Audit Questions

[WDIK]

A client recently underwent an audit. Two of the major concerns with the IRS agent (who appears to be an "old-timer") were:

1) The plan was adopted/executed in October and had a retroactive effective date of the prior November 1st.

2) Contributions made after the end of the plan year (but before the extended due date of the corporate return) were deducted for that plan year.

The second part should be fairly easy to resolve using Section 404(a)(6). I am having trouble finding an applicable citation for the first issue. I have reread several topics that address the issue of a new business entity set up mid-calendar year and IRS spokespersons opining that a 1/1 effective date is OK, but none of these provide a source. Any help or suggestions would be appreciated immensely.

Needless to say, I am somewhat flabbergasted.

[Belgarath]

You could try 1.401(b)-1(a). There may be a better source than this, but take a look at the last sentence. That's all I can think of. Hard to believe that an IRS auditor would waste your time with this! Maybe you can reverse the field on the auditor - ask for documentation that it ISN'T permissible, and if he gives you ahard time, talk to his supervisor.

[WDIK]

I've considered your suggestion, but would first like to try and provide the information so that the client isn't placed in an adversarial situation.

[Guest DMK]

Is this a 401(k) plan?

[WDIK]

It is a defined benefit pension plan.

[Lynn Campbell]

There is another recent question on the Defined Benefit Board under "New Business and First Plan Year" that may help you. It seems relevant. Good luck!

[mwyatt]

You're kidding me, right? This guy is questioning an adoption of the plan prior to the end of the first plan year, and also questioning IRC 412? Good luck...

Reminds me of the good old days when we had an IRS agent in our office blatantly using our phones to call in bets to his bookie. Be thankful that his questioning points are easily parried.

[Guest rhp]

You might also try Rev. Rul 81-114.

[GBurns]

Rev Ruling 81-114 talks about the Trust corpus. I read the original post as asking whether or not a Plan can be retroactively adopted as being the first issue at question.

What is the effect of retroactive adoption of a Plan on the tax deductibility of the contributions, especially the employee's elections?

[mwyatt]

GBurns, the employee contributions issue (ie 401(k) deferrals) is an apt reference for late year adoption of a plan. In this case, however, we're talking a DB plan adopted during the year so this issue is moot (or should be in the eyes of the auditor). This may be why this particular agent is harping (mistakenly) on this DB audit.

I just went through an audit of a longstanding doctor DB plan. Agent was nice enough, but I felt like I was teaching DB plans 101 to her. She wanted to be able to calculate every accrued benefit and to demonstrate to her my calculations. Not so bad with the rank and file people, although a little maddening having this occur right before 4/15. Finally we came to the doctor, which included IRC 415 calculations back to TEFRA (including a switch in NRA in the 80s, several transitional calcs for TEFRA, IRC 416, and TRA '86). Real fun explaining the details of 83-10 and combined plan IRC 415(e) calcs. She finally gave up and we got a clean bill of health letter after I sent in 12 pages of calculations (which I'm assuming she regretted asking for...).

[MGB]

Only 12 pages??? You must use very small fonts.

[mwyatt]

Even more fun for her, tiny handwriting (I'll be darned if I was going to recopy everything if she didn't have a prayer of understanding it anyway ).

[GBurns]

mwyatt

What am I missing?

The original post has 2 questions and stated that # 2 was easily resolved but #1 was the problem. The query therefore centers, as per the post, on:

"1) The plan was adopted/executed in October and had a retroactive effective date of the prior November 1st.

The second part should be fairly easy to resolve using Section 404(a)(6). I am having trouble finding an applicable citation for the first issue. I have reread several topics that address the issue of a new business entity set up mid-calendar year and IRS spokespersons opining that a 1/1 effective date is OK"

The Plan was therefore not adopted in the same year but in the next year "prior November 1st" versus adopted in October. The prior November to any October is always in the previous calendar year.

We are NOT talking about a " DB plan adopted during the year" so it would not be correct to say "so this issue is moot".

As I see it the problem is an issue of retroactive adoption which would affect the employee'seductions made before the effective date. The problems exist regardless of whether or not this is a DB Plan or any other type of plan.

BTW, there is a very similar thread on the 401(k) Forum.

[mbozek]

GB-" the prior November to any October is always in the previous calendar year" is accurate but irrevalent for the purposes of deductibility since it is the employers tax year, not the calendar year which determines the 12 month period. A plan adopted in Oct would be adopted in a timely manner if the employer's tax year begins on the prior Nov. 1. See IRC 404(a)(6); Rev. Rul 81-114.

[mwyatt]

Hey GBurns:

What I understood from the original post was that the plan was adopted prior to October 31, XXXX with an effective date of November 1, XXXX-1. I took this to mean that the plan year was November 1 to October 31 and that the plan was adopted prior to the end of the initial plan year, which didn't seem to be a problem to me given that this was a DB plan. In a 401(k) plan, you can't do a "retroactive" effective date for deferrals, but that didn't seem to be the point. I didn't see anything in the original post to indicate that the sponsoring entity wasn't in existence as of the effective date, November 1, XXXX-1, nor that the fiscal year of the sponsoring entity differed from 11/1-10/31. Now if that is the case, (ie, let's say the entity itself didn't come into existence until after the effective date), I could see where there would be problems. Maybe we should have some clarification on that point as to plan year, fiscal year, and date of existence of the sponsoring entity. If that is the case, the DB thread currently around would add some guidance to this issue.

[WDIK]

I once heard that experts in communication can only understand each other about 80% of the time. I don't know where that leaves me. It all seemed so clear at the time.

Mwyatt's assessment was correct. PYE=10/31; FYE=10/31; Plan effective date was 11/1 of calendar year preceding October adoption. (i.e. within the same fiscal year.) The entity was in existence prior to the effecitve date.

I read RR 81-114 as relating to 404(a)(6) and the issue of deductibility.

I have been watching other threads, but did not see a particular citation that could be given to the auditor concerning retroactive effective dates within the fiscal year.

I appreciate the attention that this rather odd situation is receiving.

[mbozek]

WDIK: I am not sure what you are trying to prove. If the plan was timely adopted before the end of the employer's tax year (i.e. by 10/31) then the employer can deduct the contributions for that year because the plan is deemed to be in effect for the entire year, regardless of the date of adoption. Rev. Rule 81-114 states that position clearly. It appears that the agent is attempting to prove somehow that the plan was not adopted by the end of the employer's taxable year; therefore the contributions made after the end of the taxable year but before the due date for filing the return cannnot be claimed as a deducton for the tax year in which the plan was adopted.

[WDIK]

Honestly, I'm not sure what else needs to be proven to the agent either. In this instance, I do not have a personal interaction with the agent. I am just trying to help a client. The concern, as relayed to me, was that the plan could not have an effective date of 11/01/1997 if the document was executed on on 10/30/1998.

The appropriate information has been provided to the agent regarding the deductibility issue, and I would not anticipate a problem there. The hope is that the effective date issue will be dropped once the deductibility is resolved.

[mwyatt]

I would stand your ground; possibly bump this up over the agent's head (he isn't your friend anyway, don't worry about hard feelings). Your client is entirely in the right here. MBozek has provided the clear reference that there isn't any problem here whatsoever.

I'll add this following link on an issue where the IRS reviewer was in the wrong - don't be scared to stand your ground:

Interest Rates

[WDIK]

Not that anyone will care, but I wanted to pass along the outcome of this audit as it pertained to the original two points posted.

The original auditor brought along a second auditor from "the pension side" and the two issues quickly went away.