One of the drawbacks that is often cited about multiple employer plans is the so-called “one bad apple rule.” It provides that if a single participating employer in a MEP allows its part of the plan to operate in a non-compliant manner, it puts the entire plan and all of the other participating employers at risk. Although there have been numerous proposals in Congress to eliminate the one bad apple rule, none have made it across the finish line.
On July 2, 2019, the IRS and Treasury Department threw their hats into the ring to see if they can accomplish what Congress has not been able to manage. The proposed regulations spell out the steps that a MEP administrator can take to keep that one bad apple from spoiling the entire plan.
Before getting into the details, we should provide a couple of caveats.
First, this proposal only applies to actual MEPs…those that meet the current law definition of a MEP. It does not apply to arrangements that, while marketed as so-called “open MEPs”, do not meet the current DOL definition.
Second, it does not seek to expand the availability of MEPs in any way. Although proposals from both the Department of Labor and Congress would do so, those changes are still just proposed. Between Congress’ being embroiled in political issues and a court striking down key language used in the DOL’s proposal, it is anyone’s best guess as to whether/when any of these expansions will be finalized.
Can You Give Me the TL;DR?
In a nutshell, the proposed regulations provide relief from the one bad apple rule. They create a method for someone who is responsible for operating a MEP to limit repercussions for a compliance failure to just the adopting employer responsible for the failure without exposing the rest of the plan. That is certainly a welcome change from a compliance perspective, but it is not a simple process. The MEP operator must provide an unresponsive, non-compliant participating employer with a series of notices over a period of up to two years. If the offending employer still does not take the necessary corrective action, it’s portion of the plan is automatically spun-off and terminated. But, as you probably suspect, there is more to it than just that.
Which Plans Are Eligible?
In addition to being a true MEP, there are several additional requirements the plan must meet to qualify for this relief:
- Internal Controls There must be established practices and procedures in place that are designed to facilitate overall compliance. This is similar to requirements that exist in the IRS’ primary plan correction program.
- Plan Document Language The plan document must include specific language that describes this process. The proposed regulations indicate that the IRS intends to publish a model amendment that can be used to add this language once the regulations are finalized.
- Audit The plan cannot be “under examination” or have received any sort of notice of a pending audit.
- Isolated Failure The failure must be isolated to an unresponsive participating employer rather than being general and/or widespread across the plan.
What Specific Steps Must Be Taken?
Before working through the actual methodology, we should quickly paraphrase several new terms that the IRS included in the proposed regulations.
- Unified Plan Rule Another name for the one bad apple rule
- 413(c) Administrator The party with legal responsibility to maintain the MEP
- Unresponsive Participating Employer An employer participating in the MEP who is not responding to requests from the 413(c) Administrator to provide additional information or take remedial action
- Known Qualification Failure An identified qualification failure by an unresponsive participating employer
- Potential Qualification Failure A suspected compliance issue by an unresponsive participating employer that leads the 413(c) Administrator to reasonably believe that a qualification failure may exist
If the 413(c) Administrator takes a series of actions, it can ensure that the entire MEP is not jeopardized by the qualification failures committed by an unresponsive participating employer.
Now that we’ve taken a page and a half to set the stage, let’s look at the actual process, which starts with the 413(c) Administrator (MEP Admin) providing a series of notices to the Unresponsive Participating Employer (PE).
The first notice is relatively straight-forward and must include the following information:
- Description of the failure,
- Description of the remedial action the PE is expected to take,
- Notification that the PE has 90 days from the date of the notice to take the expected remedial action,
- Description of the consequences if the PE fails to act, and
- Notification of the PE’s right to initiate a spin-off of its portion of the plan.
If the PE does not take the appropriate action, the MEP Admin must provide a second notice no later than 30 days following the close of the initial 90-day period.
The second notice must include all of the same information as the first notice plus a bit more. It must also include a statement that if the PE fails to act within 90 days from the date of the second notice, the MEP Admin will issue a third notice that will also go to the affected plan participants (and their beneficiaries) as well as the Department of Labor.
If the PE remains unresponsive, the MEP Admin must provide a third notice, again no later than 30 days following the close of the second 90-day notice period.
Same song, third verse. The third notice must repeat all of the same information from the first notice. It must also include the following:
- Notification that if the PE does not act, its portion of the plan will be involuntarily spun-off and terminated, and
- An affirmative statement that affected plan participants and the DOL are receiving a copy of the notice.
Involuntary Spin-Off & Termination
After expiration of all three notice periods with no corrections, the MEP Admin must perform the following steps as soon as administratively possible:
- Notify the affected participants
- Stop accepting contributions from the offending PE (and its participants) into the MEP
- Implement the spin-off of the offending PE’s portion of the MEP into its own separate, stand-alone plan (using provisions that are substantively the same as those of the MEP)
- Terminate the spun-off plan.
- Notify the IRS using a new form the IRS will create
This process would follow all of the regular rules that apply to spin-offs (e.g. preserving protected benefits) and plan terminations (e.g. fully vesting all affected participants). The termination would be a distributable event, and the MEP Admin would need to provide all of the normal distribution paperwork and disclosures.
There you have it! Piece of cake, right?
You Didn't Think We Were Finished, Did You?
As if all of that wasn’t enough, there are few additional loose ends. We should circle back to how all of this works when we are dealing with a potential (rather than known) qualification failure. It’s basically the same process, only doubled. Rather than the first notice explaining the failure and remedial action, it must explain the suspected failure and describe the information the PE must provide to confirm one way or the other. If the PE does not respond to the first notice, the MEP Admin works through the other two and eventually arrives at the spin-off/termination conclusion.
If the PE does respond and the existence of a qualification failure is confirmed, then the entire notice process starts over from the beginning as described above. If you are running out of fingers and toes to count, that could mean almost two years of notices before any actual action is taken. We know what you’re thinking, and we are too. We don’t make the rules; we just report them.
Last but not least is more of a “master of the obvious” statement. If the PE actually responds (providing requested information or taking remedial action), the MEP Admin has to do its logistical and administrative part to help finalize the corrections. If the PE elects to voluntarily spin-off its portion of the plan rather than correcting and remaining part of the MEP, the MEP Admin must complete the spin-off within 180 days of the PE initiating it.
Who's Going to Pay for All Of This?
In its analysis of the impact of these proposed regulations, the IRS estimates it will take more than 20 hours of time to work through this entire process from initial notice through spin-off and termination. Apart from the fact that these estimates are usually significantly understated from reality, that doesn’t even count any costs associated with distributing notices to participants.
The proposal is not clear on which, if any, of these fees can be charged to plan participants; however, costs of plan corrections in other contexts generally must be paid by the plan sponsor. It may be possible to use forfeitures to offset any corrective contributions, but the costs and fees associated with the corrections must almost always be paid out of pocket. With that said, the Regulatory Impact Analysis in the regs does make reference to certain expenses being passed on to employees.
For costs that cannot be charged to the plan, who is going to pay them? If the PE has been unresponsive to the point of triggering this process, it is pretty doubtful that they will be eager to write a check. Does that mean the MEP Admin must eat the cost? Does that mean that the fees charged to all PEs are increased in order to build in a buffer for these situations?
What Does All This Mean?
Sometimes the IRS allows taxpayers to take advantage of proposed rules while they work their way through the process. This is not one of those cases. There is a 60-day comment period, after which Treasury/the IRS will review feedback and work to finalize the new rules. Since it is only July, it is at least theoretically possible the regulations could be finalized in time to be effective for 2020. However, since they must also draft the language for the model plan amendment and develop the new form that will be used to notify of an involuntary spin-off/termination, things might take a little longer.
Beyond that, there is some question as to how much practical relief these new rules actually offer absent some expansion of MEPs beyond what is currently permitted. The reason is that the current elements of commonality and control that the DOL requires for an arrangement to be a true MEP generally mean that one PE is not going to be overly cavalier about plan compliance when it knows it could jeopardize things for the other participating employers.
With the Washington, D.C. District Court challenging DOL’s regulatory language that would expand the availability of MEPs to associations and self-employed individuals and Congress mired in various unrelated political disputes, it is unclear if or when MEP expansion will ever be a reality. One thing you can count on, though, is that the team here at DWC will stay on top of it all and bring you the latest as it unfolds.