Phony employees (family members) = phony contributions & tax fraud

[TPApril]

Owner of a company with a large 401k plan was just convicted of many counts, including paying phony compensation to brother/sister/parents/uncle/daughter/cousins etc., many of whom never worked, or apparently never worked legitimate hours.

I'm not even sure where to begin to tackle this, but initially my question is, what does this mean for contributions tied to such phony compensation and how far back would we have to track this and take action. Also, what if owner appeals would this all be on hold?

It appears plan administrators are looking out for best interest of the plan.

[mbozek]

I don't know what the tax consequences are but my question is what can anyone do now? The funds have been contributed to the plan and under ERISA the participants have a vested interest in the benefits. Plan was an innocent bystander and is a stakeholder holding the assets.

To me this problem is similar to what happens when plan is notified that a participant is using a false identity and SS #.

Here's my question- if one of the family members request their account balance what will the plan administrator do?

[My 2 cents]

I don't know what the tax consequences are but my question is what can anyone do now? The funds have been contributed to the plan and under ERISA the participants have a vested interest in the benefits. Plan was an innocent bystander and is a stakeholder holding the assets.

To me this problem is similar to what happens when plan is notified that a participant is using a false identity and SS #.

Here's my question- if one of the family members request their account balance what will the plan administrator do?

If the people for whom the contributions were made actually earned $0, wouldn't the amounts contributed have to be disgorged from the plan as excess contributions under 415 and any open tax year individual tax filings made by the individuals claiming these fraudulent amounts have to be refiled etc.?

This is distinguishable from the situation when a participant is using a false identity and SS#. In that case, the person (whoever they may be) actually did work and actually did receive compensation. My impression from the original post is that many of people involved did not actually work and, whatever it was they received, did not earn or receive anything that could be considered compensation.

If the people did not earn enough to justify the "salary reduction amounts" credited to their accounts, they would certainly not be vested in them!

[mbozek]

What basis does the plan fiduciary have to conclude the family are not entitled to their benefits? The conviction of the company owner occurred after a trial where neither the participants or the plan were defendants so they are not bound by the court judgment. They could claim that they performed services for the company that entitled them to payment. It is possible that the Justice department will sue the family members for restitution under the Civil Asset Forfeiture Reform Act, PL 106-185, where the family members would forfeit their rights to the benefits contributed to their accounts in return for dismissal of any charges against them for the benefits contributed on their behalf.

Also the family members are legally required to pay taxes on the salaries paid to them even they performed no services so why should they not be entitled to the benefits resulting from those wages?

[david rigby]

I can think of (at least) two ways to interpret the phrase (original post) "...paying phony compensation...".

In the interest of clarity, can you define what you mean?

[TPApril]

Writing as I think...

Apparently the relatives never actually worked for the company, but yes they received pay for which they now have 401(k), safe harbor and profit sharing account balances. What happened on their personal tax forms I have no idea. Can they be vested if they never actually worked any hours (at least in the ps accounts)? Considering that one of the crimes convicted was paying these salaries, I don't know what happens from the IRS perspective with that money, and if it ultimately trickles down to the plan. If family members were never actually employed, then are they now considered terminated which means they can make a distribution request? Plan Administrators want to protect the plan and are wondering if they can not make such payment in the meantime, but under what legal grounds. It appears with the current internal turmoil of trying to keep the company afloat, they have limited resources and have not engaged an attorney at this time for such benefit plan issues.

[GBurns]

I think that you need much more information.

Whether their pay was properly taxed on the payroll and properly reported otherwise, should not be a concern of the plan. Tax fraud by the company owner and/or the relatives should also not be a concern.

The only issues of concern that i see are:

1. Eligibility.

2. Possible failure to operate the plan as per the Plan Documents.

The issue of eligibility is, in this case, different from a case in which an actual employee uses either a fake or someone else's SS#. In this case, the participant never was an employee and therefore could not have met any hours or time requirement.

Failure to operate as per the documents. hinges on the same principle, the plan has eligibility requirements which could not and were not met.

These participants also should not be able to meet the vesting requirements, which means they would not be entitled to some of the account balance.

I do not have a solution. but I do think that you need more information in order to proceed. As mbozek pointed out, the relatives might have to forfeit any claims in order to settle with the Justice Dept. and IRS. This is some of the information that you need.

[mbozek]

Before getting carried away need to answer the following:

1. was the owner sentenced or was there only a guilty verdict? Legally a conviction only occurs when the defendant is sentenced.

2, After sentencing defendant can appeal sentence and conviction which can be reversed.

3. Evidence of owners conviction is not probative as to whether individual employees performed services because they were not defendants in the owners case. Does plan have any information that they did not perform services independent of the evidence produced at trial.

4. Plan participants have all the rights afforded to them under ERISA including provisions for claiming benefits under Section 503.

[david rigby]

Assuming the original poster is the plan's TPA, the advice in posts 7 and 8 seems appropriate. However, the TPA still has to observe proper procedures. Likely, that includes "taking orders" only from certain people, which may include legal counsel for the plan.

The TPA may have observed (correctly) a criminal act, but that does not give the TPA authority to act outside its procedures. Perhaps the TPA will get advice from its own legal counsel.

[GBurns]

mbozek

Are you saying that if there is no conviction, the Plan can knowingly have participants who never met the eligibility criteria and that such participants have vesting rights although they were not eligible participants, initially nor subsequently? I do not see where conviction matters, the Plan and the TPA have to operate the Plan in accordance with its documents and applicable law, regardless of a conviction.

Regarding ERISA 530. I think that in order to make an eligible claim for benefits, they would have to first be eligible plan participants.

As david rigby points out, "Perhaps the TPA will get advice from its own legal counsel."

[mbozek]

Under the plan each of the family members have an account showing their benefits under the terms of the plan.

Plan provides for payment of benefits upon termination of employment.

Under what provision of ERISA would the plan administrator deny payment of vested benefits?

As op reminds us the Plan administrator has limited resources to hire counsel to review this matter.

If pan denies benefits to plan participants it needs proof that they did not work. If participants have w-2s there is a presumption they worked since they paid taxes. If there is no conviction how can plan deny benefits?

Denying benefits to participants can be expensive because plan would have to retain counsel if participants sue and if they prevail plan would also have to pay participants legal fees.

If there is no judgment of conviction there is no probative evidence and participants could always claim that they worked even if no hours were reported (e.g., they were victims)

[GBurns]

But could they show that they enrolled, elected deferrals etc ?

I would think that they would have to show eligibility and participation before they can claim benefits. Otherwise anyone could turn up at a TPA and claim benefits from any Plan.

Let us see how this turns out.

[austin3515]

April, is there any press on this case? I would love to circulate this around to people. If it was public information in the press I don't see how it would be a breach of confidence, but hey, I would understand...

[mbozek]

All that is needed is the name of the defendant and federal court where case was tried which is public information. US attorneys routinely publish press releases of convictions for tax fraud.

[austin3515]

Well when you put it like that I almost feel guilty for asking I have a feeling she's not going to tell me his name. And yes I realize that giving a link to the article would have been the same thing (hence the guilt)...

I actually tried googling it but found nothing. I actually think this would be a good article from one of those law-firms. The expression "oh, let's put your spouse on the payroll" is something that I have heard many times before. I always clarify when I hear it by saying, "No, let's find a job for Spouse to do for which we can compensate them." I think if I could say "here's an example of a guy who was convicted in court for doing this" my warnings would have more bite!

[david rigby]

If the TPA has a service agreement with the plan/sponsor, that agreement may (likely?) prohibit the TPA from divulging any such information, even if all or a portion is public knowledge.

[mbozek]

Every seminar on small business taxation that I have attended always has CPAs telling business owners to hire their family members to deduct their salaries. Kids as young as 13 can work as janitors or stock persons and spouses can work as the office manager or bookkeeper from home. Back in the day I represented a surviving spouse whose husband gave her and the rest of the family no show jobs and contributions to the company profit sharing plan. Spouse's benefit was more than 6 figures. Plan administrator/executor claimed that she was only entitled to 50% of the vested balance as a death benefit. Spouse sued under ERISA in fed court and the plan agreed to pay her the full 100% of her account balance before the trial commenced because the plan document had been altered to reduce her vested benefit to 50%. What the executor didn't know was that I had obtained the plan document that was adopted and witnessed.

No one including the federal judge cared whether the spouse had a no show job, only that she had vested benefits under the plan.

[MoJo]

Personally, I think if the TPA has "knowledge" that the plan sponsor has improperly included NON-employees in the plan, the TPA does, in fact have some responsibility.... We can argue what that responsibility might be - but burying their head in the sand nd blindly operating as if nothing is wrong, is wrong. At the very least, I would suggest the TPA immediately resign - lest hey actually exhibit the exercise of some discretion which may in fact compound the situation (and potentially give credence to an argument that they are "fiduciaries" with respect to the management of the plan). If someone comes claiming benefits in the interim, give them the DOL's number - and have them file a complaint. The explanation the TPA can give the DOL for not processing a distribution is questioning whether the plan remains "qualified," whether there is actually one who can give instructions to process distributions (since the big guy may be destined for the big house), and questions concerning the status of the claimant. At MOST, the TPA may be required to process the distribution, but I would guess the "phony employees" would not be too willing to pursue a regulatory solution.

Best advice is still to seek the advice of counsel. If the TPA has none, get the company to provide a legal opinion from their counsel, or ask the DOL themselves to have the plan hire counsel using plan assets.

[GBurns]

I am not an expert in retirement plans, but mbozek's post reminds me that health insurance was treated the same way "back in the day". This is no longer done, not because of ACA , because ACA is not applicable to such small employers, but because the courts agreed with the IRS that there had to be a bona fide employee relationship. Many of these cases involved BIzPlan and AgriPLan which are now run by tasconline.com. The Shellito and Speltz cases come to mind:

http://www.forbes.com/sites/robertwood/2011/10/05/farmer-hires-wife-grows-tax-benefits-treats-irs-like-weeds/

http://www.tomcopelandblog.com/peter-and-maureen-speltz-vs-irs-commissioner.html

TASC now breaks down their offerings into 2 categories :

1. Microbusiness

2. Group

The Microbusiness offerings of BizPlanNow and AgriPlanNow are aimed primarily at self-employed or entities which have no non-family employees and are the sort of businesses which would use what mbozek described. In fact, his wording is very similar to their wording. However, for their Group offering they use very cautious wording:

"The most important concept surrounding a Section 105 Plan is legitimate employment between spouses or any other named employee. This issue is closely scrutinized by the IRS, and it is absolutely vital that the relationship be in existence. Fabricated relationships are absolutely discouraged. Therefore, the following items must be in place to ensure the plan operates smoothly and the tax advantages are maximized:

A written employment agreement
A log of hours worked by the employee
An established cash (salary) compensation payment amount and schedule"

(My highlights in red .)

While not said, it stands to reason that if there was an employee contribution, a salary reduction/deferral agreement would also be needed as shown in Speltz above.

Although retirement plans are different from health plans, both are employee benefits plans and I just cannot see that the treatment could be that different so that any person, probably with no documentation of any sort, could be entitled to benefits, without having met either the eligibility to participate or the vesting requirements.

[mbozek]

GBurns:

Short answer: You are discussing matters governed by the IRS under the tax laws. EBSA does not regulate or have any oversight over IRC provisions regulating qualified plans. EBSA inquiry is focused on whether employee has a vested benefit in the plan under ERISA TITLE I. If the answer is yes then the benefit must be paid.

If you think about it, allowing plans to deny benefits to employees whose benefits are documented in plan records but which are not confirmed by employment records would be an invitation to deny benefits to all participants where the records of employment are routinely destroyed as part of the employer's document retention policy. It could also be construed as a violation of Section 510 of ERISA.

[MoJo]

mbozek said:

"If you think about it, allowing plans to deny benefits to employees whose benefits are documented in plan records but which are not confirmed by employment records..." (my emphasis)

ZACTLY! - What mbozek says is TRUE - but only with respect to EMPLOYEES.... If there is a question as to whether an individual who has a plan documented benefit is NOT an employee - then the argument fails.

The question is really, who gets to determine whether the individuals in question are employees? There is "information" that perhaps the company fraudulently called these people employees when in fact they may not have been. Ignoring that information is done so at the TPAs peril.

Seek counsel....

[TPApril]

tpa on this particular account is new and was thinking this type of situation of family 'employees' may have happened in other cases. tpa does not as of yet have any actual full census data. intent on here was to get a general idea on how to approach what it all means in terms of plan qualification, correction, potential distribution. Initial plan is to advise plan sponsor to obtain and consult counsel with these questions.