From the November 2000 issue of Entrepreneur

It's a well-known fact: If you want to receive tax benefits from the IRS, you must comply with a host of requirements. This is especially true when dealing with qualified retirement plans. To be considered tax-qualified and enjoy the tax benefits that go with that, retirement plans must adhere to a laundry list of regulations.

Therein lies the problem. Many retirement plans, especially those offered by small and midsized businesses, don't meet all the plan requirements. The IRS found, for example, that about half the qualified plans examined in 1997 were not in compliance, says Pat Navin, a principal in charge of the employee benefit specialty tax group for Deloitte & Touche.

If you know your plan has defects or you suspect it may have problems, beware. You are not only running the risk of being hit with a huge tax bill, but the IRS could disqualify the plan altogether. When the IRS disqualifies a plan, it no longer enjoys tax-favored status. For business owners, that means you lose the deduction you received for contributions made on behalf of your employees. Also, the tax-deferred earnings in the plan become taxable.

Take the case of a podiatrist in Long Island, New York, who was glad he could finally set up a profit-sharing retirement plan for himself and his employees. However, his satisfaction quickly turned to disgust when the IRS decided to audit the plan.

The plan's administrator was a large and reputable brokerage firm, but it didn't alert the podiatrist of changes, resulting in the plan not being amended to reflect changes in the law regarding eligibility and vesting rules. As a result, the IRS expected the podiatrist to pay taxes owed on the plan's earnings, says Seymour Goldberg, a CPA and senior partner in the law firm Goldberg & Goldberg PC in Garden City, New York, and author of Goldberg Reports, an online pension distribution plan information service. After lengthy negotiations with the IRS, in which Goldberg represented the individual, the podiatrist paid $12,000 instead of the $21,000 originally assessed.


Joan Szabo is a writer in Great Falls, Virginia, who has reported on tax issues for more than 13 years.

Widespread Trouble

This case is typical of what entrepreneurs face regarding qualified retirement plans, says Goldberg. The complexity and ever-changing nature of federal plan rules contribute to the problem.

Take the example of the Small Business Job Protection Act of 1996, which brought about a number of changes in retirement plans. One change involved modifying the nondiscrimination rules for 401(k) plans, says Dennis Coleman, a principal with Pricewaterhouse-Coopers. As you know, nondiscrimination rules provide guidance for determining which employees are highly compensated for retirement plan purposes. Therefore, retirement plans were required to reflect this change.

Although this act makes administering retirement plans easier, "employers still have to amend their plans to comply with these and other technical rules," Coleman explains. Too often, entrepreneurs aren't aware of the need to make changes or they incorrectly believe the plan's administrator is making the changes for them, says Goldberg.

In addition to the complexity and changing rules, many employers, like the podiatrist mentioned earlier, use "prototype plans" offered by banks and brokerage houses to set up their retirement plans, and that can get them into trouble as well. Often, those institutions overlook mistakes employers make on the prototype plans, and they may even add mistakes of their own. Banks and investment houses maintain that they are not responsible for plan defects, declaring that the plan's terms are the responsibility of the business that establishes it.

As you review your retirement plan, keep in mind that the IRS randomly audits plans. In addition, the IRS has taken steps to make it easier to uncover retirement plans that may not be in compliance. Under a recently issued revenue procedure, the IRS now requires that banks, brokerage firms and mutual funds maintain and provide to the IRS, when requested, lists of employers that have adopted their prototype plans. The institutions must also alert companies of any steps they must take to remain in compliance.

As a result of this change, the IRS can now not only go to banks, brokers and mutual funds and request those lists, but also ask which employers have been notified about noncompliance issues, explains Goldberg, who declares that "It's a new ballgame."

How To Cope

Here are some important tips on keeping your plan out of IRS trouble:

Select your plan administrator carefully. For small and midsized companies, the administrator is likely to be a bank, a brokerage firm or a local third party that specializes in administering plans. Your aim, Navin says, is to find an administrator who has an outstanding reputation in the community. Be sure to check with your accountant or attorney for a referral. In addition, he recommends that you focus on the individual who will be administering your plan and not the institution.

Once you have found the right administrator, he or she will make sure your plan is kept up to date, all the required consent forms are filed, plan eligibility rules are correctly followed, benefits aren't paid too early or too late, and the amount of employee benefits are properly calculated.

Perform a self-audit. With the help of a retirement plan specialist, make an effort at the end of each year to determine whether you have administered the plan correctly, says Coleman.

Don't ignore trouble if you find it. Things are probably a lot easier to fix than you might think. If you find a problem, you can make use of the IRS' Employee Plans Compliance Resolution System (EPCRS). It is designed to make it easier and less costly than before for business owners to fix plan errors.

EPCRS has four programs at your disposal: the Audit Closing Agreement Program (Audit CAP), the Walk-in CAP, the Administrative Policy Regarding Self-Correction (APRSC) and the Voluntary Compliance Resolution program (VCR). Which of the four programs you use depends on the type of problem your plan has and whether the IRS is actually auditing the plan. Be sure to seek the advice of an expe-rienced pension plan expert to learn which compliance resolution program is right for you. This is complex stuff, and some very lucrative tax benefits are at stake. Says Goldberg, "Don't try to go it alone."


Plan No-Nos

A number of qualified retirement plans contain some violations that will cause them to fail IRS plan qualification tests. Here are some of the most common ones:

Failure to keep the plan up to date to reflect changes in the law

Neglecting to get a spouse's notarized consent for an employee's plan distribution

Incorrectly following plan eligibility rules

Making improper loans from the plan and not fully documenting loans


Contact Sources