Compliance check for section 457(b) deferred compensation plans

Recently the IRS announced that it is going to undertake a compliance check on section 457(b) plans operated by non-governmental tax-exempt organizations.

Background

Federal law generally permits section 501(c) tax-exempt organizations to sponsor Code Section 457(b) "Eligible" plans of deferred compensation. Assuming the qualification requirements of the statute and the regulations are met, amounts deferred under a tax-exempt organization’s Eligible 457(b) plan are includible in the gross income of a participant or beneficiary for the taxable year in which paid or otherwise made available to the participant or beneficiary under the plan.

If the tax-exempt organization is subject to the provisions of Title I of ERISA, participation in these plans must be limited to a "select group of management or highly compensated employees", which is known as the "top hat" group. This group is generally reserved for executives of the organization such as high-level managers, directors, or officers of the tax-exempt organization. In enacting ERISA, Congress recognized that these individuals, by virtue of their position or compensation level, have the ability to affect or substantially influence, through negotiation or otherwise, the design and operation of their deferred compensation plan without needing the substantive rights and protections of Title I of ERISA.

Upcoming IRS compliance check

With this review, the Employee Plans Compliance Unit of the IRS intends to send compliance check letters to approximately 400 tax-exempt organizations sponsoring 457(b) Plans, 200 in fiscal 2013 (ending September 30, 2013) and 200 in fiscal 2014 (ending September 30, 2014). The goals of this project are to learn more about the operation of non-governmental section 457(b) plans, verify the plan’s compliance with the relevant statutory and regulatory requirements, identify issues of noncompliance and recommend ways to remove any barriers to compliance by these tax-exempt organizations.

The letter will be in the form of a request for information and will address the following issues:

  1. Verification that the deferrals reported on Forms W-2 represent a 457(b) Plan
  2. Determination of eligibility to sponsor a 457(b) plan
  3. Verification that the plan participation is limited to the "top hat" group
  4. Determination that the plan does not contain features not permitted in a top hat plan such as loans, age 50 catch-up provisions, or contributions placed in trust for the exclusive use of participants
  5. Determination as to whether any distributions on account of unforeseeable emergency have been made

Organizational considerations

Tax exempt organizations should not ignore this request once received. The letter will include a statement indicating that, "we will not inspect your books and records to determine a filing liability for a particular period." However, if a tax exempt organization does not respond in a timely manner, the IRS has advised that they "may need to take other steps to ensure compliance, including an audit of your plan or organization."

If a compliance issue is found during the review process, the IRS will instruct the organization on the appropriate action, which could range from correction under the IRS Voluntary Correction Program (VCP) or an audit of the plan.

If your organization receives the letter, please contact your Baker Tilly advisor for guidance on the response. If your organization’s plan isn’t established or operated in accordance with section 457(b), your Baker Tilly advisory may be able to correct the plan under the VCP.

If you have any questions regarding this topic, please contact your Baker Tilly advisor or send an e-mail to tax@bakertilly.com.