EP Exam Projects - LESE Projects - Project #9 – Exams of Forms 5500 that Reported Employer Contributions per Participant Greater than $135,811
The reason for this project was to obtain a snapshot view of qualified plans where the ratio of the employer contribution cash amounts, per participant, as determined from Form 5500 entries, exceeded $135,811. This project’s criteria were based on recommendations from our TE/GE Research and Analysis unit.
This review required, in part, an analysis by our examiners of either defined benefit or defined contribution plans to verify whether the amount of employer cash contributions for the year resulted in any applicable limits exceeded. This could include such applicable limits as Internal Revenue Code (IRC) §§401(a)(17), 404(a), 404(j) and 415 (related to plan benefit compensation limits, deduction limits and maximum IRC §415 limits).
Specifically, we used the Form 5500 line item that reported employer cash contribution amounts, as reported on Form 5500, Schedule H or Schedule I, and then divided this amount by the line item(s) that reflected the total number of participants. We then identified those returns where the average cash contribution amount exceeded $135,811. From this universe, we selected our sample for examination.
This project commenced approximately March 2008 and utilized the focused examination concept to perform our examinations. As such, the pre-identified issues required to be considered by our examination agents were 1) Plan Qualification - Compliance with current tax law in form; 2) IRC §415 Limits; and 3) Deduction Limits (IRC §404). Under the focused examination concept upon which the examination was performed, the scope of the examination requires the agent to determine compliance in three pre-identified areas. However, the agent has the discretion to expand their examination beyond the three pre-identified areas to any other areas based on their independent judgment as they deem warranted.
Our initial sample selected and examined totaled 49 plans (e.g., 49 Form 5500 returns). As a result of these examinations, five (5) subsequent and/or prior years Form 5500 and four (4) delinquent Forms 5330 were also picked up and examined.
Nondeductible Employer Contributions: The most common issue was the making of nondeductible employer contributions to three defined benefit plans. The impact was loss of deduction, as well as filing of delinquent Forms 5330 with payment of the 10% excise tax (equal to 10% of the cumulative nondeductible contributions made to the plan). The Background section at the bottom of this page provides a brief discussion of the nondeductible employer contributions and IRC §4972.
There were other failures noted, but no specific trends or other types of recurring errors. The isolated instances included:
- Late or Non-amender: This issue involved the failure to timely amend the plan document, in form, for various law changes, starting with the law changes required by GUST (i.e., GATT, USERRA, SBJPA, and TRA ’97) and subsequent statutory and regulatory changes. When we discover this defect during our audits, the resolution of this defect involves our Audit Closing Agreement Program (Audit CAP), with the applicable retroactive amendments secured and the payment of a negotiated tax sanction.
- IRC §401(a)(9) Required Minimum Distribution: This issue involved the failure to make the required minimum distribution under IRC §401(a)(9) to a participant. In general, IRC §401(a)(9) requires minimum distributions to commence annually, beginning with April 1st following the calendar year in which the key employee attains age 70 ½ or, for non-key employees, the calendar year in which they attain the later of age 70 ½ or retirement. Thereafter, the required minimum distribution is due by the last day of subsequent calendar years. Correction necessitated the required distribution made and included into the participant’s current income prior to the close of our examination.
- Excess Distribution (IRC §415(b)): Defined benefit plans are limited to a maximum distribution amount based on the IRC §415 (b) limits. Essentially, benefits paid cannot exceed the maximum benefit permitted by law (and plan provisions). Correction involved return of the excess to the plan.
- Eligibility Failures: This issue involved the failure to include eligible employees as participants in accordance with plan terms. The employer inadvertently applied, in operation, a one year of service requirement, even though the plan required immediate participation (i.e., no service requirement). The point to address here is the need to be aware of plan terms and ensure that they are followed in operation. Correction required restorative contributions plus lost earnings made by the plan sponsor to the trust on behalf of the improperly omitted participants.
- Inadequate Bonding: This issue involved inadequate bonding under ERISA Act §412. Correction involved the securing of adequate bonding. Bonding of plan fiduciaries and persons, who handle pension funds, is required by Title I of ERISA, unless one of the limited exceptions is met. The amount of bonding should not be less than ten percent of the amount of funds handled, but in no event less than $1,000, nor more than $500,000. However, with respect to a plan that holds employer securities, the upper level of the amount of bonding is increased from $500,000 to $1,000,000.
- Actuarial Calculation Errors: The failure involved errors with the actuarial calculations. Errors including valuing assets at less than fair market value and normal cost calculation errors. However, fortunately, these errors had no impact on deduction or minimum funding for any of the plans involved.
- SEP Plan Non-Amender: This project was not intended to include SEPS, however; a SEP plan improperly filed a Form 5500 and was selected for examination in this project. The SEP plan deficiency involved the issue of not amending timely for EGTRRA. The first item in the SEP Fix-It Guide explains how to find, fix, and avoid this error.
Avoiding the Errors:
Discuss with your plan administrator or pension professional steps taken to ensure proper plan administration. Setting up operating procedures and appropriate internal controls for the plan and/or related trust is an important first step. If you need help, a benefits professional can help you set up a system that works for you and your retirement plan.
Consider an internal self-audit or review to ensure that the plan is being operated in accordance with plan terms. In addition, please reconcile any deduction taken on the plan sponsor’s tax return with contributions made. This reconciliation should not only verify the amount and timing of contributions made, but also verify that such contributions are in accordance with plan terms and within the maximum deductible limits. In addition, you should ensure that all returns related to the plan and trust’s operation are filed in a timely manner. For example, if nondeductible contributions are made and not timely corrected, the employer is required to file the Form 5330 excise return with the applicable 10% excise tax, as well as ensure that that the excess contribution is not improperly deducted on the plan sponsor’s tax return.
If during a self-audit or other means, you discover that your plan was not operating in accordance with written plan provisions or in accordance with applicable laws and/or regulatory requirements and your plan is not “under audit”, then you should consider availing yourself of our Employee Plans Compliance Resolution System (EPCRS). EPCRS can also be utilized if you determine that your plan was not amended timely, in form, to comply with certain law and/or regulatory changes. This page also contains links to assist you in finding, fixing and avoiding common plan errors.
IRC §404 (Deduction Limitations):
IRC §404 provides limitations on the maximum amount of deduction allowed each tax year and the timing for making deductible contributions to qualified pension plans. This maximum is set forth in IRC §404 and is a function of many items, including, but not limited to, the type of plan, the plan formula, the participants’ compensation and years of service. For defined benefit plans, the actuarial report, including its integral assumptions and calculations, will help determine the maximum deduction.
IRC §4972 (Tax on nondeductible contributions to qualified employer plans):
IRC §4972 provides that nondeductible contributions (not timely corrected) made to qualified plans are subject to an excise tax equal to 10% of the nondeductible contribution (determined as of the close of the taxable year of the employer). This is a cumulative amount and due until corrected or otherwise deductible in a subsequent year. Forms 5330 should be filed to report any nondeductible employer contributions, along with the payment of the applicable 10% excise tax.
For purposes of this excise tax, note that any excess contribution for a taxable year that is distributed back to the employer on or before the due date for filing the taxable return plus extensions, as provided in IRC §404(a)(6) for such taxable year, may be disregarded.
Note that this excise tax is in addition to an adjustment to the plan sponsor’s tax return to disallow the excess deduction.