January 2002

Conforming Qualified Plans to IRS Requirements

By Seymour Goldberg, Goldberg & Goldberg, P.C.

Many employers have established qualified plans in order to provide employees with adequate funds for their retirement. The employer generally contributes to a trust for the benefit of the employee participants and receives a current income tax deduction for the contributions. The funds grow tax-free while in the trust. Employee participants pay income tax only when they receive distributions from the trust. In order to receive these benefits, the employer sponsor must create a valid legal plan document that satisfies IRS standards and administer the plan in accord with that plan document.

Prototype Plans

Employer sponsors that attempt to create and administer their own qualified plans frequently discover that small mistakes in the paperwork and administration of a qualified plan can result in significant additional costs. Such employer sponsors generally use a prototype plan sponsored by a financial institution, which requires the completion of an adoption agreement and the determination of several variables:

Once an option is selected, the employer sponsor is bound by it unless it is properly changed. In addition, as the law governing qualified plans changes, the employer sponsor is legally obligated to make conforming changes in the plan document in a timely manner. Problems arise when the employer sponsor either selects the wrong option or fails to select an option, which could lead to serious legal problems with both the IRS and the employee participants.

For example, a sole proprietor professional adopted a qualified plan with a financial institution. He assumed that his employees would enter the plan after two years of service. When the IRS reviewed the plan several years later, it was determined that the prototype plan required immediate participation with no eligibility requirement. The proprietor reached a voluntary settlement with the IRS.

In another example, a doctor adopted a qualified plan, completing a financial institutionís prototype document with the advice of an accountant and a stockbroker. A review indicated that not only was the pension formula option improper but also that the required pension returns had not been filed. IRS penalties accrue at the rate of $25 per day to a maximum of $15,000 for such oversights. The doctor reached a voluntary settlement with the IRS.

Many small employers adopt prototype plans and assume that they will be valid. However, the prototype may not satisfy current IRS rules and the employer sponsor might complete prototype documents incorrectly. Another frequent problem arises because an otherwise valid plan is not consistently administered.

According to Carol Gold, the director of employee plans at the IRS national office, pension investigations frequently encounter a planís failure toó

Revenue Procedure 2000-16

On February 7, 2000, the IRS issued Revenue Procedure 2000-16, which explains in detail the options for employer sponsors to voluntarily correct plan errors before being audited. Voluntary corrections generally incur much lower IRS sanctions than those found under examination. Revenue Procedure 2000-16 provides a system to correct qualified plans that may not currently satisfy, or may have never satisfied, the requirements of IRC section 401(a).

Revenue Procedure 2000-16 differentiates between plan document failures and operational failures. Plan document failures are errors in the underlying plan documents that require formal amendment of the plan in order to be corrected. Operational failures are the result of not following IRS rules and plan provisions in plan administration. Both types of failures can be corrected by following the special walk-in closing agreement program (Walk-in CAP). Under this program, employer sponsors may bring a plan document failure or an operational failure to the attention of the appropriate IRS employee plans office and negotiate a sanction that is usually far less than that would be applied otherwise. Sanctions for plans with 10 or fewer participants range from $500 to $4,000. Revenue Procedure 2000-16 indicates the steps and the paperwork necessary for correcting both document and operational failures.

Operational failures of plans not under examination, or insignificant errors of plans under examination, can often be self-corrected without submission to the IRS under the administrative policy regarding self-correction (APRSC) provisions of Revenue Procedure 2000-16. In addition, some operational failures may be voluntarily submitted to the IRS National Office under the voluntary compliance resolution program (VCR) for plans not under examination. VCR submissions avoid sanctions, and the fees are lower than those for the Walk-in CAP.

Revenue Procedure 2000-16 also indicates that IRS sanctions should be considered in light of the nature and severity of the violation if an IRS audit discovers operational or plan document failures that subject the taxpayer to the audit closing agreement program (Audit CAP).


Sheldon M. Geller, Esq.
Geller & Wind, Ltd.

Mitchell J. Smilowitz
GBS Retirement Services Inc.

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