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Is an ESOP Right for Your Community Bank?

 

What do you know about ESOPs?

Unless bankers have participated in a qualified retirement plan that invests in employer stock early in one’s career, many know little about employee stock ownership plans (ESOPs). Here’s some information about ESOPs to add to your knowledge base.

ESOPs invest in the bank’s stock

regional banksAn ESOP is a qualified retirement plan that invests in the bank’s own stock. The bank can contribute stock to the plan or it can contribute cash used to acquire bank stock, which is allocated to employees’ accounts. In a leveraged ESOP, the plan acquires a large block of shares from the bank or its shareholders by borrowing money from another bank, usually at favorable rates.

As with other qualified plans, your bank’s contributions to the ESOP are tax deductible (generally up to 25% of eligible participants’ compensation). In addition, ESOPs must comply with specific rules and regulations, including strict nondiscrimination requirements. Closely held banks must have their stock valued by a qualified, independent appraiser when it establishes the ESOP and annually thereafter.

When ESOP participants retire, die, become disabled or terminate their employment, their benefits are distributed as stock or cash. Closely held banks are required to give employees a “put option” — that is, the right to sell the stock back to the bank at its current fair market value. Some banks limit stock ownership in the corporation so that participants must sell their stock to the bank or the plan at distribution. These options can generate significant “repurchase liabilities” that your bank should plan for and monitor.

Equity attracts employees

Equity is a powerful incentive you can use to attract, retain and motivate employees. Sharing ownership with employees through an ESOP also ties them to your community bank and aligns their interests with your objectives and strategies. As your bank grows and its stock value increases, employees share in the success.ESOP

Another advantage of an ESOP is that your bank can spread the wealth in a tax-advantaged manner. Earnings and appreciation on stock held by an ESOP are tax-exempt, so employees’ accounts grow on a tax-deferred basis. Participants recognize taxable income only when they withdraw their benefits from the plan. Distributions are taxed the same as 401(k) plans and other qualified plans, including a penalty for withdrawals before age 59½, with certain exceptions. Additionally, like a 401(k), distributions from the ESOP must begin in the year the employee reaches age 70½.

The bank and owners also benefit

An ESOP provides several benefits  for your community bank and its owners. For example, the bank’s ESOP contributions are tax deductible (up to applicable contribution limits) and, under certain circumstances, it can deduct dividends paid on ESOP shares.

Also, a leveraged ESOP can be a highly tax-efficient vehicle for raising capital. Ordinarily, only interest is deductible on a business loan. But your bank can make tax-deductible contributions to a leveraged ESOP to cover both interest and principal payments.

For closely held banks, an important benefit of an ESOP is that it creates a market for the existing owners’ stock without necessitating a sale to “outsiders.” By selling a portion of the business to an ESOP, the owners can generate income or diversify their portfolios while retaining control of the bank.

And if the ESOP owns at least 30% of a C corporation bank’s stock immediately after the sale, the owners can defer their capital gains indefinitely by reinvesting the proceeds in qualified replacement property (QRP) within one year. QRP includes most stocks and bonds issued by publicly traded domestic operating companies.

Pros and cons for S and C corporations

ESOPs offer some remarkable opportunities for banks organized as S corporations. Notably, as pass-through entities, S corporations pay no entity-level taxes. Instead, shareholders report their share of the corporation’s profits, losses and other tax attributes on their personal income tax returns. Being tax-exempt, an ESOP wouldn’t pay tax on the S corporation’s profits.

One significant disadvantage for S corporations (over their C corporation counterparts) is that owners can’t defer the gain on the sale of their stock to an S corporation ESOP.  Additionally, the contribution limit to an S corporation ESOP is 25% of compensation for both principal and interest. There are a plethora of other considerations for both S and C corporations, which will require the advice of your bank’s financial and tax advisors.

 

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Scott N. Drake, CPAScott Drake, CPA, is a Member of the firm of Smith Elliott Kearns & Company, LLC.   Scott joined SEK&Co in 1975. He is the lead member of the Financial Institution Services Group Team which has extensive experience providing services such as external audits, SOX 404 exams, outsourced internal auditing, loan reviews, IT exams, ACH & BSA exams, SEC compliance and reporting, and taxplanning and compliance.   

 

Flashback Fridays: Opening New Waynesboro Office - 2/4/87

 

From left to Right:  Peggy B. Corley, Linda M. Bennett, Terry T. Eisenhauer, Charles L. Strausbaugh, Ronald S. Kearns, Paul R. Luka, Merle S. Elliott.

Waynesboro office1 resized 600

Hidden Assets and Liabilities Affect Business Valuation

 

To determine what a business is truly worth, appraisers must consider many aspects of its operations — from management, to products, to the health of its industry. They also need to look beyond the balance sheet, seeking any hidden assets or liabilities that may affect value and bringing them to light.

Whether in divorce matters or other kinds of litigation, appraisers often need to search for business valuationunusual, nonrecurring events in a company’s financial statements.  Such searches can provide a clearer picture of the company’s normal operations and help ensure the numbers better reflect reality.

Unearth hidden assets

An appraiser starts with the line that reports total net worth on a company’s balance sheet.  That’s the upfront part of the equation. From there, the appraiser hunts for unrecorded liabilities or contra assets, such as those with a negative credit balance. Here are several areas to examine:

Uncollectible receivables. Customer and factory receivables — those related to warranties and incentives — make up a significant portion of many companies’ total receivables. Holding items on the books that are overaged, and that the business is unlikely to collect, misrepresents its overall financial picture.

Management should review accounts receivable regularly to determine which accounts they probably won’t collect, and then adjust the allowance accordingly. The result after the adjustments is the net realizable value of the receivables.

Inventories. Of course, inventories make up an important part of many companies’ net worth. The prevalent use of the last-in, first-out (LIFO) method for valuing inventories could result in undervaluation if proper adjustments aren’t made. Thus, it’s usually proper to adjust inventory in accordance with the first-in, first-out (FIFO) method.

buy sell agreementFixed assets. For book purposes, companies may record depreciation on fixed assets (such as furniture, fixtures, tools and equipment) in several ways. Net book value, for instance, will usually differ drastically from the actual fair market value. This difference would alter the business’s net worth. The appraiser compares the net book value of a company’s fixed assets with their fair market value.

Fine-tune the value

After a valuator makes a preliminary estimate of a company’s value, he or she considers additional fine-tuning. Before finalizing the conclusion, the valuator assesses exactly what the preliminary value estimate includes. If anything is missing, the valuator makes a last-minute alteration.

Common last-minute alterations include changes to:

  • Excess/deficit working capital (compared with the company’s operational needs),
  • Contingent or unrecorded assets and liabilities,
  • Nonoperating assets, and
  • Real estate (if most industry participants rent their facilities).

When making last-minute adjustments, a valuator also adjusts the earnings for any income or expenses these assets or liabilities generate, including any tax benefits or consequences.  At this point the valuator can provide a more definitive business valuation.

Dig up the truth

Digging up hidden assets and liabilities will likely lead to a fairer presentation of a business’s succession planning true value. To make the appropriate adjustments, an appraiser needs to perform detailed analysis and have a good overview of the company’s current and future operations.

 

Sidebar: Detecting fraud

In marital dissolution cases, valuators may have to watch out (and adjust) for spouses trying to dissipate their businesses’ values. For instance, the moneyed spouse may attempt to hide business assets, delay revenue recognition or overstate expenses.

A lower bottom line benefits a moneyed spouse in two ways. First, to the extent that a company’s value is based on its earnings, reduced income lowers value.  Therefore, low profits increase a moneyed spouse’s share of the marital estate’s remaining assets. Some moneyed spouses will even hide physical assets or use fraudulent accounting tactics to lower profits reported before their divorce.

Of course, the nonmoneyed spouse has less experience and knowledge of the business, and such a charge may be baseless. But to determine whether the claim is justified or is completely without merit, valuation — and forensic accounting — expertise is essential.

 

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Jacob KaufmanJacob Kaufman, CPA, CVA is a Member of the firm of Smith Elliott Kearns & Company, LLC.   Jake joined SEK&Co in 1989. He is the lead member of the Business Valuation Team and serves as a consultant to the Accounting Services and Tax Departments in the firm's Chambersburg office. Jake's valuation experience was learned through years of study and practical experience. In addition to valuation theory and implementation, Jake possesses the relative tax, finance, and accounting experience necessary to perform a thorough quality valuation.

 

“Car Shopping” for Your 401(k) Plan Auditor

 

Choosing an employee benefit plan auditor can be like buying a car. When contemplating a “new” car purchase, most individuals don’t wander onto a car lot, pick out a car and buy it on the spotemployee benefit plan auditor without considering price, quality, and reliability. So, why do people approach finding an auditor for their employee benefit plan that way? The following is a list of things to consider when shopping for an auditor of an employee benefit plan.

Price: When buying a car, most people want a quality car at a fair price. A cheap model might get you from point A to point B, but chances are you will spend more on gas and maintenance along the way. The most expensive model will likely lead to more money spent on fancy options and upgrades you don’t need or use. The same logic can be applied to employee benefit plan auditors. Choosing an auditor based on price alone doesn’t mean you will get a quality audit. In many cases (just like with a car purchase), the cheaper the price, the less dependable and maintenance free the audit will be. The penalties for audit failures can be substantial. The Department of Labor (DOL) can assess penalties on Plan Sponsors of up to $1,100 a day (capped at $50,000) per annual report filing where the required auditor’s report is missing or deficient. Price alone is oftentimes the deciding factor, when in fact it shouldn’t be.

Quality: When buying a car, a number of factors such as age, gas mileage, and safety features are considered to gauge the quality of the car. There are a number of factors to consider when employee benefit plan audit quality centerassessing the quality of an employee benefit plan auditor. A good quality auditor is required to be a licensed certified public accountant and will be experienced in performing employee benefit plan audits. The more experience a firm has in performing these unique types of audits, the more familiar the auditor will be with benefit plan practices and operations, as well as the auditing standards and rules that apply to employee benefit plans. The AICPA Employee Benefit Plan Audit Quality Center (EBPAQC) has prepared a document to assist plan sponsors and other stakeholders in the proposal and evaluation process to obtain quality audit services for employee benefit plans. The complete document can be found at www.aicpa.org/ebpaqc and is titled Obtaining Quality Employee Benefit Plan Audit Services:  The Request for Proposal and Auditor Evaluation Process. Also, the EBPAQC maintains a directory of employee benefit plan auditors who have agreed to meet specific experience, training, and practice monitoring requirements. Smith Elliott Kearns & Company, LLC is an active member of the AICPA Employee Benefit Plan Audit Quality Center. 

Reliability: Everyone wants a dependable car; no one wants to be stranded alongside of the road. Likewise, plan sponsors want a dependable, trustworthy auditor. The employee benefit plan auditors at Smith Elliott Kearns & Company, LLC are well trained in the unique characteristics of employee benefit plans and can be relied upon to perform an efficient and effective audit. When shopping for an auditor, be sure to check references and obtain testimonials. Many firms are more likely to tell you what you want to hear because they are trying to get your business, while references are more likely to tell you what you need to hear. 

Hassle Free: The employee benefit plan auditors at Smith Elliott Kearns & Company, LLC aim to make the audit process hassle free. We attempt to do as much of the audit engagement in our 401k plan auditoffice as possible, thereby limiting the time we spend at the sponsor’s office so as to minimize disruptions to the plan sponsor’s employees.

When the time comes for you to consider a new employee benefit plan auditor, think in terms of buying a car. Keep in mind price, quality and reliability. Just as there are many different makes and models of cars to serve all types of wants and needs, there are also many different types of audits and auditors. A firm that specializes in one type of audit may not specialize in another type. Families often own more than one car; likewise there is nothing wrong with entities engaging more than one accountant or auditor for different facets of their business.

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Kara M. Darlington, CPA is an Associate Member of the Firm. Kara joined the firm in 1996.Kara Darlington  She has extensive management experience in auditing the firm’s nonprofit, governmental, employee benefit plan audit, and other clients. Kara is based in the firm’s Hanover office; her continuing education has included tax and audit considerations of nonprofit organizations and audit and compliance considerations of employee benefit plans including 401(k) plan audits.

Krystal A. Mitchell, CPA is an audit manager. Krystal joined the firm's Hanover officeKrystal Mitchell in 2008; she has over 8 years of experience in private and public accounting. Krystal specializes in accounting and auditing services for employee benefit plans. Her continuing education has included audit and compliance considerations of employee benefit plans (including 401(k) plan audits) for the past 6 years. 

Affordable Care Act Compliance Update Webinar 3-6-14

 

 

 

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Cross-collateralization Strategy Raises Concerns

 

Cross-collateralization Strategy Raises Concerns

Commercial lenders cross-collateralize loans to reduce risks. But accounting concerns and debt  restructuring issues may emerge when using multiple properties to secure a loan associated with one property.

Placing loans on nonaccrual status

cross-collateralizationGenerally, when interest payments on a loan are significantly overdue and collection of principal is deemed unlikely, the loan must be placed on “nonaccrual status.” If a bank experiences an increase in nonaccrual loans, it likely will be forced to bump up its reserves for loan losses, which may hurt its profits.

In some cases, cross-collateralization can cause multiple loans to be placed on nonaccrual status, even if some of the loans are still performing. The OCC, in its June 2012 Bank Accounting Advisory Series (BAAS), offers several examples that illustrate the potential impact of cross-collateralization on nonaccrual status.

One example involves a real estate developer that has two loans with a bank for two separate projects. Loan A is current and the bank expects full repayment of principal and interest. But loan B is placed on nonaccrual status.

According to the BAAS, placing one loan on nonaccrual status doesn’t automatically require the bank to give the other loan the same status. The guidance emphasizes that the obligors on the two loans are separate corporations wholly owned by the developer and there’s no cross-collateralization or personal guarantees.

If the bank subsequently negotiates a cross-collateralization agreement with the developer, must loan A also be placed on nonaccrual status? According to the BAAS, by entering into a cross-collateralization agreement, the bank is merely taking steps to improve its position relative to the borrower. It need not place loan A on nonaccrual status if cross-collateralization doesn’t change the repayment pattern of the loans or endanger loan A’s full repayment.

In another example, loans A and B are related to separate real estate projects, are personally bank accounting advisory seriesguaranteed by the developer, and were initially cross-collateralized. Project A has the cash flows to repay loan A in full but no excess to meet a shortfall on loan B, which is past due.

According to the OCC, if the developer has the ability and intent to make the payments on both loans, the bank could maintain both loans on accrual status. If the developer lacks the ability and intent to make the payments, both loans should be placed on nonaccrual status.

Because the loans are cross-collateralized, collectibility should be evaluated on a combined basis. The developer, as guarantor, is the ultimate repayment source for both loans, so placing only loan B on nonaccrual status wouldn’t reflect that the collectibility of the entire debt is in doubt.  To find the June 2012 BAAS, go to http://www.occ.gov/publications/publications-by-type/other-publications-reports/baas.pdf.

Avoiding TDRs

Under current accounting standards, if restructured loans are considered troubled debt restructurings (TDRs), they may result in additional valuation allowances or losses on a bank’s financial statements.  Generally, a restructuring is a TDR if a bank grants a concession to a borrower experiencing financial difficulties.

Some banks use cross-collateralization in an attempt to avoid TDR status on reworked loans.  They might, for instance, defer loan payments or reduce the interest rate in exchange for additional collateral.

Seeking expert advice

If you have questions about the strategy of cross-collateralization, contact your CPA. He or she will be able to advise you on your financial moves.

 

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Scott N. Drake, CPAScott Drake, CPA, is a Member of the firm of Smith Elliott Kearns & Company, LLC.   Scott joined SEK&Co in 1975. He is the lead member of the Financial Institution Services Group Team which has extensive experience providing services such as external audits, SOX 404 exams, outsourced internal auditing, loan reviews, IT exams, ACH & BSA exams, SEC compliance and reporting, and taxplanning and compliance.   

 

Agribusiness Tax Planning Presentation by Patrick Mulherin, CPA

 

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Make Sure Buy-sell Valuation Provisions Are Clear

 

All closely held businesses should have buy-sell agreements. If designed properly, these agreements help ensure a smooth ownership transition if an owner dies or leaves the business. They can also provide an owner’s surviving family members with the liquidity they need to pay estate taxes and other expenses.

business valuationPerhaps the most critical aspect of a buy-sell agreement is its valuation provision. This establishes the price (and thus the methodology for determining the same) for which the company or remaining owners are permitted, or required, to buy back a departing owner’s interest. Any ambiguity in the agreement’s pricing terms — or misunderstandings about what they mean — can lead to unpleasant surprises when the buy-sell agreement is triggered.

3 approaches to setting a price

In general, there are three ways to set the price: 1) an independent appraisal, 2) a formula, such as book value or a multiple of earnings, and 3) negotiation by the parties. All buy-sell agreements use one or a combination of these approaches, and each approach has its pros and cons.

Independent appraisals generally produce the best results. They account for the special characteristics that distinguish a particular business from others in its industry. They also ensure that the price reflects an interest’s value at the time it’s transferred. An appraisal is the best way to ensure that all parties are treated fairly. The downside of this approach is that it’s the most expensive.

Valuation formulas are inexpensive and easy to use, but they fail to reflect changes in a company’s value over time.  Book value, for example, might be a good indicator of value when a company is founded, but often it becomes less accurate over time because it fails to account for earnings, goodwill or the current fair market value of the company’s assets. (See the below “Book value undervalues interest by millions.”)

Formulas based on multiples of earnings or cash flow also may be unreliable. For one thing, multiples are derived from industry averages, which may not accurately reflect the buy-sell agreementscharacteristics of the business being valued. Also, the values produced by these formulas tend to fluctuate, often underestimating value in good times and overestimating it in bad times. In essence, valuation multiple formulas can result in an undesirable outcome for one or more parties to the agreement.

Negotiated pricing can be effective, so long as the parties are able to agree. If they can’t, litigation may be the only option. One potential solution is to call for a negotiated price, but provide for an independent appraisal in the event the parties can’t agree.

Terminology matters

To avoid litigation over a buy-sell agreement, it’s critical to choose terminology carefully and define key terms if necessary to eliminate ambiguity. For example, business owners often provide that the buyout price for an interest is its “value,” without specifying whether the term refers to fair market value, fair value, investment value, book value or some other standard.

It’s also important to specify the level of value, such as controlling interest or minority interest.  Often, parties to buy-sell agreements assume that in the event of a buyout they’ll receive their pro-rata share of the business’s value as a whole. But if the agreement sets the price based on “fair market value,” the price may be discounted to reflect lack of control or marketability. If the parties intend for the buyout price to be fair market value without regard to discounts or premiums, the agreement should say so explicitly.

One issue that’s often overlooked is the valuation date.  The value of a business can change dramatically over a short time, so the selection of a valuation date can have a big impact on the buyout price. Generally, it’s best to use a specific date, such as the last day of the company’s most recent fiscal year. If the date of the triggering event is used, owners may be able to time their departures in a manner that maximizes the price they’ll receive.

Get professional help

book valueIt’s always a good idea to consult a valuation professional when planning a buy-sell agreement. An expert can help you draft the valuation provision to help ensure that all parties are treated fairly, and also to make certain there are no surprises. Further, it’s imperative that the parties to the agreement periodically review it, since circumstances and issues may change over time. 

Book value undervalues interest by millions

One case — the Estate of Cohen v. Booth Computers — illustrates the dangers of relying on book value to set a buyout price in a buy-sell agreement. The 2011 case involved a family partnership agreement. In the event of a partner’s death, it called for a buyout price of net book value plus $50,000.

After one partner died, the sole surviving partner implemented the buyout clause, which set the price at $178,000. The partner’s estate sued, alleging, among other things, that the buyout provision was “unconscionable” because the fair market value of the interest at the time was more than $11 million.

The court held that the buyout provision was enforceable, noting the term “book value” was unambiguous.

 

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Jacob KaufmanJacob Kaufman, CPA, CVA is a Member of the firm of Smith Elliott Kearns & Company, LLC.   Jake joined SEK&Co in 1989. He is the lead member of the Business Valuation Team and serves as a consultant to the Accounting Services and Tax Departments in the firm's Chambersburg office. Jake's valuation experience was learned through years of study and practical experience. In addition to valuation theory and implementation, Jake possesses the relative tax, finance, and accounting experience necessary to perform a thorough quality valuation.

 

New Data Collection Form for Governmental Audits

 

data collection form The Data Collection Form is a federal form which summarizes the results of audits performed under OMB Circular A-133. The Data Collection Form itself is required to be updated at least every three years in order to keep the information accurate and relevant to federal agencies. In addition to the new Data Collection Form, the Federal Audit Clearing House developed a new internet data entry system. This new system was launched January 7, 2014.

Under normal circumstances the Data Collection Form is due 30 days after the receipt of the auditor’s report or 9 months after year-end, whichever is earlier. However, due to the delay in the forms availability, the Office of Management and Budget has granted an extension to all Data Collection Form submissions to February 28, 2014. This is an automatic extension and no application or inquiry is necessary.

A few of the significant changes to the new system and form include:

  • A new login page which requires all users (auditor and auditee) to set up personal accounts.
  • New minimum password requirements and periodic password updates.
  • Password resets no longer utilize security questions and answers.
  • An Excel template is available for each report to upload awards andpa state capital image 2
    findings for submission.
  • Only the certification official will have access to certify the report, eliminating the need for signature codes as in prior years.
  • Updated language to keep the form consistent with new Clarity Standards terminology.
  • Beginning with the 2014 submissions uploaded PDFs must be unlocked, unencrypted and 85% text searchable.
  • Also beginning in 2014 all audit findings are required to be identified by standardized reference numbers.

Smith Elliott Kearns & Company, LLC will provide specific instructions to our clients regarding the new system as part of our audits. Please feel free to contact us if you would like more information. 

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 Leighton Stiffler is an Audit Supervisor. Leighton joined the Carlisle, Pennsylvania office of Leighton StifflerSmith Elliott Kearns & Company, LLC in 2008 and provides audit services to a variety of clients including healthcare institutions, local governments and other non-profit organizations. These healthcare institutions include Federally Qualified Health Centers (FQHCs) and Long Term Care and Retirement Centers (LCRCs). The type of local governments Leighton serves includes school districts, boroughs, municipal authorities and other quasi-governmental agencies. 

Benefits of an Employee Benefit Plan Audit Without the Actual Audit

 

The word “audit” often produces negative thoughts. However, an audit can be a positive thing.401(k) plan audit Employee benefit plan audits, which are generally required for plans with 100 or more eligible participants, help to protect the assets and the financial integrity of the Plan. An audit can help ensure that funds will be available to pay retirement, health, and other promised benefits to employees. A quality audit will help ensure that the plan is being operated in accordance with the Plan Document and help reduce the risk of fines and penalties assessed by the Department of Labor (DOL) in instances of noncompliance. 

If you maintain a “small plan” which is generally defined as an employee benefit plan with less than 100 participants, an annual audit is not required. However, you might desire the benefits an audit can produce, but are reluctant to incur the full cost of an audit. If so, consider employing a firm such as ours that specializes not only in audits of employee benefit plans, but also performs third party administrations on nearly 300 plans annually, to provide consulting services or an agreed-upon procedures engagement, to specifically target a few keys areas that tend to be the most common areas of noncompliance, for big and small plans alike. In an agreed-upon procedures engagement, you tell us what “testing”, “vouching”, or “recalculating” you want us to do. This targeted approach to looking at your plan can ensure you are paying for what is most important to your overall plan structure and give you peace of mind that your plan is in compliance with the key features of the plan document and government laws and regulations, employee benefit plan auditnoncompliance with which can result in fines and penalties assessed on the plan sponsor.   

The following is a sample of the more common deficiencies noted during a plan audit and the operational provisions of the plan that result in the deficiency. Plan provisions like these could be “tested” during an agreed-upon procedures engagement to help detect noncompliance, should it exist. 

  • The application of an incorrect definition of plan compensation.  Some plans exclude fringe benefits, bonuses, vacation, overtime, commission and/or other types of wages. Furthermore, some plans’ definition of plan compensation is different for employee versus employer contributions, or it is different for various groups of employees. Scenarios like these often lead to incorrect calculations because systems are not in place to use the proper plan compensation. 
  • Failure to comply with participant deferral elections.  Plan sponsors have the ultimate responsibility to ensure that the participants’ deferral elections are processed according to their directions. Changes to employee deferral rates and amounts must be reviewed often to ensure that payroll is processing the withholdings accurately. Incorrect calculations can result in the plan sponsor being liable for missed deferrals and any corresponding employer contributions on those amounts. It is participant deferral electionalso important to be aware of the IRS deferral limits for the year and ensure that no participant exceeds the annual limit. For plans with a year-end other than December 31, it is important to note that deferral limits are based on a calendar year, not the plan fiscal year.
  • Improper calculation of employer contributions.  Plan documents specify whether employer contributions are to be determined based on each pay period’s wages or determined based on annual wages. Plan sponsors oftentimes make contributions each pay period based on pay period wages, but the plan document dictates an annual calculation is required. It is permissible for plan sponsors to make contributions throughout the year so long as the calculations are “trued-up” at year end. We often find that this “true up” is not done. Also, some plan documents contain a specific formula for calculating employer profit sharing contributions, if offered by the plan, and oftentimes the correct formula is not used. 
  • Late remittance of employee contributions.  DOL regulations require employers who sponsor large pension plans to remit employee contributions (and loan repayments) as soon as administratively feasible, but in no event more than fifteen business days after the month in which the participant contributions and loan repayments were withheld or received by the employer. Employers who sponsor small plans have 7 days from the date contributions and loan payments are withheld or received by the employer. The DOL enforces significant penalties on plan sponsors for late remittances and requires the plan sponsor to remit lost earnings when contributions are not remitted timely. 
  • Misunderstanding hardship distribution rules.  Some plans permit hardship distributions for certain causes. Plan sponsors must ensure that the plan incorrect definition of plan compenstationallows for hardship distributions before authorizing one to be made. It is imperative that plan sponsors maintain documentation supporting the cause of the hardship. Upon distribution of a hardship, regulations require that employee deferrals cease for the next 6 months. 

We find that many audit deficiencies are a result of turnover amongst payroll and human resource staff, lack of a good system of internal controls, and a lack of understanding by plan personnel and management of the plan document and DOL rules and regulations. Employers must be cautious and not rely on third party administrators to perform their fiduciary responsibilities. If you maintain a small employee benefit plan and are looking for the benefits of an audit without the full cost of an audit, please contact us to discuss fees and options. We would be happy to help you customize an engagement that fits your needs.

 

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Kara M. Darlington, CPA is an Associate Member of the Firm.  Kara joined the firm in 1996. She Kara Darlington, CPAhas extensive management experience in auditing the firm’s nonprofit, governmental, employee benefit plan, and other clients. Kara is based in the firm’s Hanover office; her continuing education has included tax and audit considerations of nonprofit organizations and audit and compliance considerations of employee benefit plans including 401k plan audits.


Krystal A. Mitchell, CPA is an audit Manager.  Krystal joined the firm's Hanover office iKrystal Krystal Mitchell, CPAMitchell, CPAn 2008; she has over 8 years of experience in private and public accounting. Krystal specializes in accounting and auditing services for employee benefit plans. Her continuing education has included audit and compliance considerations of employee benefit plans (including 401k plan audits) for the past 5 years.

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