Discontinued Contributions

[John Feldt ERPA CPC QPA]

A company makes contributions to their profit sharing plan until 2006. They do NOT have a 401k, there are no deferrals, it is profit sharing only. The last year they made a substantial contribution was for 2005.

In 2006, 2007, and 2008, they make no contribution to their profit sharing plan. They have forfeitures each year. The plan uses forfeitures to reduce employer contributions. The employer contributes nothing so the forfeitures are therefore allocated each year.

So far, $300,000 of forfeitures have been allocated since 12/31/2005. I looked at 411(d)(3) and 1.411(d)-2(d) and IRS Announcement 94-101.

1. Suppose they actually had profits in 2006, 2007, and 2008, but they just did not make a contribution. What must happen now to the amounts that were forfeited in 2006, 2007, and 2008? Would they have to be restored to the plan if they terminate the plan in 2009?

2. Suppose they did NOT have any profits in one or more of the years 2006, 2007, and 2008. Now what happens to the amounts that were forfeited in 2006, 2007, and 2008? Would they have to be restored to the plan if they terminate the plan in 2009?

3. Now suppose they are a non-profit organization. Now what happens to the amounts that were forfeited in 2006, 2007, and 2008? Would they have to be restored to the plan if they terminate the plan in 2009?

[J Simmons]

#1: Yes, I think the $300,000 would need to be restored.

#2: The plan exam guidelines suggest that the absence of profits in the years for which no contributions were made might not count towards the facts-and-circumstances test of whether there has been a de facto plan termination due to discontinuance of contributions. I would suggest to the ER that it needs to flag the position as part of its submission of Form 5310 that there has been no de facto termination until a termination amendment is now prepared and signed--but brace the ER for the IRS taking the contrary position despite its audit guidelines, and requiring another $300,000 be contributed to restore those forfeitures from 2006-08.

#3: Same answer as #2 above.

[K2retire]

John, to whom would these allocated forfeitures be restored?

[J Simmons]

The forfeitures would be restored to those employees, current and mostly former, that were paid out only part of their accrued benefits. Then the plan would need to process and pay out those as 'tailings' distributions.

[Kevin C]

I’m having trouble following how the entire $300,000 of forfeitures must be restored if you have a discontinuance of contributions.

1.401-6©(3) and 1.411(d)-2(d)(2) both say the effective date of the discontinuance is no later than the last day of the taxable year of the employer following the last taxable year during which the last substantial contribution was made. 1.401-6(a) refers to full vesting of benefits accrued as of “… the date of such … discontinuance…”. The determination that a discontinuance occurs can’t be made until well after 12/31/2006 because the circumstances that result in the determination of the discontinuance haven’t happened yet. So, I would think the effective date of the discontinuance would be 12/31/2006 assuming a calendar year fiscal year. GCM 39310 says that terminated participants who are paid their vested balances need not be further vested if the plan terminates before they incur a break-in-service. I would expect those who were forfeited on 12/31/2006 to have been terminated participants who were paid their entire vested balances before 12/31/2006. If so, then you should not have to restore the 2006 forfeitures.

I can see how you would get to the 2007 and 2008 forfeitures being restored from the regs, but that doesn’t really make sense. As of 12/31/2007 (and even through the last date you could possibly complete the 2007 valuation), you don’t have circumstances that indicate a discontinuance has occurred. You followed the terms of the plan and forfeited the amounts that were supposed to be forfeited. Now, with a discontinuance determined to have occurred, it looks like the operation of the plan retroactively fails to be in accordance with its terms. But, we are talking about the IRC and regulations, so logic and common sense are irrelevant. The important thing is that this is an operational failure, so self correction may be an option.

The employer won’t necessarily have to contribute the amount of forfeitures that need to be restored. Rev. Proc. 2008-50, Appendix B, Section 2.03(1)(b) says you can reallocate the forfeitures, adjusted for income, if someone is forfeited using an incorrect vested percentage. See Example 17. I think this should be considered an insignificant operational error, but even if it is considered significant, you should still be able to self correct. The first error should be for 2007, so the correction period runs through the end of 2009.

[Kevin C]

I helped out with an ESOP that had this issue come up during their 5310 filing. The reviewing agent set the discontinuance date as the end of the plan year following the last plan year a contribution was made. A small number of participants were forfeited in one later year, but before the plan terminated.

We proposed to correct the insignificant failure under SCP using the reallocation method in Rev. Proc. 2008-50. The agent initially said we could not use use the reallocation correction method and even argued this was a significant failure so we could not use SCP. After some back and forth and a threat to request a Technical Advice Memorandum if they didn't agree with our position, they finally agreed. When the determination letter arrived, it was conditioned on correcting the operational failure using the reallocation correction method as we proposed.