|Mistake||Find the Mistake||Fix the Mistake||Avoid the Mistake|
|1) Your organization isn’t eligible to sponsor a 403(b) plan.||Determine if your organization fits one of the eligible employer groups - public educational institutions or IRC Section 501(c)(3) charitable organizations.||Stop all contributions. Make a submission under the Voluntary Correction Program.||Understand what makes an organization eligible to sponsor a 403(b) plan and know if your organization meets one of the requirements.|
Only certain tax-exempt employers are eligible to maintain a 403(b) plan for eligible employees. Following is a list of employees eligible to participate in a 403(b) plan:
- Employees of tax-exempt organizations established under IRC Section 501(c)(3)
- Employees of public school systems involved in the daily operations of a school
- Employees of a cooperative hospital service organization
- Civilian faculty and staff of the Uniformed Services University of the Health Sciences
- Employees of public school systems organized by Indian tribal governments
- Certain ministers:
- Employed by a 501(c)(3) organization
- Ministers not employed by a 501(c)(3) organization, but functioning as a minister in their daily responsibilities with their employer, such as a hospital chaplain
IRC Section 170(b)(1)(A)(ii) defines a public school system as an educational organization that normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on. Included in this category are employees of:
- Public schools
- State colleges
Both faculty and non-academic staff (for example, custodial or maintenance staff) performing services for a public educational organization may be covered, but elected or appointed officials (holding positions in which persons that are not education professionals may serve) are not eligible. Members of the school board and university regents or trustees may not be eligible.
To be considered a tax-exempt organization established under 501(c)(3), the organization must apply to the IRS for a determination letter by filing Form 1023. There is an exception for filing for church and related organizations and other IRC Section 508 excepted organizations
How to find the mistake:
First, determine if your organization fits one of the groups of eligible employers. This may be simple if you’re a public school. If not, then you may need to determine if it’s a 501(c)(3) organization. This type of organization must have an IRS determination letter (unless organized before October 9, 1969). Some organizations may have a letter issued to a “parent” or as part of a group approval. If you've lost that determination letter or aren't certain your organization ever received a 501(c)(3) determination letter, you can check the Tax Exempt Organization Search for a list of organizations with determination letters. If your organization is not tax-exempt under IRC Section 501(c)(3), then it may not be eligible to sponsor a 403(b) plan.
Many mistakes in this area originate with hospitals that were at one time qualifying organizations until a for-profit company purchased them. A medical school associated with a hospital may meet the eligibility requirements. However, if the hospital is a for-profit company, it won't be a qualifying organization just because it's associated with a medical school. Other mistakes may occur when organizations exempt from tax under a different IRC 501(c) subsection adopt a 403(b) plan in error.
How to fix the mistake:
This mistake is an employer eligibility failure. The Voluntary Correction Program (VCP) is the only IRS correction program that allows you to fix the mistake voluntarily. If you determine the employer isn't eligible to sponsor a 403(b) plan, take the following steps to preserve the tax-deferred status of the contributions:
- Stop all contributions (including salary reductions) beginning no later than the date you file the Voluntary Correction Program submission.
- The assets must remain in the 403(b) plan and not be distributed prior to the occurrence of a distributable event listed in the plan (for example, retirement or separation from service).
- File a Voluntary Correction Program submission with the IRS.
MRC Hospital maintains a 403(b) plan for its 700 employees, all of whom were eligible to participate in the plan. The total current value of annuity contracts, and or, custodial accounts associated with the plan is over $500,000 but less than ten million dollars. MRC Hospital determined it doesn’t qualify as a public educational institution and it isn't an IRC Section 501(c)(3) tax-exempt organization. Therefore, it's not eligible to sponsor a 403(b) plan.
Organization ABC is a union organization that adopted a 403(b) plan in 2013 for its employees. At the end of 2018, it had 79 employees, all of whom were eligible to participate in the plan. Union organizations are generally tax-exempt under IRC Section 501(c)(5). Organization ABC is an ineligible employer because it isn’t a public school nor is it tax-exempt under IRC Section 501(c)(3). The total current value of annuity contracts, and or, custodial accounts associated with the plan do not exceed $500,000.
Correction programs available:
Plan sponsors may not correct this type of mistake under SCP.
Voluntary Correction Program:
MRC Hospital and Organization ABC, in Examples 1 and 2, may make VCP submissions to the IRS according to Revenue Procedure 2018-52 to resolve this failure if they are not under audit. User Fees for VCP submissions vary based on the amount of assets associated with the 403(b) plan. For 2019, the fee for MRC's VCP submission is $3,000 and ABC’s VCP fee is $1,500. VCP user fees may change in subsequent years.
Under the Voluntary Correction Program, MRC and ABC must:
- Stop all contributions (including salary deferrals) to the plan beginning no later than the date they file their VCP submissions, and
- Retain assets in the plan and not distribute them prior to the occurrence of a distributable event.
Plan sponsors are encouraged to make their VCP submission using the model documents, including Form 14568, Model VCP Submission Compliance Statement, and Form 14568-F, Model VCP Compliance Statement - Schedule 6: Employer Eligibility Failure (401(k) and 403(b) Plans only, when preparing the submission.
Audit Closing Agreement Program:
Under Audit CAP, correction is the same as described under VCP. The plan sponsor and the IRS enter into a closing agreement outlining the corrective action and negotiate a sanction that is not excessive, considers facts and circumstances; bear a reasonable relationship to the nature, extent and severity of the failures, based upon all relevant factors described in section 14 of Rev. Proc. 2018-52.
How to avoid the mistake:
You can avoid this mistake by having a better understanding of what makes an organization eligible to sponsor a 403(b) plan and knowing if your organization meets one of the requirements. After you make this determination, pay attention to any changes in your organizational structure that may make the sponsor ineligible.