Oct 25, 2009


Installing a qualified plan can be fairly complex, particularly if the plan is complicated and the employer wishes to maximize the tax benefits by having the plan effective at the earliest possible date.

Adoption of the Plan

To be effective during a particular year, the plan must be adopted by the employer during that year. For a corporation, the corporate board should pass a resolution adopting the plan before the end of its year for the plan to become effective during that year. It is not proper to back date documents for this purpose—the board must actually act legally before the end of the year. It may not be necessary to draft the final form of the plan at this time; however, the board usually can adopt a resolution merely outlining the basic provisions of the plan. If the plan uses a trust, the trust must be established before the end of the year in which the plan is to be effective. This means that a trust agreement must be executed between the employer and the trustee, and at least a nominal principal contribution may be necessary to establish the existence of the trust. If the plan uses an insurance contract as a funding instrument, the insurer must have accepted the terms of the agreement before the end of the year, although the contract may not be put into final form until sometime later. The plan and insurance contract should be finalized prior to the time the employer makes its first plan contribution other than a nominal contribution required to establish the trust or insurance contract; this usually means the employer's tax filing date, the plan contribution for a given year can be deferred to the tax filing date for that year.

Plan Year

It is possible to establish a plan with a plan year that is different from the employer's taxable year. In that case, one plan year will end and another will begin in the same taxable year of the employer. The employer can then take a deduction that taxable year for a contribution on behalf of either plan year or for partial contributions for both taxable years; however, the employer must follow a consistent procedure so there is no undue tax benefit. For simplicity, it will be assumed that the plan year is the same as the employer's taxable year.

Advance Determination Letters

A central feature of the plan installation process is usually an application to the IRS District Director for a determination letter stating that the plan as designed is a qualified plan eligible for the accompanying tax benefits. It is not necessary for the plan to have such a letter to be qualified; any plan that complies with the applicable Code provisions is a qualified plan. However, if there is no advance determination by the IRS, the IRS will not examine the plan until the time comes for an audit of the employer's tax returns. If the IRS finds at that time that the plan is not qualified, the possible tax consequences can be disastrous: the loss of the employer's tax deductions for plan contributions, the taxation of all plan contributions to participants, and the loss of the trust's tax-exempt status. To avoid this, most employers consider it desirable to have the IRS review the plan in advance and issue a determination letter. There are some other advantages to the determination letter procedure. The process of IRS review will often reveal drafting problems that might otherwise have gone unnoticed. During the review procedure, the IRS usually suggests any changes in the plan that are necessary to make it qualify.

There is a retroactive amendment procedure that allows the employer to make amendments to the plan effective for a prior year if the amendments are necessary to make the plan qualify. In general, retroactive plan amendments may be made up to the employer's tax filing date for the year in question, plus extensions. For example, if a corporate employer uses a calendar year, the tax filing date for the year 2000 is March 15, 2001, with possible extensions to September 15, 2001. Thus, an employer could install a qualified plan effective January 1, 2000, and could amend the plan retroactively to January 1, 2000, as late as September 15, 2001. The filing of a determination letter prior to this deadline extends the retroactive amendment procedure while the determination letter request is pending—this is another advantage of requesting an IRS determination letter.

Generally, the employer wishes to make the plan effective as early as possible to obtain the maximum tax deduction at the outset. This can present a problem if, on filing the application for determination, the IRS finds the plan not qualified and retroactive amendments are unavailable or the employer does not wish to make the amendments the IRS suggests. The employer's prior contributions to the plan then might not be retrievable because the trust generally must be an irrevocable trust. To avoid this problem, the plan can be drafted making the plan's existence and the employer's contribution contingent on obtaining a determination letter.

The IRS provides various forms for purposes of making an application for determination. Some of these are described in the checklist. IRS publishes an annually revised Revenue Procedure that prescribes the requirements for an Application for Determination.

One final point should be made concerning IRS determination letters. Determination letters indicate that the IRS has approved the plan on the basis of the plan documents and the facts submitted to it. They are no guarantee that the plan qualifies and will continue to qualify if these facts are not accurate or if the facts change at a subsequent date. Therefore, the continuing qualification of the plan must always be a concern of the employer and its employee benefit advisers.

Master, Prototype, and Pattern Plans

A qualified plan must be evidenced by a formal written document. Because of the many complex provisions that must be included, it is not unusual for such documents to run to 50 pages or more. If all of the plan language is custom designed, the drafting expense alone can be considerable.

Various methods have been devised to simplify plan drafting for smaller employers. One of the most common is the use of master and prototype plans offered by financial institutions and other types of plan advisers. A prototype plan is a standardized plan form, such as a prototype profit-sharing plan or a prototype money-purchase pension plan, usually offering some choice of provisions in the important features. For example, the plan might allow the employer to specify the contribution rate or choose the vesting schedule. A master plan is similar to a prototype plan, but the term master plan usually refers to a plan form designed by a financial organization and adopted only by employers that wish to use that financial organization for plan funding. The IRS also allows law firms to use pattern plans; these are plans using language that has been examined and approved by the IRS, thus allowing speedier IRS approval of plans to the extent they use the pattern language. Also, most qualified plan consultants use standardized plan language of one kind or another to a considerable extent to reduce drafting costs, even if they do not provide formal master, prototype, or pattern plans.


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