The IRS Voluntary Correction Program allows companies to correct mistakes with their retirement plan before they face an audit. Compliance can allow the plan to maintain tax-favored status and avoid costly penalties. The IRS has published the “Top Ten Failures Found in Voluntary Correction Program” to help companies avoid common mistakes.
One of the primary benefits of most retirement plans and employers is the tax-favored status it provides participants, including a 401(k), 403(b), ESOP, or defined benefit plan. In order to remain tax-favored, the plan has to meet specific qualifications. If the retirement plan no longer qualifies, employers and employees can be impacted by significant costs, eliminating the plan's intended benefits.
When failures in the operation of the plan occur, the retirement plan may lose its tax-favored status. If these mistakes are caught in time (that is, before the plan is audited by either the IRS or DOL), a business can correct those errors through the Voluntary Correction Program (VCP). The VCP allows a company to obtain a compliance statement showing that the IRS has approved the proposed correction method and bring the retirement plan back into compliance with federal tax law.
According to the IRS, the top ten failures found in the VCP include:
1. Failure to amend the plan for tax law changes by the end of the period required by the law.
2. Failure to follow the plan's definition of compensation for determining contributions.
3. Failure to include eligible employees in the plan or the failure to exclude ineligible employees from the plan.
4. Failure to satisfy plan loan provisions.
5. Impermissible in-service withdrawals.
6. Failure to satisfy IRC 401(a)(9) minimum distribution rules.
7. Employer eligibility failure.
8. Failure to pass the ADP/ACP nondiscrimination tests under IRC 401(k) and 401(m).
9. Failure to properly provide the minimum top-heavy benefit or contribution under IRC 416 to non-key employees.
10. Failure to satisfy the limits of IRC 415.
One issue that arises in many companies is that the retirement plan is compliant at the time it is designed and implemented. However, over time, tax regulations change or there is a shift in the way the plan is carried out. This may leave an employer unaware that they are out of compliance with federal tax law and that their benefit plan is at risk of losing qualified, tax-preferred status.
When a retirement plan is disqualified, it can impact the employee, employer, and the plan's trust. With a disqualified plan, the employer cannot deduct a contribution until it is includible in the employee's gross income. In addition to federal taxes, disqualified contributions are also subject to payroll taxes. This includes Social Security, Medicare, and Federal Unemployment Taxes.
Disqualification is retroactive, which could result in surprise tax liability for an employer who thought their retirement contributions were tax exempt. An employee is also prevented from rolling over assets from a disqualified plan.
According to the IRS website on the Tax Consequences of Plan Disqualification, “a distribution from a plan that has been disqualified is not an eligible rollover distribution and can't be rolled over to either another eligible retirement plan or to an IRA rollover account. When a disqualified plan distributes benefits, they are subject to taxation.”
If you have any questions about your company's retirement plan or maintaining its compliance with federal tax law, Butterfield Schechter LLP is here to help. We are San Diego County's largest firm focusing its law practice on employee benefits and business tax law. Our firm can provide fiduciary counseling, help you avoid ERISA penalties, and represent you in ERISA litigation. Contact our office today with any questions on how we can help you and your business succeed.