Retirement Plans being audited by IRS

NEW JERSEY ASSOCIATION OF PUBLIC ACCOUNTANTS
AUGUST

Retirement Plans being audited by IRS in 2008. The Internal Revenue Service has recently been conducting a campaign by way of auditing Section 412(i) defined benefit pension plans. They are seeking substantial taxes and penalties from plans that they conclude are "abusive", although they are not approaching each plan with that mindset. But some of those that have been deemed abusive have also been regarded as listed transactions, and falling into that category leads to the disastrous result that taxpayers participating in them must disclose such participation under pain of penalties for nondisclosure potentially reaching as high as $100,000 for individuals and $200,000 for other taxpayers.

There is also increased audit activity in the general area of retirement plans, aiming to catch those companies cheating their workers or the Government. Targets include traditional pensions, 401(k) plans, and profit sharing plans. Part of the reason for the harsh treatment of 412(i) plans is discrimination in favor of owners and/or key, highly compensated employees, as well as the general feeling that the promised tax relief is not proportionate to the economic realities of these transactions. In general, IRS auditors divide the audited plans into non-compliant plans and abusive plans. While the alternatives available to the plan sponsor of a non-compliant plan are problematical, keeping the plan alive in some form, while simultaneously hoping to minimize the financial fallout from penalties, etc., is frequently an option.
The plan sponsor of an abusive plan can expect to be treated more harshly. Although it may not be the rule in all cases, there possibly being situations where something can be salvaged, the possibility is definitely on the table of having to treat the plan as if it never existed, which ofcourse triggers, to the fullest extent possible, back taxes, penalties and interest on all contributions that were made, not to mention leaving behind no retirement plan whatsoever.

Perhaps the largest issue in making sure that a qualified plan satisfies nondiscrimination testing and remains compliant is the inclusion of all “related employers” as joint sponsors of the plan. That’s because many small business owners may indeed own or control more than one enterprise. It is tempting to adopt a 412(i) plan to benefit one group of employees, and not cover all the related employees, but this may not be possible under current pension law as a plan must meet specific coverage and participation rules. [IRC §410(b) and §401(a)(26)] Generally, all the employees of businesses under common control are aggregated for nondiscriminationtesting vesting and top-heavy rules. Also the 415(a) contribution and 415(b) benefit limits willaggregate as if all the employees worked in one single employer. [IRC §414(b)] Presented here are definitions of the “controlled” and “affiliated” service groups that the professional advisor must consider before recommending adoption of any qualified retirement plan.

The Pension Protection Act, which became law in August of 2006, has altered the landscape in some ways. There is the favorable treatment accorded cash balance plans; this encouragement has made them almost ubiquitous. There is also a provision requiring that all defined benefit plans, except for 412(i) plans, be fully funded. This means that one hundred percent of the present value of the future promised liability must be funded. As for the consequences of failing to fully fund, if funding is below sixty (60) percent, the Pension Benefit Guaranty Corporation is legally authorized to simply terminate the plan. Other plans that are not as seriously under funded are considered "at risk", and are subject to a wide range of sanctions.

The traditional 401(k) defined contribution plan has also become somewhat of an audit target recently. Government auditors are trained to look for failure to adhere to the terms of the plan document as well as the improper exclusion of employees, both of which could lead to the disqualification of the plan.

To avoid such a disaster, the Service recommends that employers work in conjunction with plan administrators so that both parties are knowledgeable with respect to the particulars of the plan, and that plan administrators be timely provided with the necessary information to properly determine whether each employee should be included or excluded. All parties should also be mindful of the limitations imposed by Section 415. This section limits the amount of contributions that a participant can receive in a defined contribution plan as well as the amount of benefits that a participant can accrue in a defined benefit plan. Failure to adhere to Section 415 limitations most frequently occurs in situations where the employer or third party administrator does not monitor the amount of contributions allocated or the amount of benefits that are accrued by participants.

Lance Wallach is a frequent speaker at national conventions and writes for more than 50 publications. He was the National Society of Accountants Speaker of the Year. Lance welcomes your contact. Email - lawallach@aol.com or call 516-938-5007 for more info.

The information provided herein is not intended as legal, accounting, financial or any other type of advice for any specific individual or other entity. You should contact an appropriate professional for any such advice.

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