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CCH® PENSION AND BENEFITS — 7/13/06

Calculation of PT excise tax based on interest on untimely paid elective deferrals

For purposes of calculating the excise tax on prohibited transactions, the "amount involved" if an employer does not timely pay the participant deferrals or contributions to a 401(k) plan is based on the interest on those untimely deferrals, according to an IRS revenue ruling.

Failure to transmit contributions constitutes PT

In the fact situation outlined by the IRS, an employer sponsored a 401(k) plan and a portion of the pay of each employee was withheld in accordance with a cash or deferred election made by the employee. The aggregate amount withheld for all employees for the payroll period totaled $100,000. Although the employer could have reasonably segregated this amount from its general assets and transmitted it to the plan on December 8, 2004, it did not do so, and did not correct the failure until December 30, 2005. The interest rate for underpayments during that period was 5 percent.

The failure to transmit the contribution until December 30, 2005, constituted a prohibited transaction under Code Sec. 4975(c)(1) for both 2004 and 2005, the IRS ruled. Code Sec. 4975(c)(1)(D) prohibits a transfer of plan assets or income to a disqualified person or the use of plan assets or income by or for the benefit of a disqualified person. Code Sec. 4975(c)(1)(E) prohibits a plan fiduciary from dealing with plan assets in the fiduciary's own interest or for the fiduciary's own account.

Excise tax includes interest on unpaid deferrals

Code Sec. 4975(a) imposes an excise tax of 15% of the "amount involved" with respect to a prohibited transaction for each year in the taxable period. In the facts above, the amount involved for the 2004 prohibited transaction is interest on $100,000 from December 8, 2004 to December 31, 2004. The amount involved for the 2005 prohibited transaction is interest on the new balance owed to the plan after increasing the principal as a result of the failure to correct the 2004 prohibited transaction and is calculated from January 1, 2005 to December 30, 2005.

The taxable period for the 2004 prohibited transaction begins on December 8, 2004 and ends on December 30, 2005 (the date of the correction) and the taxable period for the 2005 prohibited transaction begins on January 1, 2005 and ends on December 30, 2005.

The IRS ruling applies only for purposes of determining the amount involved under Code Sec. 4975 where there is a failure to transmit contributions or amounts that would otherwise been payable to the participant in cash and does not apply for self-dealing violations under Code Sec. 4941.

For more information on this and related topics, consult the CCH Pension Plan Guide.

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