Audit tips · All contributions listed on the Schedule B should be verified as being timely made to the trust.
· Where the Employer maintains more than one plan, verify that the contribution was made to the correct plan.
· Examine the 5500’s of related returns.
· Does the asset section of those returns show a payable to the defined benefit plan?
· Was the contribution made to the Profit Sharing Plan timely but by mistake and then later transferred to the proper plan?
The due date for filing the 5500 is 7 months after the end of the plan year.
The Employer, however, has 8 ½ months after the end of the plan year to make contributions to avoid a Funding Deficiency. If the Schedule B
indicates a Funding Deficiency, check to see when the return was filed and if it was filed timely. Then check to see if any additional contributions were made by the time required under IRC 412(c)(10). You should be able to determine any potential additional contributions by reviewing the subsequent year’s Schedule B.
Those who are familiar with defined contribution plans also know that where the Plan Year is different from the Tax Year, the deduction is determined by the Plan Year that ends within the tax year.
When the Employer’s Tax Year and Plan Year are the same, there is no problem.
The deductible limit is determined by the Plan Year that coincides with the Tax Year.
Continued on next page
Page 7-104
Timeliness of contributions to a DB plan,
Continued
An employer has a fiscal year ending 6/30/01. He adopts a profit sharing plan that has a Plan Year that end 12/31/01.
Contributions for the Plan Year Ending 12/31/01 are deductible in the 6/30/02 fiscal year, even if they are all paid by 9/15/01 (the due date for the 6/30/01 return). The tax year coinciding with the plan year ending 12/31/01 is the fiscal year ending 6/30/02. You look to the taxable year for which the plan year is ending. Thus, the plan year ending 12/31/01 is in the tax year which ends 6/30/02.
The linkage rules for DB plans differ from the DC plan rules.
Income Tax Regulations section 1.404(a)-14 provides that if the employer’s taxable year does not coincide with the plan year, the deductible limits for a given taxable year of the employer is one of the following alternatives:
1. Based on the plan year commencing within the taxable year.
2. Based on the plan year ending within the taxable year, or 3. Based on a weighted average using alternatives (1) and (2).
The regulations further provide that the average may be based, for example, upon the number of months of each plan year falling within the taxable year.
Under the regulations, the employer must use the same alternative for each taxable year unless consent to change is obtained from the Commissioner.
Continued on next page
Page 7-105
Timeliness of contributions to a DB plan,
Continued
Example-linkage with a DB plan
Example 21: An employer has a fiscal year ending 6/30/01. He adopts a defined benefit plan that has a Plan Year that end 12/31/01. The amount deductible for the plan years 12/31/01 is $10,000 and for 12/31/02 is $15,000.
He could:
1. Deduct $10,000 in the Tax Year 6/30/01 and $15,000 in Tax Year 6/30/02, or
2. Deduct $10,000 in the Tax Year 6/30/02 and $15,000 in Tax Year 6/30/03, or
3. Deduct:
· $5,000 in the Tax Year 6/30/01 ($10,000 x 6/12),
· 12,500 in the Tax Year 6/30/02 (($10,000 x 6/12) plus ($15,000 x 6/12))
· with the remaining $7,500 being added to the pro-ratable portion of the 12/31/03 contribution and deductible in Tax Year 6/30/03.
He could not deduct $10,000 in the Tax Year 6/30/1 and then deduct $12,500 in the Tax Year 6/30/2 unless he got prior approval from the Internal Revenue Service.
Audit tips · Where the Plan Year and Tax Year are different, ask the Employer which tax year the deduction was claimed on.
· Verify the Actuarial Report’s deductible limit verses the claimed deduction.
· Review the prior and subsequent year reports with the proper tax year.
· If the linkage appears to change, ask for an explanation. If it did change and prior approval was not gotten refer the case to our Actuaries.
Page 7-106
The following adjustments must be made for purposes of determining deductibility and IRC section 412 when:
1. Computing Normal Cost under aggregate type funding methods, 2. Computing Unfunded Liabilities, and
3. Computing the Full Funding Limitations.
Plan
contribution excluded from total assets
Excluded from the total assets of the plan is the amount of any plan contribution for a plan year for which the plan was qualified under section 401(a), 403(a) or 405(a) that has not been previously deducted.
Even though such amount may have been credited to the Funding Standard Account under section 412(b)(3).
For plans using a spread gain funding method
In the case of a plan using a Spread Gain funding method that maintains an Unfunded Liability (e.g., the frozen initial liability method, but not the aggregate method), the contributions described in item “1” must be included in the Unfunded Liability of the plan.
Amount
included in total assets of the plan
Included in the total assets of the plan for a plan year the amount of any plan contribution that has been deducted with respect to a prior plan year. Even though that amount is considered under section 412 to be contributed in a plan year subsequent to that prior plan year.
Plan using
spread gain method
In the case of a plan using a Spread Gain funding method that maintains an Unfunded Liability, the amount described immediately above must be excluded from the Unfunded Liability of the plan.
The first and second adjustment
The first and second adjustments apply on a year-by-year basis for purposes of section 404(a)(1)(A) only and have no effect on the computation of the Minimum Funding requirement under section 412.
Continued on next page
Page 7-107 Special rules,
ContinuedComponents of the limit under section
404(a)(1)(A)(i)
Remember that for purposes of determining the deductible limit under section 404(a)(1)(A)(i), the deductible limit with respect to a plan year is:
1. The amount required to satisfy the Minimum Funding standard for the plan year, plus
2. Any employer contributions that were required for Minimum Funding immediately preceding such plan year, and which were not deductible under section 404(a) for the prior taxable year of the employer solely because they were not contributed during the prior taxable year under IRC section 404(a)(6).
Deductible limit under section 404(a)(1)(A)(iii)
In calculating the deductible limit under section 404(a)(1)(A)(iii), the Normal Cost of the plan is:
1. Decreased by the limit adjustments to any unamortized bases due to a net experience gain, a change in actuarial assumptions, a change in funding method, or a plan provision or amendment which decreases the Accrued Liability of the plan, and
2. Increased by the limit adjustments of any unamortized 10-year
amortization bases required by paragraph for bases that are due to a net experience loss, a change in actuarial assumptions, a change in funding method, or a plan provision or amendment which increases the Accrued Liability.
Continued on next page
Page 7-108 Special rules,
Continued
Interest added Regardless of the actual time when contributions are made to a plan, for the purposes of IRC 404(a)(1)(A)(ii) and (iii), the Normal Cost and limit
adjustments are computed as of the date when contributions are assumed to be made.
They are then adjusted for interest at the valuation rate from the computation date to the earlier of:
1. The last day of the plan year used to compute the deductible limit for the taxable year, or
2. The last day of that taxable year.