U.S. Department of Labor (DOL) rules require employers to deposit employee deferrals made to a retirement plan as soon as the employer can feasibly segregate the funds. The DOL takes this rule so seriously that it even established a safe harbor back in 2010 for employers who have fewer than 100 employees. As long as the employer makes the deposit into the plan’s trust within seven business days from the date of payroll deduction, they will not be fined or penalized.
In the 1990s, before “just in time” management, Six Sigma, and many other administrative efficiencies were mainstream, the outer limit to deposit employee contributions was by the 15th day of the month immediately following the deductions. However, today, employers typically have employee deductions in the plan’s trust much sooner. In fact the DOL’s enforcement position over the last decade has been that if the employer generally makes the deposit of employee-deducted contributions within a fixed number of days after the deductions, that time becomes the expectation. For example, a company that makes deposits 10 days after each payroll period, but in one month misses that target by a few days or a week, may be considered liable by the DOL for delayed deposit of employee contributions
Why is the DOL so set on this as-soon-as-practicable/feasible deadline? Because employers who do not prioritize the time value of the employees’ deductions can use the funds and their earnings for the employer’s benefit. This is considered a prohibited transaction under ERISA and subjects the employer to a 15 percent excise tax on the amounts not timely deposited. In the spring of 2017, the DOL sued the Weinhagen Tire Co., Inc. (the company) and recovered over $41,000 for the 401(k) plan participants. The company was one of those employers who was not aware of the importance the DOL places on timely contributions of employee deductions to 401(k) plans. The sole owner of the company was also the fiduciary of his company’s 401(k) plan. The DOL conducted an audit of the 401(k) plan records. That investigation discovered that intermittently, between February 1, 2010, and May 27, 2015, the company withheld $35,363 from employees’ paychecks for their 401(k) contributions. While some deposits were made to the plan timely, the majority of employee withholdings were “temporarily” kept in the company’s corporate bank account and used for general operating expenses. While this is an egregious violation of the employee-contribution deposit rules, it demonstrates that the DOL is still taking an aggressive enforcement position on timely deposit of employee contributions.
The U.S. District Court for the District of Minnesota ordered the company to deposit the employee contributions along with the lost opportunity costs, or earnings, that would have been made on the contributions had they been timely deposited. The court also appointed a CPA to serve as the co-administrator, recordkeeper, and fiduciary of that plan.
The key thing to remember is that the deductions belong in the plan as soon as practicable, and they must go straight into the plan upon deduction, not be “temporarily” held in the corporate account.
- Check your plan document. Some plans have adopted a stated number of days within which the deposit will be made to the plan. If your document states a specific number of days, then you are obligated to meet or beat that time frame to be compliant. You might consider amending your document prospectively. But for the past, a failure to meet the time stated in your document is considered an Operational Error by the IRS and must be corrected (see below) or subject the employer to fines, penalties, and potential disqualification of the plan.
For example, if your plan has adopted a stated deposit date within five days after each payroll, but you have been making deposits 30 days after each payroll, the IRS could consider this an Operational Error due to the failure to follow the terms of your plan document.
- If your plan document does not have a precise standard, best practice would have you consult with your payroll provider or internal staff to determine the earliest date by which you can segregate the employee contributions from general assets. Then establish that as your standard and adopt internal practices to ensure you consistently meet that standard.
- If, however, unforeseen events prevent you from making a deposit on time, be sure to keep good records as to the reason the standard was missed. For example, one small employer found quite by surprise that the day the contributions were to be deposited, their executives with authority were both out of the country. This resulted in a four-day delay from their established standard. The one incident was uncovered upon audit and the company had to pay a fine. Document any extenuating circumstances and keep these with your plan records. At the end of each year, you must report any delay on the Form 5500 filing. The documentation should help, should you decide to apply to the DOL for a 15 percent excise tax waiver through their Voluntary Fiduciary Correction Program (VFCP). See below.
- Include a section in your plan’s Administrative Manual, or on your intranet, to explain the practices and procedures. Ensure each new employee is advised and trained on the timeliness of this process. Sometimes a new employee may come in with standards from a prior employer that may not be consistent with your plan document, history, and practice.
Applicable Correction Programs
Should you discover that your plan does have a stated time frame with which you are not in compliance, the IRS offers some relief programs you may follow to avoid fines and penalties. Depending upon how long the delay has been, how often it has occurred, and how long ago it was, there are three programs from which to choose. These plans are explained in IRS Revenue Procedure 2016-51 available here.
Although an employer can correct the operational mistake with the IRS above, the employee deposit delay also triggers a prohibited transaction and a 15 percent excise tax to the employer. The employer who participates in a prohibited transaction must correct it and pay the excise tax. The initial tax on a prohibited transaction is 15 percent of the amount involved for each year. If the disqualified person doesn’t correct the transaction, an additional tax of 100 percent of the amount involved may be due. Payment is made with the Filing of Form 5330. To request exemption from the penalty, you may apply to the DOL. By using the Voluntary Fiduciary Correction Program (VFCP) with the DOL, you can obtain relief from both the prohibited transaction and the excise tax.
Remember the Correction Programs are generally available where the employer self-identifies the compliance error and willingly corrects it. Employers have saved thousands (and large employers millions) by self-auditing and correcting plan errors before the DOL or IRS calls an audit. If you would like to take advantage of any of these programs, or reach out for a retirement plan compliance review, feel free to contact MSEC ERISA/Benefit Consulting Services for advice and pricing.