The Internal Revenue Service’s Employee Plans Compliance Unit recently looked at whether employee benefit plan sponsors had completed all the necessary steps after filing a Form 5500-series return showing they had adopted a resolution to terminate the plan, and found that many did not.
The IRS unit set up a Termination Project to learn if employee plan sponsors who indicated they adopted a resolution to terminate their plan had completed the termination process, complied with Revenue Ruling 89-87 for their wasting trusts, filed a final Form 5500-series return, and distributed all the trust assets as soon as administratively feasible.
The Employee Plans Compliance Unit found that some plan sponsors who indicated they had adopted a resolution to terminate their plan didn’t file a final Form 5500-series return. In general, the IRS noted, plan sponsors must continue to file a Form 5500-series return for their terminated plan until the last return filed is marked “final return/report” and shows zero assets at the end of that plan year. This is required even if the sponsor was exempt from filing a Form 5500-EZ (the annual return of a one-participant retirement plan) in previous years.
Over 75 percent of the sampled sponsors showed that, although they took additional steps to terminate their plan beyond adopting a resolution to terminate, they didn’t complete the termination process. In many cases, they didn’t file a Form 5500-series return marked as the ‘final return/report’ showing zero assets at the end of the plan year. The IRS noted that being in the process of terminating doesn’t eliminate the Form 5500-series filing requirement. Employee plan sponsors must continue filing their annual return until all plan assets are distributed.
In other cases, the plan sponsors distributed all the plan assets but didn’t mark the Form 5500-series return as final. The IRS noted that sponsors can correct this by filing an amended return. Review your Form 5500 return carefully before filing to prevent errors.
In other cases, plan sponsors terminated the plan but weren’t aware there were still assets in the trust. “All plan assets need to be distributed for the plan termination to be complete,” the IRS cautioned.
In some cases, it took a long time to distribute the plan assets because of difficulty locating participants and beneficiaries. Many plan sponsors weren’t aware of the requirements and procedures for locating missing participants and beneficiaries. Plan sponsors can use the Department of Labor’s Field Assistance Bulletin 2004-2 for guidance in locating missing individuals for benefit distributions. The IRS no longer provides letter-forwarding services (Revenue Procedure 2012-35).
In other cases, the plan sponsors distributed all the plan assets but didn’t indicate zero assets at the end of the plan year on their final Form 5500 series return. The IRS pointed out that sponsors can correct this by filing an amended return.
Other plan sponsors didn’t distribute all the plan assets as soon as administratively feasible after the plan termination date. “Some plan sponsors had difficulty distributing certain types of plan assets, such as real estate or partnership investments,” said the IRS. “Generally, a distribution which isn’t completed within one year following the date of plan termination will be presumed not to have been made as soon as administratively feasible unless facts and circumstances show otherwise (Revenue Ruling 89-87, 1989-2, C.B. 81). If sponsors don’t distribute all plan assets as soon as administratively feasible, the IRS considers the plan to be ongoing.”
If sponsors don’t complete all termination actions, there is also potential for plan disqualification, discrimination in favor of highly compensated employees, abusive tax avoidance, and administrative penalties, the noted.
Other filing errors included sponsors who mistakenly indicated they were terminating their plan when they actually did not intend to do so. Some plan sponsors incorrectly marked line 5a on the Schedule H (Financial Information) or Schedule I (Financial Information – Small Plan) of their Form 5500-series return to indicate they had adopted a resolution to terminate the plan.
Some plan sponsors mistakenly indicated the plan was terminated when it was actually frozen.
“These sponsors weren’t aware of the differences between a frozen plan and a terminated plan,” said the IRS. It noted that in a frozen plan, participants don’t accrue any additional benefits (whether because of service or compensation) except under special circumstances. A frozen plan must continue to meet annual information reporting and plan qualification requirements including having the plan sponsor amend the plan for current law by the required deadlines; otherwise, the plan may lose its qualified status for tax benefits.
Some plan sponsors mistakenly used the same plan number from a previous or different plan. Once plan sponsors use a plan number, they should continue to use it for that plan on all future filings with the IRS, the Labor Department and the Pension Benefit Guaranty Corporation. Even if the plan sponsor terminated their plan, they can’t use the same plan number for any other plan, the IRS cautioned.
There were also some processing errors that occurred before the implementation of the Department of Labor’s electronic filing system. Plan sponsors now must file Forms 5500 and 5500-SF electronically using DOL’s EFAST2 web-based filing system or through an EFAST2 approved vendor. Plan sponsors paper file the Form 5500-EZ with the IRS. Plan sponsors can’t paper file Forms 5500 or 5500-SF. For more information, see DOL’s EFAST2 site or the IRS Form 5500 corner.
The IRS recommended that employers review their terminated plans to see if they have finished all the steps in the termination process, including:
• Filing all current and prior Form 5500-series filings
• Filing a final Form 5500-series return showing zero assets
• Distributing all assets
• Finding all missing participants and beneficiaries
Plan sponsors should also recognize the differences between active, frozen, and terminated plans. They should correct any errors you discover and amend your return, if needed. Correct the plan administrative procedures so the mistakes don’t happen again. It may be helpful to ask at least two people to review the 5500 return before it is filed.