Plans With Complete Discontinuance of Contributions Treated As Terminated for Vesting Purposes

An IRS compliance project found some profit sharing, including 401(k), plan sponsors did not understand when a complete discontinuance of contributions occurs.

The Internal Revenue Service (IRS) Employee Plans Compliance Unit (EPCU) completed its Complete Discontinuance of Contributions Project, which it used to determine whether profit sharing plans, including Internal Revenue Code (IRC) Section 401(k) plans, had experienced a complete discontinuance of contributions.

In its summary of project findings, the IRS reminded plan sponsors that if there is a complete discontinuance of contributions in a profit sharing plan, the plan is treated as terminated for vesting purposes and affected employees must be 100% vested in their accrued benefit. The project found that some plan sponsors did not know that an issue of complete discontinuance arises when the employer has failed to make substantial contributions for at least three years in a five-year period, and complete discontinuance is not an issue if plan participants receive full vesting at all times.

In May 2014, the EPCU sent contact letters to plan sponsors who filed Form 5500 or Form 5500-SF returns for the 2012 or 2013 plan years showing zero contributions for five consecutive years, plan participants receiving distributions in the 2012 or 2013 plan year, respectively, and plan participants having terminated with less than 100% vesting. The responses indicated about 10% of plan sponsors had a complete discontinuance of contributions. These sponsors used the IRS self-correction program (SCP) and voluntary correction program (VCP) to correct this error and make the affected participants 100% vested in their accounts.

For a majority of the responses, the lack of contributions did not rise to the level of a complete discontinuance.

Responses showed that it was easier to determine whether Form 5500 filers were more likely to have experienced a complete discontinuance than Form 5500-SF filers. This was because unlike Form 5500, the Form 5500-SF (prior to 2014) did not contain a line item indicating whether participants terminated employment during the plan year with benefits that were not fully vested. In addition, the IRS said, some plan sponsors made errors in completing their Form 5500 series return because they did not understand the instructions for reporting terminated participants.

More information about IRS EPCU projects may be found here.