Our nongovernmental 457(b) plan suffered an operational failure where one participant contributed in excess of $15,500.

This has been caught by the IRS on audit. The IRS is stating that the Plan will be disqualified for this small operational error.

Voluntary compliance is not available under EPCRS, do you guys know of any way to correct this error without disqualifying the plan?

Is the IRS offering up anything to close the situation out without making the plan ineligible? Allow the excess to be refunded now? Anything at all, or are they just saying everything in the plan is now taxable? I have a potential client in the same situation except they are not under audit. I posted a simliar post a few weeks ago but nobody responded. I think it must be a taboo topic in the industry because nobody wants to offer anything up. I wonder if it is because there are a bunch of tax exempt 457(b) plans out there that broke the rules (either didn't do the refund or did them after April 1) and instead of making them 457(f)'s everyone is just waiting to see if they get audited. I contacted some IRS employees but they did not have anything helpful either. It would be nice to know how your situation turns out.

I'll let you know. Voluntary correction is unavailable for nongovernmental 457(b) plans. It's looking like we are going to try to settle it in the closing agreement for the audit, but we're basically at the mercy of the IRS.

I'm dealing with a similar issue. Does anyone know of any correctional methods available to a nongovernmental 457(b) plan. Specifically, is there any type of retroactive amendment procedure?

Hi, I was wondering what the resolution was to this situation. Did the IRS make them go 457(f), which I assume would make everything in the plan taxable since there is no substantial risk of forfeiture?

The end resolutions was that we did an informal appeal by basically calling one IRS supervisor after another (e.g., can I speak to your superior). (We had to do informal appeal, rather than formal appeals process, because the plan participants, not the plan sponsor, would have appeal rights.) We coupled this with pressure from our state senator. We finally got a hold of the VP for the TE/GE group in Washington, who agreed that it wasn't a big deal, but extracted a big penalty (way in excess of VCP), to keep the plan eligible.

In addition, we created a new 457(b) plan to wall of the tainted plan from new monies. I've heard that these types of audits are on the rise, so good luck.

Revenue Procedure 2008-50, section 4.09:

Availability of correction of § 457 plans. Submissions relating to § 457(b) eligible governmental plans will be accepted by the Service on a provisional basis outside of EPCRS through standards that are similar to EPCRS.

So, if you are a non-government entity, any EPCRS filing is futile. Since VCP is not available for the nonprofits' 457(b) plans, if you find an error like this, do you recommend that the refund be made right away anyway, plus earnings? Then document your files and change the procedures so this error can be prevented in the future? If you are audited later, could you explain that no correction option existed under EPCRS, so the plan sponsor did all they could to reasonably correct the error? Then hope the IRS shows mercy under audit cap because of your efforts to have already corrected the issue? I assume that if no correction is made, they will show little mercy when negotiating under audit cap. What do you think?

The 457 treasury regs give you a grace period for refunding excess contributions, I think it's April 15 of the year following, but you would need to confirm. If you correct after this time, then you are screwed. If the Plan retains excess contributions after this grace period deadline, then the IRS views the Plan as having converted from an eligible 457(b) plan to an ineligible 457(f) plan. Since the two plans are structured differently, you'll have immediate taxation on all amounts in the plan from the date of the error. This means that all amounts deferred thereafter will also be subject to taxation.

I would make the correction as you suggest, but wouldn't count on mercy. I would institute a new plan as part of the correction in case the IRS comes poking around to limit the amounts on which they can ding you. In our case, the plan had been in existence for decades and involved a very small excess (under $2,000) and it took almost a year to find someone within the IRS to show mercy. And their mercy was very expensive (relative to the amount of the error).

If the excess contribution is due to an individual limit, does 1.457-4(e) apply? This allows the plan to stay eligible but must distribute the excess and earnings as soon as administratively practicable after determining an excess exists. According to the regs. it looks like you issue a W-2 for the year the contribution should have been included in taxable income and a 1099 for the earnings (if discovered after issuance of W-2 for the year). The regs aren't real clear if this applies to both governmental and tax-exempt entities; as far as reporting the excess and earnings. Any thoughts?

JWR -- good point. I agree that you should closely look at how the limits were exceeded.

J4KBC -- Informal self-correction is all well and good but there is certainly no reliance, but I do think the IRS wll look more favorably on this approach than doing nothing and waiting to get caught. I wonder if if might be possible to pose the issue on an anonymous basis to the IRS in hopes of a favorable settlement. I have a similar situation and might try this. One could present the issue to the EPCRS' folks but my experience with them is that if it's not "by the book" they can't or won't handle it. My gut tells me that I would be better off with the local/regional TE/GE office and regular IRS appeals if necessary.

With all the voluntary correction options that are available, its an outrage that the IRS would blow up plans and cause other unsuspecting participants to suffer for relatively minor violations like this because they haven't formalized any procedure for dealing with it.