Several important changes will take effect in the determination letter program beginning in 2012. The IRS has stated that these changes are intended to (1) reduce the burden on employers for filing determination letter applications (and in some cases, eliminate the need to file an application) and (2) reduce the time it takes for the IRS to process determination letter applications. The IRS first announced these changes in Announcement 2011-82 and later published them in Revenue Procedure 2012-6. We encourage employers maintaining qualified retirement plans to consider how these determination letter application program changes will impact them, and whether they need to take any action steps now to prevent more problems later.

Why Do Employers Apply for Determination Letters?

When an employer receives a determination letter from the IRS, that letter states that the employer’s plan document satisfies the tax qualification requirements. An employer is not required to receive a determination letter. When a plan does not have a letter, however, the IRS can theoretically disqualify the plan if an error is found. The advantage of a favorable determination letter is that it gives the employer time to rectify certain drafting issues, and provides reliance that the plan document is qualified. Accordingly, employers often request determination letter applications, even if they have adopted preapproved plans (prototype and volume submitter plans). Although preapproved plans have advisory or opinion letters stating that the preapproved plan document satisfies the tax qualification rules, a determination letter is the only way the employer has reliance that its particular plan is qualified.

Because of the reliance that a determination letter provides, it is significant in the context of any plan merger or termination. For example, when an employer terminates a plan and files its final annual report on Form 5500, the IRS often looks to see if a determination letter has been issued. Tracking down prior plan documents and amendments may be difficult, if not impossible, because of employee turnover, relocation or storage issues. If the IRS has issued a determination letter for the plan, however, the IRS has its own record that the plan was qualified.

What types of plans do you currently maintain, do they have favorable determination letters, and what is the status of any application?

Considering the reliance that a determination letter application provides, now would be a good time for employers to review their plan documents to confirm whether those plans have favorable determination letters. If an employer has filed a determination letter application, it can determine whether or not the IRS has likely assigned the application to an official for review at the IRS web site. As is evident from this web site, the IRS has a large backlog of pending applications going back many years. That backlog is presumably a driving force behind the change in determination letter application procedures.

What Are the New Procedures for Filing Applications?

The determination letter program changes are designed to reduce the number of items the IRS will review in a determination letter application and generally preclude employers adopting prototype or volume submitter plans from filing determination letter applications. These changes include the following:

  • Elimination of Coverage and Nondiscrimination Demonstrations. Plan sponsors often elect to expand the scope of a determination letter by completing a Schedule Q and submitting data demonstrating compliance with various coverage and non-discrimination requirements. Beginning with applications filed on or after February 1, 2012 (for plans under a 5-year remedial amendment cycle), and May 1, 2012 (for plans under a 6-year remedial amendment cycle and for terminating plans), the IRS will not determine whether the plan satisfies these coverage and non-discrimination requirements. The IRS believes that reliance on such demonstrations is limited to facts presented in the demonstrations and does not obviate the need for subsequent testing of the plan. As such, the IRS believes the current demonstrations provide little value. The IRS, however, will continue to determine whether a plan’s benefit or contribution formula satisfies the requirements of a non-discriminatory design-based safe harbor and will also continue to determine whether a plan’s terms satisfy Internal Revenue Code Sections 401(k) (elective deferrals) and 401(m) (matching contributions).

An IRS official from the Employee Plans division explained that this change was coming in June 2011 at the Cincinnati Employee Benefits Conference. Some members in the audience expressed concern about this change, explaining that performing these demonstrations as part of a determination letter application is helpful in testing whether the plan satisfies certain nondiscrimination requirements. One attendee explained that a “Demonstration 9” helps to show that a plan’s compensation definition is not discriminatory. The IRS official responded that the IRS may create a separate program for demonstrations at some point, but added that satisfaction of the nondiscrimination requirements is an ongoing requirement. By following through with this change, the IRS appears to have maintained this view, despite the concern expressed by some employers that the demonstrations really were helpful.

  • Prohibition on Certain Prototype and Volume Submitter Plan Determination Letter Applications. Effective May 1, 2012, determination letter applications filed on Form 5307 will be accepted only from adopters of volume submitter plans that modify the terms of their preapproved volume submitter specimen plan. The IRS will not accept determination letter applications that are filed on Form 5307 on or after May 1, 2012, by employers with either prototype plans or volume submitter plans that have not made any changes to the terms of their preapproved specimen plan (except to select permitted options under the specimen plan). These employers may rely on the advisory or opinion letter issued to the volume submitter or prototype plan. The IRS, however, will continue to accept applications filed on Form 5307 through April 30. 2012, under current procedures. In addition, in cases where employers change the terms of their prototype or volume submitter so significantly that they cause the plan to become individually designed, these employers will be allowed to file applications on Form 5300.

Employer Action Steps

  1. Employers that maintain individually designed plans may want to consider filing a determination letter application by January 31, 2012, even if the application is “off-cycle.” This requires posting a notice to interested parties by January 21, 2012. An application may be helpful if the employer has experienced significant demographic or plan design changes since the last determination letter, and is concerned about any of the topics covered by the demonstrations that will not be accepted after January 31. Eliminating the nondiscrimination demonstrations may simplify the application process slightly, but employers still need to be able to demonstrate upon audit that their plans satisfied these requirements. Accordingly, the changes may not be providing employers with much greater convenience. As discussed below, an application may also be helpful in the unlikely event that the plan does not have a prior favorable determination letter.
  2. Employers that adopt prototype or volume submitter plans should consider whether they need to file a determination letter application by April 30, 2012, even if the application is off-cycle. April 30, 2012 is the deadline for adopters of preapproved defined benefit plans. In addition, plans that do not currently have a favorable determination and will not be able to request one after this date will likely benefit from an application. When a plan does not have a prior determination letter, the IRS typically requests prior versions of plan documents. The processing of finding these documents is burdensome (and potentially impossible) for the employer, and requires more review by the IRS. Finally, if any adopters of prototype or volume submitter plans (with or without a favorable letter) have any concerns about the matters addressed in the demonstrations that will be eliminated, they may benefit from an application.
  3. Looking forward, employers adopting prototype or volume submitter plans will need to consider the impact of these changes. Some employers may decide to make minor modifications to the document so as to be eligible to submit a determination application. Despite the changes in the determination letter application program, the program still affords a relatively inexpensive and easy way for plan sponsors to obtain the protection of an IRS advance ruling.