Tax Tips
Review Your Business' Retirement Plan for Defects - October 2000
Richard Scrivanich - Partner
Last month, we discussed how to qualify for the business use of your home deduction. In order to qualify for the deduction, you must meet a two-part test. The first part has three criteria, that is, the use must be exclusive, regular, and for your trade or business. The second part of the test requires you to meet only one of the following criteria: The business part of your home must be: 1) your principal place of business or 2) a place where you meet or deal with patients, clients, or customers in the normal course of your trade or business, or 3) a separate structure (not attached to your home) you use in connection with your trade or business. Once you meet these tests, you are eligible to take the deduction.
To qualify for tax advantages, a retirement plan must satisfy a broad range of requirements contained in Internal Revenue Code (IRC) Section 401(a). The IRS knows that disqualifying a plan would impose significant economic burdens on plan sponsors and participants and is unnecessary when the qualification defect is not significant or intentional. Over the past 18 years, many modifications have been made to Section 401(a) by legislation. As a result, it is possible that a plan sponsor may have inadvertently violated a qualification requirement. Fortunately, the IRS has created a number of programs to help plan sponsors correct any defects and self-monitor their programs. Plan sponsors should review the operation and documentation of their qualified plans to make sure the plans comply with all IRS regulations, and, if not to look to one of the IRS correction programs to ensure that the plans are not disqualified.
Plan defect categories.
The IRS categorizes qualification defects into three types:
- Operational failures. An operational failure is one where the plan fails to operate according to its terms. An example would be excluding an employee from participating, even though the employee has satisfied all the plan's eligibility requirements.
- Demographic failures. A demographic failure happens when the plan discriminates in favor of highly compensated employees over non-highly compensated employees. The discrimination may be in contributions, benefits, and/or coverage.
- Plan document failures. A plan document failure is one that does not fit into either of the other categories. An example would be if a plan sponsor failed to update or amend a plan document to reflect and conform to statutory changes.
IRS programs.
If a plan has one or more of these defects, there are several IRS programs to help sponsors regain their "qualified" status. A plan sponsor should choose a program based on the type of defect the plan has. In 1998, the IRS issued Revenue Procedure 98-22 to consolidate the different programs into the coordinated Employee Plan Compliance Resolution System (EPCRS). Its purpose is to provide a uniform set of correction principles, establish more standardized penalties and encourage self-correction by providing a reasonable level of assurance of the consequences. EPCRS includes the three voluntary correction programs in effect prior to 1998, and adds an audit correction program.
- Voluntary Compliance Resolution (VCR) Program. Under this program, sponsors can voluntarily disclose an operational failure to the IRS and request a "compliance statement" by paying a fixed fee. The IRS must approve the repair to the operational defect. A version of the VCR program is the Standardized Voluntary Program (SVP), in which more common types of operational failures may be disclosed to the IRS, and for which a pre-determined correction method exists. For example, if a plan fails a non-discrimination test, the plan would then be required to make a contribution on behalf of non-highly compensated employees in the amount necessary to satisfy the test.
- Walk-in Closing Agreement Program (CAP). Walk-In CAP allows a sponsor to voluntarily notify the IRS of a qualification failure it discovered and pay a compliance fee. All three types of failures are eligible for Walk-In CAP. For example, a plan that was not amended in a timely manner could be submitted to the IRS with the necessary changes. Prior to EPCRS, penalties could amount to 40% of the tax due if the plan was disqualified. Now, penalties under this program are based on the nature, extent, and severity of the defect.
- Administrative Policy Regarding Self-Correction (APRSC). Under APRSC, a sponsor of a qualified plan or a Section 403(b) plan (a tax-deferred annuity plan for certain not-for-profit organizations) may correct an operational plan failure without disclosing the defect to the IRS. This is subject to certain conditions, which include: 1) the correction must restore the plan and its participants or beneficiaries to the position they would have been had the defect not occurred; 2) significant operational failures must be corrected by the end of the plan year following the year during which the defect occurred, and 3) the defect must be repaired for all participants and beneficiaries for all taxable years. Under EPCRS, the correction period for APRSC has been extended from one year to two years following the plan year in which a substantial operational defect occurred. Operational defects that are not substantial may be corrected at any time.
- Audit CAP. The EPCRS created Audit CAP; this allows plans under examination to negotiate a monetary sanction, along the lines of a Walk-In CAP, after a plan has been selected for audit.
Conclusion.
The IRS has given plan sponsors a choice of self-correction programs, and plan sponsors should take advantage of these programs and review the operations and documentations of their qualified plans. In addition, under APRSC, many operational defects may be corrected without notifying the IRS. Other operational defects can be repaired using VCR or SVP at a much lower fee. Other types of failures and defects can be addressed using the Walk-In CAP when the sanction will bear a reasonable relationship to the extent, nature, and severity of the defect.
If you have any questions concerning your business' retirement plan or any other tax question for that matter, please do not hesitate to give me a call at (562) 698-9891.
Return to Tax Tips Archives
All rights reserved. For personal use only.
Do not duplicate or distribute without permission. All information in this
article is for informational purposes only.
Some of the articles included here were written in a prior
year or before a current tax law change. Therefore some of the information in
the older articles may not still be valid. Any dollar thresholds indicated
relate only to the year for which the article was written and could be different
for the current year. Please discuss with us your personal situation before
acting on any of the information provided. If you have any questions,
please give us a call at (562) 698-9891.
|
