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401(K) Retirement Plan Disqualification

1. What is a “qualified retirement plan”?

“Qualified retirement plans” such as 401(k) plans, pension plans and profit sharing plans are entitled to unique and generous tax benefits, including tax exempt status. However, unless such plans meet all of the numerous (and technical) requirements of the Internal Revenue Code(the “Code”), these special tax benefits can be retroactively revoked by the IRS.

2. What does it mean to say that a retirement plan can be “disqualified”?

If a retirement plan does not meet all of the requirements of the Code (including if the plan is not operated in accordance with its terms–there is no standard of materiality in the size of the error), adverse tax consequences can apply to the plan sponsor, the trust, and the employees participating in the plan for all years for which the statute of limitations is open(unless the errors are properly corrected –see Q&A #3 below).

  1. Tax Consequences to Employer:the employer can lose its deduction for some or all of its contributions made to the plan and may be liable for failure to properly report or withhold income tax/FICA/FUTA.

  2. Tax Consequences to the Trust: the trust can lose its tax exempt status.

  3. Tax Consequences to Employees: employees can be taxed on their benefits and lose the ability roll over distributions.(IRA rollovers may be subject to an additional excise tax).

  4. Other Consequences:employees may have claims against plan fiduciaries for failure to preserve the Plan’s tax qualified status.

3. What options are available for “disqualified plans?”

Once disqualified, a plan will continue to be disqualified until the disqualifying defects are properly corrected.Freezing or terminating a plan may be a way to mitigate future costs, but does not “fix” a disqualified plan.

The IRS offers a variety of voluntary correction programs to correct these and other errors, even in an audit. These include voluntary self-correction, voluntary compliance statements, audit closing agreements and walk-in closing agreements. We have extensive experience representing taxpayers with respect to these programs. For more information about the IRS’ Employee Plans Compliance Resolution Systems (“EPCRS”), please contact us.

More information is also available on the IRS website at:

401(K) Retirement Plan Disqualification
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