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The IRS' plan to stop issuing some determination letters, necessary proof for companies that their retirement plans are tax qualified, puts plan executives into the hot seat.
No formal announcement has been made, but in speeches made to several groups of tax and benefit experts this year, IRS officials said they are planning to stop the current system at the end of next year.
Under the plan, the cash-strapped agency — at its lowest level of funding since 2008 — would only provide such letters when plans are started or terminated.
Retirement plan executives no longer would be able to receive private-letter rulings showing that changes made to their plans don't affect their tax-qualified status. Only during an IRS audit would plan sponsors find out whether their plans are still compliant.
That has plan sponsors feeling vulnerable to IRS audits, in cases where a determination letter no longer applies to a modified plan, or its current five-year review period expires. The five-year cycle for issuing letters requested by ongoing plans began in 2007 as an earlier attempt to deal with backlogs. But IRS officials recently decided they still couldn't keep up with the demand.
Ending the program is “a really big change,” said Victoria Judson, IRS associate chief counsel for tax-exempt and government entities. Ms. Judson, speaking June 3 during an American Law Institute Continuing Legal Education webinar, said that with new laws like the Multiemployer Pension Reform Act of 2014 adding to its workload, the agency doesn't have the trained personnel to administer the determination letter program.
The program will end Dec. 31, 2016, Sunita Lough, IRS commissioner with the tax exempt and government entities division, told the American Bar Association's joint committee on employee benefits in May.
No formal process
The planned changes are not going through a formal rulemaking process, but concerns already raised have prompted IRS officials to seek public feedback later this summer on the best way to handle the transition.
An IRS determination letter “is a primary means of demonstrating that a plan is qualified,” said Lisa Herrnson, managing director at PricewaterhouseCoopers L.L.P.'s compensation and employee benefit plans practice in New York. Losing that qualification could negatively affect the deductibility of employer contributions, the tax-free status of investment gains and the tax-deferred nature of employee contributions.
While smaller employers might be able to take advantage of boilerplate plan designs that don't require IRS determinations, larger, individually designed plans are going to have to rely more on lawyers and consultants to make sure their plans remain qualified in the eyes of the IRS.
“It becomes even more imperative that you have a process in place” to ensure that a plan is current with tax law, said employee benefits attorney Edward Bernard, a partner with law firm Hanson Bridgett L.L.P. in San Francisco. “It's incumbent on the plan sponsor.” Once the determination letter program ends, IRS disapproval will be “in the context of an audit, so the pain will be immediate,” he said.
Plan sponsors make changes to their existing plans for many reasons. One of the biggest triggers is whenever Congress passes new tax laws or pension laws, like the Moving Ahead for Progress in the 21st Century Act in 2012, which changed the discount rates used to calculate annual contributions. Also, a change in service providers could trigger the need for new plan documents.
Determination letters are relied on for many situations, including:
• Corporate transactions, such as mergers or acquisitions, in which the acquiring company is likely to want assurance that the retirement plan for which it is assuming responsibility has the proper tax status.
• Companies going through bankruptcy proceedings, which rely on IRS determination letters to protect retirement plan assets from creditors.
• Investment managers requiring executives to prove their plans are tax-compliant, to protect the managers' exemptions that allow them to handle retirement assets.
“There will have to be more due diligence in the M&A area,” said Jan Jacobson, senior counsel for retirement policy at the American Benefits Council, Washington, which represents large sponsors and other organizations. She said that is one of the biggest concerns she is hearing from members.
If a determination letter expires or no longer fits the existing plan, participants could wind up having to pay taxes on the value of their benefits or the investment income earned, or have trouble rolling over their accounts to other plans.
“You don't need a determination letter until you need it, and then it's very important,” said Michael Hadley, a Washington-based partner at law firm Davis & Harman L.L.P. “For large plans with individually designed documents, it's pretty much considered to be a necessity. The world of benefits lawyers is going to have come up with another solution.”
One possible solution is for the IRS to develop model wording or checklists for sponsors of retirement plans. But if a sponsor wants to make more customized changes, such as a new vesting schedule or grandfathered vesting formulas for employees acquired in a merger, “you may or may not have appropriate model language,” particularly for defined benefit plans, said Ms. Herrnson.
Over the past decade, IRS officials have tried to address the backlog of determination requests by issuing more pre-approved prototypes, and creating a “volume submitter” process that lets service providers offer to plan sponsors pre-approved documents.
“The IRS has made the (pre-approved) program more attractive over the years, with lower user fees,” said Craig Hoffman, general counsel for the American Retirement Association in Arlington, Virginia. He estimates as many as two-thirds of retirement plans use some type of pre-approved document, with roughly 90% of determination letter applications coming from larger, individually designed plans. The ARA has recommended the IRS add cash balance plans to the master prototype program; that program would not change when the determination letter program ends.
As more plan sponsors become aware of the potential impact of the IRS doing away with rulings for ongoing plans, many practitioners say that Congress could also step in to make sure large plan sponsors are not left scrambling for legal protections that they have long enjoyed.
Hazel Bradford writes for Pensions & Investments, a sister publication of Business Insurance.
The U.S. Treasury Department and Internal Revenue Service on Thursday issued new guidance designed to make it easier for employers to manage automatic enrollment and contribution increases in 401(k) and other types of retirement savings plans.