Prohibited Transactions

[justatester]

I am pretty sure this transaction is wrong on many levels, but not sure even where to begin.

Plan susupended their match. It had about $200,000 in the forfeiture account. The plan used the forfeitures to fund pretax contributions. So, they plan "withheld" $500,000 in pretax contributions and only wired $300,000 in funds and used the forfeitures for the balance.

Pretty sure this is some sort of prohibited transaction...Please let me know your thoughts. Would this be considered "criminal"? As recordkeeper, what is our obligation to report this and to whom do we report?

Thanks!

[rcline46]

What does the document say about the use of forfeitures? They may have a failure to follow the terms of the document.

[Kevin C]

Deferrals can't be prefunded [1.401(k)-1(a)(3)(iii)], so I don't see how you can treat forfeitures as deferrals.

Also, amounts withheld from paychecks become plan assets as soon as they can reasonably be segregated from the assets of the employer. If they don't deposit the full amount, it looks to me like the employer is still holding plan assets, which would become a PT.

§2510.3-102 Definition of "plan assets" --participant contributions.

(a)(1) General rule. For purposes of subtitle A and parts 1 and 4 of subtitle B of title I of ERISA and section 4975 of the Internal Revenue Code only (but without any implication for and may not be relied upon to bar criminal prosecutions under 18 U.S.C. 664), the assets of the plan include amounts (other than union dues) that a participant or beneficiary pays to an employer, or amounts that a participant has withheld from his wages by an employer, for contribution or repayment of a participant loan to the plan, as of the earliest date on which such contributions or repayments can reasonably be segregated from the employer's general assets. [Amended January 14, 2010 by 75 FR 2068.]

As for reporting this, there is a question on the Form 5500 about PT's. You might also want to read up on paid preparer penalties.

[austin3515]

From the EOB, 2009. Shockingly, they're saying pre-2006 this would have been OK. I can't imagine the DOL would agree with that statement, but I suppose it is a moot point today, as I think we all agree that now BOTH the IRS and the DOL would not like this at all... And for the record, this would definitely be a PT, in addition to a violation of the new 401k regs.

1.e. Could forfeitures be used to reduce elective deferrals? IRC §402(e)(3) provides that "[f]or purposes of this title" (i.e., the entire Internal Revenue Code), elective deferrals under a 401(k) plan are not treated as employee contributions. In other words, they are treated as employer contributions. So, if the 401(k) plan contains language that provides for forfeitures to be allocated to reduce the employer's contribution liability, and does not specifically confine the definition of employer contributions for this purpose to matching contributions and/or nonelective contributions, is the employer able to use the forfeitures to pay for its elective deferral contribution liability? Regulations that took effect in 2006 address this issue directly. See 1.e.1) below. However, before those regulations were issued, there was no published guidance that precluded such an approach, so the IRS permitted forfeitures to be used in this manner. See the Q&A session at the ASPPA Conference in Washington, D.C., on October 25, 2004.

1.e.2) Use of forfeitures to reduce elective deferrals prohibited in post-2005 plan years. Treas. Reg. §1.401(k)-1(a)(3)(iii)© prohibits the contribution of elective deferrals made on behalf of an employee before the employee performs the services to which the elective deferrals relate (or before the compensation would have otherwise become currently available had the deferral election not been made). No exception is made for forfeitures that are allocated to satisfy the employer's contribution obligation with respect to elective deferrals. Note an exception for forfeitures applies for matching contributions (see 1.d.3) above), but not for elective deferrals. Thus, the allocation of a forfeiture to another employee's account to satisfy the employer's obligation to contribute the employee's elective deferrals would be in violation of §1.401(k)-1(a)(3)(iii)©. These regulations are effective for plan years beginning on or after January 1, 2006, unless the employer elects to apply them to earlier plan years ending after December 29, 2004.

1.e.2) Example. A 401(k) plan has unallocated forfeitures in the amount of $35,000. The employer has a contribution liability of $72,000 with respect to salary reduction elections made by eligible participants. The employer deposits $37,000 and has the remaining liability satisfies with the $35,000 forfeiture account. This would violate the regulations described in 1.e.1) above. However, for pre-2006 plan years, so long as the plan document allowed for forfeitures to reduce employer contributions, and did not preclude the application of such rule to the employer's elective deferral contribution liability, the allocation of the forfeitures in this manner was permissible.