IRS Issues Relief for Safe-Harbor 401(k) and 403(b) Plans
Earlier this year, the Internal Revenue Service (“IRS”) released Notice 2016-16 providing greater flexibility to amend safe harbor 401(k) and 403(b) plans mid-year.¹ Plans designed with safe harbor provisions provide relief from performing annual non-discrimination testing and, in some cases, relief from the top-heavy provisions. Prior to the change, IRS regulations severely limited plan sponsors’ ability amend or adopt a safe harbor plan after the first day of the affected plan year.
Background: Safe Harbor Regulations Restrict Amendment Timing
The 401(k) safe harbor regulations generally provide that sponsors may not adopt or amend a safe harbor plan unless the change occurs before the first day of the plan year and the change remains in effect for an entire 12-month plan year, with limited specifically described exceptions.² Additionally, any amendments affecting a 401(k) plan’s safe harbor provisions require a notice to participants within a reasonable time before the beginning of the plan year (generally at least 30 but no more than 30 and 90 days before the beginning of the plan year). Changes also require a special election period for employees if the change limits the frequency or duration of an employee’s deferral elections under the plan. Employees under a special election period must be provided with a 30-day election period to make a change. Failure to comply with the restrictions on mid-year changes risks plan disqualification if the plan cannot pass the required non-discrimination tests.
Although the IRS has allowed some mid-year changes,
Mid-Year Changes Allowed
The new guidance takes an expansive approach. The IRS clarifies that changes made to a safe harbor plan or to a plan’s requirement safe harbor notice content do not violate the regulations merely because the change occurs mid-year. However, mid-year amendments now require timely notice and a new election opportunity. Additionally, the guidance outlines specific changes that are impermissible.
Timing of Notice Requirements and Election Opportunity
Notice 2016-16 did not change the requirements for providing both a notice and an election opportunity when a mid-year change occurs. However, the timing requirements for each must now coincide with the change, and need not be provided prior to the beginning of the plan year. Both the participant notices and election periods must still comply with the notice content requirements found in the safe harbor regulations.
When amending a plan mid-year, safe harbor notices must now be provided to each participant within a reasonable period before the effective date of the change. A reasonable period is at least 30 (but not more than 90) days before the effective date of the change. Notices provided after the change are still timely so long as they are provided as soon as practicable, but no later than 30 days after the change is adopted.
The timing for a reasonable opportunity to change an employee’s deferral elections must also be within a reasonable period. A 30-day period before the effective date of the change is reasonable, or as soon as practicable, but not later than 30-days after the change is adopted.
Restrictions to Mid-Year Changes
Despite this added flexibility, the IRS continues to prohibit certain mid-year changes, including amendments that would:
Increase the number of completed years of service required for an employee to have a non-forfeitable right to her account balance;
Reduce or narrow the group of employees eligible to receive safe harbor contributions;
Switch to or from the safe harbor plan, i.e. a change from a traditional 401(k) safe harbor to a 401(k) QACA safe harbor plan; or
Modify or add a formula used to determine matching contributions if the changes increase the amount of matching contributions or permit discretionary matching contributions.
Even small changes to a plan can lead to unintended consequences with the plan’s qualified status. It is advisable to speak to your plan’s advisors prior to amending the plan to ensure the change is both beneficial to your employees as well as in compliance with the myriad of rules governing retirement plans.
¹ Safe harbor plans refer to 401(k) plans designed to comply with Code Sects. 401(k)(12), 401(k)(13), 401(m)(11) or 401(m)(12), as well as 403(b) plans designed under 403(b)(12).
² The regulations currently allow mid-year changes including: (1) adopting a short plan year, (2) adoption of safe harbor status on or after the beginning of the plan year, and (3) the reduction or suspension of safe harbor contributions or changes from safe harbor plan status to non-safe harbor plan status.
ACA Employer Shared Responsibility Assessable Payments
The deadline for large employers to file their Affordable Care Act (ACA) reporting Forms 1094-C and 1095-C electronically with the Internal Revenue Service (June 30, 2016) is fast approaching. Information about what comes next is scarce at best.
If an employer owes an “assessable payment” (the IRS’s name for the employer shared responsibility tax under Section 4980H of the Internal Revenue Code (Code), sometimes referred to as the “pay or play” or “employer mandate” penalty), the IRS has said that the employer should not include the payment with its return. Instead, the IRS will calculate the payment and contact the employer to inform it of any potential liability. At that point the employer will have an opportunity to respond before any assessment is made. If the IRS determines that the employer is liable for the tax, it will send a notice and demand for payment.
Note that this IRS notice and demand is not the same as the certification that an employer may receive from a state exchange (or marketplace) that one or more employees have received a premium tax credit. These certifications are sometimes called “marketplace notices,” and there is an entirely separate process for responding to and/or appealing them. Employers are not prejudiced with respect to an assessable payment by failing to respond to or appeal a marketplace notice.
Regarding the timing of assessable payments, the IRS has said that it does not intend to contact an employer about an assessable payment until after the due date for the individual income tax returns of the employees of that employer. Although the IRS has not explicitly said so, we believe this means the due date after taking into account any extensions that might apply. Accordingly, employers should not expect to be contacted bythe IRS regarding an assessable payment until after October 17, 2016, which is the deadline for individual income tax returns for 2015.
There has been much speculation about the IRS’s ability to process the shared responsibility returns and impose assessable payments. Some have said they doubt the IRS is capable of responding to the deluge of returns that will be filed. We believe that it will be relatively easy for the IRS to identify an employer who owes an assessable payment under Code Section 4980H(a)–that is the tax ($2,080 per full-time employee for 2015) that is owed when an employer fails to offer substantially all of its full-time employees minimum essential coverage. In many, if not most cases, substantially all of the data for determining the 4980H(a) tax is on the face of the return. The principal exception is the determination that at least one full-time employee has obtained a premium tax credit from the state exchange. The tax is calculated (generally on a monthly basis) by multiplying the number of full-time employees, which is reported on lines 24 through 35 of the Form 1094-C, reduced by 80, times $173.33, which is the monthly tax under 4980H(a) (the annual tax for 2015 of $2,080 divided by 12). If the employer is reporting its full-time employee count for all 12 months on line 23, then the tax is calculated by multiplying the number on line 23, reduced by 80, times the annual tax ($2,080 for 2015). If the employer is part of an aggregated applicable large employer (ALE) group, then the IRS must reference the Forms 1094-C of other members of the group in order to determine the number that should be used to reduce the full-time employee count in determining the tax. For the entire aggregated ALE group, the number is 80 for 2015. That number is allocated among the members of the group in proportion to each employer’s number of full-time employees.
The calculation of the Code Section 4980H(b) tax is a much more complicated process. The 4980H(b) assessable payment is the tax that an employer owes for each full-time employee who buys subsidized health coverage (obtaining a premium tax credit) from a state exchange. (Note that an employee will not be eligible for a premium tax credit if the employer has offered affordable coverage that provides minimum value.) To calculate the 4980H(b) tax ($3,120 per applicable full-time employee for 2015), the IRS will need to know which of the employer’s full-time employees has claimed the premium tax credit on his or her individual tax return for each calendar month. Only then can the IRS calculate the assessable payment owed by the employer. We expect this may take some time since it requires coordination of data received from the employer on the Forms 1095-C it files and from the individual tax returns of the employers’ employees.
Employers should be prepared to respond to an IRS contact regarding a potential assessable payment. Those individuals who are listed as the contact person on the Form 1094-C filed by the employer should have in place a game plan. Boutwell Fay is ready to assist employers to respond to IRS inquiries.
Those large employers who have not filed or furnished their ACA reporting forms by the applicable deadlines are potentially subject to information reporting penalties. Employers that have failed to comply with the reporting requirements should know that the penalties increase over time, so an employer can reduce the potential penalties by completing the reporting sooner rather than later. The IRS has said that it will not impose penalties for reporting incorrect or incomplete information if the employer can show that it made a good faith effort to comply with the reporting requirement for 2015. However, in order to qualify for this relief, the employer must timely file the required returns and furnish to employees the required statements. Even if an employer fails to timely comply with the reporting requirements, it may still be eligible for penalty relief under Code Section 6724 if it can show reasonable cause.