Employee Plans Compliance Unit (EPCU) – Interim Report – Minimum Funding Deficiencies Project - What We Have Learned So Far (2005-08)
The Employee Plans Compliance Unit (EPCU) Minimum Funding Deficiencies project began in May 2005. The Project began after the Treasury Inspector General for Tax Administration (TIGTA) issued a report recommending an increased focus on monitoring and correcting funding deficiencies. This interim summary report relates to project cases from 2005, when this project began, until 2008.
The Project goals were to determine if the:
- Reported funding deficiencies still existed, and if yes, to secure correction,
- Applicable excise taxes were reported and paid, and
- Sponsors filed for funding waiver, plan termination with IRS or PBGC, or bankruptcy.
This information helps Employee Plans have a better understanding of qualified plans and assists with development of compliance tools, guidance and enforcement efforts.
Early in the Project, responses showed that:
- Funding deficiencies mostly resulted from the 1½ month timing gap between the due date for filing a Form 5500 series return and the due date for plan contributions, and
- Closures were mostly full correction with funding deficiencies eliminated, excise taxes paid and Forms 5330 secured.
As the economy declined, responses showed many more funding deficiencies without full correction. The main reasons for this shift from timing differences to actual funding deficiencies were:
- Increased funding requirements caused by plan investment losses and devaluation of assets, especially for defined benefit plan sponsors, and
- Inability to meet funding requirements because of reduced plan sponsor income.
We also found that:
- Most of the contacted sponsors took their funding responsibilities seriously. This attitude was reflected in every category of sponsor whether large, small, public or private, etc.
- Sponsors explored many avenues to fulfill their funding obligations because they valued the promises made to their employees.
- When asked about why they didn’t terminate their plan, the most common response was sponsors thought the economy would turn around shortly and felt confident they would be able to correct and meet their funding responsibilities. Some sponsors also said they didn’t know they could terminate their plan.
A minimum funding deficiency occurs when the employer contribution is less than the minimum funding requirements for the plan year when the sponsor files the Form 5500 series return. In most cases, a funding deficiency results from the sponsor’s failure to:
- Calculate the correct funding requirements, or
- Pay the plan contribution timely.
A timing difference exists between the due date of the Form 5500 series return and the due date for the final timely plan contribution in regards to the minimum funding requirements. The due date for the Form 5500 series return is generally by the last day of the 7th month after the plan year end or up to 2 ½ months later, if on extension.
The period to make timely contributions to a plan is within 8 ½ months after the end of a plan year; beyond the due date for filing the Form 5500 series return if it is not on extension. Sponsors may therefore appear not to have met the minimum funding requirements when timely filing their Form 5500 series return, even though they actually comply with the minimum funding requirements.
When a plan has a funding deficiency, Internal Revenue Code (IRC) section 4971(a) imposes an excise tax of 10% (5% for multiemployer plans) of the unmet funding requirements at the end of the plan year regardless of mitigating circumstances. This excise tax is not subject to waiver. If the sponsor has not corrected the funding deficiency within the taxable period, IRC section 4971(b) imposes a 100% excise tax on the funding deficiency.
The plan sponsor (employer) reports IRC section 4971 excise taxes on Form 5330, Return of Excise Taxes Related to Employee Benefit Plans, for the sponsor’s tax year-end. The Form 5330 is due by the later of:
- 7 months after the end of the employer’s tax year, or
- 8 ½ months after the last day of the plan year that ends with or within the employer’s tax year.
Prevention and Correction of Errors
The EPCU published a Project article on preventing and correcting minimum funding deficiencies in the Employee Plans News. See The EPCU Insider – Funding Deficiencies Project, March 23, 2011 (Issue 2011-4).
We designed the Project to learn whether plan sponsors that reported funding deficiencies of $5,000 or greater on their Form 5500 series return took appropriate action to correct those deficiencies. The Form 5500 series return is the annual information report used by IRS, Department of Labor (DOL) and the Pension Benefit Guaranty Corporation (PBGC) to monitor compliance with pension plans. It includes Form 5500, Annual Return/Report of Employee Benefit Plan, Form 5500-EZ, Annual Return of One-Participant (Owners and Their Spouses) Retirement Plan and Form 5500-SF, Short Form Annual Return/Report of Small Employee Benefit Plan.
We asked over 5,000 plan sponsors for information about their plans to learn whether they were complying with their annual reporting and plan qualification requirements. If a sponsor didn’t correct the funding deficiency, we took action to secure correction including payment of excise tax.
When sponsors don’t comply with their minimum funding requirements, the potential exists for decreased benefits for plan participants and increased likelihood of:
- Minimum funding waivers,
- Discrimination in favor of highly compensated employees,
- Plan disqualification for failure to follow the terms of the plan,
- Plan terminations, and
- Abusive tax avoidance.