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This article is one in a series of articles on interesting issues presented under the 408(b)(2) regulation and its disclosure requirements.
Expanded Discussion on Failure to Disclose
By Fred Reish, Partner/Chair, Fiduciary Services ERISA Team at Drinker Biddle & Reath LLP
In a previous article, I described the
likely consequences of a failure to comply with the disclosure
requirements—that is, the compensation paid to the service provider would need
to be restored to the plan, together with interest. In that article, I also
mentioned that there would be penalties imposed by the government. This article
expands on that discussion. Article provided by Fred Reish. Reish is a partner Drinker Biddle in Los Angeles. He works in the firm's Employee Benefits & Executive Compensation Practice Group and is chair of the Financial Services ERISA Team. He has specialized in employee benefits law since 1973 and works with both private and public sector entities and their plans and fiduciaries; representation of plans, employers and fiduciaries before the governing agencies (e.g., the IRS and the DOL); consulting with banks, trust companies, insurance companies and mutual fund management companies on 401(k) investment products and issues related to plan investments; and representation of broker-dealers and registered investment advisers on issues related to fiduciary status and compliance, prohibited transactions and internal procedures.
The failure to provide the disclosures on a timely basis
causes the relationship between the plan and the service provider to be a
prohibited transaction. The prohibited transaction rules are found in both the
Internal Revenue Code and ERISA , and each law has its own requirements and
Under the Internal Revenue Code, an excise tax of 15% is
imposed on the "amount involved.” In the case of a 408(b)(2) disclosure
failure, the amount involved would be the compensation. Thus, for the first
year of the failure, the tax would be 15% of the compensation paid that year.
In the second year, there would be an additional 15% tax imposed on the amount
that was paid in the first year, together with a new 15% tax on the amount that
was paid in the second year. The tax would continue to grow in that fashion
from year to year until it is corrected.
In addition, once the IRS discovered the failure, it would demand
that the transaction be reversed and corrected and, if that was not done within
90 days, the IRS could impose an additional tax equal to 100% of the amount
The IRS would also require that tax returns be filed and that
the tax be paid. Since, under the circumstances, the tax would not have been
paid on a timely basis (since, in all likelihood, the service provider would
not have recognized the failure on a timely basis), and thus there would be
additional penalties for failure to file and failure to pay taxes.
The DOL could also impose penalties. Under Section 502(l) of
ERISA, the DOL can impose a 20% penalty on amounts recovered for an
ERISA-governed retirement plan. Thus, if the DOL investigated and identified
the failure, it would demand that the "amount involved” be restored to the plan
and, when the service provider complied, the DOL, depending upon the
circumstances, could would impose an additional 20% penalty since it would have
"recovered” the money for the plan. Fortunately, the IRS imposed taxes can be
offset against the DOL penalty.
It goes without saying that these penalties are severe. As a
result, service providers need to make every effort to comply with the
408(b)(2) disclosure requirements.
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