One of the most significant errors in retirement plans is the calculation of compensation for plan contributions. The IRS views such errors as very serious, with consequences that can lead to operational failures and ultimately, disqualified status. Here are examples of compensation errors:

-          Contributions to the plan by the employer on base compensation only. If a plan document states that profit-sharing contributions are to be calculated for base compensation plus commission, be sure that contributions are also made for commissions paid to the employee.

-          Exclusion of overtime or other ‘extra’ pay from definition of compensation. If overtime or other pay is excluded, then the contribution rate becomes unequal for highly-compensated vs. non-highly-compensated employees.

-          Using a higher amount of compensation than allowed by the IRS Code §404. Going above the approved IRS amount may result in a nondeductible contribution and the employer owing additional tax, including excise tax.

-          Failure to use the IRS’ statutory definition of compensation. The IRS specifies limits and minimums.

Here are tips from the IRS to avoid compensation-related failures:

1. Review your plan document’s definitions of compensation for each plan purpose.
2. Use the statutory definition of compensation when required.
3. Transmit accurate compensation data for each employee to your payroll processor and plan administrator.
4. Consider amending your plan to use one definition of compensation for all plan purposes.
5. Periodically review your plan for errors and fix them as quickly as possible using IRS correction programs.

One of our readers asked a question about the small employer health insurance credit. For the answer, I consulted Lisa Potter, CPA and senior tax manager, who has a blog that focuses on issues for nonprofit organizations, www.990taxhelp.com.  Our firm also has a blog specific to churches, www.thefaithfulsteward.com.

The question:

Our church has three pastors.  One pastor has a family plan that we pay.  The other pastor is retired and we reimburse him for him and his wife’s Medicare and Medicare supplement insurance.  The third pastor’s wife works and has insurance through her employer.  We reimburse him the amount withheld from her check for insurance.  Are any of these eligible for the 8941 tax credit?

Response:

The credit for small employer health insurance premiums is only available for premiums paid directly by the employer.  This means
that any reimbursements paid to employees are considered fringe benefits to the mployees, but the employer may not claim credit on Form 8941 for reimbursements for payments employees make to other plans.

Whether or not a credit may be claimed for the pastor on the family plan depends on several criteria.

1) The church must pay premiums for employee health insurance under a plan offered by the church.  This credit (25% for non-profit entities) is claimed by filing Form 990-T along with Form 8941.

2) The church must have fewer than 25 fulltime equivalent employees (FTE’s) for the year.  Ministers do count as employees for the purposes of calculating this credit, even though they are treated as self-employed for social security and Medicare purposes.

3) The church must have paid average annual wages for the tax year of less than $50,000 per FTE.

If you think you have met the three criteria listed above, you should then refer to the Form 8941 instructions.  This credit involves many complex calculations that must be considered on a case-by-case basis to determine whether the credit is available and worth filing the necessary paperwork to claim it.

If you think you qualify for the credit, and would like additional assistance, please contact one of our tax advisors and set up a consultation to discuss the details of your particular situation.

401(k) plans require much maintenance to meet fiduciary requirements. There are many mistakes that can creep in over time that put you out of compliance. Here’s a list of potholes that can wreck your plan with the IRS:

-         Not updating your plan to reflect current laws

-         Not operating the plan in accordance with the plan document

-         Incorrect definitions of compensation for deferrals and allocations

-         Lack of consistency with employer matching contributions

-         Failing the 401(k) ADP and ACP nondiscrimination tests

-         Excluding eligible employees

-         Not making timely deposits of employee elective deferrals

-         Incorrectly administering participant loans or hardship distributions

-         Not making required minimum contributions

-         Delaying filing the Form 5500-series return

-         Not distributing a Summary Annual Report to all plan participants

Instead of losing sleep over the problems that come with non-compliance, the IRS provides a simple to understand 401(k) plan fix-it guide. The guide includes how to find, fix and avoid mistakes. Regular review of this list and making note of your compliance actions can save you time and work when it’s time for an audit.

A determination letter from the IRS gives you the assurance and validity that your plan meets the criteria for contributions to the plan to be tax exempt (non-Roth IRAs). However, if you make any changes to your retirement plan, including amendments, then you need a new determination letter. So, if you made changes to the plan that were due by December 31, make sure that you also take care of these three things:

1. Request a new determination letter. Work with your third party administrator to ask the IRS to review your revised plan document and issue you a favorable determination letter. The plan prototype may already have been deemed acceptable by the IRS and if this is the case make sure that you retain a copy of the letter.

2. Check the letter for consistency with your amendments. If you find an error, fax the letter sent to you with an explanation of the correction needed.

3. Administer the plan to according to the plan document. Failure to follow your plan document can nullify the tax exemption awarded by the IRS’ determination letter.

To request corrections for errors or to get a copy of your current determination letter, send your request via fax to 513-263-4330 and include:

-         Plan sponsor’s name, EIN and phone number

-         Plan name and number

-         Year that the letter was issued

-         Fax number to send the copy of the determination letter

If you prefer to mail your request, send to: Attn: Manager, EP Correspondence, IRS, P.O. Box 2508, Room 5-120, Cincinnati, OH 45201

For more information, see a list of FAQs about determination letters.

See if any of the following action items apply to your retirement plan and take action prior to December 31, 2011:

1. Make discretionary amendments for plan design changes

Whether a defined benefit (DB) or defined contribution (DC) plan, any plan design changes that you want to be effective for the 2012 plan year need to be adopted by the
end of 2011. Examples of amendments include changes to automatic enrollment or matching amounts.

2. Complete in-plan Roth conversions

Earlier this year, I wrote about in-plan conversions to Roth accounts, part 1 & part 2. If you have an employee who wants to split the conversion amount between 2011
and 2012, be sure that proper documentation is executed prior to December 31, 2011.

3. Amend DC plan documentation if you suspended 2009 required minimum distributions

The Worker, Retiree and Employer Recovery Act (WRERA) of 2008 allowed DC plans to treat 2009 required minimum distributions (RMDs) as eligible rollover distributions. Make sure that your plan document is amended to reflect the 2009 RMD rollovers if you took advantage of this provision. (You were able to defer documentation until now.)

Many workers are staying in jobs past traditional retirement age, and the rules regarding distributions at age 70 ½ can be complicated. Plan participants can make contributions and take required minimum distributions at the same time. As an employer, you’re required to continue making contributions for an employee as long as they are employed and participate in your plan. Here are IRS guidelines that you need to know and follow:

When to distribute:

-         Required minimum distributions (RMDs) are required at age 70 ½ or the year in which the participant retires (if after age 70 ½).

-         In the case of a SIMPLE IRA, SEP or if the participant is at least a 5% owner, RMDs must occur at age 70 ½, regardless of retirement status.

How to calculate required minimum distributions:

-         Generally, the value of the retirement plan or IRA on December 31 of the prior year is divided by the life expectancy of the plan participant.

-         Life expectancy is determined by one of three tables in Publication 590 (Appendix C), based on marital status and age difference of spouse.

When to schedule payment:

-         Participant must take the first RMD by April 1 of the year following age 70 ½ or retirement.

-         In the following years, the participant must take the RMD by December 31, including the year that the distribution was taken by April 1.

Additionally, you must also give your employee the option to continue deferring salary after age 70 ½, if permitted by your plan.

The IRS announced cost of living adjustments for contributions to various types of retirement plans in the 2012 tax year. You can use the information in an IRS easy-to-understand chart to communicate contribution limits to your employees.

The IRS recently announced that employees will be able to contribute $17,000 to defined contribution plans for 2012, a $500 increase over the previous amount. And this week, the DOL announced a new regulation regarding investment advice that frees plan sponsors to be able to provide resources for quality investment advice with certain parameters.  Plans may offer third-party investment advice through:

-         Certified computer models for investment option comparisons

-         Investment advisors who are paid a level fee not dependent on the choice of investment

Plan sponsors will have the opportunity to select the investment advisor, but aren’t responsible or liable for the investment advice. If you use either of the investment advice options, you must disclose the advisor’s fee amount to participants and must submit to an annual audit.

While related to fiduciary responsibility, the latest rule adjustments for retirement plans are not the same as the anticipated new definition of fiduciary. The new definition is expected in early 2012.

For more information, see the DOL’s announcement.

With different types of distributions come different rules for withholding federal income tax. The IRS has clear, concise guidance on when and how much and to withhold from retirement plan distributions.

Here are seven tips for employers to remain compliant regarding financial distributions from 401(k) plans:

1. Include language in your plan document regarding the circumstances for which distributions can occur. (Include definition of hardship distributions.)

2. If the loan document allows loans, then all nontaxable loans should be made prior to making a hardship distribution.

3. If a hardship distribution is made, be sure that the distribution does not exceed the total elective contributions.

4. Retain hardship application files in case of an IRS audit.

5. If an employee receives a hardship distribution, then he or she is prohibited from making elective contributions for at least six months after the distribution is received.

6. Participant account statements need to document elective contributions vs. other types of contributions, such as employer contributions.

7. File form 1099-R for all employees who receive distributions.