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Employee Plans Compliance Unit (EPCU) - Completed Projects - Project with Summary Reports – Small Plan 415 Limit Project

Small Plan 415 Limit Project  - Summary

The Employee Plans Compliance Unit (EPCU) Small Plan 415 Limit project began in February 2012 and ended in July 2012. Compliance contact letters were sent to 79 plan sponsors of defined contribution plans who filed an annual return (Form 5500-SF, or Form 5500-EZ) which  reflected contributions in excess of the Internal Revenue Code Section 415(c) limit. IRC Section 415(c) limits apply to each participant’s allocation of the plan contribution. Plan contributions in the aggregate were used to approximate participant allocations. If an allocation to any participant exceeds the IRC Section 415(c) limit, the trust is not qualified trust under Code section 401(a).

Results

The purposes of the project were achieved, although there were only two instances of IRC Section 415 violations. The project elevated a concern that IRS’ transcription process must be corrected if we want to use Form 5500-EZ series return information to determine whether or not a return should be examined and reasonably expect a change case. The knowledge of why no change codes occurred may be applied to implementing procedures so EP has better case selection.

The criteria for identifying IRC Section 415 violations is impaired by IRS transcription errors and preparer errors. Other impediments to choosing cases to identify this specific issue involve changing Form 5500-EZ and 5500-SF instructions and the addition of lines to the returns so the returns reflect information applicable to the plan year; i.e. returns should reflect accrual accounting.

There were 18 No Change closures, disposal code (DC) 16. The reason for the DC in each case was cash basis accounting gives the appearance of a Code section 415 violation. There were 17 Processing Error closures, DC 24. This does not include three cases with processing errors that were closed as agreed tax change cases. The most common IRS error was the addition of a digit to a contribution amount. There were 25 Taxpayer Error closures, DC 19. Two instances were directly attributable to difficulties encountered when using EFAST2, and four instances resulted because self-employed persons who sponsored 401(k) plans recorded all contributions as employer contributions instead of allocating them between employer and employee contributions.

There were 7 Agreed Tax Change closures, including one excise tax case and one employment tax case. The excise tax liability and three income tax liabilities were paid by sponsors who are sole proprietors. The additional employment tax liability was paid by a sponsor who files a Form 1120. (Self-employment tax was adjusted for self-employed persons, but their adjustments are recorded for this project as an income tax adjustment.) The adjustments were generally the result of coincidence instead of the attributes used for case selection; e.g. three cases that closed with an agreed tax change were selected for the project, because of an IRS transcription error.

Six cases were closed with DC 9, Referral to EP Exam. Two cases were referred to exam, because there was an appearance of an IRC Section 410 issue. Two referrals were made because the contributions to the plan could not be reconciled to the tax returns. One was referred, because there appears to be a IRC Section 415 issue based on tax filings, and the taxpayer’s inability to provide a response. Finally, one was referred, because the corporation is a non-filer, the employer’s deferrals were late.

One case was closed with DC 38, Voluntary Compliance. This taxpayer inadvertently violated IRC Section 415(c). The other taxpayer whose allocation exceeded the IRC Section 415(c) limit asserted the excess was allocated for the 2011 and met the conditions for SCP. The “SCP” case was closed as a referral for a deduction issue.

Recommendations include:

  1. Change the Instructions for Forms 5500-EZ and 5500-SF, so that taxpayers do not report two different plan years’ activity on a single return. Applying accrual accounting rules is consistent with allowing taxpayers to claim deductions in accordance with IRC Section 404(a)(6).
  2. Program logic checks into data entry and transcription programs.
  3. Add another section to our 401(k) Plan Fix-it Guide applicable to self-employed persons to explain the differences between IRC Sections 402(g) and 404(a)(3) and their limits as well as provide guidance regarding IRC Section 415 with regard to both of those limits.
  4. Program logic tests into our systems; e.g. Form 1040. Line 28 can be compared to 25% of a self-employed person’s earned income, and assume all Schedule C’s income should be included for the purpose of the calculation.

Background

Sponsors were asked to answer questions about their plan to determine if they had mistakenly made allocations that exceeded the IRC Section 415(c) limit. There were two purposes of the project:  

  1. to determine why the Form 5500-SF and Form 5500-EZ returns indicate a potential issue with regard to excess annual additions (macro view: results can be applied to help others avoid IRC Section 415 noncompliance and unnecessary contacts with IRS); and
  2. to assist taxpayers to understand their tax responsibilities (micro view: resolve IRC Section 415 violations for taxpayers who are part of this project).

The project goals were met, and focus points for EP were identified including recommendations to enhance compliance.

The project was designed to look at defined contribution plans with less than 100 participants; and determine if allocations exceeded the 415(c) limit. The plans in the sample were identified by the plan sponsor as having made contributions, which if assumed to be allocations for the plan year, would have resulted in allocations in excess of the IRC Section 415(c) limit.

A potential tax issue was envisioned as a possibility. The allowable deduction is limited to 25% of the sum of all eligible participants’ compensation, and $0 for that portion of the contribution that results in an allocation in excess of the IRC Section 415 limit.

The results from this project will enable EP to improve enforcement efforts.

Page Last Reviewed or Updated: 03-Nov-2014