Undocumented Workers Become a Missing Participant Problem

Nothing in ERISA says an undocumented worker cannot participate in a retirement plan, but making a distribution to one could be a problem.

It can happen and has happened—a retirement plan sponsor discovers an undocumented worker is participating in the retirement plan.

Eric W. Gregory, an attorney with Dickinson Wright in Troy, Michigan, tells PLANSPONSOR he has found that the Affordable Care Act (ACA) has diminished the instances of illegal immigrants obtaining a Social Security number and using it to get employment. “That mismatch between name and Social Security number could go undetected, but, with the ACA, employers send Social Security numbers to the IRS to show an employee has health care coverage, and the IRS is cross checking numbers against names. That has caused a lot of employers to get mismatched information from the IRS and has led to a rising level of employers finding out about false Social Security numbers,” he says.

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According to Gregory, the undocumented worker can’t be kicked out of the retirement plan just because it was discovered he was undocumented. There hasn’t been a lawsuit that has come out to say this, and the Employee Retirement Income Security Act (ERISA) doesn’t have any exceptions for workers who are not legally authorized to work in the United States.

In a blog post, Gregory noted that the Department of Labor (DOL) has taken the position that undocumented or under-documented workers are “employees” under the Fair Labor Standards Act (FLSA) and the Migrant Seasonal Agricultural Worker Protection Act (MSPA), but it has not done so explicitly in the context of ERISA.

“Most retirement plans include a ‘common law’ definition of ‘employee,’ which does not take into consideration whether a worker is authorized to work in the United States,” Gregory wrote.  “Therefore, unless a retirement plan has a specific exclusion for unauthorized workers or workers whose participation arose as a result of fraud, it appears to be inconsistent with both ERISA and plan terms to exclude those workers from participation, or cause them to forfeit their benefits.”

There still are ramifications for plan sponsors, though.

If a current employee is determined to be an undocumented worker, his employment will be terminated.

If an undocumented worker is vested in any retirement benefits, the time for a distribution will come. It may be that the retirement plan requires a cash out of small balances, or a former employee who was an undocumented worker will reach age 70 1/2—the current age at which minimum distributions are required.

In a best-case scenario, described by Gregory in Part II of his blog post, unauthorized workers may qualify as U.S. Persons merely based on the amount of time (legally or illegally) they have spent in the U.S. He said a plan sponsor may consider confirming that tax status by providing the participant with Forms W-8BEN, W-9 and W-7. The Form W-8BEN permits the participant to attest whether he is a U.S. Person and determine whether he will claim benefits under an applicable tax treaty. A Form W-9 gives the plan sponsor a record of the participant’s name, address, individual tax identification number (ITIN) or Social Security number (SSN), which may allow him to be treated as a U.S. Person, pursuant to rules for U.S. Persons. In case the participant is eligible to take advantage of treaty benefits, he will need to complete a Form W-7.

Often, though, an employee who is discovered to be undocumented, doesn’t want to be found, Gregory tells PLANSPONSOR. Or, an undocumented worker has moved, or been deported, to a place outside of the U.S.

According to Gregory, the IRS in audits has recently said plan sponsors can forfeit the retirement benefit of a missing participant and reinstate it if the participant shows back up, but the DOL says that’s a prohibited transaction. He says some employers just wait for the situation to resolve itself, following guidance on trying to locate missing participants.

Gregory points out that if the retirement plan sponsor and recordkeeper do not have a valid Social Security number of ITIN for a plan participant, a distribution cannot be made because one or the other is required for issuing a 1099R to the IRS and the participant. Gregory says it is unlikely for a worker to show back up at his employer saying he applied for an ITIN.

He explains: “When employers are required to make distributions to employees who have provided invalid Social Security Numbers, they are faced with a quandary because Internal Revenue Code Section 6109 generally requires that any person required to file a return, statement, or other document with the IRS must include an identifying number. That identifying number is generally a Social Security Number.”

In order to make distributions that are otherwise required to be made to individuals who have provided a false or incorrect Social Security Number who will not provide an ITIN, some employers have relied on previous guidance from the IRS that relates to W-2s. “That guidance suggests that employers should enter all zeroes in the Social Security Number field of a Form W-2 for reporting earnings for someone who was hired or worked in error when an accurate Social Security Number was not obtained. However, recordkeepers typically do not want to prepare 1099-Rs with missing Social Security Numbers,” Gregory says.

If a plan sponsor has issued a required distribution to an undocumented worker and the check is never cashed, the IRS has recently issued a Revenue Ruling saying plan sponsor’s still have an obligation to withhold and pay taxes on required distributions and report it on a 1099R.

Gregory says, “If a plan sponsor came to me, I would first want to know if it is dealing with a large or small group of employees. I would first suggest the plan sponsor ensure it is following immigration rules and determine whether it knows if the employee has an invalid Social Security number.”

He would first suggest the plan sponsor tell the employee or employees to fill out a Form W-7 to get an ITIN so a distribution can be made. But, he concedes they may not be eligible to get one. Plan sponsors should follow plan provisions with respect to when it is appropriate to make a distribution.

“If the employee doesn’t have a W-7 or if the employee has a balance larger than the automatic cash out limit, the plan sponsor is at the mercy of it recordkeeper about whether it can issue a 1099R,” Gregory says.