Failure to Allocate Transferred DB Assets - 4980 Reversion?

[EBECatty]

A 401(k) plan received transferred assets from the plan sponsor's terminated DB plan. The 401(k) plan has standard provisions allowing the sponsor to allocate, but at least as fast as the seven-year requirement under section 4980.

The assets were put into a suspense account but were never allocated. Still within seven-year period but 401(k) plan is now terminating. 

VCP does not allow correction/relief specifically from 4980 reversion tax. 

Thoughts on whether to attempt VCP based on an "operational error" (i.e., failure to allocate as required by the plan) vs. allocating prior years now (plus plan termination allocation) and filing 5310?

[Luke Bailey]

EBECatty, 4980(d)(2)(C) requires the amount to be allocated ratably over the 7-year period, except to extent blocked by 415(c). I think you have to do VCP.

[EBECatty]

That was my initial thought as well, but section 6.09(1) says EPCRS is "not available for events for which the Code provides tax consequences other than plan disqualification (such as the imposition of an excise tax or additional income tax)." The section then goes on to list a few exceptions, but section 4980 isn't included.

Seems like an odd error not to be able to correct, especially since the money is still all sitting in the plan and can easily be allocated. 

[Luke Bailey]

Good point. But it seems strange that the plan document did not parrot the Code provision re allocation, precluding an argument that disqualification for failure to follow plan's terms.

If that does not work, then the IRS has a correction program outside of EPCRS for problems/errors that do not involve plan qualification. You can go to this web page: https://www.irs.gov/retirement-plans/employee-plans-voluntary-closing-agreements and check it out. Then you will probably want to call Paul Hogan or Thelma Diaz and explain your facts without divulging identity of client. Maybe then can help. If they will, they will give you a closing agreement.

[EBECatty]

The plan document has the seven-year ratable allocation requirement, but it wasn't followed.

I also considered that as a hook to get in through VCP, but it still seems to tie back to the underlying 4980 allocation requirement. If the plan hasn't met the seven-year allocation test, we still have an operational failure, but it seems to me that we also now have a reversion triggering the excise tax. 

Or do you think there's an argument to be made that the disqualifying operational failure to follow the plan terms supersedes the reversion tax? 

A closing agreement is also a good thought, but it looks like from a quick skim that they will not negotiate excise taxes or interest, which seems fairly self-defeating....

[Luke Bailey]

OK. Yes, I believe the non-EPCRS corrections group would not negotiate away an excise tax.

But I think you would have a shot at getting EPCRS to handle the "failure to follow plan" disqualification defect (in theory, you have to do that anyway, since you don't want both a plan that is disqualified and an employer that pays the excise tax, right), and then maybe the allocation would work retroactively with respect to the excise tax. I would talk it through with someone in EPCRS.

It's really a complicated problem, right, because the money is in the plan and should have been allocated in the past under the plan's terms. It's not like the company can use any of it to pay the excise tax, I don't think. And if you allocate it all in the final year, you potentially face claims from folks no longer employed and also could run into 415(c) issues.

[VeryOldMan]

I have a DB case with a $1,500,000 surplus and 2 participants. The plan has been terminated and we are doing a 4980 direct transfer to a new QRP which is a profit sharing plan. Based on the 415 limit of $57,000 AA limit, and a reasonable investment posture of cash, money markets and short term bonds, the balance after 7 years is still over $500,000. The plan doc for the QRP says the balance in the suspense account reverts back to the Employer. What I am unclear on is the penalty rate 7 years from now. Is it 50% or 20% or something else, given regulatory posture can change over time. Is it better to take the 20% rate now and forego the QRP entirely?