Plan Permanency Rule

[Idioteque9004]

Hi everyone,

We are currently working on ways to prevent unnecessary churn with our clients and one of the things we were looking at was making clients aware of the IRS Plan Permanency Rule that essentially states a plan must be established with the intent to be permanent,and if it is terminated within a few years, besides any of the approved reasons by the IRS, then they are at risk of violating that rule which could potentially lead to retroactively being disqualified.  My questions are:

1. Is this really something the IRS even checks? In my six years in the industry, which granted isn't a ton of time, this is something I previously never heard of before and I don't believe it's ever been communicated to any of my previous company's clients when they requested a termination. Are that many people just not aware of it?

2. One of the approved termination reasons is a change in ownership. Does simply selling your business fall under that category?

3. Lastly, is the 5310 form actually required or is that only if they essentially want the IRS's blessing that the termination reason is qualified?

The goal is ultimately to make them aware of this rule in the hopes they might delay the termination of the plan, and although it might not save a ton of business, I think it could definitely deter clients from terminating for reasons like " I just don't want one anymore" , or "my wife and I are going to rollover to an IRA (not Simple) and the employees will figure something else out"

Any feedback is much appreciated!

[Paul I]

Plan permanency is a "thing".  It is best discussed with an employer BEFORE the plan is adopted.  This takes away the first excuse an employers makes is "no one ever told me so". 

Is the IRS serious about it?  Yes, it's in the regulations and the IRS Manual.  See https://www.law.cornell.edu/cfr/text/26/1.401-1 and 1.401-1(b)(2) in particular.  Also see the IRS Manual Section 7.12.1.13 Permanency Requirements/Reasons for Termination https://www.irs.gov/irm/part7/irm_07-012-001#idm139730249437392 .  This latter link provides a lot of details on what is considered by the IRS in reviewing a plan's permanency, and you will find the answers to your questions and a lot more information.

Is this something the IRS even checks?  Yes.  One way the IRS can learn about the issue is during a review of a company's tax returns.  Seeing a deduction for a contribution in one year but not in subsequent years likely will trigger a question. 

Another way depends in part on whether to plan has filed a Form 5500-EZ, 5500-SF or 5500.  The IRS has a formal Entity Control Check that it uses to keep track of filings made year over year.  See page 24 of the IFILE User Guide https://www.efast.dol.gov/fip/pubs/EFAST2_IFILE_User_Guide.pdf .  The IRS can track filings for the pairing of the employer's EIN and Plan Number.  If there are too few or an abrupt end with no designated final filing, this may trigger an inquiry.

Keep in mind that a discontinuance of contributions also can lead to a plan being considered terminated.  Take a peek at IRM 7.12.1.14.  If you convince a plan to delay terminating but the employer makes no contributions, you potentially are making the situation more complicated. 

Consider cutting your losses with these clients, and focusing your time and resources on educating employers before they sign up.

[TheBoxMan]

While it should be something the IRS looks at, I don't see that the IRS actually cares. I see many small qualified plans set up for 2 or 3 years, paying the Dentist or the Doctor who sponsored the plan millions of dollars, and the rest of the employees get a few thousand dollars. The plans even submit the termination to the IRS for the final determination letter and I don't see the IRS question it. 

[Bri]

Millions for a 2-3 year plan sounds more like a 415 issue than it does a permanency issue!

[Bird]

15 hours ago, Idioteque9004 said:

The goal is ultimately to make them aware of this rule in the hopes they might delay the termination of the plan, and although it might not save a ton of business, I think it could definitely deter clients from terminating for reasons like " I just don't want one anymore" , or "my wife and I are going to rollover to an IRA (not Simple) and the employees will figure something else out"

Your goal should be compliance. See Paul I's comments, especially about making sure they are aware of the rules before they establish the plan.

Having said that, I don't think the IRS cares. We generally tell folks they need 3-5 years, and maybe that is enough because we have never ever been challenged on the permanency issue. I'm not aware of any enforcement in this area, and frankly, think that's a shame. 

[TheBoxMan]

2 hours ago, Bri said:

Millions for a 2-3 year plan sounds more like a 415 issue than it does a permanency issue!

I may have exaggerated slightly, in that a doctor's office pays 4 or 5 doctors a couple million and the rest of the participants a few thousand each. Top heavy plan, covered in a profit sharing plan. Still just a way to pay tax deferred profits to the owners of the business. 

[CuseFan]

1 hour ago, Bird said:

We generally tell folks they need 3-5 years,

The IRS presumption is that 10 or more years is deemed permanent and won't be questioned. I suggest anything less than that have a reason other than "changed our mind." I use the 3-5 year period for changes, so as not to have a pattern of frequent amendments that create a discretionary arrangement that is not a "defined" benefit. That said, there are a lot of business reasons that could substantiate earlier termination, just be careful you do not have a blatant short-term tax deferral.

[CuseFan]

I have not seen an IRS challenge to any client's early termination, but that doesn't mean there is little to no risk for an unsubstantiated early termination.

[rocknrolls2]

I agree that the IRS has the permanency requirement and that it takes it seriously, as pointed out by Paul I. Regarding whether or not the IRS still cares, there are a lot of IRS policies and positions taken regarding qualified plans that can be fairly old and seem inapplicable, but do not fool yourself into believing that they have become obsolete and that they no longer apply. For example, there is a 1956 regulation governing the times when certain types of qualified plans can make distributions, including in-service distributions. This regulation is still frequently cited as the reason why a distribution can or cannot be made from that type of plan. See 26 CFR Section 1.401-1(b)(1)(i) - (iii). 

Regarding permanency, the IRS does not regularly cite that as a policy and none of its rulings or other guidance have relied upon it. The reason is that primarily under defined benefit plans, there was more of a potential for abuse by the top echelon of companies to terminate their plans and obtain substantial fully funded pensions upon plan termination and, if the plan were fully funded, to recover the reversions. When this was a factor, even before ERISA, generally employees were not vested at all until they were at or substantially near normal retirement age. The numerous legislative and regulatory changes that have been put into place in the intervening years, such as 415 limits, compensation limits, stricter nondiscrimination regulations, benefit accrual rules, top-heavy rules, etc. have tended to greatly curb the potential for abuses, at least to the extent of calculating benefits and providing for more meaningful benefits for rank and file employees. In today's defined contribution plan environment, the potential for such substantial disparities in favor of owners and upper echelon management is substantially attenuated. So, while it is still on the books and considered by the IRS, its prominence as a substantial arrow in the IRS' quiver of controlling abuses is greatly diminished.

Responding to your question regarding the Form 5310, an employer may but is not required to file for a determination letter from the IRS stating that the plan's termination will not adversely impact its qualification. Although it is optional, it is widely considered to be prudent to apply for such a determination letter. If the employer merely adopts a resolution stating the plan is terminated, distributes all of its assets and files a final Form 5500 for its final year of operation, there is always the risk that the IRS might conduct an audit on the plan's termination.  

[ESOPMomma]

18 hours ago, Idioteque9004 said:

1. Is this really something the IRS even checks? In my six years in the industry, which granted isn't a ton of time, this is something I previously never heard of before and I don't believe it's ever been communicated to any of my previous company's clients when they requested a termination. Are that many people just not aware of it?

2. One of the approved termination reasons is a change in ownership. Does simply selling your business fall under that category?

3. Lastly, is the 5310 form actually required or is that only if they essentially want the IRS's blessing that the termination reason is qualified?

1 - as others have already addressed proficiently, yes they check but they may not press the termination.

2 - yes... I actually had a 100% ESOP established in 2021, company was acquired in 2023 and plan terminated... 2½ years for an ESOP is crazy short, but the sale was in the best interest of the shareholders (the plan participants).  We will have a few more years of administration waiting for the FDL from the IRS and for the escrow hold out, but selling your business can most certainly fall under the change in ownership category.

3 - the 5310 is not required to terminate the plan.  It's only necessary if you want the IRS' blessing on the termination of the plan.  In an acquisition situation like I describe above, the buyer may REQUIRE the plan sponsor request the FDL so they know the plan has no issues, or there may be language written into the transaction that if the IRS finds errors requiring correction the onus is on the company being acquired to absorb the cost for corrections.

[Roycal]

I have had the IRS challenge early terminations, but that was a very long time ago.  Sale of company and new owners would seem like a legit reason for termination due to material change in circumstances.  I'd have no problem arguing that.  5310 is not required, but certainly the best practice.  I would not bless a termination without one.

[Paul I]

The IRS does not have the resources to check everything every year.  Each year, they will announce special projects or initiatives to take an in-depth look at a specific topic.  For example, they had a project to look at plans that had a discontinuance in contributions.  The found about 1/3 of their sampling of plans had a deficiency in how the discontinuance was handled (mostly due to vesting, and they found some plan terminations, too).

The IRS has an expectation that a plan will operate in compliance with the rules, and we cannot assume that they don't care about early terminations.  Any client who is cavalier about an early termination at least should be informed of the potential consequences of their decision.

[Bird]

I have too much time on my hands and will rant a bit here. My thoughts on doing the 5310 are completely contrary. My viewpoint is that of someone who works mostly on micro plans.

I've been doing this long enough to remember when there was no fee for the 5310, and you got an FDL within a few months. Then they started charging for it, and taking longer and longer. It used to be something that we insisted on, then gradually became a client option, and now we barely mention it. The main thing that triggered my policy change was that we had a plan that was audited, after we received a FDL. I said "but but but but we have an FDL" and the agent said "yeah but we "just" need to review some operational things, and the FDL doesn't cover that." So they did the audit, and it was a major PITA because the company had shut down; fortunately they had some stuff in a warehouse. Of course they found nothing.

Unless you have an individually designed plan and need the FDL to cover the document, I  do not think it is worth it. Basically you have a choice of 1) getting the FDL and spending a decent amount of money and waiting an interminably long time for an answer, and still being subject to an audit of the plan's operation, or 2) not getting the FDL and being subject to an audit of the plan's operation. You really should not have a document issue if you are using a pre-approved document. 

I don't believe the ADPs and Paychex of the world are submitting 5310s, and they have way more plans.

[CuseFan]

Agree with Bird, we rarely see small plan clients on pre-approved documents submit for plan termination determination letters.

On permanency, I think you can craft an early termination excuse out of just about anything. 

[Idioteque9004]

On 1/9/2024 at 1:30 PM, Bird said:

Your goal should be compliance. See Paul I's comments, especially about making sure they are aware of the rules before they establish the plan.

Having said that, I don't think the IRS cares. We generally tell folks they need 3-5 years, and maybe that is enough because we have never ever been challenged on the permanency issue. I'm not aware of any enforcement in this area, and frankly, think that's a shame. 

Oh 100%, of course that's the goal. Unfortunately, in many companies I've worked at Implementation doesn't always do the greatest job of setting the client up for success. And so as someone who is on the plan administration team, and handles the plan terminations for the company, I am at the mercy of hoping someone already explained before they get to me. More times than not I bet it's not explained because they don't want people to get cold feet because they feel like they're selling their soul once they sign that plan doc. Do I think that's right? Definitely not. But it's probably what happens.

The point of this post was more so to get some more clarity on how vigilant the IRS is about enforcing this rule. Because let's be honest we all know there are certain things RKs and TPAs due that they know would not fly with the IRS/DOL but they do it anyway cuz they know it probably won't be caught. E.g. Attaching an Accountant's Opinion placeholder on the 5500 🙄

[Peter Gulia]

Whatever responsibility (if any) one might have for providing advice or information, the advisee or information recipient is responsible for what it decides or does.

Many practitioners consider it professionally permissible to provide truthful information about nonenforcement. Others suggest omitting information that might lead an advisee or information recipient to noncompliance.

A caution: If the information is nowhere published and instead is based only on anecdote or perception, it might be difficult to defend what one said about nonenforcement. Unless one warned the information had only that grounding, and can prove she said it.

[Luke Bailey]

On 1/13/2024 at 11:10 AM, Peter Gulia said:

Many practitioners consider it professionally permissible to provide truthful information about nonenforcement. Others suggest omitting information that might lead an advisee or information recipient to noncompliance.

I was told by someone who is an expert in this area of the law and whom I trust that it is against the ethical rules that apply to lawyers to counsel a client on the odds of getting caught. That may be in Circular 230.

 

On 1/10/2024 at 1:39 PM, CuseFan said:

On permanency, I think you can craft an early termination excuse out of just about anything. 

I have not had a lot of experience with this issue's being audited, but I tend to agree with CuseFan and I think a couple of key facts are (a) did the small employer that terminated the plan need the cash for some personal reason, e.g. to pay a debt or buy a house, and (b) did they start a new plan soon thereafter when their financial position improved? Those two facts would tend to cast doubt on the bona fides of what otherwise might seem a decent termination excuse.

[C. B. Zeller]

Luke, you are correct. Circular 230 sec. 10.37(a)(2)(vi) forbids a practitioner from taking into account "the possibility that a tax return will not be audited or that a matter will not be raised on audit."

Section 10.37 is titled "Requirements for written advice." Does that imply that you can advise a client on this as long as it is not in writing?

[Peter Gulia]

The Treasury’s Regulations Governing Practice before the Internal Revenue Service (reprinted as Circular 230) includes this:

Requirements for written advice

The practitioner must [when giving written advice on a Federal tax matter]— Not, in evaluating a Federal tax matter, take into account the possibility that a tax return will not be audited or that a matter will not be raised on audit.

31 C.F.R. § 10.37(a)(2)(vi) (emphasis added).

If that rule governs a practitioner’s advice-giving, it applies only for written advice, and only for written advice that evaluates a matter.

Even if one follows the IRS’s assertions that the Circular 230 rules govern everything a once-recognized practitioner does that, however indirectly, relates to her practice before the Internal Revenue Service, § 10.37(a)(2)(vi) does not restrain one from providing truthful information, not advice, about nondetection or nonenforcement.

Beyond those tax-practice rules, whether a lawyer must, may, or must not provide advice or information about nondetection and nonenforcement remains a subject of considerable academic and professional discussion.

In summer semesters, I teach a law school’s course on Professional Conduct in Tax Practice. Here’s an edited excerpt from a reading list I give them:

Jamie G. Heller, Legal Counseling in the Administrative State: How to Let the Client Decide, 103 Yale L.J. 2503 (1994) (suggesting a lawyer educate her client with full-picture counseling about the law’s provisions, practical application, potential nondetection, potential nonenforcement, and purposes so the client can make fully informed choices).

Stephen L. Pepper, Counseling at the Limits of the Law: An Exercise in the Jurisprudence and Ethics of Lawyering, 104 Yale L.J. 1545 (1995) (suggesting modes of reasoning about whether it is appropriate for a lawyer to advise a client about potential nondetection or nonenforcement).

Linda Galler, The Tax Lawyer’s Duty to the System, 16 Va. Tax. Rev. 681 (1997).

Robert W. Gordon, Why Lawyers Can’t Just Be Hired Guns [chapter 3] in Ethics in Practice: Lawyers’ Roles, Responsibilities, and Regulation (Deborah L. Rhode, ed. 2000) (“Lawyers have to help preserve the commons—to help clients comply with the letter and purpose of the frameworks of law and custom that sustain them all; and their obligation is clearly strongest where there is no adversary with access to the same body of facts to keep them honest, and no umpire or monitor to ensure conformity to legal norms and adequate protection of the interests of third parties and the integrity of the legal system.”).

Frank J. Gould, Giving Tax Advice—Some Ethical, Professional, and Legal Considerations, 97 Tax Notes 593 (2002).

Michael Hatfield, Legal Ethics and Federal Taxes, 1945-1965: Patriotism, Duties and Advice, 12:1 Fla. Tax Rev. 1-56 (2012).

Michael Hatfield, Committee Opinions and Treasury Regulation: Tax Lawyer Ethics, 1965-1985, 15 Fla. Tax Rev. 675 (2014).

Milton C. Regan, Tax Advisors and Conflicted Citizens, 16 Legal Ethics 322-349 (2014) (suggesting that ethics or professional-conduct expectations ought to vary with whether a lawyer serves as an advocate or an adviser, and for advisers by the context in which an advisee seeks advice).

John S. Dzienkowski & Robert J. Peroni, The Decline in Tax Adviser Professionalism in American Society, 84-6 Fordham L. Rev. 2721 (2016).

Heather M. Field, Aggressive Tax Planning & The Ethical Tax Lawyer, 36 Va. Tax Rev. 261 (2017) (suggesting a lawyer “identify and implement her philosophy of lawyering” about tax planning).

Michael Blackwell, Conduct Unbefitting: Solicitors, the SRA and Tax Avoidance, 2019-1 British Tax Rev. 31-54 (2019) (criticizing the Solicitors Regulation Authority for wrongly suggesting that a solicitor who facilitates tax avoidance necessarily breaches the SRA Code of Conduct).

Rashaud J. Hannah, Betwixt and Between: A Tax Lawyer’s Dual Responsibility, 34 Geo. J. Legal Ethics 991 (2021).

******

I imagine few of us want to coach a client on getting away with the wrong thing. But there are situations in which law is ambiguous, or how the facts relate to law is ambiguous. And even when there is no ambiguity, there are circumstances in which some of us think it’s appropriate to furnish information and let a client decide what the client does or omits.