Employee benefit plans Helping you navigate through the complexities Quarterly newsletter
Table of contents Select changes to the 2023 Form 5500 � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � 2 SECURE Act changes to long- and part-time employee eligibility and IRS Form 5500� � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � � 3 New DOL regulations regarding the ESOP valuation process � � � � � � � � � � � � 5 Workforce reduction impacts on 401(k) plans � � � � � � � � � � � � � � � � � � � � � � � � � � 6
Select changes to the 2023 Form 5500 In February 2023, the U.S. Department of Labor (DOL), Internal Revenue Service (IRS), and the Pension Benefit Guaranty Corporation released two Federal Register Notices (29 CFR Part 2520 RIN 1210-AB97, Annual Reporting and Disclosure and 29 CFR Part 4065 RIN 1210-AB97, Annual Information Returns/ Reports) announcing changes to Form 5500 (Annual Return/Report of Employee Benefit Plan) effective for plan years beginning on or after January 1, 2023. Some of the key changes resulting from these two Federal Register Notices include the following: • Consolidated Form 5500 for defined contribution retirement plan groups This change implements the SECURE Act requirement that the DOL and IRS jointly develop to provide a consolidated annual reporting option for certain groups of defined contribution retirement plans. The final form revisions and regulations include a filing option for a new type of direct filing entity called a DCG reporting arrangement and a new Schedule DCG (individual plan information). DCGs will generally be subject to the Form 5500 requirements for large pension plans. Large plans in a DCG arrangement and small plans not meeting the audit waiver conditions will still be subject to a separate plan-level audit by an independent qualified public accountant (IQPA) as if they were filing separately. • Reporting by PEPs and other MEPs This change includes modifications to the Form 5500 to further implement SECURE Act changes that establish PEPs as a new type of retirement plan. These steps will be accomplished primarily by the new Schedule MEP (multiple-employer retirement plan information). • Change in participant-count methodology for small plan simplified reporting options The counting methodology has been revised for determining the 100-participant threshold for certain small plan simplified reporting alternatives, including the conditional waiver of the IQPA annual audit. The counting methodology for defined contribution retirement plans will be based on the number of participants with account balances, rather than the current method (pre-January 1, 2023 plan year) that counts individuals who are eligible to participate even if they have not elected to participate and do not have an account in the plan. This change is intended to reduce expenses for small plans and encourage more small employers to offer workplace retirement savings plans to their employees. • Schedule H breakout of administrative expenses Breakout categories have been added to the “administrative expenses” category of the income and expenses section of the Schedule H (financial information) balance sheet to improve fee and expense transparency. • Funding and financial reporting by defined benefit plans The 2023 final forms revisions that build upon the 2022 revisions include changes to Schedule R and Schedule SB to further improve PBGC-covered defined benefit plans’ financial and funding reporting. • Selected tax qualification compliance questions The final forms revisions add certain Code compliance questions to improve tax oversight and compliance of tax-qualified retirement plans, including plans in a DCG filing. 2
SECURE Act changes to long- and part-time employee eligibility and IRS Form 5500 Two significant regulatory changes to retirement plans require immediate attention from plan sponsors, both to ensure current operational compliance and to comply with upcoming deadlines. Many long- and parttime (LTPT) employees are now eligible for 401(k) retirement plans; there is also a new method of counting defined contribution retirement plan participants on Form 5500 Annual Return/Report. It’s important to note that a retirement plan’s audit status could be affected as these changes take effect. In addition to understanding the far-reaching implications that could help avoid missteps with LTPT employee eligibility and revised participant headcounts, we will explore how to correct any missteps that have already occurred. New eligibility opportunities for LTPT Prior to the SECURE Act of 2019 and SECURE 2.0 Act of 2022 (collectively, SECURE), employers could exclude employees from their tax-qualified defined contribution plans based on the number of hours they worked per year. Typically, this meant that part-time employees were ineligible to contribute to their employer’s retirement plan — no matter how many years they had worked for their employer. An IRS Employee Plans Newsletter issued on January 26, 2024, defined LTPT employees as workers who have worked at least 500 hours per year in three consecutive years, although the consecutive year condition will be reduced to two years in 2025. SECURE expanded LTPT employee access to employer retirement plans by requiring 401(k) plans to allow employees that meet the LTPT requirements to make elective deferrals starting with the first plan year beginning on or after January 1, 2024. Employers are not required to make employer contributions for LTPT employees. However, the burden of identifying, notifying, and enrolling these newly eligible LTPT employees falls on the employers. Failing to inform LTPT employees of their eligibility as of January 1, 2024, may have resulted in noncompliance. To rectify any compliance issues, employers can consider using the IRS amnesty program known as the Employee Plans Compliance Resolution System (EPCRS). It is essential to understand this new requirement because LTPT employee eligibility may affect two other administrative functions for plan sponsors: Form 5500 filing and the annual employee benefit plan audit requirement. 3
A key change when counting participants for Form 5500 Prior to 2023, IRS Form 5500 — an essential part of ERISA’s reporting and disclosure framework — required defined contribution retirement plan sponsors to include employees who were eligible to make elective deferrals on the first day of the plan year. In most organizations, LTPT employees would be excluded from this headcount unless the employer’s plan allowed them to make contributions to the retirement plan. Now, employers need only include participants with an account balance in the defined contribution retirement plan as of the first day of the plan year (but, for new plans, the participant account balance count is determined as of the last day of the first plan year). This may sound like a simple change, but the potential increase in participants who are LTPT employees complicates the matter. The impact on a plan’s audit requirement An organization’s obligation to have an annual audit of its retirement plan is dependent on the number of plan participants as of the first day of the plan year. Beginning with the 2023 plan year, defined contribution plans that have more than 100 participant accounts as of the first day of the 2023 plan year generally must have an annual independent audit. Before 2023, all plan participants who were eligible to make salary deferrals were included in headcounts as participants even if they had not made any plan contributions. The DOL changed the rules starting in 2023 to include only those with account balances as participants. Keep in mind that the number of participants can be decreased by taking advantage of rules that allow distributions of small account balances (accounts valued at less than $7,000 starting in 2024) to former participants, if the defined contribution plan adopted these provisions. The audit requirement of plans with 100 or more employees may change since employees without account balances are no longer counted. An organization may find that the defined contribution plan no longer requires an audit if eligible employees have not contributed to the 401(k) plan, but the audit requirement may be triggered when previously excluded LTPT employees begin to make elective deferrals. Navigating the new normal for certain retirement plans The LTPT employee rules take effect for plan years beginning on or after January 1, 2024 (for calendar yearend plans). If your organization missed the deadline to allow LTPT employees to participate in your plan, the good news is that there is a path to compliance. However, implementing these complicated changes in the law requires in-depth knowledge of the complex issues surrounding tax-qualified retirement plans. Experienced consultants can provide guidance and support throughout the process in the following ways: • Analyze plan documents and employee data to identify any compliance gaps or issues that need to be addressed • Engage in detailed discussions with plan sponsors to explain the intricacies of the changes and helping them understand the necessary steps to ensure compliance • Facilitate communication with service providers to aid in a smooth transition and implementation of any required changes • Calculate corrective actions required to rectify any noncompliance issues and confirm future compliance • Guide the employer in enrolling in the IRS’s amnesty program (EPCRS), if necessary, to self-report noncompliance issues • Help plan sponsors track the path taken to incorporate the necessary changes into the plan documents, ensuring ongoing compliance and avoiding future issues • Discuss Form 5500 preparation considerations, including participant head count 4
Lack of guidance vexes the ESOP community Historically, the ESOP community has relied on the DOL’s audit findings, process agreements, and the courts for interpretive guidance on the valuation process, which has led to inconsistencies. This leaves ESOP trustees unsure of how to determine an appropriate share price. Using the correct share price for the sale of private company stock to the ESOP is of paramount importance since the sale would be a prohibited transaction if the ESOP paid more than “adequate consideration” for the shares. Technically, the sale of employer stock to the ESOP is an ERISA-prohibited transaction, but a statutory exemption allows such sales, so long as the ESOP pays no more than “adequate consideration” for the shares. Additionally, the industry has dealt with costly litigation and investigations associated with ESOP valuations. According to the National Center for Employee Ownership, ESOP court cases have cost defendants an estimated $385.5 million over the past decade. Between 2007 and 2017, the Employee Benefits Security Administration found ERISA violations in more than 1,000 cases; ESOP valuation and loan term issues were the most common violations found. 5 New DOL regulations regarding the ESOP valuation process While a legal framework for employee stock ownership plans (ESOPs) was established by the Employee Retirement Income Security Act of 1974 (ERISA), formal guidance for determining the fair market value (FMV) of private company shares sold to an ESOP has not been issued in the past 50 years. The U.S. DOL is now poised to issue proposed regulations (perhaps as early as March 2024 according to the DOL’s most recent regulatory agenda) clarifying what constitutes adequate consideration for such shares, which has been a long-standing concern for the ESOP community. Requested clarification and SECURE 2.0 Over the years, ESOP groups requested clarification on this issue. Enacted on December 29, 2022, the SECURE 2.0 Act requires the DOL to issue regulations for what constitutes “adequate consideration” for sales of private company stock to an ESOP for purposes of the ERISA statutory exemption. During 2023, the DOL met with ESOP industry professionals to gather preliminary input about the proposed regulations. Early discussions indicate that the regulatory focus is more about the general valuation process than on issuing specific rules that might limit the ability of ESOP trustees and other advisors to exercise their professional judgment. Interim best practice considerations While the industry awaits the DOL’s proposed regulations, the following are some best practices to consider when seeking to mitigate ESOP valuation risks: • Work with skilled advisors who have deep experience with ESOP valuation analysis. • Interview and thoroughly vet a potential ESOP trustee prior to engaging them. Look for a trustee who has developed a process and strong track record for determining FMV of private company stock. • Use a trustee who has no ties to the company being appraised (i.e., is independent) and has experience with similar size companies in the company’s industry. • Hire valuation firms that understand both ESOPs and the industry of the company sponsoring the ESOP. An ESOP valuation process should be transparent and balanced for all stakeholders (i.e., the trustee, sponsor, and ESOP participants). It is crucial to address potential valuation concerns at the earliest stages of ESOP planning.
Identifying partial 401(k) terminations An important part of 401(k) management is understanding how workforce reductions can affect the plan itself, as a complete disqualification of the plan by the IRS is being considered when a partial termination goes unnoticed or is mishandled. According to IRS regulations, a partial 401(k) termination may occur upon the involuntary termination of 20% or more of employees who are plan participants at the beginning of the year. It is likely that some of the employees will be fully vested, while others will not meet the plan’s requirements for 100% vesting of employer contributions. Employers, and Human Resources departments specifically, should monitor fluctuations in employee headcounts and watch for events that can trigger a large workforce reduction that, in turn, could result in a partial 401(k) termination. However — and this is where confusion sometimes occurs — the 20% workforce reduction count is cumulative, can span more than one plan year, and can be triggered by events other than layoffs and plant closings, such as: • Business restructuring that decreases the size of the workforce. • Amendments to the 401(k) plan where the number of eligible employee participants decreases. • Employee turnover for positions that are not expected to be replaced. The IRS calculates the turnover rate using a specific formula: TR = A / X + Y. TR means the turnover rate equals the number of participants who were terminated (A) divided by the number of participants at the end of the prior year plus any who were added during the plan year (X+Y). For example, if 20 employees were terminated at a company that had 80 participants, the turnover rate would be 25%. If it appears that a company’s workforce has dropped or is expected to drop by 20% or more, employers, Human Resources professionals, and plan administrators should closely scrutinize 401(k) plan documents and the laws and regulations governing such retirement plans. Workforce reduction impacts on 401(k) plans Employee turnover often triggers a wave of issues for a company and its Human Resources department. Even 401(k) retirement plans — one of the most sought-after employee benefits — can be impacted when a substantial number of employees are involuntarily terminated. This can constitute a partial 401(k) plan termination where full vesting of the affected employees must occur to satisfy legal and regulatory requirements, yet partial terminations are often easy to overlook. Workforce reductions and the 401(k) plan How does the termination of employee participants affect a company’s 401(k) plan? Between the complexity of 401(k) plan regulations and vigorous IRS oversight, it is crucial to understand that significant employee turnover and other workforce-related events can have an impact on retirement plan operations and forfeiture accounts. If it is determined that a partial 401(k) termination occurred, employers must fully vest the affected employees regardless of plan requirements. For example, plan documents might require an employee to work six years to become fully vested in the employer’s contributions to the 401(k) plan. If a layoff occurs and includes employees with less than six years of service, then the employer must vest these employees at 100%. Vesting, in part, is a result of these employees not being given the opportunity to meet that six-year benchmark. The same is true for other events, such as business restructuring and plan amendments that affect employee eligibility. Immediate vesting of a large number of departing employees could potentially create financial hardship for the business. The plan’s forfeiture accounts may be available to fund the vesting of employees without a significant immediate impact on cash flow. However, any required adjustments to vesting must occur whether the forfeiture accounts will cover the cost or not. It is important to identify and plan for any event that could jeopardize the 401(k) plan. Failing to recognize a partial 401(k) plan termination is common, but companies can enhance their monitoring procedures and increase awareness. 6
Avoiding partial termination missteps The IRS can completely disqualify a 401(k) plan if vesting is not handled properly after a partial termination. Consider the following best practices to help mitigate the risk: • Learn the rules. Rules and regulations surrounding partial terminations tend to be complex so consider consulting with an employee benefit plan professional or ERISA attorney to understand the rules. • Know your plan. Become familiar with plan document provisions related to partial plan terminations, vesting provisions and the use of forfeiture accounts. • Establish oversight policies and procedures. Monitoring employee voluntary and involuntary terminations by the plan sponsor and management should be ongoing. Consider turnover trends during the plan year as well as across multiple years. • Document all terminations. It may be necessary to prove to the IRS whether a departure was voluntary or involuntary for the turnover calculation. The IRS may classify voluntary terminations as involuntary terminations if the employer cannot provide support for the nature of the employee’s departure. • Manage forfeiture accounts. The balance of the forfeiture account can include a variety of sources, including funds previously forfeited from participant accounts that are affected by a partial plan termination. The funds in the forfeiture account may be needed to reinstate the accounts of the affected participants. • Correct vesting failures. The IRS offers the IRS Employee Plans Compliance Resolution Systems that can be used to correct this compliance failure. New York One Battery Park Plaza 27 Fl New York, NY 10004 T: +1 212 709 4500 F: +1 212 709 4680 Washington, DC 1818 N. Street, NW Suite 460 Washington, DC 20036 T: +1 202 293 7500 F: +1 202 465 3149 Philadelphia 1818 Market Street 29 Fl Philadelphia, PA 19103 T: +1 215 561 7300 F: +1 215 569 8709 Baltimore 111 South Calvert Street Suite 2700 Baltimore, MD 21202 T: +1 410 385 2729 F: +1 410 385 5201 Chicago 333 West Wacker Drive Suite 2650 Chicago, IL 60606 T: +1 312 332 4964 F: +1 312 332 0181 Newark One Gateway Center Suite 2600 Newark, NJ 07102 T: +1 973 645 9463 F: +1 973 622 8160 About Mitchell Titus Mitchell & Titus, LLP is the largest minority-controlled accounting firm offering Assurance, Tax and Advisory services in the US. Our inclusive environment and diverse talent result in creative thinking and innovative approaches for our clients. Mitchell Titus’ tenured team of quality and seasoned professionals bring varied insight to every engagement. For more information about our organization, please visit mitchelltitus.com. This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, or other professional advice. Please refer to your advisors for specific advice. New York 80 Pine Street 32 Floor New York, NY 10005 T: +1 212 709 4500 F: +1 212 709 4680 Washington, DC 1625 K Street NW Suite 775 Washington, DC 20006 T: +1 202 293 7500 F: +1 202 465 3149 Philadelphia 2000 Market Street Suite 620 Philadelphia, PA 19103 T: +1 215 561 7300 F: +1 215 569 8709 Baltimore 200 East Pratt Street Suite 4100 Baltimore, MD 21202 T: +1 410 385 5200 F: +1 410 385 5201 Chicago 141 West Jackson Blvd. Suite 2030 Chicago, IL 60604 T: +1 312 332 4964 F: +1 312 332 0181 Newark One Gateway Center Suite 2600 Newark, NJ 07102 T: +1 973 645 9463 F: +1 973 622 8160 About Mitchell Titus Mitchell & Titus, LLP is the largest minority-controlled accounting firm offering Assurance, Tax and Advisory services in the US. Our inclusive environment and diverse talent result in creative thinking and innovative approaches for our clients. Mitchell Titus’ tenured team of quality and seasoned professionals bring varied insight to every engagement. For more information about our organization, please visit mitchelltitus.com. This material has been prepared for general informational purposes only and is not intended to be relied upon as accounting, tax, or other professional advice. Please refer to your advisors for specific advice. Contacts Irene Davis Employee Benefit Plan Leader and Partner [email protected] +1 215 825 8034 Uzma Malik Partner [email protected] +1 202 466 0162 Frederick Davis, Jr. Tax Services Partner [email protected] +1 212 709 4541 7 Our commitment to excellence inspires our commitment to you.