457(b) Document Compliance and Enforcement

[Randy Watson]

We have a new client that has a tax exempt 457(b) plan that has not been updated for about 10 years (before the 2003 regulations).

How strict is the IRS with regard to document compliance in this area? Would a retroactive amendment be in order here? Does anyone have any experience with 457(b) document issues and the IRS? I'm trying to get a sense of how much leeway we have with the document.

[mbozek]

We have a new client that has a tax exempt 457(b) plan that has not been updated for about 10 years (before the 2003 regulations).

How strict is the IRS with regard to document compliance in this area? Would a retroactive amendment be in order here? Does anyone have any experience with 457(b) document issues and the IRS? I'm trying to get a sense of how much leeway we have with the document.

reg. 1.457-9(b) states that a tax exempt 457b plan ceases to be an eligible plan on the first day it fails to meet any of the requirements of regs 1.457-3 to 8 or 10. Reg. 1.457-11 states that an individual is taxed on the deferred amounts in an ineligible plan in the first year when the deferred amounts are not subject to a substantial risk of forfieture. Since the benefits in the 457b plan are 100% vested its seems they are taxed on the day the plan ceases to be an eligible plan. From the participant's point of view there is income tax exposure for the last 3 years.

[Peter Gulia]

Before too quickly moving toward an IRS correction procedure or correcting earlier years' W2s, one might first look into whether there is a document defect (or an operational defect).

For a nongovernmental deferred compensation plan, it's at least possible that a document written many years ago could, despite later tax-Code changes, state a 457(b) eligible deferred compensation plan.

For example, a document from late 1986 could say everything that's needed, and might not have any "disqualifying" provision.

For deferred compensation between a nongovernmental exempt organization and its employee, the essential conditions haven't changed much since 1974 (ERISA) and 1954 (the restatement of the Internal Revenue Code).

Have you found a particular provision that you think makes the plan an ineligible plan?

[mbozek]

Before too quickly moving toward an IRS correction procedure or correcting earlier years' W2s, one might first look into whether there is a document defect (or an operational defect).

For a nongovernmental deferred compensation plan, it's at least possible that a document written many years ago could, despite later tax-Code changes, state a 457(b) eligible deferred compensation plan.

For example, a document from late 1986 could say everything that's needed, and might not have any "disqualifying" provision.

For deferred compensation between a nongovernmental exempt organization and its employee, the essential conditions haven't changed much since 1974 (ERISA) and 1954 (the restatement of the Internal Revenue Code).

Have you found a particular provision that you think makes the plan an ineligible plan?

I dont think this is possible b/c of changes made in 2001 to require that distributions to employees be made under MRD rules. Under prior law distributions to participants had to be paid over no more than 15 years in a level amount. Also the 2003 changes to the 457 regs required amendments to most plans.

[Peter Gulia]

Matt Bozek is right in describing an unlikelihood that a plan written before 2001 would meet all current conditions for treatment as a 457(b) eligible deferred compensation plan. But however unlikely, it remains possible. (Just to choose one illustration, it's possible that a plan that provides only a single-sum distribution at a fixed time after the employment ends might not trip on any of the distribution rules.) In this bulletin-board hypothetical, we're all imagining what the facts might be. In real practice, we'd read the plan.

To return to Randy Watson's query, if there is a defect, whether and how gracefully the IRS will negotiate relates to the tax amounts in play, the persuasiveness of the employer's explanation about why the employer neglected to maintain the plan, and the skill of the practitioner who presents a suggested solution. Outside EPCRS, the opportunities (good and bad) are more open.

[Randy Watson]

Great comments as always. Thank you everyone!