Fiduciary Corrections

Background

Prohibited transactions are specific types of retirement plan errors that result in excise taxes and could also result in civil penalties and personal liability. Responsible parties include plan sponsors, officers, trustees, plan administrators and other fiduciaries. Prohibited transactions generally involve misuse of plan assets and/or self-dealing (transactions with a “party in interest”). Several specific prohibited transactions can be fixed through the Department of Labor’s (DOL) Voluntary Fiduciary Correction Program (VFCP).


Many well-intentioned transactions can be prohibited transactions. If you have the participants’ best interest in mind when making an investment or selling a plan asset, that may not be enough. You also often need to ensure the transaction does not involve a party in interest. The rules are complex. If you aren’t sure, consult an outside expert to help you determine if the transaction is proper.


Parties in Interest

In addition to prohibiting general misuse of plan assets, the prohibited transaction rules prohibit self-dealing with plan assets. The definition of a party in interest is basically what defines the “self” in self-dealing. Parties in interest is a broad category that includes:

plan administrators, officers, trustees, custodians, attorneys, or employees of the employee benefit plan (including plan fiduciaries) or their family members;

  • persons providing services to the plan or their family members;
  • the employer or employee organization whose employees/members are covered by the plan;
  • owners, direct or indirect, of 50 percent or more of the plan sponsor (or employee organization) or their family members;
  • certain subsidiaries, partners and joint venturers; and
  • officers, directors, 10 percent or more shareholders, certain highly compensated employees of an employer, employee organization, parent or subsidiary.

Family members are defined broadly (spouse, lineal descendants and spouses of lineal descendants) and constructive ownership rules also apply to determine ownership (for example, stock owned by a trust is considered as owned by the beneficiaries of the trust).


Prohibited Transactions

In addition to prohibiting misuse of plan assets, the law generally prohibits parties in interest from benefiting financially from the plan. Parties in interest are prohibited from receiving the income or assets of the plan (with certain exceptions) and from dealing with the income or assets of a plan in his own interests or for his own account. The following specific transactions between a plan and a party in interest are prohibited:

  • sale or exchange, or leasing, of any property;
  • lending of money or other extension of credit; and
  • furnishing of goods, services, or facilities.

A simple example of a prohibited transaction would include the plan purchasing assets in real estate from an officer of the plan sponsor. The investment could be an incredible opportunity for the plan and create enormous sums of money. It’s still a prohibited transaction. Several other common prohibited transactions are covered by the VFCP, described below.


Fiduciary Errors and Prohibited Transactions Covered by the VFCP

The DOL’s VFCP covers only certain fiduciary violations/prohibited transactions and provides methods to correct each. The prohibited transactions that can be fixed by the VFCP are:

  • Prohibited transactions involving parties in interest
    • Purchase/sale of assets by plans from/to parties in interest
    • Sale and leaseback of property to sponsoring employers (plan sells property to the sponsoring employer who leases it back to the plan)
    • Payment of dual compensation to plan fiduciaries (a fiduciary who is already receiving full-time pay from the plan sponsor, may only receive reimbursement for reasonable direct expenses properly and actually incurred in the performance of his duties with the plan)
    • Delinquent/late deposit of participant contributions and/or participant loan repayments
    • Loans to parties in interest
  • General misuse of plan assets:
    • Purchase (sale) of assets from non-parties in interest at more (less) than fair market value
    • Holding of an illiquid asset previously purchased by plan
    • Benefit payments based on improper valuation of plan assets
    • Payment of duplicate, excessive, or unnecessary compensation
    • Improper payment of expenses by plan (there is a complex analysis of what expenses can properly be paid from the plan instead of paid by the sponsoring employer)
    • Below market interest rate loans
    • Participant loans failing to comply with plan provisions for amount, duration, or level amortization*
    • Defaulted participant loans*

* Note that these loan errors require filers to use the IRS’s Employee Plans Compliance Resolution System (EPCRS) to fix the error and then file the compliance statement with DOL’s VFCP.


VFCP Process

For each error, the regulations set forth the proper process to correct the error. No matter which type of error, in order to file with the VFCP, you must:

  1. Calculate and restore any losses or profits with interest, if applicable, and distribute any supplemental benefits to participants. The DOL provides an online calculator to assist with the calculations.
  2. File an application with the appropriate DOL Employee Benefits Security Administration (EBSA) regional office that includes documentation showing evidence of corrective action taken. The DOL’s guidance has a detailed checklist of all the items that should be submitted with the filing.


If the DOL is satisfied with the correction, it will issue a no-action letter. Persons using the VFCP must fully and accurately correct violations. Incomplete or unacceptable applications may be rejected. If rejected, applicants may be subject to enforcement action, including assessment of civil monetary penalties.


Penalties

Penalties are assessed by both the DOL and the Internal Revenue Service (IRS) against the party in interest. The maximum penalty is 5% of the amount involved for each year or part thereof during which the prohibited transaction continues. If the transaction is not corrected within 90 days after notice from the DOL (or such longer period as DOL may permit), the penalty may not exceed 100%. If a no action letter is issued under the VFCP, no civil penalties will apply.

The IRS imposes an excise tax equal to 15% of the amount involved with respect to the prohibited transaction for each year (or part thereof) in the initial period. In any case in which a 15% initial tax is imposed and the transaction is not corrected within a certain period, the tax is equal to 100% of the amount involved. In certain VFCP cases, the IRS will waive the excise tax.


Excise Tax Relief

The following prohibited transactions, once corrected through VFCP, will not be subject to the excise tax:

  • Purchase/sale of assets by plans from/to parties in interest at fair market value
  • Sale and leaseback of property to sponsoring employers at fair market value (plan sells property to the sponsoring employer who leases it back to the plan)
  • Delinquent/late deposit of participant contributions and/or participant loan repayments
  • Loans made at fair market interest rates to parties in interest
  • Holding of an illiquid asset previously purchased by plan
  • Certain improper payment of expenses by plan (Use of plan assets to pay expenses to a service provider for services that must be paid by the plan sponsor and not the plan are characterized as “settlor expenses,” provided such payments were not expressly prohibited in the plan documents.)


Summary

Finding or discovering errors is often the most difficult part of the corrections process. Errors often occur precisely because a process or person is not being closely monitored or because parties in interest are not aware of the rules. Regularly reviewing plan procedures, consulting with outside experts and establishing policies is the best way to catch errors quickly and prevent errors from occurring. Once an error is discovered, timely discussing the errors with outside experts will help ensure the correction is not costly for the plan.