Unwinding a Plan

[Gary]

I was asked to review two separate IRS proposal letters for two DB plans (not ones that I put in) that sets forth their procedure for unwinding each plan.

They do not consider it a plan disqualification, but instead just an option to go into a closing agreement and agree to unwind the plans.

I do not know if there is a specific technique to unwind a plan. The IRS says unwinding the plan would be treating the plan as if it never existed at all or like a non qualified plan.

One of the plans is a 412i plan and the other is a tradtional DB plan.

Both plans only include the husband and wife as plan participants.

In the case of the standard DB plan the IRS proposes that the the trust be distributed and the participants take the proceeds as income. Simple and straight forward and does not remove corporate tax deductions.

In the case of the 412i plan, the IRS proposes that all prior plan contributions be treated as income to the corporation for each year and that now the total value of contributions (i.e. premiums) be taken as income to the participants in 2008 and that a corresponding corporate deduction be taken in 2008. This large corporate deduction creates a large loss that will never be able to be offset with income. Clearly the unwinding is much more severe with the 412i plan.

With the traditional plan the individuals are only taxed once; for the distribution.

With the 412i plan the corporation (i.e. individuals) is taxed and then the same individuals are taxed for receving the distribution. That is, taxed twice in this case.

On the one hand the 412i plan sponsor can raise the issue of inconsistency, though it may be futile.

And on the other hand, the IRS can just say they can do whatever they want in each case.

Any suggestions on what the 412i plan sponsor could propose? The 412i plan sponsor already requested that the IRS just tax the individuals once by means of a taxable distribution and not tax the corporation as well. The IRS rejected the suggestion, but yet seems to offer the same option for the other DB plan.

Not a pleasant project to work on, so I can understand any reluctance to give an opinion here.

Thanks.

[J Simmons]

Maybe propose that a true unwind would be to tax the H & W when and as the 412i contribs were made. They were compensation paid. The corporate deductions ought to remain intact. This suggestion would require doing amended returns for several years, but at least they would not have double taxation--though there could be penalties and interest on past returns of H & W as amended.

[Mike Preston]

In some of the 412i cases that are being processed, the IRS is "allowing" the taxpayer to consider the plan as always having been a "regular" db plan. Some deductions are maintained when that method is employed.

[Gary]

Thank you.

I agree with John's unwind proposal too.

When I presented such a method to the IRS, I proposed it in the context of a disqualified plan, where the contributions would be income to the individual when contributed since they were immediately 100% vested. Essentially the same thing as in John's post.

The IRS said that they didn't accept such a proposition saying that they couldn't go back and treat the contributions as income since the Social Security and Medicare taxes were not withheld at that time.

The IRS definitely will not the 412i plan be converted to a traditional plan for many reasons including a coverage violation and an excess deduction violation.

[Gary]

To try and make a very long story just long.

The IRS proposes that the 412i plan be unwound as follows:

1. Tax corporations for premiums made in each year from 2002 through 2007.

2. Tax individuals finally in 2008 as compensation in an amount equal to total premiums paid to plan

3. Finally in 2008 they would give corporation an equivalent deduction for compensation

4. The IRS claims that a final 5500 terminating plan would be filed with no sanction

5. The IRS also states that there would be no 4972 excise tax for non deductible contributions.

From what I understand: disqualifying the plan may be a better alternative then the IRS proposed settlement. My impression of a plan disqualification would entail:

1. All premiums (i.e. plan contributions) taxed as compensation to employee for each year made and correspondingly deducted by corporation. Taxed only once. Perhaps there would be interest and penalties related to the amended individual returns, but atl east taxation only occurs in one instance.

2. I am not sure of what, if any sanction would occur with the final 5500, if the plan were disqualified.

3. I am not sure how there would be any 4972 excise taxes (or how it could apply) for non deductible contributions, since the plan is disqualified and there are no dedductible contributions anyway.

My questions are now:

1. Are there other interpretations of the disqualification of a plan?

2. Does anyone know of any sanctions related to a disqualified plan?

3. Does anyone know of any 4972 excise taxes in connection with a disqualified plan?

4. Does anyone recommend a good reference source pertaining to the rules and procedures in connection with the disqualification of a plan?

Sorry for the detailed post.

Thank you.

[RayJJohnsonJr]

Gary,

Was this 412(i) unwind resolved and if so, how? I am having the exact same situation right now,

Thank you

[goldtpa]

I also have a 412i issue. The 412i has excess death benefit and the client never made their annutiy contribution for '09 or '10. They just made their premium payments. I would like to the IRS to treat it as always having been a "regular" db plan, as Mike suggested.

Do you go through VCP to voluntarily correct these issues??