In the last issue of Illuminations, you read about some initial consequences you may face if you find that your 401(k) plan is out of compliance with an IRS or DOL rule. In this week’s issue, check out the second part of the article that explains the statute of limitations and how you can work to rectify any issues you may have with your business’s retirement plan. To refresh your memory, you can read the first part of the article here.
Effects of statute of limitations
If the IRS retroactively disqualifies your plan, the disqualification (and the IRS’s ability to impose taxation) is effective only for taxable years for which the statute of limitations has not expired.
The statute of limitations period with respect to the tax-exempt trust ends three years after:
– The date the plan administrator or employer files the annual return (Form 5500 series) for the plan with the DOL; or
– The last day allowed by law or regulation for filing annual returns
If your plan administrator or you fail to file the annual return, the statute of limitations does not begin to run for the trust.
Statute of limitations for the employer
The statute of limitations with respect to your tax deduction for plan contributions is three years after:
– The due date of your tax return, or
– The filing date of your tax return
Statute of limitations for the employees
The general statute of limitations for imposing additional tax upon your employees is three years after:
– The due date of the individual’s tax return, or
– The filing date of the individual’s tax return
However, the statute of limitations increases to six years if the failure to include income results in a 25 percent or more understatement of gross income.
Disqualifying a closed plan; tax consequences for the open years
The IRS generally applies its unpublished “tainted assets” theory and imposes tax consequences for open years on a disqualified closed plan, unless you, as the employer, choose to re-qualify the plan. In this case, the IRS believes it has the authority to disqualify a plan for failing to amend timely for a tax law even if the statute of limitations for the plan year has expired. The IRS is most likely to apply its “tainted assets” theory to plan document failures in closed years (non-amenders). The IRS has confirmed its intent to apply the tainted assets rule to plans that were amended after the remedial amendment period closed. The IRS recently has won a court case successfully disqualifying a plan retroactively back to its inception in the 1980s.
Re-qualifying a retirement plan
To “re-qualify” your plan, you would need to correct qualification failures under the IRS’ Employee Plans Compliance Resolution System (EPCRS). For plan document and significant operational errors for which more than two years have passed since the error, you need to file under the Voluntary Correction Program. For insignificant errors, you should be able to use the Self Correction Program to correct the error. If the IRS discovers a plan error on examination, the plan may avoid disqualification by resolving the error under the Audit Closing Agreement Program (Audit CAP).
In practice, the IRS seldom disqualifies plans. Instead they go through Audit CAP. So do these disqualification consequences matter?
Yes, these consequences matter. EPCRS requires an employer payment to use Audit CAP. That sanction is a negotiated percentage of the “Maximum Payment Amount.” The Maximum Payment Amount is the total of the taxes and penalties the IRS could assert, if it disqualified the plan, against the trust, the employer, and the participants, after considering the statute of limitations. It also takes into account taxes for deemed distributions of loan failures.
Ohio 401(k) Plan Administration Help
If you sense something is not right with your 401(k) offering or become aware of a problem with your plan, contact Rea & Associates. Our Ohio Retirement Plan Services team can help you correct any problems and minimize potential penalties and taxes.