IRS Linking 403(b) Plans to Former 501(c)(3) Organizations

The questionnaire focuses on whether employers that had their 501(c)(3) nonprofit status revoked still offer a 403(b) tax deferred annuity plan to employees.

By way of background, the Pension Protection Act of 2006 requires that, effective with the 2007 annual period, a nonprofit organization file the appropriate Form 990 series (“Return of Organization Exempt from Income Tax”) at least once within a consecutive three-year period.  Failure to do so results in the IRS’ automatically revoking the employer’s tax-exempt status. An impacted employer could regain federal tax-exempt status by submitting an application to the IRS, and to the extent that the employer can demonstrate reasonable cause for not timely filing the Form 990 series, request that the reinstatement be retroactive to the date of revocation. 

The latest Employee Plans Compliance Unit (EPCU) project—known as “Ineligible Employer – 403(b) Project Compliance Check”—targets employers that have received a notification of revocation of tax-exempt status from the IRS (known as a Notice CP120A) in 2010 (the first year following the new Pension Protection Act filing requirements that an organization’s tax-exempt status could be revoked). 

The Compliance Check consists of five areas of inquiry:

1.    Determination of whether the organization’s employees are participating in a 403(b) plan;

2.    Eligibility to sponsor a 403(b) plan; recognizing the impact of an automatic revocation of tax exempt status, one of the options is “A Previously Exempt Organization under Code Section 501(c)(3);”

3.    Confirmation of whether deferrals reported on employees’ IRS Form W-2 (“Wage and Tax Statement”) for the 2010 year were coded as contributions to a 403(b) plan;

4.    Identification of deferrals made to the 403(b) plan after the organization’s tax-exempt status was revoked (according to a footnote in the Compliance Check questionnaire, typically the automatic revocation occurring in 2010 would be May 17, 2010, 5½ months after the end of the 2007-2009 consecutive year period in which the Form 990 series was not filed); and   

5.    Determination of whether the organization has submitted Form 1023 (“Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code”) to the IRS to regain nonprofit status.

The accompanying cover letter seeks the return of the completed Request for Information by mail or fax within 30 days of the date of the letter.  If an employer does not respond to the Compliance Check, the IRS reserves the right to audit the 403(b) plan.

If the employer is no longer considered a 501(c)(3) organization and does not meet any other Internal Revenue Code criteria to sponsor a 403(b) plan, the IRS will notify the employer within 30 days of receipt of the completed Compliance Check to address any corrective measures needed with respect to the 403(b) plan.

It is not clear whether the EPCU would consider the correction method to be under the Employee Plans Compliance Resolution System’s Voluntary Correction Program (VCP) (with an IRS user fee accompanying the application) or under an Audit Closing Agreement Program (where a monetary sanction would be assessed as part of the closing agreement process). In either event, the correction method would be the same—participants could preserve the tax-deferred status of the contributions under the plan, provided that (1) the plan is frozen, and (2) participants can only access their accounts when they have a distributable event as described in the plan (such as terminating employment, becoming disabled, reaching age 59½, or dying).

Additional information about the latest Compliance Check can be found at http://www.irs.gov/Retirement-Plans/Employee-Plans-Compliance-Unit-EPCU-Current-Projects-Ineligible-Employer-403(b)-Project.

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Linda Segal Blinn, J.D.*, is vice president of Technical Services for ING U.S. Retirement Solutions’ Tax-Exempt Markets.  In this capacity, Blinn leverages her nearly 25 years of experience administering and designing defined contribution plans to provide general legislative and regulatory information to assist public and non-profit employers in operating their retirement plans. 

This material was created to provide accurate information on the subjects covered.  It is not intended to provide specific legal, tax or other professional advice.  The services of an appropriate professional should be sought regarding your individual situation.  These materials are not intended to be used to avoid tax penalties, and were prepared to support the promotion or marketing of the matters addressed in this document.  The taxpayer should seek advice from an independent tax advisor.