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Publications | September 29, 2015
3 minute read

When is Less IRS a Bad Thing?

When the IRS stops issuing determination letters, that’s when!

The IRS is making changes in its “determination letter” program for 401(k) and other retirement plans. While this may not be front page news, the IRS’ move is going to have important implications for employers who sponsor 401(k) plans, pension plans and other similar programs.

The IRS has historically reviewed individually designed qualified plans and issued a “favorable determination letter” to the employer sponsoring the plan. This favorable determination letter then prevents an IRS auditor from reviewing the plan’s language during an audit. An auditor can still review the plan’s operation, but the determination letter stops any questions about the plan language in their tracks.

Now, the IRS has announced that it will no longer issue determination letters with respect to certain plans and has hinted that it may stop issuing determination letters for an even larger segment of the plan market in the near future.

The IRS’ move is ostensibly due to budget cutbacks affecting its ability to maintain historical service levels, but the IRS has also made the policy decision to shift the burden to employers to maintain a qualified plan and accept the risk of the plan not being qualified.

While at this point we cannot tell exactly how this will play out, we anticipate a number of consequences for our clients.

  • First and foremost, you won’t be affected at this point if you currently use the Warner volume submitter plan document, at least until the IRS further restricts the determination letter program.
  • IRS audits will likely become longer, more expensive and riskier for the employer. IRS auditors will now be able to second-guess plan language. If you receive notice of an upcoming IRS audit of your plan, contact your attorney immediately. Handling an IRS audit was never a do-it-yourself project, but now it becomes even more imperative to get an expert involved.
  • Contact your attorney about potential changes in your plan’s operation as far ahead of time as possible.
  • The cost of having an individually-designed plan will increase. The “cure” of using a prototype plan may limit your flexibility, and a prototype plan may be inadequate and therefore unavailable to larger employers and governmental entities, which tend to have more complex plans. (See http://www.wnj.com/Publications/Youre-Moving-to-a-Prototype-Say-It-Isnt-So).
  • If your plan covers union employees, you should consider adopting collective bargaining agreement language allowing the employer to unilaterally amend the plan to maintain its qualified status (but disavowing any obligation to do so).
  • Perhaps most importantly, if you are acquiring another entity, you will likely want significantly stronger representations and warranties regarding the target’s qualified plans, along with strong indemnification language in case its plan proves later to have contained disqualifying language. In fact, this development will probably increase the likelihood that the acquiring entity will force the acquired entity to terminate its plans prior to the acquisition. Conversely, if you are acquired, expect heightened scrutiny of your benefit plans, strict representations and warranties regarding their language and qualified status, and associated indemnification demands for problems with plan language.

So, unfortunately, this is one situation where less IRS is not a good thing.

Contact any member of our Employee Benefits Practice Group to help you navigate these IRS changes.