IRS expands determination letter process for certain retirement plans
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For years, plan sponsors voluntarily obtained determination letters from the Internal Revenue Service (Service) confirming that their tax-qualified plans (e.g., 401(k)s, profit sharing plans, pensions, ESOPs) actually satisfied the Internal Revenue Code’s (Code) tax qualification requirements, at least in form. The Service issued thousands of determination letters every year, and allowed a limited remedial amendment period for non-compliant plans to be brought into compliance.
But, in 2016, much to the dismay of plan sponsors everywhere, the Service eliminated the greater part of the determination letter process for individually designed tax-qualified plans. After the elimination, the Service issued determination letters for individually designed plans only with respect to new plans and with respect to terminating plans, consistent with the process described in Revenue Procedure (Rev. Proc.) 2016-37.
A determination letter is a ruling by the Service that the form of a retirement plan document (but not its operation) satisfies the requirements for tax-favored treatment to plan sponsors and plan participants. Tax-qualified status generally allows plan sponsors to take a tax deduction for contributions made to such plans and allows a deferral of tax with respect to plan participants (in both cases, subject to certain limits). Employers, along with their lenders, creditors and transaction partners, came to rely on determination letters as assurance that their retirement plans were in fact tax-qualified.
This week, in Rev. Proc. 2019-20, the Service responded to comments from the benefits community by opening the determination letter program to individually designed “statutory hybrid plans," i.e., cash balance plans, and to merged plans formed when two or more plans merge in a corporate transaction.
In 2016, the Service announced that it no longer had the resources to continue the determination letter process for individually designed plans. Accordingly, for this and other reasons, the determination letter process for individually designed plans was abruptly ended, except with respect to newly-established plans and terminating plans.
The determination letter process was not eliminated, however, for “off-the-shelf” pre-approved tax-qualified plans. Plans pre-approved in form by the Service allowed plan sponsors a measure of confidence in the pre-approved plan’s qualified status without having to seek an individual determination letter on their own (with some exceptions). The Service has expressed the view that pre-approved plans are more efficient to administer and encourage uniform compliance with the tax qualification rules. Many plan sponsors, especially smaller ones with, for example a plain-vanilla 401(k) plan, sought out pre-approved plans. However, many individually designed plans are too customized and complex to fit within the fixed parameters of a pre-approved plan. The Service refers to plans which are not pre-approved as individually designed plans.
Limited expansion of the determination letter process
Under Rev. Proc. 2019-20, effective Sept. 1, 2019, the Service will open the determination process to two types of individually designed plans, including:
- Statutory hybrid plans (e.g. pension plans with a “hybrid” benefit formula, such as a cash balance plan) during a 12-month period from Sept. 1, 2019, to Aug. 31, 2020, and
- Merged plans, for an indefinite period with no specific filing cutoff date.
For plans seeking a determination letter under Rev. Proc. 2019-20, the IRS has provided a limited extension of the remedial amendment period under Code section 401(b) to allow retroactive amendments to non-compliant plans to come into compliance with applicable statutes and regulations and with Rev. Proc. 2016-37.
Under certain conditions, the Service may impose a sanction for any plan document failure discovered by the Service in its review of a plan submitted for a determination letter pursuant to Rev. Proc. 2019-20.
Rev. Proc. 2019-20’s limited expansion allows individually designed statutory hybrid plans and merged plans to seek a determination letter from the Service prior to the plan’s ultimately termination. This expansion provides plan sponsors with an increased amount of certainty historically available prior to Rev. Proc. 2016-37. Now, plan sponsors of at least these two types of individually designed plans will not have to wait until the plan terminates to seek approval of interim changes made to hybrid plans (especially with respect to permissible interest rates) and of the method and effects of a plan comprised of two or more plans merged in a corporate transaction.