Expanded Discussion on Failure to Disclose

This is another in a series of articles about interesting issues under the 408(b)(2) disclosure regulation.

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.

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 penalties.

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 involved.

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.
