Printer Friendly
The Free Library
22,719,120 articles and books

What to do if the IRS audits your pension plan.

Many small and medium-sized pension plans are now more vulnerable than ever to an Internal Revenue Service attack if they are not administered by competent professionals. CPAs should advise their companies and clients that many more plans will be required to go through IRS An abbreviation for the Internal Revenue Service, a federal agency charged with the responsibility of administering and enforcing internal revenue laws.  pension plan audits and that the IRS has been successful in disqualifying dis·qual·i·fy  
tr.v. dis·qual·i·fied, dis·qual·i·fy·ing, dis·qual·i·fies
a. To render unqualified or unfit.

b. To declare unqualified or ineligible.

 plans that do not meet its strict audit standards.

The disqualification of a plan that accumulated large sums of money is a traumatic experience for the business owner, the employees, the owner's accountant and other professional advisers. The employer faces disallowed employer contributions to the plan for all years not barred by the statute of limitations A type of federal or state law that restricts the time within which legal proceedings may be brought.

Statutes of limitations, which date back to early Roman Law, are a fundamental part of European and U.S. law.
; employees may have taxable income Under the federal tax law, gross income reduced by adjustments and allowable deductions. It is the income against which tax rates are applied to compute an individual or entity's tax liability. The essence of taxable income is the accrual of some gain, profit, or benefit to a taxpayer.  to the extent of their vested interests vested interest
1. Law A right or title, as to present or future possession of an estate, that can be conveyed to another.

2. A fixed right granted to an employee under a pension plan.

; and the pension trust loses its tax-exempt status and is taxed as a complex trust.


The IRS developed a program to serve as an alternative to plan disqualification. An IRS newsletter dated January 1992 describes this program as follows:

"A new alternative method of resolving plan qualification issues... involves the use of the Service's closing agreement program (CAP) [which] has become a permanent element in the expanding employee plans examination program.

"Under CAP, Employee Plans agents may enter into closing agreements with taxpayers to resolve plan qualification defects without the sanction of disqualification. Taxpayers who do not enter into a closing agreement to resolve plan defects in form or operation, of course, are subject to retroactive disqualification of their plans."

In general, cases with disqualification defects are eligible for inclusion in the CAP. However, the CAP will not be applied to cases involving significant discrimination in favor of highly compensated employees; exclusive benefit violations resulting in the diversion of trust assets; and repeated, deliberate or flagrant violations.


In order to enter into a closing agreement, a taxpayer must agree to correct all plan defects completely, both retroactively and prospectively. (A retroactive correction may require reallocation Noun 1. reallocation - a share that has been allocated again
allocation, allotment - a share set aside for a specific purpose

2. reallocation
 of plan assets, as if the defect never occurred.) Correction also may involve making plan amendments and implementing the procedures necessary to bring the plan into compliance with Internal Revenue Code The Internal Revenue Code is the body of law that codifies all federal tax laws, including income, estate, gift, excise, alcohol, tobacco, and employment taxes. These laws constitute title 26 of the U.S. Code (26 U.S.C.A. § 1 et seq.  section 401(a).

In addition to correction, the taxpayer must agree to make a nondeductible payment to the U.S. Treasury U.S. Treasury

Created in 1798, the United States Department of the Treasury is the government (Cabinet) department responsible for issuing all Treasury bonds, notes and bills. Some of the government branches operating under the U.S. Treasury umbrella include the IRS, U.S.
; in return, the IRS will not revoke the plan's qualified status. The amount of this payment will be based on

* A particular case's equities, such as the number of affected nonhighly compensated pension plan participants Plan participants

Employees or other beneficiaries who are eligible to receive benefits from a company's employee benefit plan.

* The relative insignificance in·sig·nif·i·cance  
The quality or state of being insignificant.

Noun 1. insignificance - the quality of having little or no significance
unimportance - the quality of not being important or worthy of note
 of the defect in the context of all the facts in the case.

* Taxpayer actions (such as promptly and completely correcting the defect and requesting a closing agreement) after the discovery of a disqualifying defect and before the selection of the plan for audit.

The closing agreement program and the administrative error policy directive described below are essential to the IRS's broadened examination effort. They provide pragmatic alternatives to the technical disqualification sanction. Compliance-minded practitioners should keep these alternative IRS policies in mind when moving to correct pension plan defects.


In addition to the CAP, the IRS also issued an administrative policy directive authorizing agents to resolve certain minimal operations violations simply by requiring correction. An operations violation of section 401(a) requirements is not a disqualifying event if all the following criteria are satisfied:

* The operations violation made by the plan must be an isolated, insignificant instance.

* The plan either must have a history of section 401(a) compliance (other than the nondisqualifying event) both in form and operation or must have corrected the operations violation before examination, with no evidence of noncompliance noncompliance

failure of the owner to follow instructions, particularly in administering medication as prescribed; a cause of a less than expected response to treatment.

 in other areas.

* The plan sponsor or plan administrator must have established practices and procedures (formal or informal) to ensure section 401(a) compliance, including procedures involving the area in which the violation occurred.

* The established procedures must have been followed; the operations violation occurred through an oversight or mistake in applying those procedures.

* Any dollar amounts (such as excess contributions or excess allocations) are insubstantial in view of the entire case.

* The taxpayer must have immediately and completely corrected the violation upon discovery, so no participant or beneficiary suffered a loss.


Given the widened scope of the new program, CPAs should advise companies or small business clients to take the following actions:

1. The business owner must make sure all qualified plans are amended in a timely fashion.

2. The plan sponsor or plan administrator should assign an employee with pension administration expertise or engage a competent pension consultant to monitor the plan in operation.

3. The plan sponsor or plan administrator must establish a checklist of items to be monitored in the administration of the plan.

4. For statute of GLOUCESTER, STATUTE OF. An English statute, passed 6 Edw. I., A. D., 1278; so called, because it was passed at Gloucester. There were other statutes made at Gloucester, which do not bear this name. See stat. 2 Rich. II.

 limitation purposes with respect to the pension trust, the optional trust statement, schedule P (form 5500), should be attached to the annual return or report each year.

5. Any error by the plan administrator should be corrected immediately upon discovery. Correcting an error before receiving an IRS audit notice is important and will be helpful in negotiating a resolution.

6. If the IRS determines there is an error in the plan operation or that the plan has defective language, the plan sponsor should correct the error immediately to limit the number of years for which the plan may be disqualified dis·qual·i·fy  
tr.v. dis·qual·i·fied, dis·qual·i·fy·ing, dis·qual·i·fies
a. To render unqualified or unfit.

b. To declare unqualified or ineligible.

 should the defect or error trigger plan disqualification.


An IRS official confirmed at a meeting with the AICPA AICPA

See American Institute of Certified Public Accountants (AICPA).
 employee benefits taxation committee in December 1991 that the agency will devote greater resources to examinations and audits of pension plans. In such a climate, it is important that CPAs keep clients and companies aware that qualification defects do not necessarily require the severe penalty of disqualification. Alternative resolutions, including the CAP and corrective action A corrective action is a change implemented to address a weakness identified in a management system. Normally corrective actions are instigated in response to a customer complaint, abnormal levels if internal nonconformity, nonconformities identified during an internal audit or  program, may be applicable.

Seymour Goldberg, CPA (Computer Press Association, Landing, NJ) An earlier membership organization founded in 1983 that promoted excellence in computer journalism. Its annual awards honored outstanding examples in print, broadcast and electronic media. The CPA disbanded in 2000. , JD, is a senior partner of the law firm Goldberg & Ingber, P.C., Garden City, New York Garden City, New York is a village in central Nassau County, New York in the USA, which was founded by multi-millionaire Alexander Turney Stewart in 1869. The village is located 18.5 miles to the east of mid-town Manhattan, on Long Island. , and a professor of law and taxation of Long Island University. He has written articles for the Journal and is the author of an AICPA continuing professional education training program, Coping with Problems ub Pension and Profit-Sharing Plans, portions of which have been used as material for this article.
COPYRIGHT 1992 American Institute of CPA's
No portion of this article can be reproduced without the express written permission from the copyright holder.
Copyright 1992, Gale Group. All rights reserved. Gale Group is a Thomson Corporation Company.

 Reader Opinion




Article Details
Printer friendly Cite/link Email Feedback
Title Annotation:A Resource for Small Businesses
Author:Goldberg, Seymour
Publication:Journal of Accountancy
Date:Aug 1, 1992
Previous Article:Redemptions versus cross-purchase agreements.
Next Article:Locating a 401(k) provider: what to do when a client asks for help.

Related Articles
Age-based pension plans approved, delighting small business owners.
IRS small pension plan audit (and amnesty) program; March 31 deadline nears for program that resolves cases quickly and reduces taxpayer liability.
IRS penchant for auditing small business pensions.
Congress does not repeal limited-scope pension audits.
IRS offers some QDRO help.
New self-correction policy for retirement plans.
Who's eyeing your 401(k)?
New pension plan self-correction programs.
Small business market-share strategies and transfer-pricing certainty.
Best practices in EBP audits: regulatory pressure is heating up the market.

Terms of use | Copyright © 2014 Farlex, Inc. | Feedback | For webmasters