answer.
Avaneesh: Okay, basically I would look at two categories of areas that you'd have to check. One would be the mistake of fact issue i.e. whether this would qualify as a mistake of fact contribution. You may be able to correct by reversion to the employer. It's a legalistic answer in the sense that you would have to take a look at Revenue Ruling 91-4, and other guidance to see whether this would fall under the definition of mistake of fact that we would use for the purpose of allowing a reversion back to the employer. It is something that requires a closer look at the guidance that's available and it's not a lot, to be honest.
The other option you have is under the correction program. I know that the fund typically does not provide for employer contributions, but one option would be, which would be the safest option, would be to basically provide for a one time employer contribution equal to the improper amount contributed which would be sitting in an unallocated account and then have that amount allocated to the employees based on that one time contribution formula and then you can go back to your elective deferral only arrangement going forward. Those would be two possible solutions that you could consider.
Stephanie: Now, we're going to go on to the next question. This question is that, on occasion they have a few vendors who will only fund the excess when using the Employee Plans Compliance Resolution System. If and when there is a distributable event, such as the separation from service, somebody reaching age 59 1/2, etc. What could be done to make the vendor comply?
Avaneesh: The Service doesn't really have a direct role in terms of making vendors comply, if you will. That's something that's between the employer and the vendor. Sometimes, though, what may be helpful is in some certain situations where if you come in for an application where you propose a certain correction and we issue you a compliance statement, there are times when a vendor will look at our compliance statement and then implement the correction proposed because now they know that it's something that we have approved as part of correction proposal.
Stephanie: Now we're going to go to another question and this question is that, is there specific definition of compensation that must be used in calculating elective deferrals in order to meet the universal availability requirement? Then the follow up question is, is it satisfactory to use the definition which satisfies code section 414(s)?
Avaneesh: I'm not aware of any particular restriction that a written plan would have for the purpose of determining whether employee might be entitled to receive. There, I think you should probably be okay if you use a 414(s) definition of compensation, because that will be a broad enough definition and then you could use that for other discrimination purposes although for elective deferral, if you don't have any ADP test to worry about but to show that you're complying with the universal availability. I think there you'll need a broad enough definition of compensation to make sure that everybody has a legitimate shot at making elective deferrals there and I think 414(s) definition probably serves that purpose.
Stephanie: Okay, moving to the next question. This person's saying that it's not uncommon in a 403(b) plan to not only have multiple investments with one vendor but also to have multiple investments with multiple vendors. Participant has funds with multiple vendors and the error occurred across vendors and each vendor uses a different method of calculation.
For example, one uses that a reasonable estimate and one uses the precise calculation based on the funds and trading involved. In such cases, we're aware that the revenue procedure allows reasonable estimates to be used when a probable difference between the approximate and the precise restoration of a participant's benefits is insignificant and the administrative cost of determining the precise restoration would significantly exceed the probable difference. That's a direct quote. Based on the difficulty in making a determination of the probable difference, can we just use the DOL, Department of Labor's, fiduciary correction program online calculator?
Avaneesh: This is a common issue that comes up off and on. Maybe when we consider the next revenue procedure, that's a suggestion that we could look at as to whether we should get tie ourselves to some particular estimate such as the DOL calculator and not even bother with the thing. However, remember, our goal is to restore participants to the position they would have been in had the failure had not occurred. In that case, we really have a bias towards actual earnings. I'm not sure whether the probable difference determination is really that complicated, because it doesn't mean you have to make a calculation for each person, but you could take three or four scenarios that would cover a cross section of the participant population and then come up with an estimate based on those scenarios and make a determination based on that. It shouldn't be that difficult if it's done properly.
Stephanie: Now, we're going to move on to another question. This is a pretty broad question, butplease address any tax reporting correction that need to be made in the case of overpayment and then they provided an example. For instance, if an overpayment wasn't eligible for a rollover because for instance, the employer dollars were distributed at age 59 1/2 when the plan didn't provide for in- service distributions of employer dollars. Does the 1099(R) need to be corrected to show a one, if the original 1099(R) had a G or 7. That's a pretty specific question in the end.
Avaneesh: In here, I guess I'm sort of a little bit out of my league because we don't really work the 1099(R ) end of it, so my answer may or may not hit them exactly what you want to hear. In general, if you are making a correction, an EPCRS correction, I think there is an EPCRS category in the 1099(R) instructions. In that case, I think you would enter the gross distribution amount in box one and assuming all of it is taxable, like you don't have basis in those amounts, but that amount carries true to box 2a, the taxable amount.
For EPCRS overpayment corrections, you would enter code E in box seven. Again, I'm not sure if I'm on target with respect to what your question is. This is an answer, whether it's the right answer or not. The overall impact of whatever you report would be basically to ensure that the proper amounts are recognized as income and they're not eligible for rollover and also at the same time, they don't have the consequence of being subject to the 72(t) early distribution tax either.
Stephanie: We're going to move to another question. Must an employer adopt a written plan document for a frozen 403(b) plan that stopped receiving contributions in 1989 and includes participants who are still employed with the employer? The employer has another active and unrelated 403(b) plan and one vendor of which is the sole vendor for the frozen 403(b) plan.
Avaneesh: I think the answer would be yes. I think if you look at Notice 2009-3 and the regulations require that plans in existence on or after January 1, 2009, should have a written plan in place.
Stephanie: Not a question as can a pre-2009 failure, that was a failure under revenue procedure 2008-50 which is the failure to satisfy universal availability, can that be corrected under revenue procedure 2013-12?
Avaneesh: Yes. In order for an operational failure that occurred prior to January 1, 2009 to be eligible for correction, it must be one of the failures listed in revenue procedure 2008-50. Since universal availability is a failure that's listed in 2008-50, it could be addressed for pre-2009 years as well. In other words, the source of a failure is not just the failure to follow plan terms, but a violation of a specific statute that does have a provision in revenue procedure 2008-50.
Stephanie: Do we have time for one more question? This question is, what is the remedial amendment period for a discretionary amendment to a 403(b) plan?
Avaneesh: Generally, the provisions of 401(b) that we refer for remedial amendment period, it extends relief for qualified plans. So unless there's specific guidance that extends the remedial amendment period (for 403(b) plans), you don't have it. You don't have a remedial amendment period. In essence, you would have a remedial amendment period for situations where your plan in form fails certain requirements for 403(b). In situations where you're operating your plan in variance with what the plan document provides, the general recommendation, we would have it that as soon as you change the way your plan's going to be operated, you adopt the amendment first before implementing your change.
The effective date is the date in which your change takes place. That's the date you would use for amending your plans. Your plan synchronizes with the way it's operating. You don't have a remedial amendment period for changing the way that the plan is operated. Basically, you make the plan change first before implementing the operation.
Speaker 1: Okay, that would be it Stephanie, Avaneesh. If you may tell them what you plan to do for the questions that you did not get to …
Avaneesh: I think, actually, that we covered a good chunk of them, but for the few that we didn't get to, what we'll do is we'll send the individual questions in separate email in due course so that those concerns are addressed. Thank you.