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Your Tax-Exempt Status Has Just Been Revoked!

Adam C. Pozek 04/19/11

It’s funny how the human brain (or maybe it’s just my brain) forms associations with words or phrases.  Whenever I hear the word “revoked,” I immediately think of a scene from one of the Lethal Weapon movies.  The bad guy had been using his diplomatic immunity to get away with all sorts of nefarious deeds.  At the end of the movie as he lay clinging to life after being on the wrong end of a shoot-out, Danny Glover’s character says rather pithily, “Your diplomatic immunity has just been REVOKED.”

The Pension Protection Act of 2006 created a new filing requirement for small not-for-profit organizations (“NFPs”).  The IRS is required by statute to revoke the tax-exempt status of any NFPs that fail to satisfy the new filing requirement for three consecutive years.  A Guidestar whitepaper on the subject is available here (free registration required), and the IRS has an FAQ on its site.

When I first heard the time had come and the first round of revocations are imminent, I had visions of Danny Glover and Mel Gibson kicking down doors of local NFPs and shouting, “Your tax-exempt status has just been REVOKED.”

What does all of this have to do with retirement plans?  If you are or work with an NFP that maintains a 403(b) plan and is the unfortunate recipient of one of these revocation letters, quite a bit.

Only 501(c)(3) NFPs and certain educational institutions can sponsor 403(b) plans.  That means a 501(c)(3) with a 403(b) that has its tax-exempt status pulled is no longer eligible to make contributions to the plan, nor can any of the participants.  This is referred to as an Employer Eligibility Failure that must be corrected under the IRS Voluntary Correction Program as described here.  In short, all contributions must cease, and the plan must be maintained as a frozen plan until each participant has a distributable event, e.g. termination of employment, death, disability, etc.

One of the fundamental requirements of VCP is that a plan must make full correction.  Therefore, NFPs finding themselves in this situation would be well served to conduct a full review of their plans to determine if there are any other “skeletons in the closet” that must be addressed prior to the VCP submission.

While an NFP that loses its tax-exempt status may believe it has more pressing issues, the 403(b) plan is equally worthy of attention.  Otherwise, Mel and Danny may be kicking down the door to make the same exclamation about the plan also.

Topics: 403(b), IRS, DWC


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The views expressed in this blog are those of the authors and do not necessarily represent the views of any other person or organization. All content is provided for informational purposes only and is not intended to be tax or legal advice.