Guest Article

(From the April 4, 2011 issue of Deloitte's Washington Bulletin, a periodic update of legal and regulatory developments relating to Employee Benefits.)

Funding Deficiencies Reported on Form 5500 Will Trigger IRS Compliance Check

A recent IRS release explains that if a funding deficiency is reported on Form 5500 the Employee Plan Compliance Unit (EPCU) will initiate a compliance check if it appears that a deficiency indeed exists. The purpose of this initiative - the "Funding Deficiencies Project" - is to determine whether the plan sponsor corrected the deficiency, filed the required excise tax returns and paid the appropriate excise taxes.

The Funding Deficiencies Project involves those plans - defined benefit and defined contribution - that are subject to the minimum funding requirements of Code § 412 and which report funding deficiencies on Form 5500 (e.g., Schedule R, Schedule MB, Schedule SB). Code § 4971(a) subjects a plan with a funding deficiency to an initial, non-waivable excise tax of 10 percent (or, in the case of a multiemployer plan, 5 percent) of the unmet funding requirement. In addition, Code § 4971(b) imposes an excise tax equal to 100 percent of the funding deficiency if it is not corrected within the taxable period (i.e., not corrected before a notice of deficiency is mailed, or tax assessed, with regard to the initial excise tax). Form 5330 is used to report these excise taxes and is due 7 months after the close of the employer's tax year, or 8½ months after the close of the plan year that ends with or within the sponsor's tax year, whichever is later.

If a plan sponsor obtains a funding waiver, additional time is granted to make the required contributions and to avoid imposition of the excise taxes. However, requests for funding waivers must be filed within 2½ months after the close of the plan year and the sponsor must meet certain requirements in order to qualify (i.e., business hardship).

According to a recent IRS release, the EPCU found two main reasons for funding deficiencies: sharply increased funding requirements due to investment losses, and reduced plan sponsor income. The EPCU compliance check is initiated usually by a letter to the plan sponsor that requests a response to certain specific questions (e.g., why the Form 5330 was not filed, whether the funding deficiency was corrected, etc.) within twenty days. A sponsor who fails to timely respond could later be audited, the release states.

A compliance check is different from an audit or IRS investigation, according to an IRS summary. It does not preclude a sponsor's use of IRS correction programs to correct certain problems (e.g., under the Voluntary Correction Program under the Employee Plans Compliance Resolution Program). Also, although a compliance check involves verifying information on a return or filing, it does not involve an inspection of books and records.

The information in this Washington Bulletin is general in nature only and not intended to provide advice or guidance for specific situations. If you have any questions or need additional information about articles appearing in this or previous versions of Washington Bulletin, please contact: Robert Davis 202.879.3094, Elizabeth Drigotas 202.879.4985, Mary Jones 202.378.5067, Stephen LaGarde 202.879-5608, Erinn Madden 202.220.2692, Bart Massey 202.220.2104, Tom Pevarnik 202.879.5314, Sandra Rolitsky 202.220.2025, Deborah Walker 202.879.4955. Copyright 2011, Deloitte.