Physicians News Health news for doctors and patients.
By Gary J. Gunnett, Esq.
Qualified pension, profit sharing and 401(k) plans are excellent vehicles by which physicians can accumulate retirement savings and provide retirement benefits for their employees on a tax-favored basis. Unfortunately, the rules which apply to these plans are almost constantly being changed by Congress. Therefore, qualified plans can also be a trap for the unwary; employers who fail to amend their plans for required changes in a timely manner may have to pay sanctions to the IRS in order to avoid disqualification.
While it may seem like just yesterday that your practice last adopted a required plan amendment, no amendments have been required as a result of new legislation since 1994. Since that time, Congress has passed a number of new laws affecting retirement plans, including the Small Business Job Protection Act of 1996 and the Taxpayer Relief Act of 1997. The deadline for adopting amendments for compliance with these laws is the end of the plan year beginning in the year 2000. For example, the deadline for an employer with a plan year coinciding with the calendar year is December 31, 2000, whereas the deadline for an employer with a June 30 plan year is June 30, 2001.
As a practical matter, most of the required changes are technical rather than substantive. Therefore, they most likely do not affect the operation of your plan to any substantial degree. An exception is the provision for the 401(k) “safe harbors” which are first available in 1999. Under the safe harbors, the nondiscrimination test which applies to elective contributions to a regular 401(k) plan (the “Actual Deferral Percentage” or “ADP” Test) is deemed to be passed, provided that one of two safe harbor contribution requirements is met. The safe harbor contributions are:
• A fully-vested “nonelective” contribution of three percent of compensation, or
• A fully-vested dollar for dollar matching contribution up to three percent of compensation, plus a fully-vested matching contribution of 50 cents per dollar on 401(k) contributions from three percent to five percent of compensation.
In order to take advantage of either of the safe harbors an employer must provide a formal notice to employees. While the notice must normally be provided at least 30 days prior to the beginning of a plan year, a special transition rule allowed an employer to provide the notice for the 1999 calendar year as late as March 1, 1999. An employer who missed this deadline for 1999 can implement a 401(k) safe harbor for 2000 or any later year.
Most professionals who are responsible for clients’ plan documents (attorneys, third-party administrators, brokers, banks, etc.) automatically notify their clients when plan amendments are required in order to maintain qualified status.
However, deadlines are often missed when an employer has severed its relationship with the party who originally drafted the employer’s plan. Without notification from a responsible professional, most employers have no way of knowing when changes are required.
Other employers miss amendment deadlines simply because they neglect to properly execute documents provided by their advisors. Technically, from the IRS point of view, an employer with an unsigned plan document is no better off than an employer with no plan document.
The execution of a plan document containing all of the required tax law provisions is more critical today than it was ten years ago. Prior to the beginning of this decade, the IRS had no options with respect to defects in qualified plans other than plan disqualification (i.e., revocation of the tax benefits enjoyed by employers and employees with plans meeting the qualification requirements). However, since disqualification is such a harsh result (and as a matter of policy, our government does not want to discourage employers from maintaining private retirement plans), disqualification was pursued only in the most egregious circumstances. Typically, when an IRS examiner found a plan document which was out of date, sanctions were usually no more than a slap on the wrist.
Today, the IRS arsenal includes its Closing Agreement Program (CAP). A Closing Agreement is an agreement pursuant to which the IRS agrees not to disqualify a plan, in spite of some defect in the plan (e.g., the lack of a plan document meeting all current tax law requirements), in exchange for the employer’s payment of a monetary sanction. The amount of the sanction generally depends on whether a delinquent employer is discovered on audit or discloses its failure to amend voluntarily (under “Walk-in CAP”). Since Audit CAP sanctions are a negotiated percentage of the taxes that would be paid if the plan were to be disqualified, they can be substantial. Walk-in CAP sanctions are generally determined under a schedule based on the size of the plan, measured by the number of plan participants ($2000 for a plan with 10 or fewer participants, $4000 for a plan with 11 to 50 participants, etc.).
Terminating plans involves special considerations. The requirements of the Small Business Job Protection Act of 1996 are generally effective for plan years beginning in 1997. (Although plan amendments are not required until the 2000 year, employers must operate their plans in compliance with the new rules beginning as of the earlier effective date.) If an employer terminates its plan in 1999, but does not amend for changes effective in 1997, the plan will not be qualified on a termination basis. This presents a practical problem, since most “prototype” plan documents (standard documents typically provided by banks, insurance companies and other institutions) have not yet been updated for the required changes. The only solutions available to a prototype adopter desiring to terminate its plan are to postpone the plan termination until the document provider has updated documents, or to adopt a customized amendment provided by a third party such as an attorney. In most cases, the second option is more attractive, since customized amendments can be provided at a relatively low cost.
To maintain compliance and avoid CAP sanctions, all employers should contact the parties responsible for their plans or retain new advisors as necessary to make sure that amendments are properly adopted. While the cost for document updates mandated by Congress is no doubt frustrating to small businesses such as physician practices, the cost of current compliance can be much less than the penalties paid to the IRS after a deadline is missed.
Gary J. Gunnett, Esq., is a shareholder in the Pittsburgh law firm of Houston Harbaugh, P.C.
