Armed with several recent Tax Court opinions on the issue of plan disqualification, the IRS has established the Employee Plans Closing Agreement Program in order to resolve plan disqualification disputes.

Closing agreements may be an alternative to plan disqualification in cases involving:

1. Failure to timely amend the plan to conform to TEFRA, DEFRA and REA;

2. Improper application of integration rules;

3. Partial termination;

4. Operational top-heavy violations; or

5. Other qualification issues as determined by the EP:EO Division Chief.

Closing agreements may not be used in situations involving the following:

1. Significant discrimination in favor of highly compensated employees;

2. Exclusive benefit violations resulting in diversion of trust assets; or

3. Repeated, deliberate, or flagrant violations.

In order to enter into a closing agreement, if one is available, the plan sponsor must make retroactive and prospective corrections of all plan defects.

The closing agreement must contain the following elements:

1. Participants who were affected must be made whole;

2. All necessary amendments must be executed;

3. Any necessary employer contributions must be made;

4. Corrections must be made retroactively for all prior years in which the violation occurred;

5. Additional contributions are deductible only to the extent of the deduction limitation; and

6. A payment to the IRS must be agreed upon in exchange for the plan retaining its qualification.

The amount of the payment is based on the facts and circumstances of the case. Factors that will be considered include:

1. The types of plan defects;

2. The maximum tax liability, interest and penalties if the plan were disqualified; and

3. The strengths and weaknesses of the case.

The Role of the EP Specialist

The EP specialist will advise the taxpayer about the closing agreement program and the possibility of avoiding disqualification of the plan. The EP specialist and the IRS closing agreement specialist may agree to resolve the case with the taxpayer in an amount that is less than 100% of the maximum tax liability. If the taxpayer is interested in the closing agreement program, then negotiations regarding specific items will commence. If a resolution cannot be agreed upon, then the agent will recommend disqualification of the plan and the maximum tax sanctions plus interest and penalties.

If the taxpayer enters into the closing agreement, the tax liability may be allocated between the employer and the trust on an equitable basis. The tax payment is not deductible.

The IRS has an administrative policy toward minor errors that occur in the operation of a plan. These are considered to be non-disqualifying events and must meet the following criteria:

1. The violation must be an isolated, insignificant occurrence;

2. The plan must have a history of compliance both in operation and in form;

3. The plan sponsor or plan administrator must have established procedures for administering the plan;

4. The procedures must have been followed, but through an oversight or mistake, a violation occurred;

5. Where dollar amounts are involved, the amounts are insubstantial in view of the total facts of the case; and

6. An immediate and complete correction must be made as soon as the violation is discovered.

As a result of this new audit program taxpayers and their professional advisors must establish detailed administrative procedures for handling their employee benefit plans. A failure to operate the plan in a defensive manner may result in substantial tax sanctions.