What regulation says a plan doesn’t tax-qualify if not administered according to its written plan?

[Peter Gulia]

A retirement plan, to tax-qualify under Internal Revenue Code § 401(a), must meet all conditions not only in the written plan but also in actual administration according to that written plan.  The Internal Revenue Service’s Employee Plans Compliance Resolution System presumes the point; the Revenue Procedure defines an Operational Failure as one “that arises solely from the failure to follow plan provisions.”  Rev. Proc. 2019-19, 2019-19 I.R.B. 1086, 1099 § 5.01(2)(b) (May 6, 2019).  (Thank you, C.B. Zeller.)  Unlike some other points made in the Revenue Procedure, this one cites no Treasury regulation as support for the point.

 

Writers often say a plan must tax-qualify not only “in form” but also “in operation”.  There are Treasury regulations and court decisions that support the in-form point.  But I’m not (yet) seeing a regulation, court decision, or other law source that clearly states or supports the in-operation point.

 

I’m hoping BenefitsLink mavens will teach me.  Will you please help me?

[Tom Poje]

I'm not even sure what you are looking for.

for example Code Sec 401(a) Requirements for qualifications and it lists all the basics.

Since these are required, if you didn't follow even one of them in operation, then you have failed to meet one of the requirements

 

or are you saying

yes, while these are required you don't have to follow them in operation because in operation means something else?

 

https://www.irs.gov/retirement-plans/a-guide-to-common-qualified-plan-requirements

https://www.irs.gov/retirement-plans/tax-consequences-of-plan-disqualification

 

[Peter Gulia]

I assume the law requires operating a plan according to its written plan as a condition for tax-qualified treatment.

I'm just looking to find a law source that says so.

Thank you for the pointers to the IRS's explanations.

But I'm looking for a regulation or something that has the effect of law.

And it's not because I doubt the point of law.  Rather, I hope to support it with a citation.

 

[MoJo]

I don't know about a cite to IRC provisions or regs, but ERISA clearly makes following the plan documents one of the four fundamental "fiduciary" obligations (along with the exclusive benefit rule, the prudent expert rule,and the duty to diversify) in Section 404 (29 U.S.C. Section 1104).  Failure to incorporate all of the provisions required for qualification in the plan document then would make it deficient in "form."  Failure to abide by it's terms would be a fiduciary failure directly, perhaps indirectly (as a failure of the prudent expert rule - which implicitly (arguably) requires one to preserve the tax qualified status of the plan (as any "prudent expert" would).  Hence, "operationally" a failure would be violative of these "fiduciary requirements" and otherwise a bad thing....  Not sure you need a cite to anything else....

[Belgarath]

Hi Peter - as you know, I am neither an attorney nor a legal expert. It does seem to me that Basch Engineering Inc. V. Commissioner clearly refers to a plan requiring compliance in both form and operation. This also provides links to Buzzetta and to Ludden, which say the same thing. Does this help at all? Excerpt from Basch below, as well as the Basch link which you can follow through to the others, if they are helpful

"A qualified profit-sharing plan both by its terms and its operations must meet the statutory requirements. Buzzetta Construction Corp. v. Commissioner [Dec. 45,555], 92 T.C. 641 , 646 (1989). "

https://www.leagle.com/decision/199054159ddtcm4821434

[Peter Gulia]

Mojo and Belgarath, thank you for helping.

 

An administrator’s, trustee’s, or other fiduciary’s failure to administer an ERISA-governed plan “in accordance with the documents and instruments governing the plan” (insofar as those documents are consistent with ERISA’s title I and title IV) is, under ERISA § 404(a)(1)(D), a breach of the fiduciary’s responsibility.  That’s so even if what is done otherwise breaches no duty under § 404(a)(1)(A)-(C).  But such a fiduciary breach doesn’t explain why a failure to administer a plan according to the written plan is a failure of the Internal Revenue Code § 401(a) conditions for treatment as a tax-qualified plan.

 

While Basch Engineering, Buzzetta Construction, and Ludden recite that a plan must meet the tax-treatment conditions in operation, none of them based its finding on a mere failure to follow the written plan that was not also a failure of a particular tax-qualification condition.

 

I’m thinking about situations in which the only ground for tax-disqualifying the plan is a failure to follow a provision in the plan’s governing document when the provision is not one the Internal Revenue Code requires to be stated in a plan’s document.

 

So far, my reasoning goes like this:

 

Under 26 C.F.R. § 1.401-1(a)(2), a qualified plan must be “a definite written program and arrangement which is communicated to the employees and which is established and maintained by an employer[.]”  A failure to administer a plan according to the “definite written program” might mean the employer does not maintain that plan.

 

It would be nice to find a law source that states the point more directly, or at least expressly adopts the reasoning.

 

But maybe there’s nothing to be found.

 

Again, Mojo and Belgarath, thank you for helping.

[MoJo]

59 minutes ago, Fiduciary Guidance Counsel said:

....But such a fiduciary breach doesn’t explain why a failure to administer a plan according to the written plan is a failure of the Internal Revenue Code § 401(a) conditions for treatment as a tax-qualified plan....

 

 

 

I guess I'd look at it a bit differently, then.  The fiduciary breach is just that - a fiduciary breach.  With respect to the failure to follow the document is a "qualification" issue under the IRC - I would suggest it "depends" (I am an attorney...) on what provisions were not followed.  For example, a plan document may provide for an appeal period for a denial of benefits, and if the plan sponsor doesn't follow that provision and ignores that provision in the plan, it is a violation of the terms of the plan document, but it is NOT a qualification issue (nothing in 401(a)(1) et swq.) indicates you must make follow that provision.  You may have other issues (ERISA (non-qualification) rules, the fiduciary breach, a "quasi-employment" contract issue, possible an equitable issue) that might force you to correct the situation, but absent a violation of 401(a)(1) et seq., it isn't a qualification issue.  It would still be an "operational" issue, but not necessarily a "qualification" issue.  If however you violate a term of the plan documents that is REQUIRED by the qualification rules in 401(a) (coverage, the (k) and (m) rules, etc.), then your violation of that particular provision is a "direct" violation of the qualification rules - and you can be held accountable for that.  The fact that you also violated the terms of the plan isn't relevant to the "operational" failure causing a qualification issue - which would have to be addressed.

In any event, our advice to clients is "R.T.F.D." (Read The ... final ... Document) - and understand it).

[Peter Gulia]

MoJo, thank you for this further analysis.

 

[jpod]

FGC:  Example:  Plan says distributions are payable only upon termination of employment or death.  In operation, distributions requested at or after age 59-1/2 are made.  Are you asking what provision in the law, which in my view would include case law, or regulations, is the authority for saying that these distributions result in plan disqualification?   I don't  have a cite for you, but there must be one.  The late, great Marty Slate wrote a comprehensive article about 30 years ago (which helped to create EPCRS).  I would check that out.      

[ESOP Guy]

Interesting question as you are taught from day one you have to follow the terms of the document. 

This IRS website says that but doesn't document the legal reason why.

https://www.irs.gov/retirement-plans/a-guide-to-common-qualified-plan-requirements#2

 

Basically all the other requirements they do document a reason why it is a requirement. 

[QP_Guy]

I think the requirement to follow the plan terms come from the "definitely determinable" rules. See 1.401.1(b)

(b)General rules. (1)(i) A pension plan within the meaning of section 401(a) is a plan established and maintained by an employer primarily to provide systematically for the payment of definitely determinable benefits to his employeesover a period of years, usually for life, after retirement.

definitely determinable benefits require that the employer follow the plan terms precisely (otherwise the benefits aren't determinable ahead of time).

[Peter Gulia]

jpod, while we might like to think there must be a citation, I haven't yet found it.  Thank you for pointing out Marty Slate's article; I'll look.

ESOP Guy, thank you for confirming what we saw (and saw missing) in some IRS publications.

QP_Guy, the "definitely determinable" idea is some support IF the plan provision an administrator failed to follow is one that could affect the allocation of a profit-sharing contribution.  (For this conversation, I'm ignoring pension benefits.)  But it doesn't explain why there is a tax-qualification failure if the provision not administered cannot affect an allocation of a contribution.

Thank you, everyone, for continuing to help me.

[Doc Ument]

Don't take this response personally, I am just pontificating at the public square.

Suppose Harry goes to a lawyer and does everything proper to leave all his assets to his eldest son upon his death.  Harry dies, and the executor gives Harry's assets to Harry's ex-spouse instead.   Do you see a potential problem with that, and if so why?   When it is okay to ignore the provisions of a will?   I don't know, but I can imagine there are circumstances that would permit it, but unless you can find that greater authority, then what is the point in making the will in the first place if people don't have faith in the notion that the terms of the will be carried out (absent superseding law)? 

It would neither surprise me nor trouble me if there is no statute or regulation saying that the terms of wills must be carried out.   Even so, I still am willing to pay a lawyer to write a will because I believe a court will feel compelled to carry out my wishes if it is asked to do so by someone who is named in my will and if the conveyance to that named person is otherwise lawful.

When an employer signs a plan document, the employer is setting down their intent in plain sight.  A participant can sue the employer for failing to follow the intent stated in the document if they can show they are harmed, yes?  It seems to me that participants have successfully done so.

In my opinion, it doesn't matter if the plan provision at issue has anything to do with a legal or qualification requirement.   The document says that forfeitures are allocated pro-rata on deferrals as an additional match, and the employer uses them instead for some other lawful purpose that could have been, but wasn't, put into the document, such as reducing the profit sharing contribution.  I really don't think the government (or private) audit will go well from the employer's perspective.  The document is the governing body.   It's the "constitution," the bill of rights, the law of the land for that particular set of plan participants.  In contrast, if the document says that the employer can reduce contributions or allocate to participants or some combination of both, then the employer in my example won't get in trouble for using all the forfeitures to reduce the profit sharing contribution because the document gives the employer the authority to exercise a certain amount of discretion in determining what to do with the forfeitures.

If the employer signed the document, then what makes a retirement plan less compulsory in is language than a will?  If employers can ignore the terms of a document (even if complying with the Code as they do so), how does one determine what rights and obligations the employer and employees have?  Do participants have a right to a match if forfeitures must be used to fund a match according to the document?  There is no legal requirement that forfeitures must be used to provide a match, but the employer chose to sign a document giving participants that right.  Words and signatures matter.

And yes, personally, I'd very much appreciate having someone find a citation to the rule that the terms of the document must be followed, but I would not hesitate to tell employers that the terms of the document must be followed.  (Decades ago, I saw a cartoon with the caption for an IRS supervisor telling the newbie IRS agent "Just because you don't understand it, and I can't explain it, doesn't mean we can't enforce it.")

[Luke Bailey]

 

1 hour ago, QP_Guy said:

I think the requirement to follow the plan terms come from the "definitely determinable" rules. See 1.401.1(b)

(b)General rules. (1)(i) A pension plan within the meaning of section 401(a) is a plan established and maintained by an employer primarily to provide systematically for the payment of definitely determinable benefits to his employeesover a period of years, usually for life, after retirement.

definitely determinable benefits require that the employer follow the plan terms precisely (otherwise the benefits aren't determinable ahead of time).

 

I believe that QP_Guy has identified the regulation that the IRS mostly bases its argument on. As others have pointed out above, the IRS has been upheld in the courts several times on the issue.

Where the departure from the terms of the plan document is inadvertent (because the employer doesn't know that what they are doing is inconsistent with the document), consistently done, and favors participants in all cases, without violating any Code provision, the doctrine that the failure to follow the plan document nevertheless is a qualification lapse has always been troubling. Rev. Proc. 2019-19 is a welcome admission of that from IRS.

The ERISA issues are separate, and you are into Verizon and a handful of other cases. Participant should be able to enforce lawful terms of plan if they favor him or her, as long as not clearly an error.

[Peter Gulia]

Doc Ument, thank you for an interesting analogy.  Of course, ERISA (or, if a plan is not ERISA-governed, a State’s law of trusts and other fiduciary relationships) requires a fiduciary to obey documents that govern the fiduciary relationship, at least insofar as a document is not contrary to applicable law.  And a plan’s participant or beneficiary has rights to ask a court to compel a fiduciary to obey a governing document, and to make good the plan’s losses that resulted from disobedience.

 

Luke Bailey, thank you for your observation.  One reason no one knows exactly how the tax law sorts out is that the corrections programs cover so much.  Almost all of what otherwise might become a dispute gets administratively resolved.

 

My research in the Federal courts’ decisions and the Tax Court’s decisions found none in which a plan was disqualified because of a mere failure to follow the written plan without another failure to meet an Internal Revenue Code tax-qualification condition.

 

It seems 26 C.F.R. § 1.401-1, whether in -1(a)(2) or -1(b), is a source for reasoning that an employer must maintain the “definite written program” it established.

[loserson]

I think you are looking for a 401(a) equivalent of Treas Reg §1.403(b)-3(b)(3):

Quote

(3) Plan in form and operation.

(i) A contract does not satisfy paragraph (a) of this section unless it is maintained pursuant to a plan. ...

I am not sure that there is an equivalent Treas Reg provision for 401(a) plans.  It's sprinkled in various places already identified in this thread.

I guess you could cite the EPCRS rev rul.  It goes into plan document failures.  It at least goes to the IRS' interpretation and enforcement standard.

Agreed that fiduciary failure under ERISA does not translate into tax disqualification, unless there is some provision I am not thinking of.

Almost no qualified plan get disqualified because IRS and employers both want to avoid it and all advisors try desperately to avoid it.  But if the IRS said "you have some plan doc failures, go fix them" and you refused to cooperate with the IRS at all, I think your intransigence might eventually get to disqualification.  Similar to how the DOL has the power to get a court order to force plans to comply, but they basically never use it because the plans all know to do as they are told before it gets to that point.