Not Updating Retirement Plans: How to Avoid IRS Plan Disqualification and Penalties by Using VCP

Website design By BotEap.comIn our fast-paced world, many retirement plans are written and often neglected. In extreme cases, plans are shelved without being updated. Some plan sponsors have been unable to restore their plans for years or even decades. For many people, retirement plan accounts represent the majority of their wealth. As the following discussion will illustrate, failure to protect this valuable and important asset by keeping the retirement plan in full compliance with applicable retirement plan laws could have very unpleasant, costly, and unforeseen financial repercussions.

Website design By BotEap.comRetirement plan laws have always required plans to be updated based on tax law changes. Before 2003, the IRS allowed plans to be periodically updated for tax law changes that occurred over many years. This resulted in major periodic rethinking of the main plan. However, since 2003, the IRS has required retirement plan modifications for each new tax law, resulting in more frequent “interim modifications.” [For those of you interested in a more detailed discussion of these required interim amendments since 2003, please go to my questions answered at my Linked-In profile.] For many plans, the deadlines for many of these plan updates or interim amendments have already passed. Current rules state that plans that have not been redesigned to meet required prior reformulations or interim amendments cease to be qualified as of their applicable timeframes.

Website design By BotEap.comIn the worst case, the IRS can require that the plan be retroactively disqualified. If the IRS is successful in disqualifying the plan, the plan sponsor’s tax deductions for contributions taken in the year of disqualification and subsequent years would be forfeited. The taxes owed by the plan sponsor due to the disregard of previously claimed retirement plan deductions plus applicable interest and penalties could be enormous. In addition, plan participants would have to treat as taxable income the value of their plan account on the date of such disqualification. Taxes, interest and penalties to participants as of the date of plan disqualification could be equally exorbitant. This would be a truly disastrous and harsh outcome for both the employer plan sponsor and the disqualified plan participants.

Website design By BotEap.comHowever, in most cases, current IRS policy is to impose monetary penalties rather than the more severe penalty of plan disqualification. Still, when the IRS raises these failures as a result of an audit the penalties can be quite severe. Penalties can range from $2,500 to $80,000 depending on the faults involved and the size of the plan. It’s worth noting that in recent years, the IRS has increased its auditing of retirement plans.

Website design By BotEap.comHere is good news: how to solve this impending problem

Website design By BotEap.comThe IRS has a voluntary corrective program called a VCP (voluntary compliance program) to correct these deficiencies in plan documents. The IRS position is that retirement plans can be requalified only if the plan sponsor voluntarily submits to an IRS audit by filing newly drafted delinquent returns and/or interim amendments to the IRS in accordance with certain procedures and very detailed documentation in accordance with the Income Procedure 2008-50. Once the IRS reviews and hopefully approves the newly drafted application and required documentation, the plan is deemed to be in full compliance with applicable law and said plan is retroactively eligible for taxes.

Website design By BotEap.comInstead of paying a hefty monetary penalty, filing a VCP results in paying a filing fee to the IRS. Sometimes, if the violation is fairly limited, the filing fee can be as low as $375. (Remember, you will still have to pay for documentation services associated with plan updates and interim amendments. However, these costs would have been incurred in any event to keep your plan in full compliance with the law.) The important point here is that using the VCP program avoids the risk of disqualification from the plan or the imposition of a significant monetary penalty.

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Website design By BotEap.comThis office has submitted numerous applications for the VCP program under the applicable Revenue Procedure 2008-50. This application along with the necessary plan reformulations and interim amendments must be carefully drafted to ensure efficient negotiations and a successful outcome with the IRS.

Website design By BotEap.comThe bottom line:

Website design By BotEap.comPlan sponsors must act promptly and voluntarily to correct plan deficiencies under the more taxpayer-friendly and cost-effective VCP program before the IRS audits their plan. Once the IRS begins an audit, the VCP submission strategy is no longer an option and your plan is subject to disqualification and/or severe monetary penalties.

Website design By BotEap.comLooking ahead, you should establish a program with your plan advisor to ensure your plan complies with laws regarding plan updates, interim amendments, and changing IRS filing requirements and deadlines. This will prevent you from having to deal with all these problems again in the future. In fact, the Revenue Procedure requires a disclosure in the VCP application about what new procedures the plan sponsors will use to avoid this problem in the future.

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