IRS Determination Letters

One long standing practice in our industry is the ability of a company adopting a retirement plan to submit that plan document to the IRS approval. This is done in the form of a “Determination Letter” from the IRS. IRS approval can mean a lot of different things. Most IRS retirement plan approvals simply confirm that the language of the plan documents is acceptable. The approvals do not validate (nor does the IRS review) how the plan actually operates in the real world. There is often confusion on this point. The IRS charges for issuing a determination letter.

In addition, there are special cases where the IRS can offer a more extensive review. Some plans rely on complex testing to be sure certain requirements are met. In some cases, where employees of multiple companies are involved, there are assumptions made about which employees must be covered under the plan. In the past, the IRS has offered the option of reviewing these issues. Actually, the IRS does not review the real world compliance testing for a plan, or whether or not 2 companies would form a "controlled group" or "affiliated service group." What the IRS does do is review the facts presented on the Determination Application. For testing, the IRS reviews the testing methodology. If a plan is subject to a subsequent audit, the IRS agent is entitled to look at the actual facts. If the IRS submission accurately reflected these facts, then all is fine. If not, then the Determination Letter has no positive impact.

A Retirement plan document can either be a Pre-approved Documents (PD), or an Individually Drafted Plan (IDP). A PD is a plan for which the IRS has performed a very detailed initial review of the language. PD's are submitted either by law firms, administration firms like E.R.I.S.A., Inc., or firms that specialize in drafting these kinds of documents. The firms that draft PD's can sell "subscriptions" to these documents to other practitioners for the practitioners to use with their clients. PD's can either be prototype or volume submitter plans.

PD's allow a range of choices for items such as eligibility, vesting, service, benefits, etc. The initial review process typically takes over a year and carries a high cost (the IRS charges a lot for this). Once completed, the document is deemed pre-approved. This means that if no changes are made, i.e. the company adopting the plan just fills on the blanks and checks boxes, the plan document will be considered automatically acceptable by the IRS. This means it meets the many requirements under the Internal Revenue Code Regulations, and additional IRS guidance. This has been the rule since 2002. Prior to that time, the IRS actually required adopters of PD's to submit to the IRS to have basic approval.

Companies that adopt Volume submitter plans, a type of PD, are allowed to modify the standard “boilerplate” language that the IRS initially approved when the original document was submitted for review. For example, the plan could add a distribution option, or early retirement subsidy that was not one of the choices it could have selected in the original PD. If these "minor modifications" are made, then the company adopting the plan for its employees must submit to the IRS for approval (currently the IRS fee for a small plan is $325).

An IDP must be reviewed by the IRS, in full, each time it is adopted. There is no pre-approval process. So it is more costly to draft and more costly to be reviewed. Most plans, except those for large companies or with unusual customized provisions, can be placed on PD's. In addition, certain kinds of plans are always treated as IDP's. These include cash balance pension plans and ESOP's.

In Revenue Procedure 2012-6, the IRS has made a major adjustment to its approval process. For any PD, the IRS will not offer an approval option, unless it is a Volume Submitter Plan making a minor modification(s). The special approvals of testing methodologies and in many cases related businesses will no longer be available. These changes mark a major change in IRS policy probably driven by budget constraints in an effort to conserve resources. The full changes took effect in 2012.