– but you should be aware that the IRS
is vigilant about making sure that 403(b) plan sponsors also ensure that all of
their eligible employees know they have the opportunity to participate in the
403(b) plan, and the IRS has a
method to monitor just that – the Compliance Check Questionnaire mailing.
Background about the IRS Compliance Check
2006, the IRS began a pilot
mailing of a Compliance Check questionnaire to public school districts in New
Jersey, Missouri, and the state of Washington to determine if schools were
appropriately extending the opportunity to participate in their 403(b) plans to
all eligible employees. In 2007 and
2008, the IRS took the Compliance
Check initiative nationwide, mailing the questionnaire to a representative
sampling of K-12 public school districts.
that sampling is now complete, the IRS
has stated that it intends to expand the scope of the Compliance Check to
private college and universities. In addition, based on information from
the K-12 compliance check initiative, the IRS
plans to follow up with those K-12 school districts whose completed
questionnaires indicated eligibility defects to determine whether and how those
defects were resolved.
What Is the IRS Compliance Check Questionnaire?
The Compliance Check Questionnaire mailing seems innocuous enough. An employer who sponsors a 403(b) plan receives a questionnaire from the IRS that solicits information about who can participate in that 403(b) plan. The questionnaire essentially has four themes:
- Who cannot participate in the 403(b) plan?
- What are the requirements for participating in the 403(b) plan?
- How are employees informed about the chance to participate in the 403(b) plan?
- Does the employer maintain any other plans that permit employees to make elective deferrals?
accompanying cover letter notes that this Compliance Check is “not an
audit” and that the employer should return the completed questionnaire
within 15 days of the date of the letter.
Working Without a
the IRS questionnaire appears
simple, actually it is precisely focused on whether an employer’s 403(b) plan
violates the Internal Revenue Code by not allowing all eligible employees to
participate. Under the federal tax laws,
an employer must generally give all employees (with very few, limited
exceptions) the opportunity to participate in its 403(b) plan if at least one
employee has the ability to defer at least $200 a year, either as pre-tax or
Roth 403(b) contributions, to the plan.
This requirement, known among tax practitioners as the “universal
availability rule,” ensures that employee contributions made to an
employer’s 403(b) plan are nondiscriminatory in accordance with the Internal
the employee who is the point of contact for the 403(b) plan may not appreciate
the IRS’ mission in sending this questionnaire.
After all, the Compliance Check is a brief questionnaire. What could go wrong?
Plenty. For example, the K-12 Compliance Check
included a question on whether substitute or part-time teachers, janitors, bus
drivers, or cafeteria workers are excluded from participating in the employer’s
403(b) plan. The IRS
rationale behind this question was to determine whether the 403(b) plan is
indeed being offered to all eligible employees.
employer may not understand that underlying assumption and this then becomes a
trap for the unwary. Suppose that an
employer outsources its custodial services to a third party. The employer receiving the Compliance Check
in turn answers that janitors are excluded from participating in its 403(b)
plan – they aren’t participating, of course, because those individuals are not
employees of the employer.
the IRS doesn’t know this – from
an IRS perspective, the sponsor
responded that not all of its employees are told about the 403(b) plan and, as
a result, the IRS thinks the 403(b) plan is defective.
Do not assume that the IRS knows each 403(b) sponsor’s specific employee and independent contract arrangements. Be sure that your response to an IRS Compliance Check Questionnaire identifies any classifications that are outsourced and thus are not considered your employees.
The Cost of
if all individuals providing services to the employer are in fact
employees? What would be the downside if
an employer inadvertently has not been including all of its eligible employees
and responds accordingly on the IRS
Compliance Check? The IRS will issue a form letter warning to the employer
that its 403(b) plan is "at risk of losing its tax-favored status,
resulting in the loss of the retirement savings and tax benefits provided to
its participants." To remedy this violation of the universal availability
rule, the IRS will require that
the employer make a non-forfeitable contribution to an account for each
employee who was inappropriately excluded from the 403(b) plan for each year he
or she was excluded.
For each year that an employee was excluded from participating in the employer’s 403(b) plan, the employer must contribute an amount determined to be the "lost opportunity cost," calculated as follows:
- 50% of the average deferral percentage for that year of the group of employees to which the excluded employee belongs (non-highly or highly compensated employees); or
- 1.5% of the excluded employee’s annual compensation for that year; or
- an alternate means of correcting this defect, after discussion with and approval by the IRS.
the employer’s 403(b) plan has matching contributions, the employer must also
contribute the full matching contribution on the "lost opportunity cost"
after Fixing the Defect
that the employer’s responses to the questionnaire indicate that employees were
improperly excluded and the employer makes this "lost opportunity"
contribution. There is the possibility that the IRS will contact the employer again. Part of the Compliance Check initiative
includes the IRS issuing a
follow-up letter to those 403(b) sponsors that had eligibility defects in the
initial compliance check to determine whether and how those defects were
Don’t Go it Alone
what should an employer do if it receives a Compliance Check letter from the IRS? Most
importantly, proceed with caution. Do
not assume that the point of contact in the organization understands the
precise context of the IRS
terminology or that the IRS knows
how the organization operates. Seek help
in responding to the Compliance Check from legal counsel or a tax adviser.
should get their 403(b) plans in order now.
The cost of "wait and see" is too high.
- Linda Segal Blinn, JD, Vice President of Technical Services, ING
NOTE: This feature is to provide general information only, does not constitute legal advice and cannot be used or substituted for legal or tax advice.