“We were late with a few employee deferrals over the last couple of years. Our colleague suggested we consider filing a VCP (Voluntary Correction Program) to own up to the error. What do you think about this? What should we do?”
As explained more fully below, the failure to timely remit to a plan deferral contributions withheld from employees’ salaries is considered by the Department of Labor (“DOL”) to be a fiduciary breach as well as a prohibited transaction (a “PT”), and subject to both civil penalties and a PT excise tax. The DOL has established the Voluntary Fiduciary Correction (“VFC”) Program to address certain enumerated fiduciary violations (as distinguished from the IRS “VCP” program designed to address tax-qualification defects under a tax-qualified retirement plan). If the delinquencies are corrected under the VFC program, the DOL will issue a “no-action” letter, pursuant to which the DOL will not initiate an investigation of the involved fiduciary (limited to the issue(s) disclosed in the VFC submission) or assess any civil penalties on the amount remitted to the plan. Also, the fiduciary may qualify for an exemption from the PT excise tax.
The question whether or not to take advantage of the VFC program and the PT exemption is inherently factual. I generally recommend to clients that they should take advantage of the VFC program, but my advice on whether or not to take advantage of the PT exemption will vary with the circumstances.
DOL regulations provide that salary deferral contributions are considered to be assets of the plan as soon as such contributions can be segregated from the employer’s general assets, but no later than the 15th business day of the month following the month such amounts are withheld from employees’ salaries. (This DOL regulation is commonly referred to as the “plan asset rule”.) Under other ERISA requirements, an employer, as either a fiduciary or “party-in-interest” to the plan, is not permitted to hold plan assets. Doing so is considered a PT, and subjects the fiduciary to a PT excise tax.
A common misconception is that the plan asset rule gives employers permission to remit salary deferral contributions by the 15th business day of the month following the month of the withholding. To the contrary, the DOL has made it clear that the rule requires the remittance to occur as soon as the salary withholdings can be segregated from the employer’s general assets. Given the sophistication of today’s computerized payroll systems, depending on the individual circumstances, the DOL generally interprets this to mean the employer has only a matter of days to remit the salary withholdings to the plan before the withholdings are considered to be plan assets. Note that the plan asset rule provides a safe harbor for plans with fewer than 100 participants as of the beginning of the plan year - in that case, remittances are considered to be timely if made no later than the 7th business day following the withholding.
The DOL established the VFC program to permit plan fiduciaries to voluntarily disclose and correct certain enumerated fiduciary breaches in exchange for a “no-action” letter. Delinquent remittance of employee salary deferral contributions are one such eligible breach that may be corrected under the VFC program. (Do not forget that loan repayments withheld from salary also are covered by the plan asset rule and to the extent remitted to the plan late, need to be considered under the VFC program.) Separately, the DOL also established an exemption from the PT excise tax (“PT exemption”). Unlike the IRS’s VFC program, the submitting fiduciary is not charged a fee to use the DOL’s VCP program or to take advantage of the PT exemption.
So, assuming that payroll withholding and plan records exist and can be provided to the DOL in demonstration of the untimely remittance and the appropriate corrective remittance to the plan (which includes a remittance to the plan of missed earnings resulting from the delay), the advantage of making a submission is that the responsible fiduciary(ies) will be freed from any possible DOL investigation of the matter or any civil penalties that the DOL might assess on the amount remitted to the plan.
However, in order to qualify for the PT exemption, the salary withholdings must be remitted to the plan no later than 180 days from the withholding date, and in certain instances, the affected employees must be provided with a notice that describes the delayed remittance, the steps taken to correct the mistake, as well as provide a 30 day period for such employees to contact or provide the local DOL office with comments (and include the address and phone number of such DOL office). Further, a fiduciary may take advantage of the PT exemption only once every 3 years. As a result, certain fiduciaries either are not eligible for the PT exemption, or simply choose to calculate and pay the PT excise tax. (The PT excise tax is reported and paid on Form 5330.) It should be noted that the calculation of the excise tax can be somewhat burdensome: each instance of a delinquent remittance (i.e., each payroll period for which deferral contributions are remitted untimely) is considered a separate PT, and each such PT is considered to be an additional PT each January 1st thereafter until the PT is corrected (and the PT excise tax paid). As such, the excise tax works like an inverted pyramid, growing and expanding if correction is not made timely.
As a result, it is generally advisable to make a VFC program submission. Whether or not a fiduciary takes advantage of the PT exemption is dependent on the facts and circumstances.