Sec. 403(b) plans - voluntary correction program could save exempt organizations large penalties.

• Author: Bosco, Philip R.

The IRS recently expanded its enforcement initiatives to include tax-sheltered annuity plans (Sec. 403(b) plans) maintained by exempt organizations such as hospitals, colleges and universities. Several large exempt organizations have already been assessed significant fines, signaling an increased risk of substantial penalties being imposed for Sec. 403(b) plan violations. Fortunately, the Service recently introduced a voluntary correction program that can help many exempt organizations rectify violations and avoid significant fines. (This program is not available, however, after the onset or notice of an IRS examination.)

IRS audit initiative

This increase in enforcement began in 1992 as part of a Coordinated Examination Program (CEP) initiated by the Service that specifically targeted hospitals, colleges and universities. The focus of the CEP was the organizations' overall operations, not just their Sec. 403(b) programs.

Although the CEP initiative did not originally focus specifically on the targeted organizations' Sec. 403(b) plans, the Service discovered that few, if any, of these plans were in compliance with IRS rules. The Service then assigned specially trained employee-plans personnel to support this Sec. 403(b) initiative. Due to its success in uncovering tax-compliance problems, this initiative has rapidly expanded throughout the country to all exempt organizations, not only those under the CEP.

IRS auditors determine operational compliance based on whether an exempt organization operates its Sec. 403(b) plan in accordance with plan documents and applicable statutory requirements. As with any audit, employers are required to fulfill extensive data requests. IRS auditors scrutinize payroll and other plan data to verify that testing procedures regarding issues such as nondiscrimination testing or contribution limits are properly implemented, that all eligible participants are able to make plan contributions and that plan contributions are invested in the proper type of annuity or custodial account.

Many of the rules governing Sec. 403(b) plans are complicated and difficult to understand. As a result, many exempt organizations which, in good faith, attempt to comply with such rules unknowingly are not in compliance. Other exempt organizations that permit employees to purchase tax-sheltered annuities without any direct employer involvement mistakenly believe they do not maintain employer-sponsored Sec. 403(b) plans and, therefore, are...