Inane IRS Funding Deficienty Letter

[Guest astonewall]

We have three clients who have recently received form letters from the IRS asking for "an explanation to support" how and when a funding deficiency was corrected or why it was not corrected. The entry on line 9p indicating the plan had a funding deficiency triggered the inquiry.

In all three cases, the form 5330 has already been filed and the excise tax paid. Evidently, the IRS is asking the clinet to confirm what the IRS already knows somewhere else in its bowels. In essence, the form 5500 schedule B people cannot communicate with the form 5330 people.

Is anyone else experiencing this? It appears to us this is more of an annoyance than a real problem, but I want to make sure I am not missing something.

[WDIK]

We received a similar letter.

If I recall, they mentioned something about trying to coordinate information for an upcoming change in agency responsibilities.

[Blinky the 3-eyed Fish]

I find it disconcerting that they are spewing these letters so quickly. I hope they aren't trying to act if the deficiency is not corrected. See the recent post by AndyH, because a funding deficiency can certainly be reduced by the sheer basis of the next year's valuation. If the IRS demanded correction now, they could actually cause a nondeductible contribution.

I had 2 clients with funding deficiencies for 2003 but haven't received letters (yet).

[MGB]

First, read the law. There are two levels of excise tax. The first, which you filed with a 5330 is the "initial tax" (see Code Section 4971(a)), and is only 10%. The second is the "additional tax" (see Code Section 4971(b)), and is applied once the IRS decides to apply it, even though the law says it is automatic if the deficiency is not corrected in the "taxable period".

These letters are part of the procedures to trigger the automatic 100% excise tax. If you respond to them saying it has been corrected, or have a very good outline of how it will be corrected, life goes on and they don't impose the 100%.

But, if you ignore them, or respond to them using words like "inane", they will impose the 100% excise tax immediately. They have been lax in the past in following up on the 100%, but have changed their ways and are ready to impose it at a drop of the hat.

[Belgarath]

While I agree that it is wise not to provoke the IRS, (and I suspect astonewall was using this for our reading pleasure, and wouldn't necessarily tell the service that they were inane), does it necessarily matter? My understanding is that there is an automatic abatement of the second tier tax (see IRC 4961) IF you correct it within the correction period under IRC 4963(e). In this case, you have 90 days after the IRS mails the notice of deficiency. So in spite of the fact that folks shouldn't deliberately confront the tiger in his lair, it doesn't remove your correction and abatement remedies available under the law. Of course, they might just then decide to audit your plan, etc... - so MGB's advice is very sound!

I do agree that this is more of an annoyance than a real problem - the problem has been corrected, and you just have to prove that to the IRS. Again.