3747 / What is the penalty for underfunding a qualified plan that is subject to the minimum funding standard?

If a plan subject to the minimum funding standard ( Q 3742 to Q 3746) fails to meet it, the employer sponsoring the plan is penalized by an excise tax, but the plan will not be disqualified.¹ Imposition of the tax is automatic; there is no exception for unintentionally or inadvertently failing to meet the standard or for having intended to terminate the plan.²

For a single employer plan, the tax is 10 percent of the aggregate unpaid minimum required contributions for all plan years ( Q 3742 to Q 3746) remaining unpaid as of the end of any plan year ending with or within the taxable year.³ (In the case of a multiemployer plan, the tax is 5 percent of any accumulated funding deficiency; in the case of a CSEC plan, 10 percent of such deficiency.) In one case, an employer was liable for the 10 percent tax where a contribution was made on time according to the terms of the plan, but not within the period specified in IRC Section 412.⁴

If the 10 percent tax is imposed on any unpaid minimum required contributions and if it remains unpaid as of the close of the taxable period, or if the 10 percent tax is imposed on a multiemployer plan’s accumulated funding deficiency, an additional tax of 100 percent will be imposed on the employer to the extent that the minimum required contribution or accumulated funding deficiency is not corrected within the taxable period.⁵ This additional 100 percent tax will be abated if the deficiency is corrected within 90 days after the date when the notice of deficiency is mailed. This period may be extended by the Secretary of the Treasury.⁶

An additional tax is applied to certain defined benefit plans with a funded current liability percentage of less than 100 percent that have a “liquidity shortfall” for any quarter during a plan year.⁷ Such a plan may be subject to a tax of 10 percent of the excess of the amount of the liquidity shortfall for any quarter over the amount of such shortfall paid by the required installment for the quarter.⁸ If the shortfall was due to reasonable cause and not willful neglect, and if reasonable steps have been taken to remedy the liquidity shortfall, the Secretary of the Treasury has the discretion to waive part or all of the penalty.⁹

An uncorrected deficiency will continue in later years and will be increased by interest charges until it is paid.¹⁰ When an employer fails to contribute a plan’s normal cost in any year, that amount will not, thereafter, become a past service cost to be amortized. The funding standard account will show the amount as a deficiency subject to tax each year until corrected.

If the employer is a member of a group that is treated as a single employer under the controlled group, common control, or affiliated services group provisions ( Q 3933, Q 3935), then each member of the group is jointly and severally liable for any tax payable under IRC Section 4971.¹¹ The tax is due for the tax year in which (or with which) the plan year ends. The IRS has determined that general partners were jointly and severally liable for a partnership’s excise tax obligation resulting from failure to satisfy the minimum funding standard.¹²

Where a plan chooses to keep both a funding standard account and an alternative minimum funding standard account, the tax will be based on the lower minimum funding requirement.¹³

None of the excise taxes payable under IRC Section 4971 are deductible.¹⁴

Note that neither MAP-21 nor HATFA 2014 changed the definition or calculation of unfunded vested benefits upon which the tax is calculated. See Q 3743 for more information on the important changes that were made by MAP-21 and HATFA 2014.

If a plan is maintained pursuant to a collective bargaining agreement or by more than one employer, the liability of each employer will be based first on the employers’ respective delinquencies in meeting their required contributions, and then on the basis of the employers’ respective liabilities for contributions.¹⁵

The tax does not apply in years after the end of the plan year in which the plan terminates. If the accumulated funding deficiency has not been reduced to zero as of the end of that plan year, then the 100 percent tax is due for the plan year in which the plan terminates.¹⁶

For further guidance on the tax penalty for underfunding, see Treasury Regulation Section 54.4971-1 and Proposed Treasury Regulation Sections 54.4971-2 to 54.4971-3. Also see Q 3743 regarding HATFA 2014 limitations on executive compensation as a consequence of selecting deferred funding of qualified plans.