One of the last great tax deductions for small businesses, including sole-proprietors and LLCs, is the ability to make tax deductible contributions to a retirement plan. If an entity does not currently have a plan in place and they expect to make deductible contributions for 2016, then a plan must be established no later than December 31, 2016.
At this time of year, as part of year-end tax planning, business owners strategize about possible retirement plan contributions and the establishment of a new plan if one does not currently exist. The most common types of plans established at year-end are solo 401k plans, profit sharing plans, which include 401k plans, and defined benefit plans (traditional or cash balance). While other plan types exist, these are typically the most popular at tax planning time. Frequently, the Simplified Employee Pension (SEP) is considered; however, SEPs can be established post year-end prior to the extended due date of the Employer’s tax return.
Each plan should be considered carefully so that the associated costs and benefits meet the business’ goals, objectives, and cash flow limitations. These plans require different levels of evaluation and time to set-up. The solo 401k plan for example, can be evaluated and set-up in a couple of hours, if not less. While a defined benefit arrangement could take several days at a minimum, given the need to consult with an actuary and the consideration needed to commit to potentially very large contributions; not to mention the other potential time drags that may occur as a result of needing to find an investment advisor or evaluate potential plan vendors. The spectrum of what is involved in getting a plan put in place is wide and varied.
As year-end quickly approaches, businesses should be well into tax planning, with new plan considerations in full force. Some plan vendors are nimble and have flexible deadlines for establishing plans by year-end, while others are extremely rigid and may require new plans to be set-up several weeks prior to year-end. Business owners should be mindful that plan establishment challenges increase exponentially the closer to year-end we get, especially with all of the holiday season demands.
Don’t wait if you are seriously contemplating establishing a new plan for 2016, you need to get the process going as soon as possible. For questions regarding retirement plans, please contract Aronson’s Compensation and Benefits Practice Director Mark Flanagan at 301.231.6257.
Several weeks ago, the IRS released two new revenue procedures (2015-27 and 2015-28) designed to make plan corrections easier and less costly to employers through the Employee Plans Compliance Resolution System “EPCRS.” Rev. Proc. 2015-28 provides particular relief related to the correction of certain employee salary deferral errors for employers sponsoring 401(k) and 403(b) plans.
Retirement plans are required to operate per the rules set forth by the Internal Revenue Code and the governing plan document. Failure to abide by these rules gives rise to a plan failure called an operational defect. The EPCRS was established by the IRS in order to provide a framework for the correction of such operational failures so that employer-sponsored plans could maintain their qualified tax status. Correction of these errors can be made through a formal submission via the EPCRS or through self-correction depending on the facts and circumstances of the error(s). The IRS has worked diligently over the years to encourage employers to correct errors as soon as possible and to streamline corrections under the EPCRS.
Prior to the new revenue procedure, the standard correction for missed employee pre-tax salary deferrals was a corrective contribution made by the employer equal to 50% of the missed salary deferral and 100% of the missed employer matching contribution plus lost earnings. Revenue procedure 2015-28 established some new safe harbor correction methods for certain missed deferral errors that require reduced corrective contributions by the plan sponsor.
A general description of the new safe harbor corrections is detailed below:
Failure to Implement an Automatic Contribution Feature – Includes auto enrolling an eligible participant at the auto percentage, implementing an affirmative election made by a participant in lieu of the auto percentage, and failure to implement the proper auto escalation percentage. If the failure to implement the correct withholding does not extend past 9 ½ months after the year of failure, then no corrective employer contribution is required to correct the missed deferral. However, the entire missed matching contribution must be contributed as if the participant withholding began when it should have. Earnings must be included as part of the corrective deposit and notice must be provided to the participant no later than 45 days after correct deferrals begin.
If the failure to implement the correct automatic contribution withholding extends past 9 ½ months but deferrals begin prior to the end of the second year following the end of the year the failure began, then the employer must make a corrective contribution equal to 25% of the missed employee contribution. The remainder of the correction methodology follows the process detailed above.
Failure to Implement Employee Deferrals – If the failure to properly implement employee salary deferral elections is corrected by the first payment of compensation three months after the failure occurred, then no employer corrective contribution is required. However, the entire missed matching contribution must be contributed as if the participant withholding began when it should have. Earnings must be included as part of the corrective deposit and notice must be provided to the participant no later than 45 days after correct deferrals begin.
If the failure to implement the correct contribution withholding extends past three months but deferrals begin prior to the end of the second year following the end of the year the failure began, then the employer must make a corrective contribution equal to 25% of the missed employee contribution. The remainder of the correction methodology follows the process detailed above.
Errors caught after the timeframes referenced above or failure to provide the required notice revert back to the standard correction methodology. This clearly provides additional motivation for employers to police their plans carefully so they can benefit from these new safe harbors and reduce the cost of certain plan corrections.
This is designed to merely be a brief description of the new correction rules. Any employer that believes they have plan errors that can be corrected through the new safe harbor methods should contact Mark Flanagan of Aronson’s Employee Benefit Plan Services Group at 301.231.6257
The employee benefit plan audit season, which lasts from April through the extended Form 5500 filing deadline of October 15th, is well underway and we are finding that lack of proper documentation for plan transactions – typically hardship distributions, participant loans, and rollovers into the plan – is still an issue for many plan sponsors.
Earlier this year the Internal Revenue Service (IRS) posted clear guidance on its website reminding plan sponsors that obtaining and retaining records related to hardships and loans is their responsibility, even when recordkeeping for the plan is outsourced to a third party administrator. Specifically, with respect to hardship distributions, the following documentation should be kept:
While the plan sponsor can accept a participant’s self-certification regarding his or her immediate and heavy financial need, the other support should be collected by the plan sponsor and retained in either paper or electronic format.
With respect to participant loans, the IRS website indicates the following records should be kept:
With respect to loans with terms in excess of five years to be used for the purchase or construction of a primary residence, the website is very clear that self-certification of the eligibility for these loans is not acceptable. Failure to start the repayments is a common finding in our audits, so be sure to have procedures in place to initiate these repayments as soon as the loan is issued.
The audit of rollover contributions is another area where we often cannot see evidence that anyone considered whether the incoming funds were from a qualified plan. In 2014, the IRS issued Revenue Ruling 2014-9 to provide some safe harbor procedures for a plan sponsor to follow to ensure a rollover contribution is from a qualified plan, including the employee’s certification of the source of the funds, verification of the source of the payment (i.e. the name of the former plan or IRA), and, if a former plan, looking up the most recent Form 5500 filing on the Department of Labor’s EFAST2 database.
If you are the party responsible for approving these transactions, be sure to follow the guidance!
For more information on employee benefit plan documentation requirements, please contact Aronson’s Employee Benefit Plan Services Group at 301.231.6200.
‘Tis the season many start thinking about converting regular IRA accounts into a Roth IRA. After all, unlike the taxable withdrawals out of a regular IRA account, funds coming out of a Roth are completely tax-free after age 59½.
Many individuals have made non-deductible contributions into their regular IRA accounts, thereby resulting in the IRA having a basis. A surprising number of these individuals believe that one can pull the basis out of the IRA and deposit that into a Roth IRA, for a tax-free conversion. Therein lies the trap.
One cannot pick and choose what part of the IRA is being converted. The conversion is deemed to come from all dollars in all IRAs equally. Note that a SEP and SIMPLE are also IRAs and count in this computation. A 401(k) is not an IRA.
Example: A self-employed individual has an IRA account worth $100,000 and has previously made $30,000 of nondeductible contributions (basis). He also has a SEP worth $200,000, and a 401(k) worth $700,000 from a previous employer. The individual wants to convert $40,000 to a Roth.
Is this tax free? No! In fact, only 10% of the conversion will be nontaxable. This percentage is determined by dividing the basis ($30,000) by the value of all IRA accounts ($300,000).
Note that if the individual would have rolled his 401(k) into an IRA, the nontaxable percentage of the conversion would drop to a paltry 3%, leaving 97% of the conversion to be taxed. Thus, careful consideration should also be given to rolling over 401(k) balances into an IRA.
For assistance with this issue or any other tax matters, please contact your Aronson tax advisor at 301.231.6200.