Disqualifed Top Hat plan

[Guest BobParks]

I am having trouble thinking this through so any input would be appreciated.

As I see it:

If a Top Hat plan were found to be disqualified -

the choice would be to continue the arrangement with all of the expense and hassle of a QRP OR

cease operation.

I can not imagine "qualifying" the arrangement so what happens if the employer stops the plan? Please tell me those things I am missing.

Any vested accounts would be taxable to the executive and the employer (assuming reasonable comp) would get a deduction - right?

Executives who were not vested would lose their account balances but no tax - right?

The employer would do some accounting and log the NQDC funds back onto the books as cash and extinguish a liability - right?

Is there any penalty to the employer if IRS/DOL rule the Top Hat plan is not qualified?

Any and all inputs will be much appreciated.

[mbozek]

Please define what you mean by disqualfied.... A top hat plan is a unfunded non qualified plan under the IRC. Benefits are taxed under the rules for constructive receipt. It is exempt from ERISA provided that it is limited to a selct group of mgt or Highly comp. employees. If other employees are covered then the plan must hold assets in trust and and employees will be taxed on vested benefits held in the trust. The employer can terminate a non qulfied plan at any time and either pay out the deferred amt to the employees or freeze the plan and make payments as temployees terminate or die.

[Guest BobParks]

What if a plan for NQDC had been operating for 5 years and had 3 participants, all SVP earning 500,000 annually so they are clearly Top Hat people?

Two years later the CEO told HR to enroll his nephew Fred in the plan. Fred is mail room supervisor and earning $30,000 annually.

Now the IRS was doing a normal audit and the examiner looked at the plan and said it is not an exempt plan because not all of the participants are Top Hat.

Continuing the plan with normal ERISA rules for the 800 other employees is not an option so the employer wants to cancel the plan.

Vested employees will have immediate income and tax but the Golden Handcuffs are gone. Fred was never vested so he has nothing. But what of the sponsor?

For 2 years they had a plan that was not qualified but they didn't gain any tax benefit so do they have a problem? If so what kind and under what Code sections?

[Guest Libby]

Why not just modify the arrangement so it is truly a top hat plan? Kick Fred out of it - give him a bonus.

Also, you've got other problems with trying to terminate the arrangement. The employees have a contractual arrangement to get the nonqualified benefit. Would the company be able to just forfeit nonvested accounts - not if I were the executive - I'd say I've got a contractual right to vesting unless I terminate employment before I'm vested. I'd also argue that you promised me a tax deferred benefit, and to the extent I'm taxed, you ought to pick up the taxes.

Also, terminating the plan doesn't negate the ERISA issues. If the arrangement is not a top hat plan, the covered employees can assert that the benefits can't be forfeited under ERISA vesting rules, and that the plan has to be funded. As to the tax consequences, as noted above the employer might be responsible for them too.

If you have compliant employees, things would be easier - but don't count on it if there's much at stake.

[mbozek]

Bob: Since when is the determinaton of the top hat group fall within the jurisdiction of the IRS? The eligibility for a top hat plan is determined under solely the DOL rules - the IRS cannot make such a determinaton ( Only thing the IRS could do is refer the case to the DOL but the DOL does not issue rulings on top hat eligibility.) Maybe your client should question the agent's authority as a first step. Second can you argue that there is a separate plan for each participant? Have you retained counsel? Can fred be terminated from the plan without any accrued benefit?

One way defend is to come up with every possible defense counsel can think of and try to wear the agent down. If you let the IRS agent define the rules then your client will lose.

Also have you though through the agents theory. If the plan is a not a top hat plan then it is subject to the participation, vesting and trusteeship requirement of Title I of ERISA, not the IRS rules. Dol ( Not IRS) could require that plan assets be held in trust and if the plan is not a qualified plan then all participants would be taxed on their vested interest to the extent the plan is funded-but what if the plan has no assets?-What if the employer asserts that the plan is a top hat plan- What authority is there under the IRC for making a determinaton that it is not since this is a DOL determinaton? IRS agents are required to give a taxpayer who requests it a statement of the authority under the tax law law to enforce a tax. The taxpayer does not have to offer a defense first. I think you have an over eager IRS agent who has crossed the boundary between the IRS and dol regulation on nonqual plans.

[Guest wmacdonald]

If the plan is "disqualified", won't they be subject to the $1,000 a day penalties under ERISA for ever day they are out of compliance?

[Kirk Maldonado]

It's been a while since I looked at this issue, but I seem to recall that the $1,000 per day penalty only applies where there is a failure or refusal to file the Form 5500. In that regard, I believe that you get a 45 day grace period following notice from the DOL to correct any prior deficiencies in any filings that are rejected by the DOL.

This is not to say that the employer wouldn't have some liability. If the plan fails to qualify as a top hat plan, then the plan should have filed Form 5500s for those prior years. The employer could minimize its liability with respect to the failure to file those Form 5500s under the DOL's delinquent filer program, but there would still be some costs.