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CCH® PENSION — 04/29/11

Failure To Amend For EGTRRA Causes Disqualification Of Profit-Sharing Plan

from Spencer’s Benefits Reports: Failure to amend a profit-sharing plan to reflect recent tax law changes results in disqualification, even for a one-person plan, ruled the U.S. Tax Court in Christy & Swan Profit Sharing Plan v. Commissioner (T.C. Memo. 2011-62, March 15, 2011).

On Jan. 1, 1976, David S. Swan Jr., established the Christy & Swan Profit Sharing Plan. The company was the plan sponsor and administrator. Mr. Swan was the trustee of the plan and its only participant during the years in dispute. The plan received a favorable determination letter from the Internal Revenue Service on Sept. 24, 1986.

In 2000 and 2001, Congress enacted changes to pension law that required plan sponsors to amend their plans to remain in compliance: the Community Renewal Tax Relief Act of 2000 (CRA), appendix G of the Consolidated Appropriations Act of 2001, and the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). The Christy & Swan Profit Sharing Plan was not amended to comply with these three law changes.

An IRS audit of the plan in June 2007 resulted in a series of letters concerning the qualification of the plan. In one letter, Mr. Swan asserted that the plan had ceased to exist and that the plan had matured into a “repository trust,” having discontinued contributions and the admission of new participants. His letter stated that “As such, any subsequent rules or laws applicable to profit sharing plans are not applicable as this Plan ceased to be a Profit Sharing Plan as of 1/1/01.” (The plan had filed a Form 5500-EZ for its 2005 plan year.)

The IRS revoked the qualification of the plan on Sept. 16, 2009, for the plan year ending Dec. 31, 2001, and for all subsequent years. The plan then sought a declaratory judgment from the Tax Court in order to keep its qualification.

Court Upholds Disqualification

The plan argued that the IRS could not disqualify the plan for 2005 and earlier because IRC Sec. 6501(a) prescribes a three-year statute of limitations. The Tax Court rejected this assertion, stating that there is no statute of limitations on the IRS’s “broad authority to audit retirement plans and, if appropriate, to revoke retroactively a favorable determination letter…” because it did “not involve the imposition of any tax.”

The Tax Court pointed out that the plan had not actually been terminated. While Mr. Swan said that contributions had been discontinued, no official plan termination date had been established. “Rev. Rul. 69-157, C.B. 1969-1, 115, provides that a trust which is part of a qualified plan—and has not been formally terminated—may retain its tax-exempt status despite the fact that contributions have been discontinued. Because no formal termination occurred, the plan was still required to comply with the requirements of Sec. 401(a) in order for the plan to be eligible for continued favorable tax treatment.”

Mr. Swan admitted that the plan had not been amended, but argued “that because the plan was so simple, there was no need to amend the plan for statutory changes that would have had no effect on the operation of the plan.” The Tax Court disagreed. “The evaluation of the plan’s failure to amend to meet statutory changes must be made in the context of what might have happened, not what actually occurred, during the years in issue.”

The Tax Court concluded, “The requirements that a plan must satisfy for qualification under Sec. 401(a) must be strictly met. Vague, general references in plan correspondence to such requirements are insufficient.”

For more information on this and related topics, consult the CCH Pension Plan Guide, CCH Employee Benefits Management, and Spencer's Benefits Reports.

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