December 9, 2018

December 07, 2018

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Why Your Qualified Plan – Isn’t

There are many generous tax benefits that come from having a “qualified” retirement plan (such as a section 401(k) plan). For example, as an employer, you can deduct your plan contributions, but participating employees don’t have to recognize the contributions as income until they receive a distribution; usually many years later. However, those tax benefits disappear if your plan loses its qualified status.

What can cause a plan to lose its qualified status?

Several things, but there are three types of problems that frequently arise:

  • Failure to adopt required plan amendments in a timely fashion. The IRS issues reams of guidance that require plan amendments. Fail to adopt even one on time, and your plan is technically disqualified. 
  • Failure to administer the plan in accordance with its terms. Your plan document probably contains hundreds of pages of fine print and technical jargon. Most employers have never read it, at least not all the way through. But you are required to follow it to the letter. Slip up one time and your plan can be considered disqualified. 
  • Failure to satisfy the Internal Revenue Code’s various tests. The Code contains a number of mathematical tests which specify who must benefit from the plan and what benefits must be provided. These tests also prohibit “discrimination” in favor of highly compensated employees and others. Many of those tests are extremely complex and easy to violate. Fail one of them, and fail to correct it within the allowable time periods, and your plan will be disqualified.

How to correct qualification failures

Luckily the IRS has provided ways to correct most qualification failures. For example, their “Employee Plans Compliance Resolution System” or “EPCRS” allows plan sponsors to correct qualification failures through a variety of methods, such as employer contributions, retroactive amendments and corrective distributions. Generally those corrections are designed to put the plan in a position as if the qualification error had not occurred. But these require experienced and knowledgeable advisors to navigate.

Conclusion

To help avoid disqualification, make sure that:

  • Your advisors are monitoring your plan to help eliminate potential causes of disqualification. 
  • Your plan document is up to date, and matches the way you actually administer your plan. Don’t make a change to your plan without telling your document provider and third party administrator. 
  • Someone in your organization is reviewing your plan’s discrimination testing and dealing with violations.

If you see a problem, correct it as soon as possible – before the IRS audits you. This way you can keep your qualified plan “qualified.” 

© 2018 Dinsmore & Shohl LLP. All rights reserved.

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About this Author

Ben F. Wells, Dinsmore Shohl, Wealth Planning Lawyer
Partner

 

Ben Wells is a Partner in the Corporate Department and is Chair of the firm's Tax, Benefits and Wealth Planning Practice Group. He leads the firm's Fringe Benefits Committee and is a member of its Practice Management Council. Over a period of more than 25 years, Ben has advised and counseled clients on a full range of issues relating to employee benefits and executive compensation.

Ben works with Fortune 500 companies, privately held employers, not-for-profit employers, state and local governmental entities, health care providers, private equity investors, ERISA plan...

513-977-8108
William Freedman, Employee Benefits Practice Attorney, Dinsmore law firm,
Partner

William M. Freedman is a Partner in the Corporate Department. Bill's employee benefits practice serves a diverse client base with respect to the design, preparation and implementation of pension and welfare benefit plans and their ERISA-related issues, including the effect of laws such as ERISA, the Internal Revenue Code, the Age Discrimination in Employment Act, the Older Workers Benefit Protection Act, COBRA requirements, and HIPAA health care coverage.

Bill's tax and estate planning practice involves advice to individuals and businesses, including corporations, partnerships and limited liability companies. His experience includes federal individual, partnership, and corporate tax planning; disputes with the Internal Revenue Service; and planning for deferred compensation, qualified retirement, and IRA/403(b) plan distributions. 

513-977-8232