Common problems with Form 5500 filings and employee benefit plan audits.
The Department of Labor (DOL) has proposed to assess significant penalties for improperly filed Forms 5500, Annual Return/Report of Employee Benefit Plan (With 100 or more participants). ERISA Section 502(c)(2) permits the DOL to assess a penalty of up to $1,000 per day for failure to timely file a correct Form 5500 or 5500-C/R, Return/Report of Employee Benefit Plan (With fewer than 100 participants). This penalty applies to all employee benefit plans required to file such forms. In addition, the IRS can impose a penalty of $25 per day, up to $15,000, for late filing of Forms 5500, 5500-C/R and 5500EZ, Annual Return of One-Participant (Owners and Their Spouses) Pension Benefit Plan, for qualified retirement plans, group legal-service plans, cafeteria plans and certain educational assistance programs (Sec. 6652(e)).
The most common reasons for a DOL rejection of a Form 5500 include the audit opinion's failure to refer to the supporting schedules required by the ERISA; failure to provide comparative statements of net assets; failure to provide an audit report for certain plans with assets invested with insurance companies and certain welfare plans funded with employee contributions; and failure to fully describe the valuation method for employer securities. Plan supervisors should also be aware of the reporting of gains and losses on plan investments and reportable transactions for ERISA plans.
Proposed penalties and abatement requests
As part of its stepped-up effort to enforce the ERISA's reporting requirements, the DOL has proposed substantial penalties for numerous deficient 1988 Form 5500 filings. These penalties have ranged up to $90,000, including penalties of up to $50,000 for deficient audit reports. These fines are imposed on the plan administrator, not on the plan. The DOL also has authority to replace existing auditors and appoint new auditors if the circumstances warrant. (In addition, the DOL has referred approximately 50 allegedly deficient ERISA audits to the AICPA Ethics Committee for possible action.)
The DOL has authority to consider timely filed requests for abatement of ERISA Section 502(c)(2) penalties. In considering the first group of such requests, the DOL focused on whether there was reasonable cause for the deficient filing. In some cases, penalties were fully abated, others reduced and others were left intact. In all cases, however, if the administrator did not timely file a "statement of reasonable cause" and a fully satisfactory annual report within 45 days after issuance of the DOL proposed penalty notice, the DOL automatically affirmed the penalty.
The DOL does not ordinarily assess penalties based on new issues that could have been, but were not, raised in its initial request for additional information. In some cases, however, after the DOL asked a plan administrator for certain items and those items were furnished (e.g., an audit), the DOL later issued a "notice of intent to assess a penalty" letter based on a deficiency that was not identified in the original correspondence (such as failure to respond to a particular question or include a required schedule). If this happens, the plan administrator should file a statement that the proposed penalty is based on information available to the DOL at the time of its original notice. This fact normally will be considered to be reasonable cause for penalty abatement.
ERISA audit rejections
A common cause for rejecting the audit report of an employee benefit plan is the report's failure to specifically refer to the supporting schedules required by the ERISA. ERISA Section 103(a)(3)(A) requires that the auditor's opinion refer to the plan's financial statements and all required supporting schedules, even when an ERISA disclaimer is issued. These supporting schedules include a schedule of assets held for investment, a schedule of party-in-interest transactions, a schedule of loans in default, etc. (Note that a separate schedule of assets acquired and then disposed of during the same year is also required; see the 1990 Form 5500 instructions, page 13, for a list of asset types that can be excluded from this schedule.)
The DOL requires a separate schedule of assets held for investment, even if this information is included elsewhere in the financial statements or footnotes. Failure to include this schedule or to subject it to audit (unless the limited audit-scope exception applies) are grounds for rejecting the filing and assessing a penalty.
Another cause is failure to include comparative statements of net assets available to pay benefits. This failure is especially prevalent for multiyear audit reports that cover both a short year and the immediately preceding or following full plan year. For example, if the audit covers the year ended Dec. 31, 1989 and the short plan year ended June 30, 1990, the statements of net assets available to pay benefits as of June 30, 1990, Dec. 31, 1989 and Dec. 31, 1988 must be presented and covered by the auditor's report.
The third most common reason for rejecting the audit report is an inappropriate application of the ERISA's limited audit-scope exception. This exception is available only for assets held, and information certified, by an insurance company, bank, thrift institution, trust company or similar institution that is subject to regular and periodic examination by a federal or state agency. It is not available for assets held by registered broker/dealers or registered investment companies/advisers.
A fourth problem area is the reported value of nonpublicly traded employer securities. Form 5500 instructions require all plan assets held for investment to be reported at "current value." The current value of nonpublicly traded employer securities is usually determined by either an independent appraisal or a fair valuation formula (e.g., net book value or a multiple of earnings). While the Internal Revenue Code requires that securities held by employee stock ownership plans (ESOPs) be independently appraised, other types of plans may determine the value of nonpublicly traded employer securities under a formula contained in a stockholders' agreement or a specific formula applicable to the plan's securities (such as for preferred stock). In any event, the basis for determining the current value of nonpublicly traded employer securities should be fully described in a footnote to the plan's financial statements.
ERISA audit omissions
Failure to include an audit report: In addition to proposing penalties, the DOL sent 5,600 letters to plan sponsors who filed a 1988 Form 5500 without submitting a seemingly required audit report. These letters resulted from a computer analysis and precede the issuance of "notice of intent to assess" letters. The letters went to administrators of both pension and welfare plans. They were selected because their Forms 5500 indicated that their plans included trusts or had invested assets, but had not included audit reports.
A common reason no audit is performed appears to be a misinterpretation of the audit exception for fully insured pension plans. To avoid an audit, a plan must invest solely in fully allocated insurance contracts. This means that all risk for benefit obligations has been shifted to an insurance company. Most pension plans do not meet this standard. For example, many pension plans transfer assets to an insurance company under an administrative services only (ASO) contract. Under such an arrangement, there may be an agreement to purchase annuities at some future date. Currently, however, the insurance company merely invests the plan's assets in such vehicles as guaranteed investment contracts (GICs), deposit-administration contracts, immediate participation guarantee contracts or other insurance company sponsored investment funds. The plan continues to bear the risk for meeting benefit obligations. This type of arrangement is not "fully insured" and consequently is subject to the audit requirement. Welfare plan audits: Another issue that has recently emerged relates to welfare plans not funded through a trust, such as voluntary employee benefit associations (VEBAs). Under the DOL regulations, any such plans that include employee contributions, whether made on a before-tax or after-tax basis, must be audited unless the employee contributions are used solely to pay insurance premiums and are forwarded to an insurance company within 90 days of receipt or withholding by the employer. Many self-funded medical benefit plans are financed with employee contributions, either before tax (if the medical plan is part of a cafeteria plan) or after tax, that are held in the employer's general assets until used to pay benefits. Unless they come under the exception, these plans should be audited. They may also be subject to the ERISA's trust requirement, depending on the individual facts and circumstances. Many such plans, however, purchase stop-loss insurance to limit their liability. An audit of these plans may not be required if the annual premium for stop-loss coverage exceeds annual employee contributions. In this case, employee contributions can be treated as being used to pay for insurance. If annual employee contributions exceed the stop-loss premium, however, DOL regulations require that the plan be audited.
The possible misinterpretation of DOL Regs. Section 2520.104-44 and/or a historical lack of DOL enforcement efforts may explain why welfare plans that should be audited have not been audited in the past. The DOL has increased its enforcement efforts, however, and it is aware that many plans financed with employee contributions that are not fully used for insurance coverage are not currently being audited.
Employers that maintain non-trusteed welfare benefit plans financed by employee contributions that are not fully used for insurance should be aware of the technical requirement for a plan audit as well as the DOL's enforcement history. Furthermore, if a Form 5500 is rejected for lack of an audit, the client has 45 days to correct the filing by having an audit performed. Small plans and cafeteria plans: Plans with fewer than 100 participants at the beginning of the plan year continue to be exempt from the audit requirement. This exemption also applies to plans with fewer than 100 participants at the beginning of some previous plan year and no more than 120 participants at the beginning of any subsequent plan year, which elected to file a Form 5500-C/R for each year the number of participants was between 100 and 120. Also, note that a cafeteria plan need not be audited, although welfare plans that are part of a cafeteria plan may be subject to audit.
Additional reporting and disclosure guidance
Generally, ERISA filings for plan years beginning after Dec. 31, 1989 must calculate realized and unrealized gains or losses on plan investments based on the current value of the asset as of the later of either the beginning of the current plan year or the date of acquisition. Certain plans may be eligible for a one-year deferral of this requirement, but only if the financial institution that holds the plan's assets filed an extension request with the DOL by June 30, 1990. Several questions have been raised about the nature, extent and implication of the changes in the reporting and disclosure requirements. Possible effects of these changes include the following.
* The new method for reporting gains and losses for ERISA annual report purposes should also apply to Form 5500-C/R. * Since generally accepted accounting principles (GAAP) do not require the separate reporting of realized and unrealized gains and losses, inclusion of a one-line total in an audit report that agrees with the total in the applicable annual report (Form 5500 or 5500-C/R) should not result in a rejection of the audited financial statements and should not require a reconciling schedule (i.e., between the financial statements covered by an audit report and the financial information in the annual report). * The change in reporting for gains and losses should not affect other supplemental schedule requirements. For example, when reporting an asset sale on the schedule of reportable 5% transactions, the asset's original cost must be reported, even though the beginning of year value of assets is used to determine the 5% amount.