Matt Rustige
For the longest time, it seemed an unwritten rule that the safe and wise path of a defined benefit plan termination should include an IRS Determination Letter request. However, this approach seems to have come under much more scrutiny in recent years by sponsors and advisors of plans both large and small. With increasing filing fees, an inconsistent review process, and unpredictable timing, the Form 5310 filing may not always be the default approach. There will always be cases that clearly fall on either side of this question. Following are some points to potentially consider with that next plan termination.
What Are Possible Reasons to File?
1. To get final IRS “blessing” of the plan. This is the primary reason for requesting a DL upon plan termination. There are basically two main requirements of a plan: that its written terms satisfy the qualification requirements; and that it operationally follows those terms. Having a favorable DL provides IRS sign-off on the first requirement by definition provides the path to operational compliance. A favorable DL, assuming operational compliance, serves as the best protection for all past deductions and tax-free returns during the life of the plan. That can be quite valuable insurance for the sponsor and participants. One thing to note for individually designed plans is that under the new DL program, plan termination may be the only time for many years (potentially since inception) that the plan is able to request IRS approval.
2. If there are specific areas of concern. If a plan has certain issues that may be unusual or potentially problematic under audit or other review, a DL filing can provide assurance everything was properly handled. Issues like complicated 415 limit calculations in a plan may be worthwhile to submit to the IRS.
3. To provide additional protection in bankruptcy or other proceedings. Having a favorable DL may be required by an outside party under bankruptcy, plan sale, merger, or other proceedings. In particular, for smaller, owner-only plans, a favorable DL can be critical in affirming protection of rollover assets from creditors in bankruptcy or other claims. For larger plans, some trust custodians or annuity providers may require a DL before allowing distributions or assuming plan obligations.
4. Ability to correct any identified issues. While a plan may still need to go through the Audit CAP, any issues identified during review can be corrected in connection with the filing request process. If a DL request is not made and an issue is later identified, correction will be cumbersome or even impossible, in which case the plan may be faced with potential disqualification or significant penalties. Generally, there is also a perception that the IRS takes a softer approach to corrections made in connection with the plan term filing compared to any issues discovered down the road.
5. Low risk tolerance of the sponsor. Some sponsors — for example, law or financial services firms — may simply have a lower risk tolerance, and the added time and cost is worth their peace of mind. In particular for larger firms, there may be additional counsel involved who is much less willing to forego the DL request.
6. It is possible to file but not wait for approval to distribute. Submitting for a DL does not force the sponsor to wait for approval before distributing benefits. In the past, the IRS would not issue a favorable DL if the plan proceeded with distributions after submitting, but this is no longer the case. If desired, the sponsor can decide to move forward if a response or positive DL has not been received by a specific date. This potentially eliminates one of the largest frustrations with the DL process and allows sponsors to better control their timing. This seems to be an approach that is more common among large plans. One approach that is sometimes taken is to distribute benefits to all NHCEs while holding the trust open and waiting on HCE distributions until after a favorable DL is in hand.
What Are Possible Reasons Not to File?
1. Filing is simply not required. In fact, the IRS doesn’t seem to take a position on this either way. If the sponsor is comfortable that the written terms of the plan satisfy the qualification requirements and it has been operationally compliant, there is no obligation to submit for a final DL upon termination.
2. It can be costly, especially for a small plan. The Form 5310 filing fee for 2018 is $3,200 not including any added costs to prepare the filing, related calculations, notices, etc., along with responding to any IRS follow-up requests. If total estimated fees become significant, this may make a sponsor reconsider the cost/benefit of the filing.
3. It can be time consuming. On their filing receipt acknowledgement letter, the IRS indicates a wait period of up to 145 days, although in reality this is often much longer. The IRS timing has been very unpredictable and inconsistent in recent years, with process times ranging from just a few months to years. While processing times seem to have generally improved over the last year, the IRS gives virtually no insight into their timing. The letter-status IRS webpage has never been fully reliable and hasn’t been updated for more than six months as of this writing. Calling the IRS directly may or may not be productive. An unpredictable, protracted process can be problematic for sponsors with specific timing needs due to budgeting or other concerns. This can also create communication and other issues among plan participants who may begin to question a long delay. Timing is perhaps the single most common frustration with the DL process with no real recourse available for sponsors.
4. It becomes a de facto plan audit and actually creates exposure for the plan. Based on prior experiences, many practitioners have concerns that the DL request prompts burdensome inquiry by IRS agents. There are plenty of stories about uninformed agents making unreasonable demands during review, and this naturally has some practitioners wary of the process.
5. No perceived added value. This is a more common argument among small plans, which are most often on prototype and volume submitter documents using pre-approved language. For a fairly straightforward plan with a clean history and no 415 or other issues, there may not be much added value to the sponsor, especially since the Remedial Amendment Cycle and ongoing DL process remain in place for MP and VS plans.
Overall, the question of whether or not to submit for the DL upon plan termination is not quite the assumed step that it used to be. It’s understandable how either approach can make sense given the circumstances of various plans. Regardless of the approach your next plan takes, hopefully some of these considerations will prove helpful along the way.
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