Tax on Early Distributions

If a distribution is made to an employee under the plan before he or she reaches age 59½, the employee may have to pay a 10% additional tax on the distribution. This tax applies to the amount received that the employee must include in income.

Exceptions.   The 10% tax will not apply if distributions before age 59½ are made in any of the following circumstances.

• Made to a beneficiary (or to the estate of the employee) on or after the death of the employee.
• Made due to the employee having a qualifying disability.
• Made as part of a series of substantially equal periodic payments beginning after separation from service and made at least annually for the life or life expectancy of the employee or the joint lives or life expectancies of the employee and his or her designated beneficiary. (The payments under this exception, except in the case of death or disability, must continue for at least 5 years or until the employee reaches age 591/2, whichever is the longer period.)
• Made to an employee after separation from service if the separation occurred during or after the calendar year in which the employee reached age 55.
• Made to an alternate payee under a qualified domestic relations order (QDRO).
• Made to an employee for medical care up to the amount allowable as a medical expense deduction (determined without regard to whether the employee itemizes deductions).
• Timely made to reduce excess contributions under a 401(k) plan.
• Timely made to reduce excess employee or matching employer contributions (excess aggregate contributions).
• Timely made to reduce excess elective deferrals.
• Made because of an IRS levy on the plan.

Reporting the tax.   To report the tax on early distributions, file Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts. See the form instructions for additional information about this tax.

Tax on Excess Benefits

If you are or have been a 5% owner of the business maintaining the plan, amounts you receive at any age that are more than the benefits provided for you under the plan formula are subject to an additional tax. This tax also applies to amounts received by your successor. The tax is 10% of the excess benefit includible in income.

5% owner.   You are a 5% owner if you meet either of the following conditions at any time during the 5 plan years immediately before the plan year that ends within the tax year you receive the distribution.

• You own more than 5% of the capital or profits interest in the employer.
• You own or are considered to own more than 5% of the outstanding stock (or more than 5% of the total voting power of all stock) of the employer.

Reporting the tax.   Include on Form 1040, line 58, any tax you owe for an excess benefit. On the dotted line next to the total, write Sec. 72(m)(5) and write in the amount.

Lump-sum distribution.   The amount subject to the additional tax is not eligible for the optional methods of figuring income tax on a lump-sum distribution. The optional methods are discussed under Lump-Sum Distributions in Publication 575.

Reversion of Plan Assets

A 20% or 50% excise tax is generally imposed on the cash and fair market value of other property an employer receives directly or indirectly from a qualified plan. If you owe this tax, report it in Part XIII of Form 5330. See the form instructions for more information.

Notification of Significant Benefit Accrual Reduction

For plan amendments taking effect after June 6, 2001, the employer or the plan will have to pay an excise tax if both the following occur.

• A defined benefit plan or money purchase pension plan is amended to provide for a significant reduction in the rate of future benefit accrual.
• The plan administrator fails to notify the affected individuals and the employee organizations representing them of the reduction in writing. Affected individuals are the participants and alternate payees whose rate of benefit accrual under the plan may reasonably be expected to be significantly reduced by the amendment.

A plan amendment that eliminates or significantly reduces any early retirement benefit or retirement-type subsidy significantly reduces the rate of future benefit accrual.

The notice must be written in a manner to be understood by the average plan participant and provide enough information to allow each individual to understand the effect of the plan amendment. It must be provided within a reasonable time before the amendment takes effect or September 7, 2001, whichever is later.

The tax is $100 per participant or alternate payee for each day the notice is late. It is imposed on the employer, or, in the case of a multi-employer plan, on the plan.

There are certain exceptions to, and limitations on, the tax. The tax does not apply in any of the following situations.

• The amendment takes effect after June 6, 2001, and notice was provided before April 25, 2001, to participants and beneficiaries adversely affected by the amendment (or their representatives) to notify them of the nature and effective date of the amendment.
• The person liable for the tax was unaware of the failure and exercised reasonable diligence to meet the notice requirements.
• The person liable for the tax exercised reasonable diligence to meet the notice requirements and provided the notice within 30 days starting on the date the person knew or would have known that the failure to provide notice existed.

If the person liable for the tax exercised reasonable diligence to meet the notice requirement, the tax cannot be more than $500,000 during the tax year. The tax can also be waived to the extent it would be excessive or unfair if the failure is due to reasonable cause and not to willful neglect.

Prohibited Transactions

Prohibited transactions are transactions between the plan and a disqualified person that are prohibited by law. (However, see Exemption, later.) If you are a disqualified person who takes part in a prohibited transaction, you must pay a tax (discussed later).

Prohibited transactions generally include the following transactions.

1. A transfer of plan income or assets to, or use of them by or for the benefit of, a disqualified person.
2. Any act of a fiduciary by which he or she deals with plan income or assets in his or her own interest.
3. The receipt of consideration by a fiduciary for his or her own account from any party dealing with the plan in a transaction that involves plan income or assets.
4. Any of the following acts between the plan and a disqualified person.
   1. Selling, exchanging, or leasing property.
   2. Lending money or extending credit.
   3. Furnishing goods, services, or facilities.

Exemption.   Certain transactions are exempt from being treated as prohibited transactions. For example, a prohibited transaction does not take place if you are a disqualified person and receive any benefit to which you are entitled as a plan participant or beneficiary. However, the benefit must be figured and paid under the same terms as for all other participants and beneficiaries. For other transactions that are exempt, see section 4975 and the related regulations.

Disqualified person.   You are a disqualified person if you are any of the following.

1. A fiduciary of the plan.
2. A person providing services to the plan.
3. An employer, any of whose employees are covered by the plan.
4. An employee organization, any of whose members are covered by the plan.
5. Any direct or indirect owner of 50% or more of any of the following.
   1. The combined voting power of all classes of stock entitled to vote, or the total value of shares of all classes of stock of a corporation that is an employer or employee organization described in (3) or (4).
   2. The capital interest or profits interest of a partnership that is an employer or employee organization described in (3) or (4).
   3. The beneficial interest of a trust or unincorporated enterprise that is an employer or an employee organization described in (3) or (4).
6. A member of the family of any individual described in (1), (2), (3), or (5). (A member of a family is the spouse, ancestor, lineal descendant, or any spouse of a lineal descendant.)
7. A corporation, partnership, trust, or estate of which (or in which) any direct or indirect owner described in (1) through (5) holds 50% or more of any of the following.
   1. The combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of a corporation.
   2. The capital interest or profits interest of a partnership.
   3. The beneficial interest of a trust or estate.
8. An officer, director (or an individual having powers or responsibilities similar to those of officers or directors), a 10% or more shareholder, or highly compensated employee (earning 10% or more of the yearly wages of an employer) of a person described in (3), (4), (5), or (7).
9. A 10% or more (in capital or profits) partner or joint venturer of a person described in (3), (4), (5), or (7).
10. Any disqualified person, as described in (1) through (9) above, who is a disqualified person with respect to any plan to which a section 501(c)(22) trust is permitted to make payments under section 4223 of ERISA.

Tax on Prohibited Transactions

The initial tax on a prohibited transaction is 15% of the amount involved for each year (or part of a year) in the taxable period. If the transaction is not corrected within the taxable period, an additional tax of 100% of the amount involved is imposed. For information on correcting the transaction, see Correcting a prohibited transaction, later.

Both taxes are payable by any disqualified person who participated in the transaction (other than a fiduciary acting only as such). If more than one person takes part in the transaction, each person can be jointly and severally liable for the entire tax.

Amount involved.   The amount involved in a prohibited transaction is the greater of the following amounts.

• The money and fair market value of any property given.
• The money and fair market value of any property received.

If services are performed, the amount involved is any excess compensation given or received.

Taxable period.   The taxable period starts on the transaction date and ends on the earliest of the following days.

• The day the IRS mails a notice of deficiency for the tax.
• The day the IRS assesses the tax.
• The day the correction of the transaction is completed.

Payment of the 15% tax.   Pay the 15% tax with Form 5330.

Correcting a prohibited transaction.   If you are a disqualified person who participated in a prohibited transaction, you can avoid the 100% tax by correcting the transaction as soon as possible. Correcting the transaction means undoing it as much as you can without putting the plan in a worse financial position than if you had acted under the highest fiduciary standards.

Correction period.   If the prohibited transaction is not corrected during the taxable period, you usually have an additional 90 days after the day the IRS mails a notice of deficiency for the 100% tax to correct the transaction. This correction period (the taxable period plus the 90 days) can be extended if either of the following occurs.

• The IRS grants reasonable time needed to correct the transaction.
• You petition the Tax Court.

If you correct the transaction within this period, the IRS will abate, credit, or refund the 100% tax.

Reporting Requirements

You may have to file an annual return/report form by the last day of the 7th month after the plan year ends. See the following list of forms to choose the right form for your plan.

Form 5500-EZ.   You can use Form 5500-EZ if the plan meets all the following conditions.

• The plan is a one-participant plan, defined below.
• The plan meets the minimum coverage requirements of section 410(b) without being combined with any other plan you may have that covers other employees of your business.
• The plan only provides benefits for you, you and your spouse, or one or more partners and their spouses.
• The plan does not cover a business that is a member of an affiliated service group, a controlled group of corporations, or a group of businesses under common control.
• The plan does not cover a business that leases employees.

One-participant plan.   Your plan is a one-participant plan if, as of the first day of the plan year for which the form is filed, either of the following is true.

• The plan covers only you (or you and your spouse) and you (or you and your spouse) own the entire business (whether incorporated or unincorporated).
• The plan covers only one or more partners (or partner(s) and spouse(s)) in a business partnership.

Form 5500-EZ not required.   You do not have to file Form 5500-EZ (or Form 5500) if you meet the conditions mentioned above and either of the following conditions.

• You have a one-participant plan that had total plan assets of $100,000 or less at the end of every plan year beginning after December 31, 1993.
• You have two or more one-participant plans that together had total plan assets of $100,000 or less at the end of every plan year beginning after December 31, 1993.

Example.   You are a sole proprietor and your plan meets all the conditions for filing Form 5500-EZ. The total plan assets are more than $100,000. You should file Form 5500-EZ.

All one-participant plans must file Form 5500-EZ for their final plan year, even if the total plan assets have always been less than $100,000. The final plan year is the year in which distribution of all plan assets is completed.

Form 5500.   If you do not meet the requirements for filing Form 5500-EZ, you must file Form 5500.

Schedule A (Form 5500).   If any plan benefits are provided by an insurance company, insurance service, or similar organization, complete and attach Schedule A (Form 5500), to Form 5500. Schedule A is not needed for a plan that covers only one of the following.

1. An individual or an individual and spouse who wholly own the trade or business, whether incorporated or unincorporated.
2. Partners in a partnership or the partners and their spouses.

Do not file a Schedule A (Form 5500) with a Form 5500-EZ.

Schedule B (Form 5500).   For most defined benefit plans, complete and attach Schedule B (Form 5500), Actuarial Information, to Form 5500 or Form 5500-EZ.

Schedule P (Form 5500).   This schedule is used by a fiduciary (trustee or custodian) of a trust described in section 401(a) or a custodial account described in section 401(f) to protect it under the statute of limitations provided in section 6501(a). The filing of a completed Schedule P (Form 5500), Annual Return of Fiduciary of Employee Benefit Trust, by the fiduciary satisfies the annual filing requirement under section 6033(a) for the trust or custodial account created as part of a qualified plan. This filing starts the running of the 3-year limitation period that applies to the trust or custodial account. For this protection, the trust or custodial account must qualify under section 401(a) and be exempt from tax under section 501(a). The fiduciary should file, under section 6033(a), a Schedule P as an attachment to Form 5500 or Form 5500-EZ for the plan year in which the trust year ends. The fiduciary cannot file Schedule P separately. See the Schedule P instructions for more information.

Form 5310.   If you terminate your plan and are the plan sponsor or plan administrator, you can file Form 5310, Application for Determination for Terminating Plan. Your application must be accompanied by the appropriate user fee and Form 8717, User Fee for Employee Plan Determination Letter Request.

More information.   For more information about reporting requirements, see the forms and their instructions.

Previous | First | Next

Publication Index | 2002 Tax Help Archives | Tax Help Archives | Home