Treatment of Excess 402(g) Elective Deferrals in IRS Audits

[Guest Harvey Carruth]

The basic issue in this topic is the impact of excess 402(g) elective deferrals on amounts that must be included in gross income for participants in 403(B) plans. The "IRS Guidelines for Examination of 403(B) Plans" applies a strict interpretation of IRC Section 403(B)(1)(E) and concludes that if excess elective deferrals are made by an employer to a 403(B) contract on behalf of an employee, then the 403(B) contract "loses its 403(B) status" and the entire contribution must be included in gross income. On the other hand, "IRS Publication 571" indicates over and over again that only "the excess deferral" must be included in gross income.

I do not believe that the severe technical interpretation of IRC Section 403(B)(1) adopted by the IRS in the Examination Guidelines was the intent of Congress when it enacted the Tax Reform Act of 1986. The end result when the Examination Guidelines are applied is that participants in 403(B) plans are much more severely penalized for exceeding the elective deferral limit than are participants in qualified defined contribution plans (e.g., 401(k) plans). This seems patently unfair. Has anyone sufficiently researched the legislative history of TRA 86 to determine the intent of Congress on this issue?

IRS Guidelines for Examination of 403(B) Plans may be found at the following URL, which requires that you enter certain standard information about yourself (see Section V.A.1(4), especially Section V.A.1(4)(B)2):

http://www.ntsaa.org/compliance.html

IRS Publication 571 for 1999 may be found at the following URL:

http://www.irs.ustreas.gov/prod/forms_pubs/pubs/p571toc.htm

Although the Introduction in Publication 571 clearly states:

"The publication is for employees who participate in TSA plans. It is not for custodians or plan administrators because it does not cover many of the operating requirements of these plans."

It would seem that employers sponsoring 403(B) plans could confidently refer its employees to Pub. 571 as a definitive information source for the rules that apply to 403(B) plans, at the very least for 403(B) plans that allow only elective deferrals. Yet, the fifth paragraph in the Introduction section of Publication 571 states the following (emphasis added with **):

"There is an annual limit on elective deferrals. Generally, you cannot defer more than $10,000 for 1999 for all plans covering you, including TSA plans. If elective deferral contributions on your behalf are more than the allowable amount, you must include **the excess** in your gross income."

The technical interpretation of IRC Section 403(B)(1)(E) as it appears in the Examination Guidelines is in direct conflict with the Publication 571 statement above, and with all additional statements related to this issue, the "Comprehensive Example" at the end of the Exclusion Allowance section, and Worksheet 2. Based on the Examination Guidelines, all of these statements and worksheets should replace "you must include **the excess** in your gross income" with "you must include **the entire 403(B) contribution for the year** in your gross income."

In addition to opinions about the legislative intent behind IRC Section 403(B)(1)(E), I would be interested in whether the IRS has been challenged with respect to its strict interpretation of this Code section in audits of 403(B) plans.

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NCompliance Software and Carruth Compliance Consulting

[Ellie Lowder]

Harvey, I did, indeed, make an effort to challenge with the Employee Plans Division. You might add your voice to mine - sometime we are successful in challenging - sometimes not, as you know. Call me if you'd like to before making the contact! Not only is this a surprising change in the former IRS position on excess deferrals, it flies in the face of Publication 571, as you point out. If other readers have discussed this with IRS, please comment!