No Plan Document

[Guest ELS]

Prospect has no plan document for paired MPP and PS plans adopted in 1994. Some contributions were made in the early years to both plans, but no contributions have been made since 1996. Some 5500's were filed, but it is likely that no 5500's have been filed since 1997.

Prospect would like to implement a new 401(k) plan during 2002 and hire our firm as the TPA. They would like to pretend that the old plans never existed, and take their chances that they are never audited.

We are very concerned about potential liability associated with the prior plans, since they are out of compliance and we are aware of this fact. There are a couple of questions we have at this point in the process:

1) Since there are no plan documents, did they ever have a qualified plan subject to ERISA?

2) If the answer to #1 is that they do potentially have a qualified plan, could our firm absolve itself in writing of any responsibility/liability for the prior plans, and simply assist the client on a prospective basis? We use detailed engagement letters for all clients.

3) If the answer to #1 is that they do NOT have a qualified plan, are there any other liability issues we need to consider before assisting the client with a new plan for 2002?

Thank you for any assistance.

[Guest b2kates]

Easy rule, no document, no qualified plan.

There are tax consequences; i.e. improper tax deductions in prior years.

How do they propose to distribute the funds to the "participants"?

[mbozek]

Your client needs to retain tax counsel to review options/issues:

1. Qualfied plans must be state in a writtten document and be adopted by employer. Failure to adopt a written plan means that the employer contributions will considered made to a nonqualified plan and the employees will be taxed when the benefits are vested. However, the statute of limitations for taxing the employees on contributions made to the nonqualfied plan is 3 years after the date the tax return is due (6 years if the understatement of income exceeds 25% of AGI). Thus the IRS cannot assess back income tax against the employees for years prior to 1996 if the benefits were vested in that year and the S/l for 1996 runs out on 4/15/03. ( I am assuming that the employees filed income tax returns). If vesting on the contributions occured at a later date the s/l begins in the year of the vesting.

2. The employer penalty for a disqualfied plan is the loss of all tax deductions taken in the years the plan was disqualfied. But the s/l is no more than 6 years so 1996 contributions are at risk until 4/15/03. If the plan is nonqualfied then the emplyer takes a deduction in the year the employee is taxed on the contribution, i.e. when made available.

3. There is a separate issue of where are the plan assets held. Assets in qualified plan are required to be held in a separate trust not subject to the claims of the employer's creditors. Was susch a trust established by the employer?

4. How will the funds in the employees accounts be reported for tax purposes???

5. Will the plan be terminated and a final 5500 filing be made?

[mbozek]

Your client needs to retain tax counsel to review options/issues:

1. Qualfied plans must be state in a writtten document and be adopted by employer. Failure to adopt a written plan means that the employer contributions will considered made to a nonqualified plan and the employees will be taxed when the benefits are vested. However, the statute of limitations for taxing the employees on contributions made to the nonqualfied plan is 3 years after the date the tax return is due (6 years if the understatement of income exceeds 25% of AGI). Thus the IRS cannot assess back income tax against the employees for years prior to 1996 if the benefits were vested in that year and the S/l for 1996 runs out on 4/15/03. ( I am assuming that the employees filed income tax returns). If vesting on the contributions occurred at a later date the s/l begins in the year of the vesting.

2. The employer penalty for a disqualfied plan is the loss of all tax deductions taken in the years the plan was disqualfied. But the s/l is no more than 6 years so 1996 contributions are at risk until 4/15/03. If the plan is nonqualfied then the employer takes a deduction in the year the employee is taxed on the contribution, i.e. when made available.

3. There is a separate issue of where are the plan assets held. Assets in qualified plan are required to be held in a separate trust not subject to the claims of the employer's creditors. Was susch a trust established by the employer?

4. How will the funds in the employees accounts be reported for tax purposes???

5. Will the plan be terminated and a final 5500 filing be made?