Jump to content
Sign in to follow this  
Guest Thornton

Lost Documents

Recommended Posts

Guest Thornton

We are in a situation that may be unique, at least it is to us. A doctor who practiced until his recent death (age 87 or so) administrered his money purchase pension plan himself. There is approximately $1,200,00 in plan assets at a brokerage firm. He also filed the 5500's himself, but that's another story. It also appears that the plan has been frozen since at least 1994 sice the 5500's indicate that no contributions were made. The last 5500 filed was an EZ. No plan documents can be found.

We've been retained to correct the plan document problem. We're reasonably sure that the plan was never restated for GUST and EGTRRA. There is a good chance it wasn't updated for TRA'86 either, but we cannot tell without documents. Up until 1980 or so the plan was administered by a bank, so we're fairly certain that a document did exist at one time, but the bank no longer has a copy.

We've corrected for nonfiling under VCP, but never without any documents at all. Has anyone been in this situation? I've considered doing GUST and TRA 86 documents and filing under VCP. However, with no prior documents to begin with, I'm not sure this is the way to go. I've considered filing through VCP as a John Doe submission to get a feel for how the IRS would treat the plan. However, the family wants it resolved and time is important. Any ideas? Thank you.

Share this post


Link to post
Share on other sites

Why do you want to restore the plan to qualfied status? If the plan was disqualified 10 or so years go the s/l for taxation of the employer has has expired and very little of the plan assets would be subject to taxation of the estate or the Dr. If most/all of the assets are now after tax income why restore the funds to pre tax amounts? If I was beneficiary of the plan or the Drs estate I would have reservations about expending funds of the estate to convert after tax money into pre tax distributions subject to taxation at a rate of up to 35%, especially where there is no documentary evidence that the plan was qualified for the last 25 years.

Share this post


Link to post
Share on other sites
Guest Thornton

Thanks for your response. To the best of the estate attorney's knowledge, the plan was never disqualified. The sole participant/sponsor/trustee continued to file 5500's until he became ill a couple of years ago. There is no evidence that any of the funds have ever been taxed. Our information is at best sketchy, as no douments can be found. Are you saying that the estate executor could just assume that the assets are personal, not qualified?

Share this post


Link to post
Share on other sites

If there is no plan document how can the attorney be sure that the plan was qualified since a qualfied plan must be in writing. (I would not rely on a T & E attorney's opinion that the plan was qualified unless he gives it in writing). you cant have a qualfied plan if there is no written document adopted by the employer. A qualified plan must have current favorable determination letter. Also a disqualfied plan is required to file 5500s.

If the plan is disqualified the funds are taxed to the participant in the year of disqualification to the extent there is a vested benfit by operation of law. No 1099 form is issued. The trust becomes a non qualified trust and each year's income is subject to taxation to either the trust or the participant. The s/l for collecting taxes begins on the due date for filing the tax return for the year the plan is disqualified (provided a tax return is filed) and expires 6 years later.

This info might be over the lawyer's head and you should suggest that he consult with tax counsel to determine whether the funds have escaped taxation because of the disqualfication of the plan in a closed tax year. If the funds are not taxable it would be a mistake to requalify the plan and subject them to taxes.

Share this post


Link to post
Share on other sites
Guest Pensions in Paradise

mbozek - could you please explain to my simple mind exactly how this 1.2 million dollars suddenly became after-tax money. I'm sure a lot of my clients would like to know how to magically make their taxable benefits non-taxable.

I can't find anywhere in the original post where they indicated that the plan had been disqualified and the benefits treated as a taxable distribution to the participant.

I know you like to harp about the s/l, but if a proper return is never filed, then there is no s/l.

Share this post


Link to post
Share on other sites

I thought that a qualified the plan needed to be amended to conform changes in the IRC and the facts posted indicated that the plan has not been qualified for GUST, EGTRRA or even TRA 86 which required amendments around 1994. If there is no record of a determination letter beng issued I dont know how you could ever reconstruct plan documents, assuming that you would want to restore the qualified status of the plan.

A qualified plan is a tax exempt trust under IRC 501(a). If qualifed status is lost the plan becomes a taxable trust under IRC 402(b)(1) and the employee will be taxed under the rules of IRC 83 (vested amounts will be included in his gross income in that year). The taxation occurs under the rules for constructive receipt whether or not the participant is aware of the fact the plan is disqualified and the IRS has disqualified plans retoactively to prior years.

The return that I mentioned is the tax return of the participant. If the Dr filed an income tax return for the year the plan was disqualified then the s/l for including the benefits in his income expired 6 years later.

Share this post


Link to post
Share on other sites
Guest Pensions in Paradise

Interesting. So you're saying that if a person should have included 1.2 million on their tax return for 1994, but they failed to include such amount on their return, they are now free and clear because the s/l has expired.

Share this post


Link to post
Share on other sites

yep as long as he filed his return for 94. Thats why the plan admin needs the advice of tax counsel. It could save 300k in fed taxes.

Share this post


Link to post
Share on other sites
Guest Thornton

For this amount of money, couldn't the IRS argue that his failure to claim the income was fraud? Or, if not, how can it be determined when the plan was disqualified? Would an agent contend that it was not terminated until 2002? Just thoughts. I really enjoy these discussions!

Share this post


Link to post
Share on other sites

No- not if he was not aware that he was subject to taxation. Fraud requires intent to deceive which will be difficult to prove in the case of a dead taxpayer. It would be hard to claim the plan was not terminated until 2002 if there are no documents after the 80s. Your questions are the reason why the estate needs to retain qualified tax counsel in order to make an informed decision. There are cases where the cts have refused to allow the IRS to recover taxes after the failure to report income was discovered on audit.

Share this post


Link to post
Share on other sites
Guest Thornton

Thanks. Your comments have totally changed my direction. While I beleive that I can work with the IRS to get the plan qualified under VCP, I have thrown it back in the lap of the estate attorney to determine if that is the best course.

Share this post


Link to post
Share on other sites

Treating the distributions as being made from an nonqualfied plan will not be a walk in the park. First there needs to be a determination of the year in which the plan lost its qualified status which will be difficult if plan documents cannot be located. Second the decedent's estate needs to provide a copy of the tax return for that year to confirm that the s/l began.

Share this post


Link to post
Share on other sites

This has been a very interesting post. Following the logic, we could say the plan was never qualified because we have no evidence it was. There have been no contributions in recent years so now it's just an investment account. What about capital gains, etc... do you have information with regard to the investments in the plan, dates, cost, shares, etc... If I sell stock for which I have not records, don't I have to treat the whole thing as a capital gain?? Just wondering out loud.

Share this post


Link to post
Share on other sites

1) I am not sure that you can just simply treat a plan that you have always treated as "qualifed" as diqualified without actual IRS action.

2) Even if it can be considered disqualified, the assets are now presumably sitting in a non-qualified trust. Depending on whether the schedule P has been filed withthe 5500, you would be looking at investment returns being taxed at trust rates for 3 to 6 years.

3) Even if it can be considered disqualified, this might be a case where the IRS imposes a "duty of consistency" especially if we are dealing with a one participant plan. In other words, the IRS would argue that it relied on the taxpayer's return stating that there was not a taxable event for the $1.2 million and is now taking the opposite position.

Share this post


Link to post
Share on other sites

1. While the IRS has the discretion to allow correction of a plan that has lost its qualfied status, the premise is that plan defects would be corrected by the plan sponsor. I dont think the IRS could refuse to disqualfy a plan which was not amended to comply with current law since 402(b)(2) mandates taxation under IRC 83 in the year the plan loses its qualfied status. The IRS has retroactively disqualified plans for failure to adopt amendments to changes in the tax law and imposed taxes on distributions received 3 years prior to IRS notification of the employer that the plan's qualiafied status was revoked despite the protests of the taxpayers who received a lump sum distribution. Weddel v. CIR, 71 TCM 1950.

2. Since this is a DC plan with a vested interest in the participant, the future income will be taxed to the participant because the trust assets are not subject to the claims of the employer's or plan's creditors. See Reg. 1.83-3(e).

3. Duty of consistency has only been applied where the same taxpayer who took advantage of a tax benefit repudiates the benefit after the s/l for collecting taxes has expired. Here there is a separate taxpayer (either the estate or the beneficary) of the Dr who is repudiating the tax benefit claimed by the Dr. Also the tax deductions claimed by the Dr. may have been allowed when they were made because the plan was qualified at that time.

Share this post


Link to post
Share on other sites

1. The point is that you cannot "self-disqualify" a plan. It would appear that without IRS action on retroactive disqualification, you would not have a basis to claim the account balance tax free. Sooooo the first step in this process would be to go to the IRS and tell them that they have no choice but to disqualify the Plan so that you can get $1.2 million tax free. That should be an interesting meeting.

2. Good point. Since this is not designed as an employee grantor secular trust both the trust and the participant would be taxed on earnings.

3. I admit I haven't gone back and looked at the duty of consistency cases. However, I doubt that distinctions between a taxpayer and a taxpayer's estate would mean all that much to the IRS in such a situation.

I haven't looked for all of the potential problems in this approach, but I would think that a "lose your documents and get your money tax free" argument is jsut not going to win the day. Increasingly, the IRS is going to have no record on which plans are actually qualified in form. People with standarized prototypes rarely went in for determination letters and now the same applies for non-standardized and volume submitter. I can't imagine that just losing your documents is going to make you a non-amender for purposes of being able to take tax-free distributions after 3 or 6 years. Maybe I am wrong, but if Thornton's client takes this appoach, I would appreciate him posting the results.

That said, I have used arguments similar to this in negotiating a penalty under the old walk-in-cap program where the penatly/user fee was not set and was geared to the tax effects of disqualificaiton. However, now with standarized VCP fees, I am not sure where this gets you if you use EPCRS.

Share this post


Link to post
Share on other sites

Disqualification occurs by operation of the tax law - If a plan does not meet the requirements of the IRC and regs it is disqualified subject to correction in a future year. There is nothing in IRC 402(b) that allows disqualfication only if the IRS determines that the plan is not qualified.

Maintaining qualfied status requires that the plan contain all required provisions. If the plan is not amended to add required provisions the IRS cant make an exception from disqualfication. In addition to the document requirements, the plan may have been disqualified 17 years ago for the failure to pay MRDs.

What the IRS thinks is not as important as the applicable law. The duty of consistency cannot extend to anyone other than the taxpayer who benefited from the mistake because employees would never have any protection from back taxes due to employer mistakes in reporting income on w-2 and 1099s.

It would be inconsitent for the IRS to say that a plan without documents must be qualified when the IRS has disqualified plans for the failure to produce signed documents.

This problem will become more prevalent because plans sponsored by individuals who stopped adopting amendments after ERISA are being terminated because of the retirement or death of the sponsors.

Share this post


Link to post
Share on other sites

The S/L on the trust income won't have run because the trust hasn't filed any tax returns? You'd have all sorts of penalties for not filing or paying taxes over a long period of time if you take the position that the plan is disqualified.

Isn't the S/L on the individual's tax return extended if there is a significant understatement of income?

Is the running of the S/L on income suspended in the case of fraud? Will the estate be comfortable closing the estate if this much is at stake?

I believe that BNA has an entire portfolio on disqualified plans.

I agree with the comments that say that this is a good project for a tax/benefits lawyer and that it is risky.

Share this post


Link to post
Share on other sites

The penalty may not apply because this a non qualified plan with a separate account which is 100% vested in the participant which will result in the trust income being taxed to the participant each yr under IRC 83. There may be open yrs for the decedent's tax return to report the income.

The S/l for understatement is 6 yrs. See prior comments on applicication of fraud to a decedent.

Since there is a risk the client needs competent tax advice but there is a significant amount to be gained if the plan assets are not subject to income taxation.

Share this post


Link to post
Share on other sites

I thought that there was a series of PLRs in 1992 that stated that an employer grantor secular trust will be subject to taxation at both the trust level and the participant level (for vested participants). I think that you run a significant risk of double taxation on earnings. The fact that the participant is taxed does not establish that the trust escapes tax-free.

Share this post


Link to post
Share on other sites

KJohnson - Sal Tripodi, on page 7.496, discusses taxation of disqualified trusts, and states that the Grantor Trust rules generally don't apply. Don't know if he's right, or if you agree, just thought I'd pass along FWIW.

Share this post


Link to post
Share on other sites

Belgarath--got it thanks. Sal also indicates that the realized income to the trust will be taxed and that 1041's must be filed to report trust income (which I belive was Locusts point).

I think I confused myself-- and others-- with my terminology. The issue with regard to secular trusts that was the subject of a series of PLRs's in 1992 was employers attemepting to argue that the secular trusts were employer-grantor trusts and therefore the trust was not subject to tax under Subchapter J (641 and 1(e) of the Code.) The IRS did not buy off on this and determined that they were not employer grantor trusts and therefore you had double taxation of realized income (at the trust and vested participant level). The PLR cited by Mbozek is indeed dense reading, but I think the conclusion is the same. Realzied income is taxed at the trust level (while unrealized income is not). I know that the BNA porfolio also indicates that Subchapter J taxation rules will apply to a disqualifed trust.

So, I guess I agree with Sal the notion that grantor trust rules do not apply to disqualifed trusts and this then supports the double taxation notion.

Share this post


Link to post
Share on other sites

As to the duty of consistency...

"However, the duty of consistency is usually understood to encompass both the taxpayer and parties with sufficiently identical economic interests"

LeFever v. C.I.R., 100 F.3d 778, 788 (10th Cir. 1996)

Also I haven't read it, but a discussion of this case.

Estate of Mildred Letts v. Commissioner, 109 T.C. 15 (1997), Doc 97-32197

can be found here:

http://www.taxanalysts.com/www/tadiscus.ns...FB?OpenDocument

And the summary is

Prior cases have applied this concept to bind beneficiaries to representations made by estates. It has also been extended to husbands and wives. It would not be a great reach to extend it to estates of husbands and wives. In fact, the Tax Court in Letts held the estates of the husband and wife were a "single economic unit," and that would be an adequate basis for privity.

Finally see TAM 20040701 whcich can be found here:

http://www.irs.gov/pub/irs-wd/0407018.pdf

Share this post


Link to post
Share on other sites

KJ: While the cases are interesting, you are overlooking the purpose of the review which is whether tax counsel can render an favorable opinion within the confines of Circular 230 that the benefits would not be subject to income taxation because of the prior disqualfication of the plan. The opinion would protect the taxpayer from any penalites for substantial understatement of taxes in the event of an audit leaving the taxpayer no worse then if he paid the taxes (along with interest) in the year of receipt. Alternatively the taxpayer could decide to pay the taxes after receiving the opinion to avoid the risk of an adverse IRS audit.

Share this post


Link to post
Share on other sites

Create an account or sign in to comment

You need to be a member in order to leave a comment

Create an account

Sign up for a new account in our community. It's easy!

Register a new account

Sign in

Already have an account? Sign in here.

Sign In Now
Sign in to follow this  

×
×
  • Create New...