Case — Retirement Plan Active Participant

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TL Case Summ

THE QUESTION

What’s the definition of an active participant in a retirement plan?

THE DISPUTE

Taxpayer Says: Even though his W-2 indicates he was an active participant in his employer’s retirement plan, he should be allowed to take a deduction for his contribution to an Individual Retirement Account because he did not participate in the company plan.

Internal Revenue Service Says: Enrollment in the plan means the taxpayer was an active participant, and the deduction for a contribution to an Individual Retirement Account is not allowed.

THE LAW

From Internal Revenue Code Section 219(g): Deductions attributable to contributions to an individual retirement account may be limited if a taxpayer is an “active participant” in certain other pension, stock bonus, or profit-sharing plans.

From Federal Tax Regulation 1.219-2(b): Concerns defined benefit plans and, in particular, states: “[A]n individual is an active participant in a defined benefit plan if for any portion of the plan year ending with or within such individual’s taxable year he is not excluded under the eligibility provisions of the plan.”.

From H.R. Rept. No. 93-807, at 129 (1974), 1974-3 C.B. (Supp.) 236, 364: “An individual is to be considered an active participant in a plan if he is accruing benefits under the plan even if he has only forfeitable rights to those benefits.”

THE CAUSE OF THE DISPUTE

Contributions you make to your traditional Individual Retirement Account may be deductible on your federal income tax return. The deduction is generally subject to certain restrictions, such as your contribution limit, your income, and your status (and that of your spouse) as an “active participant” in your employer’s retirement plan.

Disputes arise because the term “active participant” is not fully defined in the Internal Revenue Code.

In this case, the taxpayer, an insurance agent, worked for a company that had a defined contribution plan as well as a defined benefit plan. He was automatically enrolled in the plans, though he did not participate or make contributions. He made no effort to participate because the defined benefit plan did not allow vesting until after five years of employment, and he knew he would be fired for not meeting sales quotas.

He worked for the company during 2008, and was fired in April 2009. He made a timely 2008 contribution of $6,000 to an Individual Retirement Account, and deducted the contribution on his federal income tax return.

He acknowledges the box on his 2008 W-2 indicating participation in his employer’s retirement plan was checked. However, because he did not participate in, or receive any benefits from, the plans, he argues he was not an active participant, and his coverage under the company retirement plan should not disallow his deduction.

The IRS says the taxpayer was enrolled in his employer’s plan, and therefore he was an “active participant”, even though he had been automatically enrolled without his knowledge, he did not make any contributions, and he did not accrue any benefits.

WHAT WOULD YOU DECIDE?

Make your selection, then see “The Court’s Decision” below for a full explanation

For the or for the

THE COURT’S DECISION

Download (PDF, 14KB)

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HL Carpenter, an experienced investor and a CPA, specializes in reader friendly articles on taxes and investing for individuals and small businesses, and publishes two newsletters: Taxing Lessons and Top Drawer Ink. Visit TaxingLessons.com and HLCarpenter.com.

This information should not be considered legal, investment or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment or tax advice. Always consult your legal, investment and/or tax advisor regarding your personal situation.

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Sorry, wrong answer :(
Right answer!
For the IRS. We agree with taxpayer that, considering the facts, the result is inequitable and does nothing to further the congressional purpose underlying the enactment of section 219. However, simply because the taxpayer was enrolled in a defined benefit plan during 2008, no matter how superficial and ineffective that coverage may have been, he is not entitled to deduct the $6,000 IRA contribution, and we so hold.
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