In our fast-paced world, many retirement plans are written and often neglected. In extreme cases, plans are shelved without being updated. Some plan sponsors have been unable to restore their plans for years or even decades. For many people, retirement plan accounts represent the majority of their wealth. As the following discussion will illustrate, failure to protect this most valuable and important asset by keeping the retirement plan in full compliance with applicable retirement plan laws could have very unpleasant, costly, and unforeseen financial repercussions.
Retirement plan laws have always required plans to be updated based on changes in tax law. Prior to 2003, the IRS allowed plans to be updated periodically for tax law changes that occurred over many years. This resulted in periodic major rethinking of the main plan. However, since 2003, the IRS has required retirement plan amendments for each new tax law, resulting in more frequent “interim amendments.” [For those of you interested in a more detailed discussion of these required interim amendments since 2003, please go to my questions answered at my Linked-In profile.] For many plans, the deadlines for many of these plan updates or interim amendments have already passed. The current rules state that plans that have not been redrafted to meet prior required reformulations or interim amendments are no longer qualified as of their applicable deadlines.
In the worst case, the IRS may require that the plan be retroactively disqualified. If the IRS is successful in disqualifying the plan, the plan sponsor’s tax deductions for contributions taken in the year of disqualification and in subsequent years would be disallowed. Taxes owed by the plan sponsor due to disallowance of previously claimed retirement plan deductions plus applicable interest and penalties could be enormous. In addition, plan participants would be required to treat the value of their plan account as of the date of such disqualification as taxable income. Taxes, interest and penalties to participants from the date of disqualification from the plan could be equally exorbitant. This would be a truly disastrous and harsh outcome for both the employer plan sponsor and the disqualified plan participants.
However, in most cases, current IRS policy is to impose monetary penalties rather than the more severe penalty of plan disqualification. Still, when the IRS raises these failures as a result of an audit the penalties can be quite severe. Fines can range from $2,500 to $80,000 depending on the faults involved and the size of the plan. It’s worth noting that in recent years, the IRS has increased auditing of retirement plans.
Here’s some good news: how to solve this impending problem
The IRS has a voluntary corrective program called VCP (voluntary compliance program) to correct these deficiencies in plan documents. The IRS position is that retirement plans can be requalified only if the plan sponsor voluntarily submits to an IRS audit by submitting newly drafted delinquent returns and/or provisional amendments to the IRS in accordance with some procedures and Very detailed documentation in accordance with the Income Procedure 2008-50. Once the IRS reviews and hopefully approves the newly drafted application and required documentation, the plan is deemed to be in full compliance with applicable law and the plan retroactively qualifies for taxes.
Instead of paying a hefty monetary penalty, filing for VCP results in the payment of a filing fee to the IRS. Sometimes, if the violation is fairly limited, the filing fee can be as low as $375. (Remember, you will still have to pay for documentation services associated with plan updates and interim amendments. However, these costs would have been incurred in any event to keep your plan in full compliance with the law.) The important point here is that using the VCP program avoids the risk of disqualification from the plan or the imposition of a significant monetary penalty.
How can we help:
This office has submitted numerous VCP program applications under the applicable Admissions Procedure 2008-50. This request along with any necessary plan reformulations and interim amendments must be carefully drafted to ensure efficient negotiations and a successful outcome with the IRS.
The bottom line:
Plan sponsors must act immediately and voluntarily to correct plan deficiencies under the more taxpayer-friendly and affordable VCP program before the IRS audits their plan. Once the IRS begins an audit, the VCP submission strategy is no longer an option and your plan is open to disqualification and/or severe monetary penalties.
Going forward, you should set up a schedule with your plan advisor to make sure your plan complies with laws regarding plan updates, interim amendments, and changing IRS filing requirements and deadlines. This will prevent you from having to deal with all these problems again in the future. In fact, the Income Procedure requires a disclosure on the VCP application about what new procedures plan sponsors will use to avoid this problem in the future.
Dont wait:
