The Internal Revenue Service (“IRS”) has issued two pieces of guidance that provide relief to retirement plan sponsors and administrators from the penalties that may be assessed under the Internal Revenue Code (the “Code”) for delinquent Forms 5500 filings. Plans that fail to timely file Form 5500 series annual reports can be subject to penalties under both Title I of the Employee Retirement Income Security Act (“ERISA”) and the Code. IRS penalties for delinquent Forms 5500 filings can reach $15,000 for each late return, plus interest.
The first piece of guidance, Revenue Procedure 2014-32 (“Rev. Proc. 2014-32”), sets forth a temporary pilot program that provides relief from Form 5500 late filing penalties for retirement plans that are ineligible to participate in the DOL’s Delinquent Filer Voluntary Compliance Program (the “DFVC Program”). The second piece of guidance, Notice 2014-35, modifies the requirements for retirement plans to qualify for IRS late filing penalty relief by requiring ERISA-covered retirement plans to file Forms 8955-SSA with the IRS in addition to satisfying the requirements of the DFVC Program.
Rev. Proc. 2014-32. Rev. Proc. 2014-32 establishes a temporary one-year pilot program providing relief from Form 5500 late filing penalties to plan administrators and sponsors of retirement plans that are subject to the filing requirements of the Code but not subject to Title I of ERISA. These plans include:
- small business plans that provide benefits only for the owner and the owner’s spouse, and plans of business partnerships that cover only partners and their spouses (collectively, “one-participant plans”); and
- certain foreign plans.
NOTE: Relief is not available where the IRS has already issued a CP-283 Notice (Penalty Charge on Your Form 5500 Return) to a plan sponsor or administrator in relation to the delinquent Form 5500.
Under Rev. Proc. 2014-32, the IRS will not impose any penalty for delinquent Forms 5500/5500-EZ filings if the applicant submits a complete Form 5500 series return, including all required schedules and attachments, for each plan year for which the applicant seeks relief. All returns submitted must be sent to the IRS in paper format and cannot be submitted electronically via the DOL’s EFAST2 filing system.
Delinquent returns submitted under the pilot program must be marked, in red letters at the top margin of the first page, “Delinquent return submitted under Rev. Proc. 2014-32, Eligible for Penalty Relief.” In addition, a completed paper copy of the Transmittal Schedule provided in the Appendix of Rev. Proc. 2014-32 must be attached to the front of each delinquent return.
No penalty or payment is required under the temporary pilot program. However, IRS has indicated that if the temporary program is replaced with a permanent program, a fee or other payment will be required. Delinquent filers can submit an application for penalty relief under the temporary pilot program from June 2, 2014 until June 2, 2015.
Notice 2014-35. Since 2002, IRS has not imposed penalties relating to delinquent Forms 5500 filings where a plan administrator or sponsor has satisfied the requirements of the DOL’s DFVC Program. The DOL’s DFVC program allows plans that fail to timely file their Forms 5500 to submit the late reports and pay a reduced civil penalty. Retirement plans participate in the DFVC Program by filing an application and submitting the late Forms 5500.
Notice 2014-35 updates the terms for retirement plans covered by Title I of ERISA to obtain relief from IRS penalties for failure to timely comply with the Code’s Form 5500 filing requirements. To obtain relief, the delinquent Form 5500/5500-SF must be filed electronically via EFAST2 in accordance with the requirements of the DOL’s DFVC Program, and the delinquent Form 8955-SSA must be filed in paper format with the IRS. If these requirements are met, IRS will not impose penalties for untimely filed Forms 5500/5500-SF and 8955-SSA.
NOTE: If a Form 8955-SSA is filed pursuant to Notice 2014-35, the filer must check the box on Line C, Part I (Special extension) on Form 8955-SSA, and enter “DFVC” in the space provided on Line C.
Delinquent Forms 8955-SSA must be filed with the IRS no later than 30 days after completing the DFVC filing for the late Form 5500/5500-SF, or December 1, 2014, whichever is later. This requirement applies to all DFVC filings submitted via EFAST2 (i.e., all DFVC filings after December 31, 2009), regardless of whether the filing was submitted before the release of Notice 2014-35.
NOTE: Form 8955-SSA must be used for years prior to 2009 even though Schedule SSA would have been filed for those years if the filing had been timely submitted to DOL.
For example, if a DFVC filing for a delinquent 2008 Form 5500 was submitted in 2012 and Schedule SSA was never filed for the 2008 plan year, a paper Form 8955-SSA must be filed with IRS for the 2008 plan year no later than December 1, 2014.
Action Steps for Plan Sponsors and Administrators. Plan sponsors and administrators for one-participant plans and foreign plans are advised to confirm that all required Form 5500 filings have been completed. Any outstanding filings discovered should be corrected while the opportunity to do so at no cost exists via the temporary pilot program created by Rev. Proc. 2014-32. Plan sponsors and administrators should also monitor the development of the temporary program to see if it becomes permanent.
Notice 2014-35 makes clear what retirement plan sponsors and administrators must now do to bring retirement plan Form 5500 and 8955-SSA filing obligations into compliance with IRS requirements. Retirement plan sponsors and administrators are advised to confirm that all required filings have been completed, and any outstanding Forms that are discovered should be corrected before IRS assesses a penalty in relation to the delinquency.
IRS Issues Updated Circular 230 Regulations
The IRS has issued updated final regulations on Circular 230 that significantly revise the manner in which practitioners are required to advise on federal tax matters. Circular 230 is a portion of the federal regulations that governs the conduct of individuals who practice before the IRS. Practitioners who violate Circular 230’s rules of conduct are subject to disciplinary actions ranging from monetary sanctions to suspension and disbarment from practice before IRS.
This article primarily focuses on the final regulations’ elimination of the covered opinion rules and the new requirements for written tax advice. Specifically, the new regulations provide practitioners with relief from Circular 230’s previously onerous rules, thereby replacing them with a more workable standard of care that is based on facts and circumstances. Because the penalties for failing to meet Circular 230’s requirements can be severe, practitioners must be aware of, and comply with, the updated regulations.
Covered Opinions. The most significant change under the updated regulations is the elimination of the distinction between a “covered opinion” and other written tax advice. The prior regulations provided very distinct rules depending upon which of these two categories of writing the advice was classified. In fact, the rules on covered opinions were very complex and imposed onerous due diligence requirements that might exceed a client’s expectations, whereas the rules for written advice not deemed as a covered opinion were far less stringent.
Because of the stricter requirements for covered opinions, practitioners made every effort to avoid inadvertently providing covered opinions to their clients. To avoid penalties relative to covered opinions under Circular 230, practitioners would include a generic disclaimer (i.e., a “Circular 230 disclaimer”) at the bottom of emails and other correspondence which provides that tax advice is not being offered to the reader. These disclaimers were often provided without narrow tailoring to the particular advice provided to the client and even where the correspondence did not involve a tax matter.
Recognizing that the covered opinion rules created onerous compliance obligations for tax practitioners while providing little benefit to taxpayers, the updated regulations provide a single, uniform set of rules governing all written advice furnished on federal tax matters.
New Rules for Written Tax Advice. The new rules governing written tax advice strive to maintain standards that require practitioners to act ethically and competently while remaining practical and flexible in view of today’s practice environment. Under the updated regulations, practitioners must satisfy all six of the following requirements when rendering written advice on a federal tax matter:
- Base the written advice on reasonable factual and legal assumptions;
- Reasonably consider all relevant facts and circumstances that the practitioner knows or reasonably should know;
- Use reasonable efforts to identify and ascertain the facts relevant to the advice;
- Not rely on the representations of others if reliance on them would be unreasonable;
- Relate applicable law and authority to facts; and
- Not take into account the possibility that a tax return will not be audited or that a matter will not be raised on audit.
The updated regulations explain that the determination of whether a practitioner has met these requirements will be based on all facts and circumstances attendant to the matter, including those not contemplated by the written advice.
Exclusions from Written Advice. The updated regulations contain exclusions from what constitutes written advice. For example, government submissions on matters of policy (e.g., commentary submitted to the IRS in response to proposed regulations) are not considered written advice. Continuing education presentations that are provided to an audience solely for enhancing knowledge on federal tax matters are also generally excluded, unless such presentations promote or market transactions.
Reasonable Practitioner Standard. IRS will apply a reasonable practitioner standard when reviewing practitioners’ compliance with the updated regulations. The updated regulations identify situations where it is unreasonable for a practitioner to rely on the representations of others (in violation of Circular 230). Specifically, it is unreasonable for a practitioner to rely on a representation if the practitioner knows or reasonably should know that a representation or assumption on which the representation is based is incorrect, incomplete or inconsistent. Also, reliance is unreasonable where the practitioner knows or reasonably should know that:
- the opinion of the other person should not be relied upon,
- the other person lacks the necessary qualifications to provide the advice, or
- the other person has a conflict of interest in violation of Circular 230.
NOTE: Practitioners should be aware that the requirement for reasonable reliance on others may create an obligation to inquire as to the advisor’s qualifications and background.
In the case of written advice that the practitioner knows or has reason to know will be used by another in promoting, marketing or making recommendations to another taxpayer, IRS will give heightened emphasis to the additional risk caused by the practitioner’s lack of knowledge of the taxpayer’s particular circumstances.
Conclusion. The final regulations, which became effective June 12, 2014, provide welcome relief to tax practitioners and clients alike by simplifying the rules for providing clients with written advice on federal tax matters. However, due to the subjective nature of the new rules, tax advisors who furnish written advice must ensure that they can demonstrate that their advice is reasonable in light of the surrounding facts and circumstances. Nonetheless, tax practitioners no longer need to incorporate Circular 230 disclaimers into their written correspondence.
IRS Issues Final Regulations to Clarify Tax Treatment of Payments by Retirement Plans for Accident, Health and Disability Insurance Premium
The IRS has issued final regulations that clarify the tax treatment of premium payments paid by qualified defined contribution plans for accident and health insurance where such payments are charged against participants’ plan accounts. Included within the final regulations is a new rule governing the tax treatment of premiums paid by defined contribution plans (and charged against participants’ account) for disability insurance that provides replacement plan contributions when a participant becomes disabled. The final regulations are effective for plan years beginning on or after January 1, 2015, but taxpayers may elect to apply the regulations to earlier taxable years.
Background. Section 125 of the Code allows employees to pay accident and health insurance premiums on a pre-tax basis. The Code also excludes from a participant’s taxable income all proceeds received under accident or health insurance policies for injuries or sickness. Additionally, Code Section 402(a) provides that distributions from qualified retirement plans are taxable to the participant in the year of distribution.
Accident or Health Insurance Premiums. The final regulations reiterate that, as a general rule, premium payments made from qualified defined contribution plans for accident or health insurance (including long-term care) are considered taxable distributions to the insured participant during the year in which the premium payments are made. Certain statutory exceptions to this general rule exist, including: (i) premiums payments made on behalf of qualified public safety officers (Code Section 402(l)), and (ii) premium payments from a qualified retiree health account (Code Section 401(h)).
Premium payments that are charged against a participant’s defined contribution plan account are treated as a taxable distribution and are deemed as being made by the participant, not the employer. In other words, the transaction is the same as if the participant purchased the coverage with after-tax dollars. Therefore, proceeds received from an insurance policy whose premiums are paid by a qualified plan are generally excludable from the participant’s gross income.
NOTE: Where a participant took deductions for the insurance premium distribution, the insurance proceeds would be taxable.
Disability Insurance Premiums. The final regulations provide that premium payments made by a qualified defined contribution plan for disability insurance that provides replacement plan contributions in the event of the participant becoming disabled are not treated as a taxable distribution to the participant if the following conditions are met:
- The insurance policy provides for proceeds to be paid to the plan if the employee becomes unable to continue employment because of disability;
- Proceeds from the insurance policy are credited to the participant’s plan account; and
- The amount payable under the insurance policy does not exceed the reasonably expected annual contributions that the participant would have made or received during the period of disability, reduced by any other contributions made on the employee’s behalf during the disability period. (Future salary increases that the participant would otherwise have received during the period of the disability may be considered in determining the “reasonably expected” amount of the contribution that the participant would have made.)
Disability insurance policies that meet these conditions are treated as plan investments and any proceeds received are treated as a return on that investment as opposed to plan contributions. Thus, proceeds from the disability insurance policy are not subject to Code rules that limit annual plan contributions. In addition, insurance proceeds are not taxable to the participant at the time of payment.
The final regulations advise that the contribution disability insurance policies can replace:
- Pre-tax contributions that a participant would otherwise have made during the period of disability;
- Any related employer-paid matching contributions the employee would have received; and
- Any employer non-elective (or profit sharing) contributions.
Action Steps for Employers. Employers that sponsor qualified defined contribution plans should carefully consider whether to provide employees with the option to purchase contribution disability insurance through the plan on a tax-favored basis. Offering such disability insurance as a plan investment option is a fiduciary decision that will expose the employer to the risk of fiduciary liability. Accordingly, employers that decide to offer disability insurance are advised to engage in an objective, thorough and analytical process to identify and select the right disability insurance policy.
Before an employer decides to offer contribution disability insurance as an investment option under its qualified defined contribution plan, the underlying plan document must be reviewed to determine what amendments are needed. Employers are advised to engage qualified employee benefits counsel to assist in the plan document review and amendment process.
NOTE: Marcia Wagner testified before the Internal Revenue Service regarding the appropriate treatment of disability insurance in the context of defined contribution plans and the very position that she espoused, by virtue of the regulations, is now the law of the land.
Supreme Court Rejects Presumption of Prudence in Stock-Drop Cases
Recently, the Supreme Court handed down a unanimous opinion in the case of Fifth Third Bancorp v. Dudenhoeffer, rejecting a long-standing rule that fiduciaries of individual account plans are entitled to a “presumption of prudence” when employer stock is offered as an investment option. The Court’s ruling impacts 401(k) plans that offer employer stock as an investment option as well as employee stock ownership plans that invest primarily in employer stock.
Many employers offering employer stock as an investment option in a 401(k) plan have been subject to class action lawsuits arising from a substantial drop in their stock price causing participants to claim that the employer breached its duty of prudence and loyalty by allowing continued investment in the stock. Prior to the recent Supreme Court ruling in Dudenhoeffer, a key defense for employers in “stock-drop” suits was the so-called “Moench presumption” of prudence, named after the 1995 decision by the Third Circuit Court of Appeals in Moench v. Robertson which was followed by a majority of Circuit Courts.
Application of the Moench presumption meant that a plan fiduciary’s decision to remain invested in employer securities is presumed to be reasonable, unless the plaintiff can show that the fiduciary abused its discretion in continuing to make employer stock available as an investment alternative. The rationale for the Moench presumption was based on an attempt to balance competing policy concerns that, on the one hand, would promote employee ownership, and on the other, protect participants against imprudent plan investments. Thus, while ERISA requires fiduciaries to diversify plan assets and to act with prudence in making investment decisions, it also provides that in the case of plans offering employer stock as an investment, they are exempt from the duty to diversify investments and are also exempt from the prudence requirement, but only to the extent that prudence would require diversification.
Lower Court’s Decision. The Dudenhoeffer case involved a 401(k) plan sponsored by Fifth Third Bancorp, which offered the company’s stock as a plan investment option. From July 2007 to September 2009, the stock’s price dropped 74%, causing the plan to lose “tens of millions” of dollars, allegedly as a result of Fifth Third Bancorp’s shift from conservative lending practices to being a subprime lender. Participants filed a class action lawsuit in federal district court against Fifth Third Bancorp alleging that plan fiduciaries breached their duty under ERISA by continuing to include Fifth Third Bancorp stock on the plan’s investment menu despite the fact that they knew or should have known that the company’s business model put its value in jeopardy.
The District Court dismissed the claim on the basis that the fiduciary’s decision was presumed to be prudent. On appeal, however, the Court of Appeals overturned the District Court and ruled that the presumption is to be applied at a later stage in the litigation when there is a more fully developed court record. The ruling by the Appeals Court in Dudenhoeffer was at odds with the majority of courts which apply the presumption in the initial stage of litigation, meaning that in most stock-drop cases, participants are denied the opportunity to engage in discovery.
The Sixth Circuit also ruled that to rebut the presumption, participants need only show that a prudent fiduciary acting under similar circumstances would have made a decision that the employer stock was an imprudent investment. This ruling was also a departure from the majority as most courts require that a participant must demonstrate that the company was in “dire circumstances” or facing “impending collapse” in order to rebut the presumption. The Appeals Court specifically rejected these “narrowly defined” tests for rebutting the presumption in favor of one that is easier for participants to prove.
Supreme Court Decision. The Supreme Court vacated the Sixth Circuit’s decision and directed the Sixth Circuit to reconsider whether the complaint in Dudenhoeffer states a “plausible” claim for a breach of fiduciary duty. In reaching its decision, the Court held that there is no “presumption of prudence” in favor of ESOP fiduciaries as there is no basis in ERISA that supports a special presumption of prudence for decisions made by ESOP fiduciaries. Instead, an ESOP fiduciary’s decision is subject to review under the same duty of prudence applicable to all ERISA fiduciaries, except that ESOP fiduciaries have no duty to diversify plan investments. While ESOP fiduciaries are not liable for losses that result from a failure to diversify, they are required to act with the care, skill, prudence and diligence that a prudent expert acting in like capacity and familiar with such matters would use to make and continue to hold the investment of employer stock.
According to the Court, in order to a claim for a breach of fiduciary duty, the claim must be based on plausible factual allegations of breach of fiduciary duty. Where a stock is publicly traded, allegations that a fiduciary should have recognized on the basis of publicly available information that the market was overvaluing or undervaluing the stock are generally implausible and thus, are insufficient to state a claim. Further, the Court instructs that in order for a complaint to state a claim for a breach of the duty of prudence, a plaintiff must plausibly allege an alternative action that the defendant could have taken, that would have been legal and that a prudent fiduciary in the same circumstances would not have viewed as more likely to harm the trust than to help it. In so ruling, the Court held that a fiduciary’s duty of prudence does not require a fiduciary to break the law and buy or sell company stock on the basis of insider information.
One of the arguments advanced by Fifth Third Bancorp was that without the Moench presumption, an ESOP fiduciary would be subject to costly duty-of -prudence “meritless lawsuits” every time there was a drop is stock price. The Court recognized this concern but concluded that the Moench presumption was an inappropriate way to weed out “meritless lawsuits.” Instead, the Court stated that the more important mechanism for weeding out meritless claims requires a “careful judicial consideration of whether the complaint states a claim that the defendant has acted imprudently.” Thus, courts must carefully scrutinize stock-drop complaints to determine whether they state a plausible claim for breach of fiduciary duty.
Implications. Even though the Supreme Court specifically rejected the application of the Moench presumption, plaintiffs still face a high burden as they must plead specific facts in order to survive a motion to dismiss, such as the specific alternate action that the fiduciaries should have taken. In addition, the Court has given ESOP fiduciaries several potential defenses as, according to the Court, they can rely on the stock market price as the best estimate of stock price. Complying with the rules on insider trading is yet another potential defense a fiduciary can raise. Finally, plan sponsors may want to consider the composition of their investment committees and whether an independent third party fiduciary should be hired to make the decision whether to continue to invest in or offer a company stock fund as an investment option.