IRS Revises Procedures for Determination Letters
Most of our clients have adopted a retirement plan on a document that has been pre-approved by IRS (including prototype plans and volume submitter plans). Clients that adopt pre-approved plans may either (i) rely on the IRS opinion letter issued to the sponsor of the pre-approved plan (generally BCG), so long as the employer does not make any significant change to the pre-approved document, or (ii) file for an individual determination letter on their plan (regardless of whether they make any changes to the pre-approved plan). Most clients choose not to request an individual IRS determination letter for their plan. Although clients that do not make any modifications to a pre-approved plan (other than to check existing boxes or select among pre-approved options) may technically rely on the IRS opinion letter issued to the sponsor of the pre-approved document, some clients elect to pay the relatively small ($300) user fee and apply for their own individual determination letter (using Form 5307).
Once every six years, there is a 24-month period during which a client may adopt the latest version of the sponsor’s prototype plan and submit that plan to the IRS for the employer’s own determination letter. Clients that have adopted an individually designed plan (as opposed to e pre-approved plan) may request a determination letter generally once every five years according to a cycle that is dependent on their tax identification number.
As a result, even as more clients adopt pre-approved plans, and even though clients may file for determination letters only every five or six years (depending on whether the plan is an individually designed plan or a pre-approved plan), the IRS is still receiving more determination letter applications than it can handle.
Under new procedures announced by IRS, some clients will no longer be able to apply for (or receive) determination letters with respect to their plans. The most significant change is that, effective May 1, 2012, the only adopters of pre-approved plans that may request a determination letter will be adopters of “volume submitter” plans that modify the terms of the pre-approved specimen plan. If modifications are not so extensive as to cause the plan to be treated as an “individually designed” plan, a short form may be filed with a modest IRS user fee of $300. If the modifications are more extensive, the plan is considered an individually designed plan which must then be filed on a longer form with a more expensive IRS user fee of $2,500. In addition, certain prescribed changes will require submission of the longer form (and payment of the larger fee) regardless of the extent of those changes.
Thus, clients that adopt a prototype plan, and clients that adopt a volume submitter plan without modification, will no longer have the option of applying for or receiving a determination letter on their plans.
Clients may, however, rely on the IRS opinion letter issued to BCG or our document sponsor. According to the IRS, this “reliance” will provide the same level of protection as an individual determination letter.
The second important (but less significant) change is that, for applications filed after the date(s) described below, the IRS will no longer provide a determination (as part of the review process) as to whether the plan satisfies the minimum coverage rules, the nondiscrimination rules, or the minimum participation requirements (which applies solely to defined benefit plans). Currently, clients filing for determination letters have the option to complete an additional schedule and the accompanying demonstrations and thereby request a ruling, based on those demonstrations, that the plan satisfies the applicable coverage and/or nondiscrimination requirements of the Code. In our experience, however, most clients do not complete this schedule Q (and pay the higher user fee) to obtain these rulings, primarily because the ruling is good only so long as the employer’s demographics do not change (i.e., the plan must still demonstrate, each plan year, that it covers a sufficient percentage of the employer’s non-highly compensated workforce, and that contributions or benefits under the plan do not discriminate in favor of the highly compensated employees). According to the IRS, the need for this subsequent testing reduces the value of these optional determinations, so it no longer intends to offer this service. This change is effective for determination letter applications filed on or after February 1, 2012 (in the case of individually designed plans other than terminating plans), and for applications filed on or after May 1, 2012 (in the case of pre-approved plans and terminating plans).
The IRS hopes that these changes will both reduce the number of determination letter applications it receives and simplify its review of the applications it does receive. The change in IRS procedure is consistent with our view that they want clients to rely on IRS opinion letters issued to document sponsors.
Clients that want to continue to receive their own determination letters will have to use a volume submitter document and limit modifications to make sure that the changes are not so significant as to cause the plan to be treated as an individually designed plan. If that is not done the [plan will require the more expensive Form 5300 filing, and must be filed during the appropriate 12-month period to be considered an “on-cycle” filing.
In addition, because we are still early in the current 6-year cycle for pre-approved defined contribution plans, it will still be two to three years before the next “window” of time for clients to adopt and file applications for pre-approved plans.