Employee Benefits & Pensions
Employers often let U.S. nationals and foreign nationals participate in U.S. qualified plans while they are on overseas assignments. Unfortunately, participation by overseas assignees can jeopardize a plan's qualified status if it causes the plan to violate the exclusive benefit rule or to experience operational failures. This item discusses how these participation-related issues arise and what plan sponsors can do to avoid or correct them.
The Exclusive Benefit Rule
The first issue to consider is whether overseas assignees' participation in a U.S. qualified plan (e.g., a defined benefit, Sec. 401(k), or profit sharing plan) complies with the exclusive benefit rule of Sec. 401(a)(2). The exclusive benefit rule requires a qualified plan to be established and maintained for the exclusive benefit of employees or their beneficiaries. Violations of the exclusive benefit rule can arise when foreign nationals or U.S. nationals (U.S. citizens, U.S. residents, green card holders, U.S. substantial-presence tax residents, and individuals electing to be treated as U.S. residents) participating in a U.S. qualified plan are not employees of a "participating employer" (one of the employers listed as participating in the plan).
However, for purposes of the exclusive benefit rule, all members of a controlled group are considered employed by a single employer. Consequently, participation in a U.S. qualified plan by assignees should comply with the exclusive benefit rule if the foreign "home employer" (the organization that transfers assignees) or foreign "host employer" (the organization to which assignees are transferred) is a participating employer or in the same controlled group as one of the participating employers. Nevertheless, if a foreign home or host employer is not a participating employer or in the same controlled group as a participating employer, the plan will not always violate the exclusive benefit rule. Rather, a violation will occur if an inbound or outbound assignee participates in the U.S. plan while he or she is considered to be a common law employee of a foreign employer that is neither a participating employer nor in the same controlled group as a participating employer. A "controlled group" is defined for qualified plan purposes in Secs. 414(b), (c), and (m). A detailed discussion of the controlled group rules is beyond the scope of this item, but parent-subsidiary controlled groups are the most common, in which one organization owns a controlling interest, generally 80%, of the vote or value of each other entity in the group.
Common Law Employee Status
Deciding whether overseas assignees are employees for their home or host employers can be challenging because assignees often provide services for and report to both employers. A service provider is an employee for qualified plan purposes if he or she is an employee under common law principles. Under common law principles, a variety of factors determine employee status. Two key factors are whether an organization has the right to control what a service provider does and how he or she does it, even if that control is never exercised. This control indicates an employer-employee relationship. Other factors include whether a service provider renders services to more than one recipient, how and to whom a service provider reports, who can fire a service provider, and whether a service provider's work is key to an organization's business.
An additional factor that employers frequently give too much weight is who pays service providers. Host and home employers often mistakenly assume that so long as they pay assignees while they are working overseas, they continue to be their employees. To the contrary, assignees can be common law employees for nonpaying employers and not considered employees of paying employers. Moreover, although assignees may be classified as employees of their home employer when they are first sent abroad, that classification may change as the individuals become more familiar with their host employer's business and the host employer assigns them more work. Therefore, it is important to remember that employee classifications may change from year to year.
Avoiding Exclusive Benefit Rule Problems
Employee-leasing agreements and split-payroll arrangements can help employers address exclusive benefit rule problems when the arrangements remove the uncertainty involved in determining an assignee's common law employee status. Employee-leasing agreements generally set out in clear language that the U.S. employer retains common-law-type rights and control over its service providers. Split-payroll agreements establish that service providers will be treated as employees of both their U.S. and foreign employers. Accordingly, both arrangements may support the claim that overseas assignees are at least part-time employees of the U.S. plan sponsor or another participating employer.
Sec. 406 is also sometimes used to address exclusive benefit rule problems. Sec. 406 allows a U.S. citizen or resident employed by a foreign affiliate of a U.S. employer to be treated as an employee of the U.S. employer if the U.S. employer has at least a 10% ownership interest in the foreign affiliate, a Sec. 3121(l) agreement for U.S. Social Security coverage is in place, and certain other requirements are met.
Although employee leasing agreements, split-dollar arrangements, and Sec. 406 can help avoid exclusive benefit rule violations, the most direct way to comply with the exclusive benefit rule is for a plan to add as a participating employer any foreign affiliate that serves as a home or host employer for overseas assignees. However, adding a foreign affiliate as a participating employer in a U.S. qualified plan raises several supplementary issues that a plan sponsor should carefully consider. First, if the foreign affiliate added to the plan is not in the same controlled group as another participating employer, then the plan will become—if it is not already—a multiple-employer plan (MEP). Although being a MEP simply means that employees from more than one controlled group participate in the plan, MEPs are subject to special nondiscrimination requirements.
Second, when a foreign affiliate is added as a participating employer, if nonresident aliens are not excluded from the plan, then all employees of the foreign company may be eligible to participate in the plan. If this is not a plan sponsor's intention, then the plan should exclude (and be amended to exclude if necessary) nonresident aliens with no U.S.-source income from eligibility.
Third, a plan sponsor should consider whether it intends to permit participation by other U.S. employees hired by the foreign affiliate (i.e., employees who are not on an overseas assignment). If a plan sponsor intends to permit participation only by U.S. nationals who have been transferred to a foreign affiliate on assignment, then the plan document should establish that limitation. Importantly, regardless of whether the plan limits participation to U.S. nationals on overseas assignment, if a foreign affiliate is a participating employer, the plan will be required to count all U.S. nationals employed by the foreign affiliate when performing certain nondiscrimination testing.
Correcting Exclusive Benefit Rule Violations
If a plan has failed to comply with the exclusive benefit rule in prior years, those violations will continue to jeopardize the plan's qualified status until they are corrected. Proper correction of past violations requires a retroactive amendment to add the foreign affiliate as a participating employer. The effective date of the amendment should be the date that the violation or violations first occurred. The IRS requires use of the Voluntary Correction Program (VCP) component of the Employee Plans Compliance Resolution System (EPCRS) to request approval of this type of retroactive amendment.
Plan Operational Failures
Operational failures occur when a qualified plan is not operated in a manner that matches the plan document. In some cases, correction of an operational failure requires a retroactive amendment to permit the operation of the plan to match the document; in other cases, it requires a correction of the impermissible operation itself. With overseas assignees, operational failures occur when assignees participate in a qualified plan but the plan document does not permit their participation. This type of operational failure can occur even if the plan complies with the exclusive benefit rule. Operational failures can also occur with cross-border assignees for a number of other reasons, such as basing an assignee's contributions or benefits on compensation that is not in accordance with plan definitions and impermissible distributions (typically at the end of a U.S. assignment but prior to separation from service from the controlled group). Fortunately, many operational failures can be corrected under EPCRS.
For U.S. nationals working abroad, the language should state that the plan continues to cover any U.S. nationals who were eligible to participate in the plan before their transfers overseas, as long as they work for a participating employer. If this language is used, the foreign host employer must be, or be added as, a participating employer. It is also crucial to remember the previously discussed supplementary issues that arise when a foreign affiliate is added as a participating employer to a U.S. qualified plan. Amendments similar to those for outbound assignees can be added to a plan to permit participation in a U.S. qualified plan by foreign nationals on inbound assignments to the United States.
Correcting Operational Failures
Operational errors that relate to failure to comply with the terms of a plan that are correctly drafted originally may be eligible for self-correction under EPCRS. However, because it is not possible to change who participated in a plan in prior years, correcting participation-related operational errors generally requires a retroactive amendment to make the plan document match what has already occurred (such as adding a foreign affiliate as a participating employer). As discussed previously, several supplementary issues arise if a foreign affiliate is added as a participating employer to a U.S. plan, and retroactive amendments intended to correct these types of failures must be submitted to the IRS using the VCP component of EPCRS. Proper correction of a prior year's operational failure or failures is necessary to maintain a plan's continued qualified status.
Violations of the exclusive benefit rule and operational failures that occur with respect to overseas assignees' participation in U.S. qualified plans generally can be avoided with fairly simple plan language. Conveniently, the same language may address both problems. Correcting a prior year's exclusive benefit rule violation or operational failure must be done in accordance with EPCRS and may require a retroactive amendment and IRS approval. Advance planning and correcting previous problems will allow participation by overseas assignees that does not jeopardize a plan's qualified status.
Mary Van Leuven is director, Washington National Tax, at KPMG LLP in Washington.
For additional information about these items, contact Ms. Van Leuven at 202-533-4750 or email@example.com.
Unless otherwise noted, contributors are members of or associated with KPMG LLP.
This column represents the views of the authors only and does not necessarily represent the views or professional advice of KPMG LLP. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. ©2015 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.