What happens if a tax-exempt organization becomes ineligible to sponsor a Section 403(b) Plan because it loses its exempt status under Internal Revenue Code Section 501(c)(3)? As an example, loss of tax-exempt status may occur automatically if the organization fails to file an annual Form 990 information return for three consecutive years. It may also lose its exempt status if the IRS revokes or terminates exempt status for other reasons.
To fix that problem, an organization may apply to the IRS for a reinstatement of its tax-exempt status; however, this only works if tax-exempt status was automatically revoked due to failure to file Forms 990. In that case, the IRS may reinstate tax-exempt status retroactively, or it may only reinstate tax-exempt status prospectively.
If an organization loses its tax-exempt status, it must immediately stop making contributions to its 403(b) Plan because it is no longer considered an eligible employer. If, however, contributions were made to the organization’s 403(b) Plan after loss of tax-exempt status and tax–exempt status is not reinstated or is only reinstated prospectively, the 403(b) Plan sponsor may voluntarily correct the eligibility failure through the IRS’s Employee Plans Compliance Resolutions System (referred to as EPCRS). The benefit of correcting the employer eligibility failure is that all money that was contributed to the 403(b) Plan while the employer was ineligible to maintain the 403(b) Plan will retain its tax-favored status, all contributions may remain in the applicable annuity contracts and custodial accounts and the organization may avoid potential penalties.
To participate in this voluntary correction program (referred to as VCP), the organization must make a VCP submission to the IRS and pay a compliance fee based on the number of employees that were eligible to participate in the 403(b) Plan. To be eligible to correct an employer eligibility failure under VCP, the organization or the 403(b) Plan cannot be under audit by the IRS, all contributions to the 403(b) Plan must have ceased, the 403(b) Plan must have complied with all applicable requirements under the final Section 403(b) regulations and must continue to comply with the distribution rules applicable to 403(b) Plans.