4.71.21 Examination Procedures for Plans in U.S. Territories

Manual Transmittal

April 16, 2019

Purpose

(1) This transmits revised IRM 4.71.21, Employee Plans Examination of Returns, Examination Procedures for Plans in U.S. Territories.

Material Changes

(1) Incorporated the provisions of the October 5, 2018, Internal Guidance Memo (IGM) TE/GE-04-1018-0024 with the subject line Single Type of Examination issued by the Acting Director, Employee Plans into IRM section 4.71.21.1.2 and IRM 4.71.21.4.1. The IGM was effective the date it was issued and provides that examinations are no longer classified as either Field or OCE. The IGM’s result is a single type of examination. The examination’s location is determined by the agent and the front-line manager on a case by case basis.

(2) Enhanced IRM 4.71.21, 1, Program, Scope and Objectives, and the subsections thereunder, and added new section IRM 4.71.21.1.3, Program Controls, to provide more information on the internal controls regulating EP Examinations. Reorganized material for improved readability and uniformity with other EP, Examination IRMs.

(3) Changed name of IRM 4.71.21.1.4 from Acronyms and Forms to Acronyms, Abbreviations, Forms and Pubs and updated table names reflect the applicable contents.

(4) Fax numbers were eliminated throughout the document because of the removal of fax machines.

(5) Made editorial changes, including changes for Plain Language (the Plain Writing Act of 2010), throughout the document.

Effect on Other Documents

This supersedes IRM 4.71.21 dated May 23,2017.

Audience

Tax Exempt and Government Entities
Employee Plans
Examinations

Effective Date

(04-16-2019)

Robert S. Choi
Director, Employee Plans
Tax Exempt and Government Entities

Program, Scope and Objectives

  1. Purpose: IRM 4.71.21, Employee Plans Examination of Returns, Examination Procedures for Plans in U.S. Territories, gives the basic examination procedures to help Employee Plans (EP) agents and their managers to apply uniform techniques and procedures when examining plans in U.S. Territories.

  2. Audience: This IRM provides procedures for agents, managers, and support staff in EP Exam.

  3. Program Owner: Director, EP Examinations sets the program for the EP examination program.

  4. Program Authority: EP Examinations’ authority to conduct examinations, resolve issues and determine tax liability is derived from Title 26, Internal Revenue Code, Subtitle F – Procedure and Administration, which includes but is not limited to:

    1. IRC section 7602 - Examination of books and witnesses, which falls under Chapter 78 - Discovery of Liability and Enforcement of Title.

      Note:

      IRC 7602 provides agents with the authority to:
      * Audit any books, papers, records or other data necessary to complete an audit.
      * Take testimony under oath to secure additional information needed.
      * Issue summons for information necessary to complete an audit.
      * Ask about any offense connected to the administering or enforcing of the Internal Revenue laws.

    2. IRC section 6201- Assessment authority, which falls under Chapter 63 - Assessment.

      Note:

      EP Examinations’ authority to resolve issues is derived from its authority to make determinations of tax liability under IRC 6201.

  5. This IRM section is authored by EP Mandatory Review. For questions, information or suggestions, contact the manager of EP Mandatory Review

Background

  1. EP Examination is the division designated to determine if a retirement plan is qualified under IRC 401 and the underlying regulations, and therefore, exempt from tax under IRC 501.

  2. The Employee Plans examination program’s primary objective is regulatory, emphasizing continued qualification of employee benefit plans (Policy Statement 4-119 and IRM 1.2.13, Servicewide Policies and Authorities, Policy Statements for the Examining Process.) EP selects and examines returns to:

    1. Promote the highest degree of voluntary compliance with the tax laws on plan qualification.

    2. Determine qualified plans’ extent of compliance and the causes of noncompliance with the tax laws.

    3. Determine whether such plans meet the applicable qualification requirements in operation.

  3. Under Policy Statement 4-117, EP agents and managers are given broad authority to:

    1. Consider and weigh conflicting information, data, and opinions

    2. Use professional judgement according to auditing standards to make findings of fact and apply the IRS’s position on issues of law to determine the correct tax liability.

    3. Exercise this authority to obtain the greatest number of tax determination agreements without sacrificing the quality or integrity of those determinations and to dispose of tax differences at the lowest level. See IRM 1.2.13, Servicewide Policies and Authorities, Policy Statements for the Examining Process.

  4. All examinations are conducted according to Policy Statement 1-236, Fairness and Integrity in Enforcement Selection. See IRM 1.2.10.37, Policy Statement 1-236.

Overview

  1. There are five major U.S. territories:

    • American Samoa

    • Guam

    • Commonwealth of the Northern Mariana Islands (CNMI)

    • Puerto Rico

    • U.S. Virgin Islands (USVI)

  2. U.S. statutory laws generally apply to the U.S. territories. Generally, U.S. territory residents are full U.S. citizens. However, for tax purposes the IRC treats the U.S. territories as foreign countries.

    1. When the IRC uses the term in a geographical sense, the "United States" (U.S.) includes only the 50 states and the District of Columbia.

    2. Income derived from the U.S. territories is ordinarily treated as foreign source income and entities organized in the territories are generally treated as foreign persons.

  3. This IRM is a general overview of how to conduct an audit of qualified retirement plans in Puerto Rico and the USVI.

    1. The audit techniques and audit scope depend on the type of plan and the jurisdiction of the plan.

    2. The agent and manager determine the examination’s location for each case.

    3. Examinations may be assigned to you as part of the general examination program or from compliance checks. See IRM 4.71.26, Case Selection Criteria and IRM 4.71.22.2, Compliance Checks.

    Note:

    In the future, we’ll revise the IRM to include procedures to address the other U.S. territories.

  4. Unless noted otherwise, apply the general examination procedures in IRM 4.71, Employee Plans Examination of Returns, to the examination of plans in U.S. Territories.

Program Controls

  1. EP Examinations established two review groups to make sure agents conduct examinations per technical, procedural and administrative requirements:

    1. Mandatory Review, see IRM 4.71.14, Employee Plans Examination of Returns, EP Mandatory Review.

    2. Special Review, see IRM 4.70.7, Special Review (SR) and Tax Exempt Quality Measurement System (TEQMS) Procedures.

  2. Tax Exempt Quality Measurement System (TEQMS) is the quality control system TE/GE uses to oversee the entire examination program. For more information on TEQMS, see IRM 4.70.7, Special Review (SR) and Tax Exempt Quality Measurement System (TEQMS) Procedures.

  3. All examinations are done per the Taxpayer Bill of Rights as listed in IRC 7803(a)(3).

    Note:

    Find additional information at: Taxpayer Bill of Rights

  4. The IRS is fully committed to protecting the privacy rights of taxpayers and employees.

    1. Privacy laws are included in the IRC, the Privacy Act of 1974, the Freedom of Information Act, and IRS policies and practices.

    2. For more information about these laws, visit the IRS Electronic Freedom of Information Act Reading Room.

    3. For questions concerning privacy, email *Privacy. For question on disclosure, email *Disclosure.

Acronyms, Abbreviations, Forms and Pubs

  1. This manual uses the following acronyms and references the following forms.

    Acronyms and Abbreviations

    Acronym Definition
    AIMS Audit Information Management System
    BIR United States Virgin Islands Bureau of Internal Revenue
    CCR Case Chronology Record
    CECA Checksheet for Employee Plans Compliance Activities
    CNMI Commonwealth of the Northern Mariana Islands
    EP Employee Plans
    ERISA Employee Retirement Income Security Act of 1974
    FDAP Fixed or Determinable Annual or Periodic Income
    HCE Highly Compensated Employee
    IDRS Integrated Data Retrieval System
    IRC Internal Revenue Code
    IRM Internal Revenue Manual
    LB&I Large Business and International
    MOU Memorandum of Understanding
    POA Power of Attorney
    PRC Puerto Rico Code
    R&A Rulings and Agreements
    RCCMS Reporting Compliance Case Management System
    TE/GE Tax Exempt & Government Entities
    U.S. United States
    USVI U.S. Virgin Islands

     

    Forms and Pubs

    Form Name
    Puerto Rico Form 499R-2/W-2PR Comprobante De Retencion-Withholding Statement
    Form 1040 U.S. Individual Income Tax Return
    Form 1042-S Foreign Person's U.S. Source Income Subject to Withholding
    Form 1120-F U.S. Income Tax Return of a Foreign Corporation
    Form 5330 Return of Excise Taxes Related to Employee Benefit Plans
    Form 5500 Annual Return/Report of Employee Benefit Plan
    Form 5650 EP Examined Closing Record
    Form 8689 Allocation of Individual Income Tax to the U.S. Virgin Islands
    Form 8898 Statement for Individuals Who Begin or End Bona Fide Residence in a U.S. Possession
    Form W-2 Wage and Tax Statement

     

Key Definitions, Terms and References

  1. Bona Fide Resident: a person who satisfies both of the following requirements under IRC 937(a):

    1. Is present for at least 183 days during the taxable year in Guam, American Samoa, the Northern Mariana Islands, Puerto Rico, or the U.S. Virgin Islands, and

      Note:

      Use IRC 7701(b) rules to determine whether a person is present for any day.

    2. Doesn’t have a tax home (determined under the principles of IRC 911(d)(3) but not considering the second sentence of that section) outside the specified possession during the taxable year and doesn’t have a closer connection (determined per IRC 7701(b)(3)(B)(ii)) to the U.S. or another foreign country.

  2. Competent Authority: a tax treaty requires the designation of a Competent Authority for each country that is a party to the treaty.

    1. The respective Competent Authorities administer the provisions of the treaty.

    2. The Commissioner, LB&I acts as the U.S. Competent Authority to administer the operating provisions of tax treaties and interpret and applying these treaties.

    3. In interpreting and applying treaties, the Commissioner, LB&I acts only with the concurrence of the Associate Chief Counsel (International). See Delegation Order 4-12 (Rev. 2).

    4. See also IRM 1.2.43.12, Delegation Order 4-12.

  3. Control Test: one or more U.S. persons must have the authority to control all substantial trust decisions. U.S. persons include:

    • A citizen or resident of the U.S

    • A domestic partnership

    • A domestic corporation

    • Any estate (other than a foreign estate)

    • A domestic trust

  4. Court Test: a U.S. court must be able to exercise primary supervision over the trust’s administration. Only a court within the geographical U.S. is considered a court within the U.S.

  5. Domestic Corporation: a domestic corporation is a corporation that conducts its affairs in its home country.

    1. A company that conducts business in a different country from the one in which it was created is called a foreign corporation.

    2. For federal tax purposes, the IRS considers a corporation founded in any state or applicable U.S. territory and subject to that state or territory’s laws to be a domestic corporation.

      Example:

      A company both founded in and operating out of Florida and Puerto Rico is considered a U.S. domestic corporation.

      Example:

      A company founded in Canada is considered a foreign company in the U.S.

      Example:

      However, a subsidiary of a foreign company that was incorporated in the U.S. may be classified as a domestic corporation.

  6. Dual Qualified Plan: a U.S. sponsor’s plan with a trust in the U.S., may operate in Puerto Rico and cover Puerto Rico employees. The Dual Qualified Plan must satisfy both the requirements of IRC 401(a) and Puerto Rico Code (PRC) section 1165(a). The sponsor of a dual qualified plan may request under the IRS’ determination letter program a plan document review for compliance with applicable rules under IRC 401(a).

  7. Employee Retirement Income Security Act (ERISA):a federal law that sets minimum standards for most voluntarily established pension and health plans in private industry to provide protection for individuals in these plans.

  8. ERISA Section 1022(i)(1):a qualified trust is located in Puerto Rico and all of the participants are Bona Fide Residents of Puerto Rico. ERISA Section 1022(i)(1) qualified trusts are treated as exempt under IRC 501(a) as if they’re part of a qualified plan under IRC 401(a). The effect is to exclude the U.S. trust income that the Puerto Rico trust earned from U.S. taxation, even though the plan doesn’t satisfy IRC 401(a).

  9. ERISA Section 1022(i)(2): provides that Puerto Rico plan trusts are treated as exempt under IRC 501(a) if their sponsors make a prospective and irrevocable election for the plan to comply with all of the IRC 401(a) qualification provisions, except for the Trust Situs requirement. The plan sponsor can either:

    • Register the election with the "Director’s Representative of the IRS in Puerto Rico" (per 26 CFR 1.401(a)-50).

      Note:

      Since the position of Director’s Representative of the IRS in Puerto Rico no longer exists, the plan sponsor/administrator may send the election to the EP Exam group manager in Plantation, Florida (EP Exam Group Manager)

    • File an election as part of an application for a favorable determination letter. See #2 in the table in IRM 4.71.21.4 (2), Examination of Puerto Rico Plans.

  10. Fixed or Determinable Annual or Periodic Income (FDAP):. U.S. Source Income that isn’t effectively connected (per IRC 864(c)) with a U.S. trade or business. Pension distributions nonresident aliens receive are generally FDAP income under IRC 871(a) and IRC 861(a)(3).

    Note:

    See IRC 871(f) for exclusions of certain annuities from income.

  11. Foreign Person: includes:

    • Nonresident aliens

    • Foreign corporations

    • Foreign partnerships

    • Foreign trusts

    • Foreign estates

    • Any person that is not a U.S. person

    Note:

    U.S. person is defined in IRC 7701(a)(30).

  12. Form 499R-2/W-2PR: a Puerto Rican form used to report Puerto Rico employment tax.

  13. Form 1042-S: information report sent by the withholding agent to the payee (a Foreign Person that received income subject to withholding under IRC 1441).

  14. The Hacienda: the Puerto Rico Department of Treasury which oversees Puerto Rico’s administration of the tax laws and its determination letter program.

  15. Mirror Code System of Taxation. The territory adopts the IRC as if it were the territory’s code, except that the name of the territory is substituted for the U.S. and vice versa. The territories that use a Mirror Code System of Taxation are the USVI, Guam and CNMI.

  16. Plan Sponsor. A designated party, usually a company or employer, that establishes a retirement plan, such as an IRC 401(k) plan established for the benefit of the organization's employees.

  17. Residual Tax Liability: generally, Bona Fide Residents of the USVI don’t have to file with the U.S. for any tax year in which they are a Bona Fide Resident during the entire tax year, if they:

    1. Report and pay tax on their income from all sources to the USVI.

    2. Identify the source(s) of the income on the return.

  18. Section 933: most residents of Puerto Rico are U.S. citizens, but aren’t subject to U.S. federal income tax, except on income from non-Puerto Rico sources.

    Note:

    They may exclude salary earned from non-Puerto Rico sources deferred under a 401(k)-type plan, subject to limitations, as long as the plan is qualified by the Puerto Rico tax authorities (the Hacienda).

  19. Tax Coordination Agreement. Tax treaties or agreements allowing the Competent Authorities of the U.S. and the tax department of the relevant territory to:

    1. Exchange information

    2. Provide mutual assistance to prevent the evasion of tax and avoidance of tax

    3. Provide mutual assistance and training

    4. Improve tax administration procedures

  20. Trust Situs. The location where the trustee performs his or her duties of managing the trust.

  21. U.S. Citizen. Under the Fourteenth Amendment to the U.S. Constitution, the term U.S. Citizen includes:

    • A person born in the U.S. or a possession

    • A naturalized citizen

  22. U.S. Source Income. U.S. Source Income generally includes income effectively connected with either:

    • A trade or business in the U.S.

    • Passive U.S. Source Income.

  23. United States Virgin Islands Bureau of Internal Revenue (BIR). BIR is the Virgin Islands Department of Treasury which oversees the administration of the tax laws in the U.S. Virgin Islands.

  24. Worldwide Source Income. U.S. Citizens and resident aliens must report income from all sources within and outside of the U.S.

    1. For a U.S. Citizen or resident alien, the rules for filing income, estate and gift tax returns and for paying estimated tax are generally the same whether they are living in the U.S. or abroad.

    2. The Puerto Rican government taxes Puerto Rico residents on their worldwide income. Puerto Rico is part of the U.S. and most U.S. laws apply in Puerto Rico.

    3. However, for Puerto Rico residents:

    • Puerto Rico source income is generally exempt from U.S. individual income tax.

    • Income from sources outside Puerto Rico is subject to U.S. taxation.

Introduction to Retirement Plans Maintained in U.S. Territories

  1. Treatment of U.S. Territories under Title I of ERISA. For purposes of ERISA Title I, the term United States includes the U.S. territories. Even though the IRC doesn’t apply within the U.S. territories, the following ERISA Title 1 requirements do:

    • Minimum participation

    • Vesting and funding rules

    • Form 5500 filing obligations

    Note:

    This means the plans maintained in the territories are subject to DOL jurisdiction.

  2. Territory Tax System and Relationship to the U.S. Tax Code. The U.S. territories of American Samoa, Guam, the CNMI, Puerto Rico, and the USVI are generally treated as foreign for U.S. tax purposes, unless otherwise specified in the Code or related statutes.

    1. Each U.S. territory has a semi-autonomous territorial income tax system it administers.

    2. Each of the territories’ tax systems imposes income tax upon individuals (including U.S. citizens and residents) who are Bona Fide Residents of the territory or who have income from sources within the territory.

    3. Various Code sections generally allow Bona Fide Residents to exclude territory source income from federal gross income. These Bona Fide Residents generally file income tax returns with their U.S. territory taxing authority and, depending on the specific territory or source of income, may be exempted from having to file a federal income tax return with the IRS.

    4. The territories of Guam, CNMI and the USVI have a Mirror Code Section of Taxation to the U.S. By contrast, the U.S. territories of Puerto Rico and American Samoa have income tax laws that are similar to U.S. income tax laws, but that aren’t necessarily mirrored or directly linked to the Code.

  3. Tax Coordination Agreements and Mutual Agreement Procedures. The IRS has entered Tax Coordination Agreements with each of the five major U.S. territories allowing the IRS and the five territorial tax departments to do the activities in IRM 4.71.21.3 (3).

    1. Tax Coordination Agreements allow the U.S. Competent Authorities and the relevant territory to resolve, by mutual agreement, inconsistent tax treatment between the two jurisdictions.

    2. Mutual Agreement Procedures exist to settle issues where there is inconsistent tax treatment between the IRS and the U.S. territories’ taxing authorities. These issues usually involve allocations of income, deductions, credits, or allowances between related persons, determinations of residency, and determinations of the source of income and related expenses.

Examination of Puerto Rico Plans

  1. Retirement plans adopted by employers in Puerto Rico are generally similar to qualified plans adopted by employers in the U.S. (e.g., defined benefit, stock bonus, and profit sharing plans).

  2. There are three types of retirement plans covering residents of Puerto Rico that provide tax-favored benefits under U.S. law:

    Plan Type Plan Characteristics
    1.) Puerto Rico plans qualified in Puerto Rico only (ERISA section 1022(i)(1))
    1. If a Puerto Rico pension plan with a trust sited in Puerto Rico (or the U.S.) is exempt under PRC section 1081.01, and all the participants are residents of Puerto Rico, the trust is treated as exempt under IRC 501(a) as though it were part of a qualified plan under IRC 401(a). The effect of ERISA section 1022(i)(1) is to exclude a Puerto Rico trust’s income earned in the U.S., from U.S. taxation even though the plan is not qualified under IRC 401(a).

    2. Participants in, and employers maintaining, an ERISA section 1022(i)(1) plan aren’t generally eligible for favorable tax treatment under IRC 402 (re: the taxability of a beneficiary of an employees’ trust) or IRC 404 (re: deductions for contributions of an employer to an employees’ trust).

    3. Although these plans aren’t subject to IRC 401(a), they are subject to ERISA Title I. Compliance with Title I of ERISA is a qualification requirement under PRC section 1081.01(a)(9).

    4. Although these plans aren’t subject to the funding standards in IRC 412, IRC 430, and IRC 431, funding standards are imposed on these plans under similar provisions in ERISA Title 1.

    5. These plans would normally not be subject to IRS examination. However, sometimes a plan may have intended to be an ERISA section 1022(i)(1) plan, but due to a plan sponsor or administrator’s action, the plan would have to qualify under IRC 401

    2.) Puerto Rico Plans electing to comply with all of the IRC 401(a) qualification provisions, except for the Trust Situs requirement (ERISA section 1022(i)(2))
    A plan administrator can either register the election with the EP Exam group manager, or file an election as part of an application for a favorable determination letter at.
    IRS - TE/GE Employee Plans
    c/o Group Manager
    7850 SW 6th Court, Group 7650
    Plantation, FL 33324
    EFax: 855-273-3124

    Note:

    The EP Exam group manager is required to store a registered trust election in a database for ERISA section 1022(i)(2) elections and send Letter 5890 to the plan administrator acknowledging receipt.

    Note:

    See the instructions for Form 5300 to apply for a favorable determination letter.

    Under ERISA section 1022(i)(2), a Puerto Rico plan sponsor may make a prospective and irrevocable election for the plan to comply with all of the IRC qualification provisions, except for the Trust Situs requirement. The election:
    1. Enables the plan to cover both U.S. and Puerto Rican employees.

    2. Once made, is irrevocable and can’t be changed. Therefore, the plan must continue to qualify until it’s terminated and all assets have been distributed.

    3. Requires the plan to meet all IRC 401(a) requirements (other than the requirement that the trust be sited in the United States) at all times.

    4. The sponsoring employer can claim a deduction under the rules of IRC 404(a)(4).

      Note:

      If a trust would otherwise be exempt under IRC 501(a) except for the fact that it is created or organized outside the U.S., contributions to that trust by an employer that is a resident, corporation, or other entity of the U.S., are deductible per IRC 404(a) if otherwise be deductible.

    5. Makes the plan subject to audit by the IRS just like any other plan in the U.S. following the same procedures, including focused examinations.

    3.) Dual Qualified Plans (Puerto Rico Plans Required to Satisfy both Puerto Rican and U.S. Law)
    1. U.S. based employer with the trust situs in the U.S. covering Puerto Rican employees.

    2. Must satisfy both the requirements of IRC 401(a) and PRC section 1081.01(a).

    3. Sponsor may have its plan document reviewed for compliance with IRC 401(a) under the IRS’s determination letter program. The standard of review is the same as for any other plan submitted with the intent to be determined to be qualified under IRC 401(a).

      Note:

      An EP Determination specialist may make a referral to EP Exam for operational defects found during the determination letter process.

    4. Because the trust of Dual Qualified Plan is sited in the U.S., it’s exempt from taxation under IRC 501(a) as long as the related plan satisfies the qualification requirements of IRC 401(a), similar to any other qualified plan/trust. However, if the plan is required to satisfy any PRC requirements that contradict the requirements of IRC 401(a), its qualified status under the Code might be jeopardized.

      Note:

      This is most likely to happen with an IRC 401(k) plan, due to different definitions of a highly compensated employee (HCE under IRC 414(q)), different methods for determining excluded employees under coverage testing, different dollar amounts that can be deferred, and different correction methods for failing the actual deferral percentage (ADP under IRC 401(k)(3)(A)) test.

    5. Employers sponsoring these plans may claim deductions for plan contributions to the extent allowed under IRC 404.

    6. Subject to examination by EP Exam.

  3. A Puerto Rico trust is considered a foreign trust under IRC 7701(a)(31)(B) and the corresponding regulations.

    1. However, a Puerto Rico trust that meets the requirements of either ERISA section 1022(i)(1) or (2) is treated as exempt under IRC 501(a) as though it were a U.S. trust. The trust isn’t subject to the tax withholding requirements under IRC 1441 unless distributions are made to participants.

      Note:

      IRC 1441 and IRC 1442 impose withholding requirements on income that nonresident aliens and foreign corporations receive from sources within the U.S. A withholding agent must withhold 30 percent of any payment of an amount subject to withholding made to a payee that is a Foreign Person (26 CFR 1.1441-1(b)).

    2. Because of ERISA section 1022(i), the trust of a Puerto Rico plan may be exempt from taxation on its U.S. investments regardless of whether the plan is treated as qualified under U.S. law.

  4. If a Puerto Rico trust doesn’t meet the requirements of either ERISA section 1022(i)(1) or (i)(2), it’s taxable in the U.S. on certain U.S. source income and subject to withholding under IRC 1441.

  5. A Puerto Rico retirement plan must qualify under IRC 401(a) for the trust to be tax-exempt if any of the following apply:

    1. It has a trust in the U.S., since it would be considered a dual qualified plan.

    2. It has employees who live in the U.S. since they are not residents of Puerto Rico.

    3. It made an ERISA section 1022(i)(2) irrevocable and prospective election for the plan to comply with all of the IRC qualification provisions (except that the trust is located in Puerto Rico).

  6. Unlike U.S. plans, all plans intending to qualify under PRC section 1081.01(a) must apply for a determination letter under the program administered by the Hacienda.

  7. Excise taxes that apply to plans qualified under IRC 401(a) (for example, excise tax under IRC 4971, IRC 4975, etc.) also apply to Dual Qualified Plans and ERISA section 1022(i)(2) plans.

    Note:

    These taxes do not apply to ERISA section 1022(i)(1) plans.

  8. IRC 402(d) allows participants in ERISA section 1022(i)(2) plans (but not section 1022(i)(1) plans) to enjoy the favorable tax treatment permitted under IRC 402 for qualified plan participants.

    Note:

    A trust that would be exempt under IRC 501(a) except for the fact that it is created or organized outside the U.S. is treated as if it were exempt under section 501(a)(IRC 402(d)).

  9. An individual who is a Bona Fide Resident of Puerto Rico for the entire taxable year, generally, may exclude Puerto Rico source income from gross income (IRC 933(1)).

    1. Individuals can exclude any distributions from a retirement plan from income for U.S. tax purposes if the income is derived from Puerto Rican sources.

    2. Individuals receiving plan distributions from both U.S. and Puerto Rican sources must determine the source of the income to calculate how to tax the distribution.

    3. The exclusion is available regardless of whether:

    • the plan is qualified under IRC 401(a) or the PR Code.

    • the sponsor has made an ERISA section 1022(i)(2) election.

Puerto Rico Plans - Pre-audit Analysis

  1. Your examination’s scope and depth for a Puerto Rico plan depends on the type of plan you are examining. Discuss with your group manager whether your audit should be:

    1. Conducted at the Employer’s location.

    2. Full or limited scope.

  2. Use Letter 1346, Examination Initial Appointment or Letter 1474, depending on the examination location, as your initial appointment letter. Use of the Spanish version of the letter might result in a faster response.

  3. Request language translation services during the audit, if needed.

    Note:

    See IRM 4.71.21 Exhibit 1 at IRM 4.71 - Employee Plans Examination Exhibits for the Spanish version of Letter 1346.

    Note:

    See IRM 4.71.21 Exhibit 2 at IRM 4.71 - Employee Plans Examination Exhibits for the Spanish version of Letter 1474, Letter Requesting Additional Information.

    Note:

    See IRM 4.71.21 Exhibit 3 at IRM 4.71 - Employee Plans Examination Exhibits for the Spanish version of Letter 1562-D, Compliance Check Initial Contact Letter.

  4. Perform a pre-audit analysis for both focused examinations and full scope examinations as you would for any other Form 5500 exam. See IRM 4.71.1.6, Pre-audit Analysis.

  5. Review the Form 5500 to determine whether the plan is required to be qualified under IRC 401(a).

    Note:

    If the plan isn’t subject to IRC 401(a) requirements, (in other words, the plan is an ERISA section 1022(i)(1) plan), don’t examine it. Survey the case per IRM 4.71.7, Survey Returns.

    1. If Form 5500, line 8b lists code 3C, the plan sponsor is stating the plan is an ERISA section 1022(i)(1) plan (the plan isn’t intended to be qualified under IRC 401, IRC 403 or IRC 408).

      Note:

      Often plan sponsors/administrators erroneously leave this line item blank.

    2. If Form 5500, line 8b lists code 3J, the plan sponsor is stating that their plan is a U.S. based plan that covers Puerto Rico residents and is qualified under both IRC 401(a) and PRC section 1165.

      Note:

      Plan sponsors should use Code 3J when they made an ERISA section 1022(i)(2) election or their plan is a dual qualified plan. Often plan sponsors/administrators read the instructions on feature codes quickly or incompletely (example, they stopped reading as soon as they see "a plan that covers residents of Puerto Rico," and mistakenly use this code for plans intended to be ERISA section 1022(i)(1) plans only).

  6. Research Integrated Data Retrieval System (IDRS) and/or Tax Exempt Determination System (TEDS).

    Note:

    IDRS command code EMFOLL gives the plan’s effective date, the favorable determination letter issue date (if there is one), and the number of participants in the plan.

  7. Request the following documents in your initial appointment letter:

    • The plan document

    • The trust document

    • All amendments that relate to the year under examination and any subsequent amendment to date

    • Forms W-2

    • Forms 499R-2/W-2PR

    • Payroll register

    • Personnel records

    • Employee census data (including dates of hire, dates of birth, dates of rehire, dates of entry and dates of termination)

    • Letter 5890 (if applicable) as prepared by the EP Exam group manager (or designee) and mailed to the plan administrator to acknowledge receipt of the election to be treated as an IRC 401(a) plan. See the second Note in IRM 4.71.21.4 (2).

    • The most recent IRS determination letter that applies to the year(s) under examination and any special demonstrations submitted with your determination letter application

    • The most recent Hacienda favorable determination letter

      Note:

      Determination letters from the IRS are optional. However, the plan sponsor must request a determination letter from the Hacienda, as they are mandatory for all Puerto Rico plans covering at least one Puerto Rico employee.

  8. Ask the following questions in your initial interview to determine the type of plan:

    • Is the plan trust located in the U.S.?

    • Does the plan cover employees who live in the U.S.?

    • Have you made an election to qualify the plan under U.S. law?

    • Does the plan have a determination letter issued by the IRS?

    • Does the plan have a determination letter issued by Hacienda?

Examination of U.S. Virgin Island (USVI) Plans

  1. EP began auditing U.S. Virgin Island (USVI) plans in fiscal year 2010, as part of a Memorandum of Understanding entered between the IRS, TEGE and the USVI Bureau of Internal Revenue (BIR).

  2. Employers in the USVI generally adopt retirement plans similar to those adopted by U.S. employers (such as defined benefit, stock bonus, and profit sharing plans). IRC 401(k) plans are the most common.

  3. The IRS has concurrent jurisdiction with the BIR over USVI plans because of:

    1. The potential for a USVI trust to earn FDAP income on U.S. investments.

    2. Individuals potentially owing residual taxes to the U.S. if a USVI plan is no longer qualified under the USVI Code,

    Note:

    See also the Memorandum of Understanding (MOU) between the IRS and the BIR in 2010 on USVI plans.

    Note:

    Furthermore, because USVI plans are covered under ERISA Title I, they also fall within the audit jurisdiction of the U.S. Department of Labor.

  4. USVI plan sponsors may submit requests for determination letters to IRS EP Rulings and Agreements (R&A) in Cincinnati using the same procedures that apply to U.S. plan sponsors.

    1. EP R&A issues determination letters on whether a plan is qualified under the U.S. IRC.

    2. EP R&A doesn’t rule on qualification under the USVI Mirror Code System of Taxation; however, the USVI BIR may recognize the determination letter for qualification under the USVI Mirror Code System of Taxation.

  5. The number of USVI plans that have received a favorable determination letter is relatively small (less than 500). Remember that all USVI plans (whether or not they have a favorable determination letter) come under the IRS’s jurisdiction, as well as that of the BIR.

  6. BIR agents conduct most of the audits of USVI plans.

    1. EP rarely audits USVI plans (for examples include referrals, additional training initiatives, special projects, etc.)

    2. The BIR refers issues they find on audits to IRS EP and vice versa.

  7. Generally, any income tax adjustments and closing agreement sanctions are payable to the BIR, as opposed to the IRS.

    Note:

    When IRS collects income taxes and/or closing agreement sanctions collected by IRS, whether conducted unilaterally or jointly with a BIR agent, we turn them over to the BIR.

  8. If you discover a funding deficiency, the plan sponsor must correct it. However, neither the IRS nor the BIR is entitled to collect excise taxes under IRC 4971. See IRM 4.71.21.5.1, Income and Excise Tax Related to USVI Plans, for an explanation.

  9. Follow the procedures in IRM 4.71.1.6, Pre-audit Analysis, with one additional requirement. Your group manager contacts the BIR as a courtesy to allow them the opportunity to assign a trained agent to conduct the audit jointly.

  10. Request the same records you’d request for the same type of plan maintained by a domestic plan sponsor.

  11. Use the same interview questions as those for the same plan type maintained by a domestic plan sponsor.

  12. Auditing techniques and audit scope depend on the type of audit. Approach both the same as you would for a plan maintained by a domestic plan sponsor.

Income and Excise Tax Related to USVI Plans

  1. Income from the USVI is subject to taxation under a Mirror Income Tax System of Taxation (Mirror Code). Under the Mirror Code, the USVI adopts the U.S. IRC as if it were the territory’s code, except that the name of the territory is substituted for the U. S., and vice versa. So, plans under the USVI Mirror Code mirror the IRC’s:

    1. Income tax requirements

    2. Procedural rules

    3. Regulations and other interpretations of the USVI Code.

      Exception:

      Other parts of the IRC, including the estate and gift tax rules and excise taxes, aren’t mirrored.

  2. In general, U.S. citizens and residents pay tax to the U.S. on their worldwide income, regardless of where they reside or where the income is sourced. However, if you’re a Bona Fide Resident of the USVI, you file your return with and pay any tax due to the USVI.

  3. U.S. citizens and U.S. residents who are Bona Fide Residents of the USVI don’t owe income tax to the U.S. and aren’t subject to IRS reporting requirements (except for any residual tax described below). So, it’s important to determine whether an individual is a Bona Fide Resident to calculate tax liability.

  4. A Bona Fide Resident of the USVI, under IRC 937(a), is generally a person who meets all of these criteria:

    1. Is present in the USVI for at least 183 days during the taxable year

    2. Doesn’t have a tax home (per IRC 911(d)(3)) outside the USVI during the taxable year

    3. Doesn’t have a closer connection (per IRC 7701(b)(3)(B)(ii)) to the U.S. or a foreign country than to the USVI.

    Note:

    Taxpayers who change their residency status to or from the USVI have reporting requirement with the IRS (IRC 937(c)). They use Form 8898 for this purpose.

  5. A taxpayer is required to file identical income tax returns with both the U.S. and the USVI per IRC 932(b) if he/she is either a U.S. citizen or resident and not a Bona Fide Resident of the USVI and has:

    1. USVI source income

    2. Income effectively connected with the conduct of a trade or business in the USVI

  6. Taxpayers required to file in IRM 4.71.21.5.1 (5) above must:

    1. Submit Form 8689, along with the tax return when they file.

    2. Pay any tax due to the USVI (only). However, that tax is allowed as a credit against the individual’s U.S. tax liability.

  7. The effect of IRC 932(c) is that Bona Fide Residents of the USVI report their worldwide income to the BIR and don’t owe tax to the U.S. even on U.S. Source Income.

    1. However, filers who don’t report all of their income and the income source to the BIR lose their status as Bona Fide Residents of the USVI under IRC 932(c) and must:

      • File with both the BIR and the IRS as IRC 932(a) filers

      • Submit a Form 8689 and Form 1040 to the IRS on their U.S. Source Income.

    2. A Bona Fide Resident of the USVI isn’t subject to any U.S. filing requirement if he/she timely files an amended return with the USVI in order to correct a previously filed return with the USVI (as stated in final regulations under IRC 932(c) example).

  8. Distributions from an employee’s 401(a) trust are taxed at the time of distribution (IRC 402(a)). Participants in a plan that would be qualified but for the fact that the trust is sited in the USVI, are nonetheless eligible for the favorable tax treatment permitted under IRC 402 for qualified plan participants (IRC 402(d)).

  9. A corporation created or organized in the USVI is considered a foreign corporation and is required to file Form 1120-F for FDAP income from sources within the U.S. and income that is effectively connected with the conduct of a trade or business in the U.S.

    1. A USVI corporation doing business in the U.S. must file a return with:

      • The IRS to report its income from U.S. sources

      • The USVI to report its worldwide income and is permitted a foreign tax credit for tax paid to the IRS

    2. Likewise, a U.S. corporation doing business in the USVI must file a return with:

    • The BIR to pay tax on income from sources in the USVI;

    • The IRS to pay tax on its worldwide income, and is permitted to take a foreign tax credit for the tax paid to the USVI.

  10. Contributions to trusts that would otherwise be exempt under IRC 501(a) except for the fact that they’re created or organized outside the U.S. by an employer that is a U.S. resident, corporation, or other entity are deductible (IRC 404(a)(4)).

  11. By virtue of having a foreign trust, a USVI plan isn’t a qualified plan under IRC 401(a). Therefore,

    1. Excise taxes that apply to plans qualified under IRC 401(a) (i.e., excise tax under IRC 4971, IRC 4975, etc.) don’t apply to USVI plans.

    2. The IRS may not assess IRC 4971 or IRC 4975 excise tax (or other types of excise tax that apply to IRC 401(a) plans) for a USVI plan, because those excise taxes, by their terms, only apply to IRC 401(a) qualified plans.

    3. Because the USVI Code doesn’t mirror the IRC’s excise tax provisions, the USVI can’t levy those excise taxes on a USVI plan.

  12. The existence of an excise tax liability is nondisclosable under IRC 6103, thus the IRS can’t share any information about excise tax or a Form 5330 filed by a IRC 401(a) qualified taxpayer (when, for example, the employer has an entity sponsoring a IRC 401(a) qualified plan that filed a Form 5330 for a prohibited transaction which involved a related entity sponsoring a non-qualified USVI). However, the MOU between the IRS and the BIR allows the IRS to share certain related information, such as facts about an exclusive benefit violation or a prohibited transaction with the BIR to help the BIR administer the USVI Code’s mirror requirements (for example, correction of a prohibited transaction).

  13. It’s unclear whether U.S. citizens residing in one of the 50 states or the District of Columbia who work for an employer who has a USVI qualified plan may be excluded as nonresident aliens for IRC 410(b) and IRC 401(k)(3) tests.

    1. On the one hand, USVI residents born in the USVI are legally citizens of the U.S., and as such don’t fit the definition of a nonresident alien under IRC 7701(b)(1)(B) as an individual who is neither a citizen of the U.S. nor a resident of the U.S.

    2. However, under the principles of Rev. Rul. 73-315, 1973-2 C.B. 225, U.S. citizens who aren’t Bona Fide Residents of the USVI are treated as nonresident aliens under the USVI Code because the U.S. and the USVI are separate and distinct taxing jurisdictions. Rev. Rul. 73-315 was obsoleted by Rev. Rul. 92-103, 1992-2 C.B. 323, but it’s unclear if that means that Bona Fide Residents of the U.S. should now be considered nonresident citizens of the USVI for taxing and testing purposes.

    3. This question requires further research as it affects not only USVI qualified plans but also U.S. qualified plans maintained by employers with employees in any U.S. possession.

Closing Examinations of Retirement Plans Maintained in U.S. Territories

  1. Follow the procedures in IRM 4.71.1.22.1, Closing Procedures for Agreed Form 5500 Examinations, when you close an agreed case.

  2. Before you close the examination, have a closing conference with the taxpayer or taxpayer's representative (POA) either in person or by telephone. In the closing conference, inform and discuss with the taxpayer and/or POA:

    1. You’ve completed the audit.

    2. You’ll issue a closing letter.

    3. The years and returns covered by the letter.

    4. The issues you found during the exam.

    5. The actions taken to resolve the issues and prevent future occurrences.

  3. Document the case chronology record (CCR) that you held the closing conference and what you discussed.

  4. Complete any RCCMS field that appears in red when you "Validate for Close" in RCCMS. These fields correspond to the required items on Form 5650. See IRM 4.71.3.4.6, Completion of Form 5650 for instruction for completing Form 5650 for an unagreed case.

  5. Complete all of the appropriate RCCMS closing actions, making sure the "Update AIMS" box is checked.

  6. Follow the procedures in IRM 4.71.7, Employee Plans Examination of Returns, Survey Returns for surveyed returns.

  7. Follow the procedures in IRM 4.71.3, Employee Plans Examination of Returns, Unagreed Form 5500 Examination Procedures and EP Exam Closing Agreements for unagreed cases.

  8. Prepare the CECA Checksheet per IRM 4.71.1.22.5, Checksheet for Employee Plans Compliance Activities (CECA Checksheets).

  9. Prepare the applicable closing letter. Mail the letter per general EP examination procedures. See IRM 4.71.1.22.1, Closing Procedures for Agreed Form 5500 Examinations, for a list of applicable closing letters.

  10. Save all copies of workpapers, forms and letters you generated in the RCCMS Office Documents folder using the RCCMS Naming Convention. See IRM 4.71.1 Exhibit 2 at IRM 4.71 - Employee Plans Examination Exhibits for the RCCMS Naming Convention.

    Note:

    Documents scanned into RCCMS must be the final version of the document that includes the date and signature, if applicable. For example, the scanned exam closing letter posted in RCCMS, it must be the one dated and signed by the Director, EP Exam.

  11. Scan (if your group has a scanner) all relevant case related documents received from the taxpayer or POA and save them in RCCMS using the RCCMS Naming Convention.

  12. Groups in Great Lakes, Gulf Coast and Pacific Coast Areas close all agreed Forms 5500 on RCCMS and AIMS to:

    IRS
    TE/GE EP Special Support Processing
    31 Hopkins Plaza
    Room 1550
    Baltimore, MD 21201

  13. Groups in Northeast and Mid-Atlantic Areas close all agreed Forms 5500 on RCCMS and AIMS to:

    IRS
    TE/GE EP ESS Group 7697
    2 Metrotech Center
    100 Myrtle Avenue, 6th Floor
    Brooklyn, NY 11201