Does anyone know of an example of actual disqualification of a plan due to section 125 violations?

Again, does anyone know of an example of actual disqualification of a plan due to section 125 violations?

What happens, for example, to the past "pre-tax" amounts? Are all past participants required to show that as taxable income for past years?

The regulations will tell you the what happens if a plan "fails" to meet all the necessary requirements. The penalty depends on the plan flaw. For most discrimination testing failures the key employees have to be taxed, but not the rank and file. If the plan reimburses anyone for a non qualified expense then that individual has to be taxed on the amount received. What exactly occured in your example? With more information I could give you a more difinitve answer.

I don't have a specific example. I am curious about what would happen if a premium only section 125 plan got disqualified for failure to follow section 125 rules. For example, say a medical plan allowed participants to go in and out at will throughout the plan year rather than following the regs for qualified (family) status changes. Say it has nothing to do with discrimination testing. Does anyone know of an example of this happening??

I think everyone would be taxed on all their contributions for every year in which the rules were not followed. How many years to go back would depend on what tax years of the employer were still open.

A cafeteria plan adopted on retroactive basis was disqualified in American Family Mutual Ins. Co. v. U.S. , DC W Wis. 12/3/92, 16 EBC 1332, 815 F. Supp. 1206.

Acompany i know of was disqualified, the company then was audited for the prior 5 years and the company had to pay the taxes, penalty, & interests. The employees were then paying premiums on an after tax basis.

Thank you very much for the useful information.

The IRS has a 125 audit program that was started a few years ago by payroll tax examiners. And if I recall correctly, the particular auditors were in the Southwest (or maybe Southeast) and those were the areas heaviest hit by audits. However, they have been training other examiners. A copy of their 1998 training is located at http://www.irs.gov/pub/irs-tege/lesson4.pdf . It was my understanding that when the program was initiated, they were primarily looking at issues like whether a plan document existed as opposed to discrimination issues, etc. In other words, since they were payroll auditors -- and not EP auditors -- they were focusing primarilyl on whether the payroll deductions were truly pre-tax. So if a plan was audited, the examiners were closely reviewing the plan document and the payroll records. I think that most or all of the issues that you are describing would be discovered by the examiner. Your chances of getting audited probably depend on whether you are in targeted industry. The greater risk might actually be with the insurance company...

The 125 audit program is extremely limited because of the lack of resources and the IRS has no standards to test for discrimination in 125 plans other than the 25 % test. Also the s/l for recovering back taxes is generally 3 years. The IRS has a policy of starting compliance/audit programs in the benefits area and then stripping it of resources when it iestablishes a new initative (e.g. 403(B) plans). IRS oversight/ compliance programs in the employee benefits area are no better than DOL or EEOC oversight, e.g, it is "symbolic enforcement" of applicable law due to the lack of resources in a declining budgetary environment. IRS resources are being directed toward those areas that will raise the most revenue, e.g., off shore accounts, tax shelters, self employed persons.

The area of concentration on audits were the Dallas Metroplex area. It was a pilot operation to gather information to teach auditors what a cafeteria plan was and things that they should be looking for. The bigest concern for the IRS was generating revenue. Jay Jenson is the one who developed this training and they were concentrating on companies with 1000 or more employees. Part of what was decided was to have the auditors that audited payroll taxes to audit the cafeteria plans. I think now you are more likely to be audited from the DOL from an employee filing a complaint than from the IRS these days. That's not to say that we don't need to have a our records and compliance up to standards it is just to say that the IRS is looking elsewhere for revenue. The DOL is where we can be hammered in audits if we are not in compliance.

If an employee complained to the DOL, because of something they feel is unfair and some type of discrepancy with their benefits comes out, would that be shared with IRS?

The first thing that would happen is the DOL's requirement to investigate the complaint. DOL would then rule and impose the necessary infractions of their finding(s). I am sure that if there was an infraction that would warrant the notification of the IRS there would be some mechanism in place for the DOL to notify the IRS.