On July 21, 2015, the Internal Revenue Service (IRS) issued IRS Announcement 2015-19 stating that the determination letter program for individually designed tax-qualified retirement plans (plans that are not based on pre-approved forms)¹ will be significantly curtailed effective January 1, 2017. The Announcement applies to both defined contribution plans (e.g., 401(k) and profit-sharing plans) and defined benefit pension plans. As a result, employers² will only be allowed to seek a determination letter from the IRS upon the adoption or termination of an individually designed retirement plan, but generally not while an individually designed retirement plan is ongoing (although the IRS is considering other circumstances in which it would permit ongoing plans to seek a determination letter). Employers who utilize a pre-approved form document for their plan are not affected by this change.

Background

The IRS determination letter program allows plan sponsors to request a determination from the IRS that the language that makes up a retirement plan meets the requirements for favorable tax treatment under the U.S. Internal Revenue Code. Such a determination is binding on the IRS.

The language requirements for retirement plans are among the most complex found in the Code. Accordingly, it has been customary for employers to seek a favorable determination letter for an individually designed retirement plan because auditors, fiduciaries, and others desire certainty and reliance on a favorable determination letter to establish that a plan's terms comply with Code requirements.

For the past several years, employers with individually designed retirement plans could apply for a determination letter either (1) every five years on a predetermined on-cycle filing that was set by the IRS or (2) through an off-cycle filing if certain requirements were met. The new Announcement ends off-cycle filings and allows the current cycle³ ending January 31, 2016, as well as the next cycle⁴ ending January 31, 2017, to continue for individually designed retirement plans.

Potential Negative Effects for Employers

The curtailment of the IRS determination letter program for individually designed retirement plans potentially is bad news for many employers because:

1. Employers with individually designed retirement plans will not be able to seek reliance from the IRS that the terms of their plan comply with the Code after adoption, which creates legal exposure with respect to the terms of an individually designed retirement plan.
2. Many employers will consider moving away from an individually designed retirement plan to a plan that is based on a pre-approved form. Individually designed retirement plans have been a way to customize plan provisions to meet an employer's own business goals, while remaining within Code requirements. Employers who want to tailor their retirement plans to meet unique business goals often have had difficulty using pre-approved, form-based retirement plans.
3. Employers who do not adopt a pre-approved, form-based retirement plan may find it difficult to satisfy auditors, investors, acquirers, and government regulators who seek certainty that the employer's retirement plan is drafted to meet Code requirements.
4. Employers who keep an individually designed retirement plan will need to consider putting administrative procedures in place to have the terms of their plan reviewed periodically by legal counsel (e.g., no less frequently than annually, and perhaps in conjunction with the plan's annual financial audit) to ensure that all required amendments are timely and properly made.
5. Acquirers in mergers and acquisitions likely will want to perform additional due diligence if a target company sponsors an individually designed retirement plan.

Going Forward

The IRS intends to issue additional guidance and is asking in the Announcement for comments from the retirement plan community on how to best move forward, including whether there should be special circumstances for determination letter requests for ongoing plans, and if so, what those circumstances should be. It is expected that guidance will be provided to allow employers who currently sponsor an individually designed retirement plan to transition to a pre-approved, form-based plan, and to provide administrative relief for employers who want to continue using an individually designed retirement plan.

¹ A form-based plan is often called a "prototype" or "volume submitter" plan that is pre-approved by the IRS.

² Most retirement plan sponsors are employers. For the sake of ease, we use those terms interchangeably in this WSGR Alert.

³ Cycle E for plans sponsored by employers with an Employer Identification Number (EIN) ending in zero or five.

⁴ Cycle A for plans sponsored by employers with an EIN ending in one or six.