Failure of employer to follow all Simple-IRA steps

[Guest Moe Howard2]

An S-corp starts a Simple-IRA. The corp has 4 employees .....1 owner employee & 3 regular employees. All 4 of them meet the eligibility requirements. The owner is the only active participant. The other 3 employees declined to participate in the plan for it's 1st year. Prior to the plan's first year, the owner walked through the office and informed each employee that the corp will match 3% for each eligible employee who elects to defer in the plan's first year. None of them choose to participate. So the owner was the only participant (he deferred $9,000 and the corp matched him at 3% in the 1st year).

The plan's 2nd year began 01/01/05. Again, none of the employees choose to participate in the second year. But the owner never informd the employees if the corp would match 3% in the 2nd year for participating employees or contribute 2% in the second year for all eligible participants.

How is the corp penalized for not having pre-informed eligible employees about the 3% or 2% requirement ?

Will such failure prevent the owner from receiving a match ?

[Appleby]

Moe,

By “walked through” , do you mean that the employer walked through and handed each employee the Notification to Eligible Employees. If I remember correctly, failure to provide this notice results in a penalty of $50 per day until the notice is provided. I am not sure if a verbal meets the notification requirement …

I will check on the other question and get back to you later.

[Guest Moe Howard2]

He verbally told each employee that the corp had started a Simple-IRA and that if anyone wanted to elect to have payroll deferrals contributed ....then they should let him know and he would get them an election form. Plus he verbally told each that the corp would match 3%.

[Appleby]

Moe,

The notification requirements are explained in IRS Notice 98-4, available at http://www.irs.gov/pub/irs-drop/not98-4.pdf. It appears that the employer failed to provide the Notice to employees for all the years. If the failure is attributed to a reasonable cause, the penalty would be waived.

I cannot find any specific cite that address whether the failure would prevent the employer from receiving a match. However, I think the issue would be whether the owner’s salary deferrals and matching ( or non-elective) contributions are even eligible for all the years the plan was maintained.

There is no indication of the point at which the $50 per day penalty would apply- however, I think you would agree that the only notification that would be of any use to the employees at this stage is the notice for the 2005 year. In my opinion, we are looking at EPCRS- possibly all the employer’s contributions to the plan before proper notification is provided to the employees being treated as excess contributions .

To be sure, I would rather defer to Gary Lesser on this one. He will be back in a few days.

[Appleby]

I am adding this link, as the topic seems to be along the same vein

http://benefitslink.com/boards/index.php?showtopic=29472&hl=

[Gary Lesser]

The $50 penalty would appear to start on the day the 60-day notice should have been provided for the 2004 year (generally) on Nov 1, 2003) and on Nov 1, 2004 for the 2005 plan year. [Notice 98-4, Q&A G-3]

As of July 21, 2005, the panalty is $44,500 ($50 x 628 days + $50 x 262 days). Arguably, the plan is valid. Unless the employer would be willing to make restorative contributions and 3 percent matching contributions (with interest on both) on behalf of all eligible employees, I doubt that EPCRS would be helpful. I don't think that "reasonable cause" can be established for this failure (most likely "egregious"). Correction under the EPCRS would however, eliminate the $50 per day penalty and legitimitize the contributions previously made.

OTOH, if the plan was not properly adopted (appropriate boxes and blanks not completed or not executed by employer), then the contributions are all excess contributions. It may take several years to correct the 2004 error without having to pay tax on the distribution because the correction amount is in excees of the amount specified in Code Section 408(d)(5). Note that the amount in 408(d)(5) is increased for SEP, but not SIMPLE, contributions. If a deduction was taken for the owner's contribution, then there can be no correction (so, amend the 2004 Form 1040 first, then start the correction process for 2004). The 2005 contribution can be corrected under Code Sectioin 408(d)(4) by removing it and any gain (positive or negative). Obviously, if the plan was considered adopted, then this approach doesn't work. The 10 percent penalty for making nondeductible contributions would lilely apply to the 2004 contributions. The 2005 10-percent penalty can be avoided by including amounts on W-2 or by not claiming deduction if self-employed.

Now for the good news (possible double taxation aside), the excess does not apper to be subject to the 6 percent panalty tax (see below), since a SIMPLE IRA is not a "traditional" IRA. See Form 5329 instructions.

FWIW, Congress never wrote any excess contribution rules for SIMPLE IRA other than to state that a SIMPLE IRA is an "an individual retirement plan under section 7701(a)(37)" that also satisfies additional requirements. [iRC Sec 408(p)(1)] This oversight is most likely the reason the IRS seems hesitant to provide any guidance. Publication 590 does not provide any additional guidance on excess SIMPLE contributions.

[Guest Moe Howard2]

Gary, does the 60 day notice have to be written ....or can it be verbal ?

[Appleby]

Moe. It has to be written. See the requirements explained under G-1…also, one of the primary requirements of the SIMPLE arrangement is that it as written, this includes any required notification to eligible employees.

[Guest Moe Howard2]

Appleby, OK I just read Notice 98-4. It says that a Simple-IRA Plan is a written arrangement.

What's the IRS's definition of "arrangement"? Does arrangement only include the "summary description". Or does it include the summary description plus the 1)employer contribution notification and 2) salary reduction election?

I don't see where 98-4 defines "arrangement" or says that the employer 's contribution notification must be written, although it does say that the model notification to eligible employees (Form 5304-simple) MAY be used.

Based on the wording of 98-4, I can see how someone could conclude that neither the contribution notification nor any employee's salary reduction election must be written. But that's only if the reader believes that "arrangement" means the summary description only.

[mbozek]

Moe: you need to state what actually happened here- did the employer adopt a Simple plan, contribute to his IRA and not provide the necessary notice or a salary reduction agreement. If the only thing that occured was that the employer opened an IRA and made a contribution which was deductible for SIMPLE then under the facts the employer made excess contributions to his IRA which are subject to the 6% excess contributions tax and he has to amend his 1040 to remove the Simple deduction and claim an IRA deduction. This situation is no different than the case of an employer who contributes to a qualified plan without adopting a plan by the end of the taxable year. The deduction is disallowed and the tax return must be amended.

The tax result is determined by what happened under the facts, not what the employer thought he did. Of course, the employer may have some vicarious risk to his employees if he made an enforceable promise to contribute to a SIMPLE plan.

[Guest Moe Howard2]

mbozek, see my original post.

The employer adopted a simple-ira through Oppenhimer in on 01/01/04. Openhimer sent him a summary description and various other papers.

The owner verbally informed each employee prior to 11/01/03, about the Simple-IRA for 2004. He informed each of them about all the required notifications, eligibility, and that he would match 3% of any amount they wished to defer. But he informed them verbally. he told them that if they wanted to participarte then they should let him know and he would give them election forms and Oppenhimer forms to set up their IRA. All of the employees told him that they were not interested.

The only 2004 participant was the owner. he deferred $9,000 in year 2004 and matched 3% for himself.

For 2005, he never gave any verbal or written notification to employees. He'll be the only one participating for 2005.

So, my current question is ... must the employer contribution notification be written (or can it be verbal)? I realize that he gave no notification for 2005. But he did give notification for 2004 (verbal). I would think that no $50/day penalty arises from the verbal notification for 2004 ... because there is no requirement that such notification cannot be verbal. He is subject to the $50/day penalty for 2005 because he gave no notification (neither verbal nor written for 2005).

[mbozek]

IRC 408(l)(2)© provides that employer notification includes providing each employee with a copy of the summary description of the plan.

[Guest Moe Howard2]

mbozek, according to the IRS ... the "notification of employer contribution" is separate & distinct from the "notification of summary description". They are two separate notifications. They are independent of one another.

It appears that you seem to think that an employer meets the "notification of employer contribution requirement" if he furnishes the employees with a summary description.

My question is: Does the notification of employer contribution have to be written?

[mbozek]

According to your posts, the employer offered to match employee contributions which requires that the employee make salary reduction contributions which necessitates that the employee be given written notice under IRC 408(l)(2)© of the opportunity to make such election including a copy of the summaary description. It would be reasonable to require written notification of the employer 2% non elective contribution since IRC 408(p)(2)(B) requires notification of the 2% contribution to employees before the 60 day period under 408(p)(5)© and under IRC 408(l)(2)© notification under (p)(5)© is required to be in writing.

[Guest Moe Howard2]

mbozek, I understand your belief that it would be "reasonable" to require written notification of the employer contribution. But as of yet, the IRS has declined to require that such notification be written.

You and I have one thing in common .... Neither of us wrote the IRS rules.

The code requires that the employer give specific notification to employees about the employer 3% match or 2% contribution, but the code does not require that the notification be made by any specific means of communication. The method of communication is therefore left up to the employer.

The fact that the code says that the summary description must be written does not mandate that other required notifications must also be written.

[Guest Pensions in Paradise]

Moe - thanks for the laugh. I like your concept of an employer satisfying the notice requirements verbally. Especially considering the facts in this case where ALL of the employees seemed to have decided they didn't want to partake of free matching money.

[Guest Moe Howard2]

Pen, the match isn't free .... they have to defer in order to get the match.

[Gary Lesser]

The notification and timing rules are designed to provide all employees with a "meaningful opportunity to participate." I do not believe that this occurred. Is there a video of the notice, a transcrript, or some other evidence that it was issued and all of the notice requiremets were met? Even, so, it may not have provided a "meaningful opportunity to participate." I do not believe that a "oral" notice can satisfy these complex rules.

[Guest Moe Howard2]

Gary, do you really think that telling someone that "For 2004 your employer elects to contribute to your Simple-IRA a matching contribution equal to your deferral up to 3% of your compensation" is really all that complex?

As far as proof that the verbal notification was given? ... I don't think that the IRS requires proof. For that matter, how would an employer prove that he gave written notification ? I've never seen a written match notification that the employee was required to sign.

[stephen]

Moe, I do not think "For 2004 your employer elects to contribute to your Simple-IRA a matching contribution equal to your deferral up to 3% of your compensation" is really all that complex. NOR do I think the employer in this case followed the rules as set forth by the IRS for SIMPLE IRAs.

I do find it interesting that NONE of the employees elected to defer anything since they were eligible to receive a 3% matching contribution by deferring 3% of compensation. Perhaps the verbal commication was not clear enough.

I also think the employer would have a hard time in court arguing that none of the employees took him up on his offer to provide the 3% matching contribution. Is is it worth all of this over $12,000 in contributions?

Parhaps he could deposit 3% for 2004 and 2005 for the staff and be done with it. This may be cheaper than the penalties that could be incurred.

[Guest Moe Howard2]

Stephen, what specific IRS rules for Simple-IRAs do you think the employer did not follow ?

[stephen]

I think the employer would have a very difficult time proving he notified all of the employees about the plan and that he had elected the 3% matching option and that all of the participants declined to particpate since he has nothing in writing.

[Belgarath]

I have no trouble believing that the employer did walk through and tell everyone that he was adopting a plan, and that the employer would match dollar for dollar, of whatever the employee contributed, up to 3% of salary. Or something generally in that vein. I furthermore have no trouble believing that none of the three employees elected to defer.

But here's the thing - I don't think that matters a hoot. I flat out do not accept the argument that the client "complied" with the requirements. Your arguments as to how the employer complied, and what constitutes an "arrangement" - etc., etc., are creative, and if I were in the client's shoes, or perhaps the shoes of the advisor from the vendor who may possibly be on the hook for something, I'd attempt to use the same arguments plus anything else I could come up with.

There's no alternative - if IRS comes calling on this, the client either pays the penalty, or hires counsel to hopefully successfully negotiate a lower settlement.

Or, on advice of counsel they may approach the IRS voluntarily in the hopes that this would improve the chances of reduced penalty. I'm just not all that sanguine about their chances - but maybe the Service would cut them some slack. They do in a surprising number of situations. Good luck!

[mbozek]

While not taking sides in whether oral notification meets the notice requirement for SIMPLE plans, how can any employer who adopts a SIMPLE plan ever provide documentary proof that written notification was provided to all eligible employees in the event of a subsequent audit. Second, what proof of notification can an IRS agent request other than a copy of the notice?

[Guest Moe Howard2]

mb, the employer does have to offer documentary proof .... the proof does not have to be documentary. The IRS can interview the employees and ask if the employer "notified" them.

Correction: Fist sentence should read "the employer does not have to offer documentary proof"...

[mbozek]

I dont know if the IRS audit guidelines permit an agent to interview or question any person other than the taxpayer subject to the audit because of all the legal rights and disclosure which must be given to a taxpayer by the IRS before an audit begins. Secondly, I dont think the employees would be comfortable being interviewed by an IRS agent who is auditing the employer.

I dont understand the first part of your post- it appears contradictory.

[Guest Moe Howard2]

Sure, the IRS can interview anyone that is willing to volunteer to be interviewed (with employer's permission). The employer would have to first make contact with the employees and ask if they would explain to IRS (or give IRS a statement) that they were notified by employer about the 3% match/ 2% contribution. This is all the proof that the IRS needs.

[jane123]

Picture this....

I am sitting at my desk- trying to make sure I complete my daily tasks on time. My boss suddenly comes strolling down the aisle, saying something about a SIMPLE IRA. I have no idea what he is talking about. I don’t even know what an IRA is. No one else seems interested- so I figured it could not be important. I continued with my work, and didn’t even think about the matter farther. I can’t even remember the subject matter if I tried .

A few years later, my boss asks me to tell the IRS that he did tell me about the SIMPLE. “What? What is a SIMPLE” I said? You mean you would have given me money (free money) if I had put money in my account? OK, I said. I will do what you ask…( 'cause I thought...after all, you conduct my review and determine if I get a raise and and and…

So the IRS agent interviews me a few weeks later.

Did your boss tell you about the retirement plan?

No. I said.

Did he not tell you about a SIMPLE IRA plan?

Oh- yes he did. A few years ago he told us at our desks.

What did he tell you?

Ummm...he said if I had put money in, he would have given me free money. Man!!If I had known that then, I would have certainly put money in. But I did not know that he would have given me money until he reminded me a few weeks ago...

Ah ha…said the agent…

[No Name]

SIMPLE terminates after 2004. Case closed.

[Gary Lesser]

FWIW, the DOL/IRS in a joint project wrote a publication called "Simple IRA Plans for Small Businesses." It refers to the Simple-IRA "Summary Description" as a "document" which is consistant with DOL regulations. In addition, it states that the employee must receive an "annual election notice."

In any event, unless it can be proved that a "proper" summary description and "proper" annual notice were provided timely (since an unofficial alternate method was chosen), there is (IMO) no notice. There is also a $50 per day penalty that would appear to be applicable.

[Guest Moe Howard2]

Gary, you're in left field.

No one in this topic post has said that the summary description can be anything but written. No one has said that an eligible employee does not have to receive an election notice.

The questions are: Does the IRS require that the notification of 3% match/2% contribution have to be written ? and Must the election notice (salary reduction agreement) that the employee must receive, have to be written?

The IRS has not defined the words.... receive, notice, or notify.

According to Webster's dictionary:

Receive = Accept

Notice = Announcement

Notify = Inform

An "unofficial alternate method was chosen" ... what does that mean?

Show me in the tax code were it says what the official method is for notifying an employee about the 3% match/2% contribution and the official method of how the employee is required to communicate his decision to defer or decline deferrals.

[Guest Pensions in Paradise]

inane = lacking significance, meaning, or point

You just confirmed that the summary description must be written. No written summary was provided to employees. Therefore, it is irrelevant whether the notice can be given verbally since the sponsor did not comply with the notice requirements by distributing a written summary description.

End of discussion, the sponsor did not comply with the notice requirements.

[Guest Moe Howard2]

Pen, good point.

But suppose the employer had given written summary description to employees & verbal notice re: 3% match/2% cont and right to deferral. Is verbal notification an acceptable method of notification ?

[stephen]

Moe, you seem to want to tell the client their verbal notice was ok and they are free and clear and to me it seems you are grasping for straws to support this argument.

To me it seems worthwhile to see if the service will let you put in the 3% for the staff for the affected years and continue the plan or terminate the plan (and probably at a minimum require the client to pay taxes and any applicable penalties on their contributions) as I would not advise a client to do anything that would not follow the law.

Another option may be to let the client know that if caught on audit the penalties are as follws: and let them chose. You are free to advise your client as you choose. The other members of this board are giving you their take on the situation. Good Luck.

[Gary Lesser]

Here's the law-- SPJPA Sec 1421(d) MODIFICATIONS OF ERISA.--

Note that (from below) "3) EMPLOYEE NOTIFICATION.--The employer shall notify each employee immediately before the period for which an election described in section 408(p)(5)© of such Code may be made of the employee's opportunity to make such election. Such notice shall include a copy of the description described in paragraph (2). Did the verbal notification include a "copy" of the description provided bt trustee/custodian?

(d) MODIFICATIONS OF ERISA.-- 

(1) REPORTING REQUIREMENTS.--Section 101 of the Employee Retirement Income Security Act of 1974 (29 U.S.C. 1021) is amended by redesignating subsection (g) as subsection (h) and by inserting after subsection (f) the following new subsection:

'(g) SIMPLE RETIREMENT ACCOUNTS.--

'(1) NO EMPLOYER REPORTS.--Except as provided in this subsection, no report shall be required under this section by an employer maintaining a qualified salary reduction arrangement under section 408(p) of the Internal Revenue Code of 1986.

'(2) SUMMARY DESCRIPTION.--The trustee of any simple retirement account established pursuant to a qualified salary reduction arrangement under section 408(p) of such Code shall provide to the employer maintaining the arrangement each year a description containing the following information:

'(A) The name and address of the employer and the trustee.

'(B) The requirements for eligibility for participation.

'© The benefits provided with respect to the arrangement.

'(D) The time and method of making elections with respect to the arrangement.

'(E) The procedures for, and effects of, withdrawals (including rollovers) from the arrangement.

'(3) EMPLOYEE NOTIFICATION.--The employer shall notify each employee immediately before the period for which an election described in section 408(p)(5)© of such Code may be made of the employee's opportunity to make such election. Such notice shall include a copy of the description described in paragraph (2).'

(2) FIDUCIARY DUTIES.--Section 404© of such Act (29 U.S.C. 1104©) is amended by inserting '(1)' after '©', by redesignating paragraphs (1) and (2) as subparagraphs (A) and (B), respectively, and by adding at the end the following new paragraph:

'(2) In the case of a simple retirement account established pursuant to a qualified salary reduction arrangement under section 408(p) of the Internal Revenue Code of 1986, a participant or beneficiary shall, for purposes of paragraph (1), be treated as exercising control over the assets in the account upon the earliest of--

'(A) an affirmative election with respect to the initial investment of any contribution,

'(B) a rollover to any other simple retirement account or individual retirement plan, or

'© one year after the simple retirement account is established.

No reports, other than those required under section 101(g), shall be required with respect to a simple retirement account established pursuant to such a qualified salary reduction arrangement.'

(e) EFFECTIVE DATE.--...

[Guest Pensions in Paradise]

I could not locate anything which states that the notice cannot be given verbally, assuming of course that the verbal notice contains all of the necessary information. However, as we all agree (I believe), the summary description must be distributed in a written format.

So here's my take on the two scenarios you have presented:

1. No written summary description distributed, only verbal notice given - employer is subject to $50/day penalty since the employer did not comply with the notice requirements.

2. Written summary description distributed, verbal notice given - I would say the employer has complied with the notice requirements.

[Gary Lesser]

In general a notice has to get to the intended recipient. Posted notices are not always sufficient. What may be practical for a small employer may be impractical for a large employer. The issue is probably more of whether the mode of distribution is going to get it out to those that need (or are required) to know something and whether it came across. The employer's election notification does not appear to require that it be in writting, but an undocumented verbal notification provides absolutely no assurance that it came across (or for that matter, ever provided to employees). The fact that everyone is passing up a 100% match is testament to that. A video presentation would have been better. Many firms require that their employee sign and return their election form, even if the choose not to participate.

OTOH, if a fair cross section of new and old nonowner employees elected to participate, then the 408(p)(2)©(ii)(II) verbal notice is ARGUABLY good

Moe, "unofficial alternate method..." refers to the SIMPLE "Summary Description" under DOL regulations (see above post quote) rather than a full blown "Summary Plan Description" otherwise required for a Title I plan under ERISA.

[Guest Moe Howard2]

Gary thanks for your comments ... [Moe, you're welcome; thanks for your participation and contributions to this message board.---gsl]

.... but my sole question has always simply been ...Does the IRS require that the employer notification of "3% match/2% contribution" or "salary reduction agreement (employee election to defer)" have to be written? And finally the answer to that question is NO.

I realize that it's best (for many reasons) to have them written, but I never asked about or was concerned about which method is best. I only wanted to know if a written requirement existed.

Thanks to everyone for their thoughts & comments. You were all helpful!

[Belgarath]

"

.... but my sole question has always simply been ...Does the IRS require that the employer notification of "3% match/2% contribution" or "salary reduction agreement (employee election to defer)" have to be written? And finally the answer to that question is NO."

At the risk of beating a dead horse, I remain unconvinced that the IRS will buy this argument. Maybe they will - I don't know. I wonder what would happen if your client applied for a PLR on this issue - would the IRS say OK, or would they come up with a resounding NYET? If you actually end up negotiating with them on this case, I'd love to hear the results. Of course, in this specific case, it sounds like the question is moot anyway, since they never provided the written SPD anyway, so they are up the creek regardless of the outcome of the Notice issue.

Keep us posted if you hear anything from the IRS on this. For any of you that may be attending ASPPA conferences, etc., this might be a good question to "pre submit" so the IRS can discuss from the podium? While I know such discussion is unofficial, it is helpful in determining their general opinion. Thanks.

[Guest Moe Howard2]

Bel, I'm not interested in what the IRS buy's or thinks. I'm not interested in what an IRS agent ,conducting a seminar, thinks. I'm only intersted in knowing if any written law, regulation, etc requires that the 2%/3% notice & salary reduction agreement notice be in writting. No one has shown me where such a written requirement exists. To "give someone a notification" means to notify them. If the method of notification is not stipulated ... then "notify" can be accomplished by verbal (if receiver can hear), written (if the receiver can read), or sign language (if the receiver understands sign language).

[Belgarath]

Cool! Fortes fortuna juvat. Best of luck in whatever approach you take. The discussion has been interesting, and has prompted me to read up on some of this stuff, which is a good thing.