A Modest Proposal to Enhance Reporting and Other Tax Compliance by Owner-Employees and Their Pension Plans

Abstract

Owner-employees often establish and maintain pension plans, which cover only themselves and their spouses (“Owner-Employee Plans”) to qualify for favorable treatment under the Internal Revenue Code of 1986, as amended (the “Code”). Qualified plans must have governing instruments satisfying the qualification requirements, must be operated pursuant to those instruments, and must file annual plan reports and annual individual reports of plan distributions. Many Owner-Employee Plans violate some or all of those requirements. Moreover, some recipients do not report benefit distributions.

Four modest changes would improve compliance with the Code requirements pertaining to (1) an Owner-Employee or his beneficiaries including a benefit distribution in his or her income; (2) an Owner-Employee older than 70 ½ receiving minimum distributions; (3) the governing instruments of an Owner-Employee Plan satisfying tax qualification requirements; and (4) an Owner-Employee Plan operating pursuant to its governing instruments.

First, individuals would be required to include on their Form 1040s the names of those pension plans, if any, whose contributions they deduct from their total income to determine exclude from their adjusted gross income. Second, Owner-Employer Plan administrators would be required to include in their Form 5500-EZ the amount of the plan’s distributions and the number of participants at least 70 ½. Third, the instructions to the Form 5500-EZ would remind plan administrators of the Code requirements (1) to report individual benefit distributions to the Service and the recipient representative, (2) to make minimum distributions to participants older than 70 ½, and (3) to operate the plan pursuant to governing instruments that satisfy tax qualification requirements. Fourth, the lenient compliance programs pertaining to violations of the annual plan filing or prohibited transaction rules would be extended to Owner-Employee Plans, the only qualified plans excluded from such programs. If the final change is not adopted, in many cases only imprudent Owner-Employee would file annual plan reports or include plan distributions in their income because such disclosures could make the Service aware of prior violations that the Owner-Employee, unlike other pension plan fiduciaries, may not be able to correct at minimal cost.

Keywords: Pernsion, Tax-Qualified, Compliance, Annual Reports, IRS, DOL, Owner-Employees, One-Participant Plans, Fiduciary, Prohibited Transactions

JEL Classification: G23, H20, H24, H29, J32, J33, K34, K49, M52