Remember to Watch Codes on 401(k) Plan Forms 5500

“Don’t sweat the small stuff.” Not always good advice — in fact, in the case of the Form 5500, it’s bad advice. The IRS found in its 401(k) Nonqualified Plans Project that plan sponsors sometimes enter information on the form that indicate that their plan is not qualified. But they don’t mean to — and their plan consultants can help head off future errors of this kind.

In the project, the IRS Employee Plans Compliance Unit (EPCU) looked at whether 401(k) plan sponsors selected the wrong pension feature on their Form 5500 Series return, entering one that described their plans as nonqualified. During the earlier study, the 401(k) Compliance Check Questionnaire Project, the EPCU had found that some plan sponsors filed a Form 5500 showing their plan was both a nonqualified plan and a 401(k) plan. The Internal Revenue Code requires a 401(k) plan to be a qualified plan; if it is not, the plan will have to pay taxes that it would not if the plan were.

The Form 5500 is a lengthy and complex form that employers and plan sponsors and administrators file with the IRS and Department of Labor to provide information about their plans. Plans with a calendar-year plan year must file the form that concerns the most recent plan year by July 31 of the next one. Thus, the Forms 5500 that concern the 2014 plan year must be filed by July 31, 2015.

The IRS designed the 401(k) Nonqualified Plans Project to learn:

• If plan sponsors incorrectly selected pension feature codes 2J and 3C on their Form 5500, which indicate they didn’t intend their 401(k) plans to be qualified plans. Pension feature code 2J means the plan has a 401(k) feature — a cash or deferred arrangement described in Section 401(k) that is part of a qualified defined contribution plan that allows employees to elect to defer part of their compensation to the plan or to receive these amounts in cash. Pension feature code 3C means the plan is not intended to be qualified under Code Sections 401, 403 or 408. 
• If plan sponsors selected the wrong codes, why they made this mistake.

Overall, the project showed that sponsors of the sampled 401(k) plans made mistakes when describing their plan characteristics and listed 3C, showing their plan was a 401(k) plan not intended to be qualified under the Internal Revenue Code. Some sponsors incorrectly selected pension feature code 2J when their plan was a profit-sharing plan, but was not a 401(k) plan. A 401(k) plan is a type of profit-sharing plan, but a profit-sharing plan isn’t necessarily a 401(k) plan.

The few plans that correctly indicated they were nonqualified 401(k) plans were those plans only intended to be qualified by the Hacienda, Puerto Rico’s tax authority, and not under the Internal Revenue Code.

The bottom line? Plan sponsors need to make sure they understand the different pension feature codes that describe a plan’s characteristics. Selecting an incorrect code on the Form 5500 could result in an EPCU compliance check or an examination of the plan. Advisors can educate their clients about that, and help make sure the plan sponsor has administrative procedures in place that will help make sure it doesn’t make such a mistake. At the very least, an consultants, or pension professionals can remind a plan sponsor to be careful.