IRS guidance on favorable determination letters for individually designed plans expected this summer
Yes, this summer we are expecting IRS guidance relating to changes in the determination letter program. The IRS has informally communicated a possible halt, beginning in 2016, to the issuance of IRS determination letters for individually designed retirement plans except for new plans or terminating plans. A formal announcement with details and an opportunity for comment is expected this summer.
Initially, this may sound like a beneficial change for employers because it eliminates a burdensome and costly process that individually designed retirement plans must generally undertake every five years.
But the potential negative impact of such a change is very concerning. While there is no federally regulated requirement to have favorable determination letters for each retirement plan, there are many good reasons for employers to seek them:
• Reliance on audit: By having a current determination letter, an employer has assurance that its plan language is tax-qualified. If a plan is audited, the employer can rely on the determination letter to prove the plan’s tax-qualified status.
• Approval of amendments to plan: Most plans are amended from time to time to incorporate new laws and optional plan provisions. A determination letter is important to demonstrate that the amended plan language meets the tax-qualified rules.
• Due diligence for corporate restructuring transactions: When corporate restructuring transactions such as mergers, acquisitions, or divestitures occur, it is prudent to obtain current determination letters to review the tax qualifications of the plans involved in the transaction.
Without the ability to secure a current determination letter, plan sponsors would not be able to confirm the tax-qualified status of their plans, thereby leaving them unprotected in the event the IRS finds the plan language to be noncompliant during a future audit. Such a finding could result in severe penalties.
Two types of plans that have been considered individually designed and for which an employer would generally seek a favorable determination letter are employee stock ownership plans (ESOPs) and cash balance plans.
Perhaps recognizing that it will be limiting the availability of determination letters for individually designed plans, the IRS has recently released guidance that would expand the preapproved plan document program to include ESOPs and cash balance plans. If an employer uses preapproved language without modifications, an employer would have reliance on the IRS opinion/advisory letter without the need for a favorable determination letter. Thus, employers with individually designed ESOPs and cash balance plans may want to consider converting their plans to preapproved plan documents in the future.
So, as we kick off summer, we are anxiously awaiting IRS guidance on the future of the determination letter program as well as watermelon, fireworks, and pool parties.