Correction of plan defects

[Guest Jayco]

Does anyone have any thoughts on how to "fix" the following problem? A governmental agency adopted a 401(k) plan for the first time in 1996 and has been maintaining it ever since.

[mbozek]

Convert it to a PS plan and designate ee contributions as employer pick up under 414(h). Then wait 3 yrs for statute of limitations to expire for taxation of employee contributions under 401k. There is no way to fix the 401k contributions retroactivey.

[Guest Jayco]

Thanks, that was what I thought, but I just wanted to see if anyone had any experience with this problem.

[Everett Moreland]

The following definition is from Revenue Procedure 2003-44 (EPCRS). I've not gone beyond finding this definition, but it suggests to me that this can be fixed in VCP:

"The term 'Employer Eligibility Failure' means the adoption of a plan intended to satisfy the requirements of § 401(a) by an employer that fails to meet the employer eligibility requirements to establish a § 401(k) plan."

[mbozek]

VCP would restore the pre tax nature of the amounts deferred before the s/l expired (2002) which are now deemed a/t. Since the IRS doesnt know if a govt has adopted a 401k plan and assuming that the plan is corrected in 2005, is VCP necessary if the plan treats all distributions under the plan as pre tax? The only benefit to VCP appears to be that it avoids audit cap penalities. The interesting Q is whether the plan could distribute all the deferrals and earnings on the 401k deferrals prior to 05 as after tax amounts after the s/l has expired.

Final Q- Are you sure this is a govt entity and not a NP.

[Guest Jayco]

As to whether this is a governmental plan, we obviously don't have a ruling to that effect, but it seems clear that it was adopted and is maintained by a governmental agency.

Rev. Proc. 2003-44 does seem to permit correction of this problem in Sectiono 6.03 "Correction of an Employer Eligibility Failure".

Also, it might be possible to treat the 401(k) as a 457(b) plan, although there are some issues with that solutions, since there may have been pre-EGTRRA rollovers or deferrals in excess of the pre-EGTRRA 457(b) limit.

As to whether distribution could be made tax-free after the statute of limitations has run, I believe (although I have not researched it) that the answer is that it could not.

[mbozek]

If the employer was not eligible to adopt a 401k plan then the contributions could never be deferred from taxable income and would be taxed in the year the contributions were made. If the taxpayer files a return, the s/l for collecting income tax is generally 3 yrs from the date the tax return is due, e.g., April 15, 2000 for contributions made in 1996.