Keep Up To Date On All Tax Law Changes Or Else...

Benjamin Franklin famously observed that nothing in life is certain but death and taxes.

It turns out he was half right.

As a recent tax court ruling regarding the 35-year-old Christy & Swan profit sharing plan illustrates, nothing is certain about the tax treatment of profit sharing retirement plans – at least those that fail to keep up with changes to the tax code.

David S. Swan, Jr. established such a plan for his real estate business in 1976 with himself as the sole participant and plan trustee. A decade later, the IRS granted Swan's plan tax-exempt status as a retirement plan under Code Sec. 401(a).

In 2000, Congress passed the Community Renewal Tax Relief Act, followed in 2001 by the Economic Growth and Tax Relief Reconciliation Act. Both made numerous changes to qualified retirement plans – and warned trustees to amend their plans or risk losing their tax-exempt status.

When Swan filed his Form 5500-EZ (Annual Return of One-Participant (Owners and their Spouses) Retirement Plan) for the plan's 2005 tax year, the IRS initiated an audit to determine whether the plan had been updated.

Swan provided the IRS with a declaration that he had "amended" the plan by general reference to incorporate all statutory and regulatory amendments to retain his tax-qualified status. He further argued that the plan had matured into a repository trust in 2001, and therefore was not required to amend for the legislative changes.

Two years later, following a lengthy series of exchanges, the IRS determined that he hadn't amended his plan as required and revoked its tax-exempt status.

On appeal, the tax court agreed with the IRS that Swan had not only failed to update the plan to code, but had failed to correctly terminate the plan as well.

Not only did the tax court uphold the revocation of tax-exempt status against Christy & Swan, it did so retroactively to 2001, despite the fact that the plan had accepted no new contributions or participants after 2000. The court's reasoning: while the termination of a plan will always end contributions, an end of contributions alone does not constitute termination of a plan.

The takeaway from this five-year legal ordeal? Mind the changes that could affect your retirement plan, however capricious or unnecessary they may seem.