The Department of Treasury has fulfilled its portion of the directive under Executive Order (EO)13847 by issuing its proposed regulation giving relief to under the “one bad apple” rule.
That EO had two MEP directives: the DOL was directed to propose regs which we permit unrelated employers to adopt MEPs (which it has done); and the Treasury was directed to issue rules which would prevent the disqualification of a Multiple Employer Plan under Code Section 413(c) should a single member of the MEP act in a way which would otherwise disqualify the plan.
This is commonly referred to as the “one bad apple” rule, which has been cited as one reason small employers would not join a MEP—and thereby miss out on the advantages of scale. The IRS now refers to this as the “unified plan” rule.
Why the “unified plan” problem even occurs is because of the nature of the Tax Code’s MEP rules: each employer participating in a MEP is required to comply with the vast majority of the 401(a) rules as if they were in a stand-alone plan.
However, if one participating employer in the MEP is out of compliance, all employers risk the penalty of disqualification.
Sounds draconian, doesn’t it?
Maybe not, because this rule has had a minimal practical effect.
A senior Treasury official and I once were ruminating on this, and we both agreed that neither of us had ever seen a complete MEP disqualified because of it. Think about: when is the last time you’ve seen any plan disqualified?
The real issue with “bad apples” is the manner in which EPCRS applies. So, self-corrections (SCP) work well for most MEP issues, and the IRS’s newly proposed reg relief won’t impact that. The IRS has already covered MEPs for VCP, with the VCP sanction (which is the filing fee) being limited to that computed on the size of the “bad apple” employer, not on the entire plan. Even then, however, with the IRS’s substantial reduction in VCP filing fees for larger plans, VCP is a very affordable option even without relying on the EPCRS MEP relief.
This leaves CAP, which seems to where the rubber hits the road. The floor for sanctions under CAP for the MEP will, according to EPCRS, be the filing fee under VCP (though the IRS is now seeking a multiple of that fee as a CAP minimum).
The real MEP problem is in the calculation of the “Maximum Payment Amount,” which includes the taxes which would be paid on all of the MEP assets, and the tax deductions of all the employers in the MEP.
But even the impact of this is limited by the instructions under EPCRS for the CAP penalty. Part VI, Section 14 of EPCRS states that the ultimate sanction is a negotiated amount:
“If a failure (other than a failure corrected through SCP or VCP) is identified on audit, the Plan Sponsor may correct the failure and pay a sanction. The sanction imposed will bear a reasonable relationship to the nature, extent, and severity of the failure, taking into account the extent to which correction occurred before audit.”
EPCRS then lists a number of factors which come into play, which significantly argue for a penalty based solely on the impact of the “bad actor.”
The IRS has also treated MEPs well over time, and we should not ignore the informal history of the broken MEP. The idea of being able to disgorge a bad actor from a MEP to preserve the MEP was the informal position of the IRS for years, as repeatedly explained by Dick Wickersham. Once Wickersham retired, so did this position.
My point in all of this?
Yes, the proposed reg is welcome, of course, as a purely technical and structural matter. But the relief may be mostly illusory. The “bad apple” problem has always sounded worse than it is and may have been able to be fixed by a simple adjustment to the Maximum penalty Amount rules under EPCRS, and to the rules as to who should be responsible for that penalty.
The IRS may want to consider this change in any event, particularly where spin-offs don’t occur for any number of practical reasons.
The proposed reg is far from the panacea that the promoters may have you believe. This is most apparent in the proposed protocols for spinning off a bad actor.
The most difficult logistical and legal challenges facing MEPs (OK, other than the DOL’s rules on “employers”) are in the forced spin-off of a recalcitrant participating employer. The IRS proposal only really addresses a small part of what actually happens under these circumstances—all of which will eventually need to be addressed. This may take a significant regulatory effort, especially if RESA/SECURE become law.
Robert Toth is principal with Toth Law and Applied Pension Professionals. Toth has more than 30 years of experience in employee benefits law. His practice focuses on the design, administration and distribution of financial products and services for retirement plans.
Robert Toth is principal with Toth Law and Applied Pension Professionals. Toth has more than 30 years of experience in employee benefits law. His practice focuses on the design, administration and distribution of financial products and services for retirement plans.
