IRS Implements Prospective Expansion of Determination Letter Program to Merged Plans

Brownstein Hyatt Farber Schreck

The IRS has announced a limited expansion of its determination letter program. Beginning Sept. 1, 2019, the IRS will accept determination letter (“DL”) applications for individually designed merged plans.1

While we are very glad to see that the IRS now will accept DL applications for plan mergers, as explained in more detail below, we are disappointed that the eligibility conditions for a merged plan to file a DL application are narrow and only apply prospectively. As a result of these narrow eligibility conditions, we believe many merged plans will be precluded from being able to apply for determination letters.

BACKGROUND

In 2005 the IRS established a system whereby every individually designed plan had a five-year remedial amendment cycle. To spread out IRS agent workloads, the cyclical periods were staggered, based on the last digit of the sponsor’s EIN. Under this system, individually designed plans could file once every five years for updated determination letters that ruled on all amendments adopted and made effective within the applicable cycle.2

Beginning Jan. 1, 2017, the IRS announced the elimination of this cyclical determination letter system for individually designed plans.3 Plan sponsors of individually designed plans were permitted to apply for determination letters only for a plan’s initial qualification and for qualification upon the plan’s termination. However, the IRS did reserve the right to add other situations enabling DL applications. Now, the IRS has announced a limited expansion of the determination letter program, which includes certain merged plans.

Why Determination Letters Are Important. There are myriad reasons why a plan sponsor seeks to obtain determination letters. Having government assurance that the form of retirement plan meets the applicable requirements under Code §401(a), and thus is tax-qualified, supports the sponsoring employer’s corporate tax deductions for contributions made to the plan. It provides the basis for the tax reporting and withholding positions taken with respect to plan distributions made to its participants. It also confirms participants’ ability to make distribution rollovers to other tax-deferred retirement vehicles. Because qualified plans have been around for a long time, the determination letter is an evidentiary document expected to be produced for internal and external audits, investment transactions, corporate credit facilities, acquisition and disposition transactions, and other transactions. Determination letters are particularly important for merged plans as it provides governmental assurance that the provisions of the pre-merger plan brought forward into the surviving plan are compliant and do not taint the qualified status of the surviving plan.4

MERGED PLAN ELIGIBILITY CONDITIONS

Beginning Sept. 1, 2019, a sponsor may file for a determination letter with respect to an individually designed merged plan only if all of the following conditions are met:

  • Corporate Transaction Required. The plan merger must flow from a corporate transaction, such as an acquisition, merger, or similar transaction involving two or more entities that are unrelated (that is, not in the same controlled group of corporations or members of the same affiliated service group).

Brownstein Comment: As a result of this condition, an employer will be unable to apply for a determination letter if it chooses to merge multiple plans that it already may sponsor. For example, the merged plan resulting from the merger of an employer’s union 401(k) plan into its nonunion 401(k) plan is not eligible to file a DL application. We would like to see the IRS expand the merged plan eligibility to cover any merged plan regardless when that plan merger may have occurred and regardless how or when the employer became the sponsor of multiple plans of the same type.

  • Plan Merger Decision Cannot Be Delayed. The effective date of the plan merger must have occurred on or before the last day of the first plan year beginning after the plan year in which the effective date of the corporate transaction (which led to the plan merger) occurs or occurred.
    • The effective date of corporate transaction must be evidenced by a corporate board resolution or “a written document signed and dated by persons duly authorized to represent the parties involved.” We expect that evidence of the corporate transaction effective date will be required as part of merged plan DL applications.

Brownstein Comment: The DL application filing period for a merged plan is the same as the special transition period under Code §410(b)(6)(C), which provides that, if a person becomes, or ceases to be, a member of a controlled group or affiliated service group, then the minimum coverage requirements (and certain other nondiscrimination requirements) will be treated as having been met by all of the plans in the group until the last day of the plan year following the plan year in which the transaction occurred, unless there is a significant change in coverage before that time (other than by reason of the transaction) and provided the requirements were met by each plan immediately before the change in the group.

Brownstein Comment: This condition may stifle the ability of an acquiring entity to decide how and when it may wish to combine plans, particularly in the case of a series of transactions over a multiple year period. The desire to obtain a determination letter on a merged plan should not be a driver for corporate planning and decision making, but given the conditions limiting DL applications for merged plans, it may become the driver. Also, requiring plans to be merged within a short period following the transaction may increase the acquirer’s expenses, particularly for an acquirer involved in serial transactions. In such instance, the acquirer will need to act to merge each plan individually and each year, rather than being able to wait until the end of the series of transactions to merge all of the acquired plans at once, or decide, based on business factors, on how it wishes to combine the acquired plans.

  • DL Application Must Be Filed Promptly. A DL application for the merged plan must be submitted within the period beginning on the effective date of the plan merger and ending on the last day of the first plan year beginning after the effective date of the plan merger.
    • The effective date of plan merger must be evidenced by (a) a corporate board resolution or “a written document signed and dated by persons duly authorized to represent the parties involved” or (b) a plan amendment. We expect that evidence of the plan merger effective date will be required as part of merged plan DL applications.

Brownstein Comment: By virtue of these conditions, the expansion of the DL application program essentially is prospective, starting with corporate transactions that occurred in 2017. However, these conditions create disparate treatment for corporate transactions that occurred in 2017, depending on when the related plans were merged. As illustrated in the table below, if calendar year plans were merged in 2017 as a result of a 2017 corporate transaction, the merged plan will be unable to satisfy the conditions because the DL application period already has ended (Example 1 below). In contrast, if calendar year plans were merged in 2018 as a result of a 2017 corporate transaction, the merged plan should be eligible to file a DL application because the DL application period hasn’t ended yet (Example 2 below). We would have liked to have seen this disparate treatment addressed by a transition rule allowing all merged plans related to 2017 corporate transactions to be able to file DL applications by Dec. 31, 2019.

Example 1

Example 2

Corporate merger date

2017

2017

Plan Year (“PY”) containing the corporate merger effective date (assume calendar year PY)

2017

2017

Deadline for plan merger date - Dec. 31 of PY following PY containing the corporate merger effective date

Dec. 31, 2018

Dec. 31, 2018

Actual plan merger date

Dec. 31, 2017

Dec. 31, 2018

Plan Year containing plan merger date

2017

2018

DL App Period Begins on plan merger date (but not before program opens on Sept. 1, 2019)

Sept. 1, 2019

Sept. 1, 2019

DL App Period Ends on Dec. 31 of PY following PY containing the plan merger effective date

Dec. 31, 2018

Dec. 31, 2019

CONCLUSION

This plan merger IS NOT eligible for DL application because filing deadline has expired per the guidance

This plan merger IS eligible for DL application because filing deadline has not expired per the guidance

POTENTIAL SANCTIONS FOR PLAN DOCUMENT FAILURES FOUND DURING DL APPLICATION REVIEW

If, as part of its review of a merged plan’s DL application, the IRS finds a “plan document failure,” the plan sponsor will be allowed to amend the plan to correct the failure and, depending on the failure, may be required to enter into a closing agreement with the IRS and pay a sanction.

  • No Sanctions. No sanction will be payable for any plan document failure with respect to a plan provision included to effectuate the plan merger.
  • Special Sanctions. If the IRS determines that (a) the amendment creating the plan document failure was adopted timely and in good faith with the intent of maintaining the plan’s qualified status or (b) the plan sponsor reasonably and in good faith determined that no amendment was required, the sanction will be equal to the applicable EPCRS Voluntary Correction Program (“VCP”) user fee that would have applied had the plan sponsor identified the failure and submitted the plan for consideration under VCP.5 The VCP user fee generally is based on the plan’s end of year net plan assets, as reported on the most recently filed Form 5500. VCP user fees are subject to change, but the current VCP user fees are:
    • $1,500 for net plan assets up to $500,000
    • $3,000 for net plan assets over $500,000 up to $10 million
    • $3,500 for net plan assets over $10 million
  • General Sanctions. If the merged plan does not satisfy the special sanction conditions mentioned above, then the sanction will be an Audit CAP sanction.
    • An Audit CAP sanction is a negotiated amount, determined based on the facts and circumstances, however, it will not be excessive and will bear a reasonable relationship to the nature, extent and severity of the failures. Generally, the Audit CAP sanction will not be less than the VCP user fee.
    • Also, if nonamender failures are discovered by the IRS during the DL application review, the plan sponsor may be subject to a sanction amount equal to 150% or 250% (depending on the duration of the failure) of the applicable VCP user fee that otherwise would apply had the plan been submitted under VCP.

Brownstein Comment: Deal counsel representing acquirers should consider whether the terms of acquisition agreements facilitate the recovery of the sanction amounts and other related expenses in the event sanctions are assessed with respect to the merger of a target’s plan into an acquirer’s plan.

1 IRS Revenue Procedure 2019-20 (May 1, 2019). The guidance also provides that the IRS will accept determination letter applications for individually designed statutory hybrid plans, but only for the limited period from Sept. 1, 2019 through Aug. 31, 2020.

2 Rev. Proc. 2005-66.

3 Rev. Proc. 2016-37.

4 IRS review of DL applications by individually designed merged plans will be based on the Required Amendments List, which was issued during the second full calendar year preceding the DL application submission, and will take into account all previously issued Required Amendments Lists and Cumulative Lists.

5 The current version of EPCRS is set forth in Rev. Proc. 2019-19. The VCP user fees are set forth in Appendix A of Rev. Proc. 2019-4 (as annually updated). See also, https://www.irs.gov/retirement-plans/voluntary-correction-program-fees.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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