If your organization lost its tax-exempt status, it’s no longer eligible to sponsor a 403(b) plan. You:
- must stop employer and employee contributions to your 403(b) plan,
- may apply for restoration of your organization’s tax-exempt status, and
- should correct your eligibility failure through the IRS Voluntary Correction Program (VCP) if you allowed contributions to be made to the 403(b) plan after your organization lost its tax-exempt status.
Common reasons for loss of tax-exempt status
A 501(c)(3) tax-exempt organization may become ineligible to sponsor a 403(b) plan if it loses its tax-exempt status because:
- it's been automatically revoked for not filing an annual Form 990 series information return for three consecutive years, or
- the IRS otherwise revokes or terminates its status.
In addition, a public educational system may no longer qualify as a public educational organization because of a reorganization or some other event.
Reinstatement of tax-exempt status if automatically revoked
Your organization can apply to the IRS for a reinstatement of its tax-exempt status only if it's been automatically revoked for failing to file Forms 990 in three consecutive years. If the IRS reinstates your tax-exempt status prospectively, but not retroactively, you should make a VCP submission if any type of contributions were made to the 403(b) plan after the organization lost its exempt status. If the IRS retroactively reinstates your tax-exempt status, you don’t need to make a VCP submission.
Consequences of plan sponsor ineligibility
If your organization is no longer eligible to sponsor a 403(b) plan and you don’t discontinue contributions:
- your organization may have to withhold and pay payroll taxes from the contributions, and
- plan participants may be liable for additional income tax because the contributions aren’t
To avoid these consequences, you can use the IRS Voluntary Correction Program under Revenue Procedure 2013-12.
Eligibility and conditions for using VCP - you can use VCP to protect the tax-favored status of the contributions made during the time you’ve lost your exempt status if:
- your organization or 403(b) plan isn't “under examination” by the IRS (Revenue Procedure 2013-12 Section 5.09);
- you've determined or received notice from the IRS that your organization’s 501(c)(3) exempt status won’t be reinstated, or you decided not to apply for reinstatement of your organization’s 501(c)(3) tax-exempt status;
- you've stopped making salary reduction and employer contributions to the 403(b) plan. Be sure you’ve complied with all other 403(b) plan rules, including the written plan requirement, universal availability, 403(b) distribution rules and any other requirement under IRC section 403(b) (Revenue Procedure 2013-12 Section 6.03); and
- you’ve ensured that the 403(b) contributions made after the organization’s lost exemption remain in the issued annuity contracts, or custodial accounts and aren’t distributed before one of the applicable distribution events in IRC Section 403(b).
Benefits - making a VCP submission benefits your organization and your 403(b) plan participants because:
- all contributions to the plan after your organization became an ineligible employer can remain in the 403(b) annuities or custodial accounts,
- participants’ accounts retain their tax favored status, and
- your organization avoids penalties.
To make a VCP submission - you must submit:
- Form 8950, Application for Voluntary Correction Program (VCP), and Form 8951, Compliance Fee for Application for Voluntary Correction Program (VCP), with the correct compliance fee based on the number of employees eligible to participate in the plan.
- Appendix C - Part 1 Model Compliance Statement and Acknowledgement Letter (IRS Letter 5265). (Note that you can’t use Schedule 6 for this type of employer eligibility failure.)
Important attachment filing reminders:
- Write your employer identification number, plan name and number on each attachment.
- Section II attachment - explain how your organization lost its exempt status, and state each year your organization wasn’t eligible to sponsor a 403(b) plan, and the amount of contributions that were paid to the plan during each of these years.
- Section III attachment - describe your proposed correction method. (Part of your correction must involve stopping all contributions from going into the 403(b) plan no later than the date you make your VCP submission.) In addition, your correction must indicate that the ineligible contributions will remain within the 403(b) annuity contracts or custodial accounts as discussed above.
- Section IV attachment - state your proposed methods to locate and notify former employees or beneficiaries (or include a statement that the failure didn’t affect and the correction won’t affect any former employees).
- Section V attachment - explain what changes you’ll make to your administrative procedures so that this failure won’t happen again.
- Include a separate attachment indicating the type of organization the plan sponsor is now or was previously and a statement that the organization has contacted all entities involved with the plan and has their cooperation to make the correction.
- Mail all documents plus attachments to:
First class mail:
Internal Revenue Service
P.O. Box 12192
Covington, KY 41012-0192
Express mail or private delivery service:
Internal Revenue Service
201 West Rivercenter Blvd.
Attn: Extracting Stop 312
Covington, KY 41011