International Issues Involving Retirement Plans in U.S. Territories

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Note - Any federal tax advice contained in this transcript is intended to apply to the specific situation described and should not be considered official guidance independent of the presentation. The tax advice and statements contained herein should not be relied upon for retirement planning purposes without first consulting a tax or retirement planning professional. This transcript has been edited for technical accuracy and may differ slightly from the audio recording of the International Issues Involving Retirement Plans in US territories phone forum.   This information is current as of March 21, 2013.  Since changes may have occurred, no guarantees are made concerning the technical accuracy after that date.

Mark:  Hi, everyone. I'm Mark O'Donnell, director of IRS Employee Plans Customer Education and Outreach. Welcome to our phone forum on International Issues Involving Retirement Plans in US territories.

Today, we'll be hearing from Charlie Petrasanta, our TE/GE International lead, Olimpia Diaz, EP group manager, and Stephanie Hunter, an EP revenue agent. Thank you all for joining us today.

Before we start, I'd like to point out a couple of things. Everyone registered for this forum will receive a Certificate of Completion by e-mail in about a week as long as you attend the entire live forum. Enrolled retirement plan agents and enrolled actuaries are entitled to Continuing Education credit for this session. Other types of tax professional should consult their licensing organization to see if today's session qualifies for Continuing Education credit. As with all our presentations, the comments expressed by our speakers should not be construed as formal guidance from the IRS.

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Without further delays, here are Charlie, Olimpia, and Stephanie.

Charlie:  Good afternoon or good morning, depending on where you are. My name is Charlie Petrasanta. I'm an actuary and international lead with the Tax Exempt and Government Entities Division of the Internal Revenue Service. I've been with the Internal Revenue Service for more than 20 years. Before joining the service, I was in private consulting.

For today's session, we are going to discuss International Issues Involving Retirement Plans in US Territories. If time permits, we will answer some of the questions that we received. If we don't get to your questions, you will be individually contacted.

Let me begin with the general update of current international activities, results of international compliance projects, and initiatives for fiscal year 2013, and then turn it over to Olimpia and Stephanie for a more in-depth discussion of activities in Puerto Rico and the US Virgin Islands.

Employee Plans continues to select and audit multinational corporations as part of our Employee Plan Team Audit Program. This is a large case program typically for employers sponsoring plans with more than 3500 employees. We've selected cases this year. One of our criteria, for example, is corporations whose Form 5500 had a foreign address.

Based on this, Employee Plan selected approximately 35 corporations for potential examination. Several of these corporations had a Puerto Rico address. In addition, we select cases that are referred to us by the Large Business and International Division (LB&I), of the Internal Revenue Service. This includes sponsors of dual-qualified plans that cover both US and Puerto Rico employees. In addition to our large case program, we continue with the Puerto Rico Hacienda Project.

Let me give a little background about the Hacienda Project. The Tax Exempt and Government Entities Division (TE/GE), Employee Plans Unit, embarked on an initiative during fiscal year 2000 to determine the applicability of the Internal Revenue Code pension plans maintained in the United States territories. Sponsors of plans covering employees in Puerto Rico must receive approval from the Puerto Rico taxing authority, the Hacienda, and may need to be qualified under United States code.

In 2006, a Memorandum of Understanding was executed between TE/GE Employee Plans and the Hacienda that provided for the exchange of information between the agencies. Sponsors of plans covering employees in Puerto Rico can elect to have those plans qualified under the Hacienda or both the Internal Revenue code and the Hacienda, dual-qualified. ERISA section 1022(i)(2) gives two methods for plan sponsors to make an irrevocable election to have dual-qualified status. They can file for determination letter with the Internal Revenue Service or they can register the election with the Internal Revenue Service's director's representative in Puerto Rico.

To distinguish the qualification intention of plans covering Puerto Rico employees, two feature codes were created for use on the Form 5500. The feature code 3C is to be entered if the plan does not intend to be qualified under the Internal Revenue Code. The feature code 3J should be entered if the plan is intended to be dual-qualified. It's our goal to properly classify plans covering employees who are residents of Puerto Rico to determine those subject to the Internal Revenue Code. For more information on the Hacienda Project, please visit our Retirement Plans website at and enter the phrase Hacienda.

Olimpia will discuss the Hacienda Project, education of local agents and taxpayers on information reporting, referrals, joint pension plan audits, and voluntary compliance in much more detail. In addition, Stephanie will discuss US Virgin Island Project.

Following down to the second bullet on slide number 4, we continue with current Employee Plans Compliance Unit projects and we're designing new projects.

Employee Plans Compliance Unit developed two compliance check projects involving international entities. We've also completed those projects. For those who are unfamiliar with the Employee Plans Compliance Unit, Employee Plans Compliance Unit or EPCU develops compliance projects and performs data analysis which focuses on areas of potential non-compliance. Taxpayers are initially contacted by correspondence and most issues are resolved without an onsite examination. The international and US territory noncompliance is a significant area of concern  for the Internal Revenue Service.

The Employee Plans Compliance Unit has been charged for the verifying compliance with international implications. A compliance check is not an order or investigation on the Section 7605(b) of the Internal Revenue Code or an audit under Section 530 of the Revenue Act of 1978. The first completed project was designed to obtain information about domestic trusts maintained by foreign employers and as I indicated, it has been completed. A trust is a domestic trust if a court within the United States is able to exercise primary supervision of the administration of the trust and one or more US persons have authority to control all substantial decisions of the trust. A trust-forming a part of a stock bonus, pension, or other profit-sharing plan of employer must be organized in the United States. A pension or retirement plan with  foreign trust can not constitute a qualified plan within the meeting of Code Section 401 (a).

The project goals were to determine if employer identification numbers begin with a number 98 are associated with domestic trust maintained by foreign employers, and their number, plan types, and related reporting history. Compliance contact letters were sent over 300 employers whose employer identification numbers begin with number 98 and who file Forms W2 indicating their employees were covered by a qualified plan.

Employers were asked to answer questions about themselves and their qualified plan's trust to determine if there was a domestic trust maintained by a foreign entity. Employer identification numbers beginning with number 98 may identify foreign entities that maintain domestic trust in the United States since IRS previously only issued  employer identification numbers beginning with the number 98 to entities that had some type of foreign affiliations.

The results of the project showed that Employer Identification Numbers beginning with the number 98 are not necessarily associated with foreign employers and can't be relied on to define a domestic trust population maintained by foreign employers. Some of the employers contacted confirmed that they were foreign employers while others said they were never foreign employers. However, many of the employers that were not foreign employers had, at some point, a foreign connection that may account for why they were issued EINs beginning with the number 98. Mostly, all of the plans were Code section 401K plans but there were some money purchase, profit-sharing defined benefit and SIMPLE plans. Regardless of whether they were foreign or not, the employers are contacted did understand, and were in compliance with the requirements to maintain the domestic trust.

The second project was designed to obtain information about early distributions received by global US persons. This information enables employee plans to have a better understanding of the international sector and helps employee plans in assessing the need to develop further tools, guidance, and enforcement efforts.

For US citizens or resident aliens, US persons, the rules for filing income, the estate and gift tax returns and paying estimated tax are generally the same whether an individual lives inside or outside the United States. The world wide income of the US person is subject to US income tax regardless of where he or she resides. This means that all US persons must report and pay tax on their world wide income even if they lived abroad.

The project goals were to identify global US persons who received an early distribution subject to the Code Section 72(t) tax but did not report the tax.  Send compliance contact letters asking them to verify information on Forms 1099-R, explain why they did not report and paid the Code Section 72(t) tax and become compliant.

Compliance contact letters were sent over 280 US citizens and resident aliens with foreign addresses who received the distributions subject to the Internal Revenue Code Section 72(t) tax but did not report the tax on the Form 1040 US Individual Income Tax Return or Form 1040NR US Non-Resident Alien Income Tax Return. These individuals were asked to answer questions about themselves and to confirm that they did receive an early distribution that was not reported on their income tax return. Then, they were asked to become compliant, file the form 1040 or 1040NR, reporting the distribution if they have not previously filed or amend the form 1040 or 1040NR if they have previously filed but have not reported the distribution and pay the additional tax owed.

The Code Section 72(t) tax provides that if you receive a distribution before age 59-1/2, or an early distribution from an individual retirement account or other qualified retirement plan, there's an additional tax imposed equal to 10% of the amount of the early distribution included in your gross income.

There are some exceptions to this additional tax including death and disability, but the Form 1099R distributions from pensions, annuities, retirement or Profit Sharing Plans, IRAs, individual insurance contracts, et cetera, that these individuals received, reporting the distribution to the Service, did not show any exceptions applied. EPCU or Employee Plans Compliance Unit reviewed and analyzed the compliance check responses to determine common reasons why the Code Section 72(t) tax was not reported or paid, and if global US persons have clear and accurate information regarding Code Section 72(t).

From the results, responses received showed it was difficult to get a complete picture of the characteristics of global US persons in the sample because of difficulty in locating them. This difficulty was due to a combination of reasons including global US persons are extremely mobile, moving between an address in the United States and another, in a foreign country, during the year or for the years at a time due to work, cost of living, healthcare and family; and incomplete address information on Form 1099R. Every responding individual confirmed receipt of the early distribution. However, they also indicated there is noncompliance regarding reporting and paying the Code Section 72(t) tax due to these following reasons: global US persons are unaware they owe tax on their world-wide income; they don't understand there may be a  filing requirement despite entitlement to a refund; or sufficiently withheld taxes, and their support persons, e.g. payers, employers, tax preparers, et cetera, need additional information regarding US filings, withholding and reporting requirements, including the Code Section 72(t) tax.

Correction was obtained by securing delinquent and amended tax returns as well as payments of tax. Referrals for examination were made in a small percentage of cases where the individuals appeared noncompliant.

The project documented that EP needs to continue directing our efforts towards outreach with publications and instructions and examinations towards global US persons, their employers and tax preparers.

For more information on both of these projects, you can go to, once again, and enter the phrase EPCU in the search box.

Now, the last bullet on slide 4 is Design and Develop New International Projects. For example, we recognized that many multinational corporation, pension trust investment strategies include alternative investment, often international. These international investments have extensive reporting obligations. These alternative investments some hard to value raised concerns from Employee Plans about the level of pension funding.

Turning to slide 5, our training. As I mentioned before, international and US territory noncompliance is a significant area of concern and focus for Employee Plans and TE/GE in general, Tax Exempt and Government Entities in general. Because of this importance, we continue to train employee plan agents. Employee Plans has developed international specific training courses which include controlled group rules, minimum coverage, distribution, and reporting rules. And guidance, once again, we work with our Employee Plans Rulings and Agreement folks. We continue to work on formal guidance on Puerto Rico trust in 81-100 group trust, and now I will turn it over to Olimpia for a more in-depth discussion of Puerto Rico activities.

Olimpia:  Thank you, Charlie, and good afternoon or good morning. My name is Olimpia Diaz and I'm the manager for Employee Plans Group 7650 located in Plantation, Florida that has been involved in the audits done in Puerto Rico. I will be talking about how the Employee Plan Division became involved with pension plans in Puerto Rico and the US Virgin Islands. If we turn to slide 7 for those who are following the live presentation, how it all began?

In the year 2000, a focus team was started by the Gulf Coast Area of the Employee Plan Division of the Internal Revenue Service to determine the role of Employee Plan Division in the Commonwealth of Puerto Rico and the US Virgin Islands. The mission of the team was to determine the applicability of the Internal Revenue Code to pension plans maintained in the US territories and to facilitate outreach and compliance activities in these geographical areas.

A preliminary research conducted by the team revealed that there were no outreach and audit initiatives in Puerto Rico and the US territories.  In order to pursue these initiatives, the group requested the assistance of Tax Exempt and Government Entities Counsel to determine what pension laws applied to the Commonwealth of Puerto Rico and the US Virgin Islands.

In April 2003, the Tax Exempt Government Entity Counsel provided a technical legal memo that summarized the applicability of the US pension laws to plans maintained in Puerto Rico and it basically identified two segments of pension plans. Those who were aware of Puerto Rico plan sponsors and who had made an ERISA 1022(i)2 election to qualify under the Internal Revenue Code and those who were US planned sponsors of plans that cover Puerto Rico residents referred to as dual-qualifying plans.

TE/GE Counsel also reported that there were inconsistencies between the Internal Revenue Code and the Puerto Rico Code which put plan sponsors in a potential posture for disqualification when administering the plans. The team held discussion with outside practitioners who expressed the same concerns. The emphasis of the team at this time became Puerto Rico plans which comprise the largest percentage of plans maintained the US territories.

In September of the same year, members of the focus team held a meeting with Hacienda, which is IRS counterpart in Puerto Rico and during this meeting, the IRS introduced the Tax Exempt Government entity management involved in this endeavor, apprised Hacienda of the focus team and its mission, provided customer service contact numbers and gave Hacienda a heads up of IRS intentions to initiate outreach and pension plan audits in Puerto Rico.

Hacienda acknowledged at that meeting the inconsistencies between the two codes. The representatives of Hacienda expressed their desire to collaborate with the IRS in an effort to resolve these discrepancies. Hacienda assigned an individual to assist the focus team in achieving its objective. In addition, there were a total of 10 pension experts and one Department of Labor agent who volunteered to join the team.

The Employee Plans international focus team as it became known, by then was comprised of several internal and external qualified individuals familiar with the technical aspects and the discrepancies between the two codes. They requested permission from the Director of International to engage in formal discussions with Hacienda to try to alleviate the burden to plan sponsors of dual qualified plan administration. The purpose of the discussion was to facilitate the process to implement the necessary procedures needed to identify and resolve the inconsistencies in an effort to make the two codes more compatible.

Our goal was to conduct effective outreach and audit activity for plans in Puerto Rico and the US Virgin Islands. In August 2004 another meeting took place between IRS and Hacienda. In this meeting, a presentation was made by an outside practitioner and an IRS Revenue Agent that covered the history and difference between the Puerto Rico and the IRS codes with respect to pension plans administered in the Commonwealth of Puerto Rico.

The presentation covered the Internal Revenue Service correction program that was implemented in the United States to assist plans to maintain their qualified status and some of the major issues at the time resulting from the difference in the two codes. Now these issues that resulted from the differing codes were trust locations. There was no trust requirement for Puerto Rico, but dual qualified plans need to have a US Trust.

With regards to profit sharing contributions, Puerto Rico still used the old US law that in order for employer contributions to be made to a profit sharing plan, the entity had to have a profit. Another area of difference was plan termination. Under Section 411 of the Internal Revenue Code, if there is a partial termination of a qualified plan, the plan's sponsor must fully vest all affected participants in the benefits they have accrued under the plan. Failure to vest these participants would result in disqualification of the plan. There was no partial termination concept in the Puerto Rico code.

With respect to the nondiscrimination test of Internal Revenue Code 401(a)(4), 401(k), 401(m) and 410.  Now non-discrimination tests are tests that are required to be completed by qualified plans to ensure that plan benefits and contributions don't discriminate in favor of officers, shareholders, employees whose principal duties consist of supervising the work of other employees or highly compensated employees.

With respect to this test, Puerto Rico's testing group incorporated only non-excludable Puerto Rico employees. The definition of excludable employees used in Puerto Rico was the same as the US but with reference to Puerto Rican residents. There was no minimum age 21 or one year of service requirement in Puerto Rico. It was entirely up to the plan terms as they were selected.

Another area of discrepancy was the definition of highly compensated employees. In the Internal Revenue Service Code, this was based on compensation or ownership threshold. In Puerto Rico, it was simply defined as the top one-third earners based on compensation alone.

With compensation, another area of discrepancy in the Internal Revenue Code, there were limits imposed by section 401(a)(17). In the Puerto Rico code, however, the only requirement was that compensation not be discriminatory based on the facts and circumstances.

With respect to discrimination testing, the US test had an objective test to provide whether there was discrimination or not, but in Puerto Rico, again, the test was done based on facts and circumstances.

Distributions. Internal Revenue Code Section 72(p) was followed and actually practiced in Puerto Rico even though there was no equivalent in the Puerto Rico code. Minimum distribution requirements, Puerto Rico code did not have an equivalent of the minimum distribution requirements of Internal Revenue Code Section 401(a)(9) and the last area that was discussed at that time was the area of prohibited transactions. Now this area generated significant discussion regarding a possible area of referrals.

Because there was no excise tax in Puerto Rico like in the US, however, unlike in the US where this issue can be resolved by filing Form 5330 and paying excise tax, in Puerto Rico, this was strictly a disqualification issue for Puerto Rico plans. Therefore, the area's most concerns identify that we needed to address in future outreach initiatives and audits became those having the most different treatment between the two codes and these were: minimum coverage test of IRC 410(b), nondiscrimination test of IRC 401(a)(4), 401(k) and 401(m), annual compensation limits of IRC 417.

Contribution limits. There was no counterpart of the Internal Revenue Code 415 in Puerto Rico code.

Minimum participation requirements. Permitted disparity and Social Security integration rules, disparity in the ADP test, there was no ACP test in Puerto Rico. The annual limit on elective deferral was different. Also, we concentrated on highly compensated definition, minimum funding requirements of Internal Revenue Code 412 and catch up contributions, and deferrals added by EGTRRA which were not permitted by the current Puerto Rican code at that time.

It was agreed that it would be a good idea to initiate at the time a memorandum of understanding since there wasn't a current agreement in place between Hacienda and the Internal Revenue Service or the Department of Labor regarding referrals.

If you turn to slide 8, audits in Puerto Rico. A common question that we always encounter in audits is why us? The number of plans selected for audits depends on what we need to fulfill the employee plans division work plan, the type of plan selected and the individuals involved in the audits that started since that time have changed depending on the objectives of the audit which have been different each time. I will address those as I discuss each wave of audits we conducted.

If you go to slide 9, we'll begin with the 2005 audits conducted in Puerto Rico. The primary objective of the Employee Plans Examination Division in every audit conducted is always to educate a particular segment of customers to improve compliance through education on audit activities and to identify ways to help you, our customers, in designing better products and publishing guidance needed.

The secondary objective of the 2005 audit was to see firsthand in what shape were the plans in Puerto Rico and to what extent the issues identified during the meetings with Hacienda and practitioners really existed. These audits were conducted only by Internal Revenue Service auditors.

Since we have never audited plans in Puerto Rico, the plans selected for audit were those that could be dual qualify or that have made an election to qualify under the US code. The selection of the plans was made based on the characteristic code shown on Line 8(a) of the Form 5500.  At that time there were only two applicable characteristic codes and they were 3-A non-US plan. This was to be used for a pension plan maintained outside the United States primarily for nonresident aliens so this doesn't apply to Puerto Rico.

The other code that existed at that time was code 3C, plan not intended to be qualified. This was the code to be used for a plan that didn't intend to be a qualified under code section 401. Therefore, a plan at that time with the Puerto Rico address should have entered code 3C on the Line 8 of the Form 5500 as an affirmative statement that it did not intend to be qualified under the Internal Revenue code Section 401. This was to be used for Puerto Rico only plan. If the plan was a dual qualified or had made an ERISA 1022(i)(2) election to qualify under the Internal Revenue Code 401, then there was no characteristic selected on the Form 5500.

If we turn to slide ten, on the 2005 audits on Puerto Rico, what did we find? After we conducted those audits, the issues we identified during the 2005 audits were on the US side, ERISA section 1022(i)(2) plans were being terminated and assets rolled over to a section 1022(i)(1) plan or Puerto Rico-only plan. Now remember that at that time, this wasn't allowed. Also we found plans, who weren't being timely amended to comply with the US code requirement. We saw plans that were operating in Puerto Rico as Puerto Rico-only plans but the trust was located in the United States which meant that they have to be subject to US code requirements as well. We also found failure to file Form 1099R for distributions made from the plan. On the Puerto Rico side, the issues identified in the 2005 audits were there was withholding on 1099R of Puerto Rico source income and we saw ADP test failures.

We turn to slide 11, the consequence of the 2005 auditing contrary to what some people believe the results of planned audits is not always negative to the taxpayer. As the result of the 2005 audit, IRS published guidance in the form of Revenue Ruling 2008-40. Before the publication of Revenue Ruling 2008-40, if a US qualified plan transferred a participant's benefit to a Puerto Rico-only qualified plan, the transfer was considered a taxable event for the participant under the United States Internal Revenue Code.

In addition, it could also jeopardize the qualified status of the US plan if the assets weren't distributable under the terms of the plan at the time the transfer occurred. The only way this treatment could be avoided sometimes was by plans requesting approval via a private letter ruling from the Internal Revenue Service. The Internal Revenue Service had issued several private letter rulings allowing the transfer of benefit from a US-qualified plan or dual qualified plan to a Puerto Rico-only plan without figuring a taxable event.

Revenue Ruling 2008, we affirmed that transfers between US qualified plans or dual qualified plans to a Puerto Rico-only qualified plan were indeed taxable events with potential disqualification of a plan. But it provided a window of opportunity in the form of transitional release for transfers of this kind to be made before January 1, 2001, without the need to request a private letter ruling. Another outcome of the 2005 audit was the addition of a new code known as code 3J to Form 5500. This code was to be used for US-based plan that cover residents of Puerto Rico and was qualified under both code Sections 41 and Section 8565 of the Puerto Rico code.

If you turn to slide 12, at 2010 audits, after the first batch of audits we did in 2005, we subsequently met with Hacienda to share the issues that we  originally found in 2005. Hacienda indicated they didn't have any auditors specializing in the employee plans areas. They requesed our assistance in training their auditors as well as the system for potential outreach efforts in the future.

As Charlie mentioned earlier in the introduction, a memorandum of understanding was filed between the Internal Revenue Service and Hacienda on August 2006 and it provided the basis of information sharing between the two agencies as well as training assistance. In March 2009 at the request of Hacienda, Internal Revenue Service and Hacienda worked together to develop a Phase 1 training for Hacienda auditors that consisted of an introduction to basic plan types, retirement plan laws and audit techniques. This training took place later in that year and 12 Hacienda auditors and two pension department staff members of Hacienda participated in the training.

For the training, the auditors in audited plans, we selected for audits representing  the typical sample of basic plan types discussed during the Phase 1 training from the Forms 5500 file that had entered this new code 3J. Now remember that this code was to be used for US-based plans that cover residents of Puerto Rico and was qualified under both Code Section 41 of Internal Revenue Service and Section 8565 of the Puerto Rico Code. Hacienda auditors conducted audit for the Puerto Rico side of the plan and IRS auditors conducted joint audits of what we thought were U.S. qualified plans. They also served as coaches in training Hacienda agents in auditing skills.

If you turn to slide 13, the issues that we identified when we did conducted the 2010 audit jointly with Hacienda were on the US side, plans that still weren't being timely amended to comply with the US code requirements. There were also plans with no fidelity bonds. We also found that the new code 3J was being used improperly. This code was supposed to be used for US-based plans only that cover residents of Puerto Rico but some of the administrators and the residents of Puerto Rico improperly selected this code.

Now on another note during these 2010 audits we did, we already saw that dual qualified plans were terminating and had proper rollovers after we solved these transitional relief provided by Revenue Ruling 2008-40. On the Puerto Rico side, the issues that we saw were plans with no Hacienda determination letter. Now, contrary to the US where a request for a determination letter is optional, a plan in Puerto Rico needs to request a determination letter from Hacienda when establishing a new plan or have amendments or when terminating the plan. We also found ADP test failures, incorrect compensation use and we found several deferral issues. We also found eligibility and participation issues resulting mainly from incomplete census data and poor record keeping on both part of the administrator as well as the employer.

You turn to slide 14, what were the consequences for the 2010 audits?  IRS issued Revenue Ruling 2011-1 which further extended the transition relief provided by Revenue Ruling 2008-40 for transfer of assets between terminating dual-qualified plans to Puerto Rico-only plans for transfers made before January 1, 2012, and also updated the rules governing group trusts.

Practitioners that we dealt during this audit were educated on when to use the new code 3J  and the proper manner to complete Form 5500. The record keeping kept by some of the pension administrative prior to the audit was minimal or lacking in what they should have been maintaining to support the information report on the Form 5500. This was mainly due to the lack of audit presence.

They developed as a result better forms requesting information from the plan sponsor, as well as, implementing better verification procedures for the information given. Some of the US fundamental issues discovered were resolved through closing agreements with the Internal Revenue and the plans were able to maintain their qualified status.  Hacienda became aware of plans not applying for determination letters as required by them.

We go to slide 15. This brings us to the latest wave of audits we conducted jointly with Hacienda in Puerto Rico. In the audits we conducted in 2010 as part of the Phase 1 training to Hacienda auditors, most of the plans selected for audits turned out to be 401(k) plan, which we found were the majority of the plans maintained in Puerto Rico.

During the Phase 1 training, 401(k) plans were covered in general due to the limited training time involved, so Hacienda again requested Internal Revenue to help them design and conduct a more in-depth 401(k) training and on-the-job training for their auditors. Again, we joined forces in designing and delivering to Hacienda a Phase 2 training, concentrating on 401(k) plans.

To complete the 401(k) training, Hacienda auditors conducted audits for the Puerto Rico side of the plan, IRS Employee Plans agents joined them in conducting our independent audits. They also serve as coaches to Hacienda agents teaching them auditing skills in the area of 401(k) plans. We started selecting a statistical sample of plans to audit that were identified as 401(k) and dual qualified on the 5500 that had a Puerto Rico address since the audits were to be conducted on site for the purpose of the training.

Due to our prior educational effort, there weren't enough plans identified that met these criteria to select the number of plans needed to train Hacienda agents. Therefore, we selected an additional statistical sample of plans that didn't identify themselves on the 5500 forms as dual qualified plan or as plans for non-resident aliens to verify the correct plan code selection and the correct plan status.

We turn to slide 16. The thanks to education and auditing presence during the prior years, the issues were identified this time around were less. On the US side, there were still plans with no fidelity bonds. There was still misuse of that new code 3J, mainly on the part of administrators who hadn't been part of the prior year audits and they were selecting incorrectly this code on Form 5500.

On the Puerto Rico side, we still saw ADP test failures, incorrect compensation being used as  well as deferral issues. We also found eligibility participation issues mainly due to incomplete census data record keeping from administrators who hadn't participated in the audit during the last time.

Currently, we continue to collaborate with Hacienda on education, outreach efforts, exchange of information and training needs in accordance with the terms of our memorandum of understanding. With this, I'll turn it over to Stephanie Hunter, who will be speaking on US Virgin Islands issues.

Stephanie:  Good afternoon. My name is Stephanie Hunter and I am an Employee Plans Revenue Agent located in Houston, Texas. I've provided retirement plans training to agents located in the US Virgin Islands, as well as, served as an on-the-job instructor to agents located in the United States Virgin Islands. This afternoon, I will be discussing the application of income tax requirements to the United States Virgin Islands, Employee Plans endeavors in the United States Virgin Islands and future outreach to other US territories.

Page 19, for tax purposes Internal Revenue Code, generally treat the US territories as foreign countries. However, for the United States Virgin Islands, the US is treated as including the relevant territories for purposes of computing United States income tax.

The United States Virgin Islands has a mirror system to the US for income tax purposes. Under the mirror system, the United States Virgin Islands adapts the US Internal Revenue Code as if it were the territory's code, except that the name of the territory is substituted for the United States and vice versa. Thus, the income tax requirement pertaining to retirement plans under the US Virgin Islands mirror code are the same as under the US Internal Revenue Code.

Parts of the code, including the estate, gift tax and excise tax rules aren't mirrored. This means that excise taxes related to prohibited transactions, minimum funding, excess contributions, and all other excise taxes described in section 4971 through 4980 of Internal Revenue Code, don't apply to the United States Virgin Islands.

The United States and the United States Virgin Islands are separate and distinct taxing jurisdictions. The term domestic as used in the US Virgin Islands mirror code refers to the territory. The rest of the world, including the United States is considered to be foreign.

For purposes of title one of the Employee Retirement Income Security Act, also known as ERISA, the term United States, includes the US territory. Minimum participation, vesting, funding rules, bonding requirements and Form 5500 filing obligations apply within the US territories.

In 2010, the Employee Plans division, begin to expand its mission into the United States Virgin Islands. A memo of understanding was executed on May 3, 2010. This memo provides for training, Employee Plans Compliance Resolution System assistance and exchange of referrals between Employee Plans in the US Virgin Islands Bureau of Internal Revenue, also known as the BIR.

In addition, a technical legal memo through collaboration between TEGE council and Employee Plans Rulings and Agreements is currently underway to address the applicability of the Internal Revenue Code to plans maintained in the US Virgin Islands. This memo indicates that the Virgin Island code mirrors that of the Internal Revenue Service code with the exception of excise tax.

Page 23, in fiscal year 2011, 10 Virgin Islands Bureau of Internal Revenue agents received pension audit and on-the-job training with emphasis on Internal Revenue Code section 401(k) plans, as this is the most prevalent plan type found in the US Virgin Islands. The Bureau of Internal Revenue agents were located in St. Thomas and St. Croix.

A phase two workshop for St. Thomas agents was held in September 2011. A phase two workshop for St. Croix agents was held in May 2012. Now that the BIR agents have received retirement plan training, they are now able to examine retirement plans in the US Virgin Islands.

Employee Plans commenced audits of Virgin Islands plans in fiscal year 2010. Issues found on these audits included non-amenders, excluded employees, incorrect IRC 404 deductions taken, defaulted plan loans, ADP and ACPtesting failures, incorrect contribution allocations, funding violations, incorrect investing percentages, inadequate or no fidelity bond. There were also a number of Internal Revenue Code Section 401(k) violations, including late deposits and missing  election forms.

The IRS also has future plans underway for other US territories, including Guam, American Samoa, and the Northern Mariana Island.

The Employee Plans division will be working on a memorandum of understanding similar to the ones drafted for Puerto Rico in the US Virgin Islands. TEGE council and Employee Plans Rulings and Agreements are working on a technical legal memo to address the applicability of the Internal Revenue Code to plans maintained in these other territories. Due to the small number of plans in these territories, consideration is being given to IRS Employee Plans agents conducting audits via our office correspondence program in lieu of training agents at the Bureaus on those islands.

Charlie:  Okay. Thank you, presenters. We have a couple of minutes left, not much time for questions. Maybe we'll just entertain two quick questions. Olimpia, would you like to just address two questions and we'll end on that?

Olimpia:  Sure. One of the questions that I received and I'll read it as it was written, makes it easier for me to answerr and it was said as follow, in Puerto Rico, a Puerto Rico only plan must file Form 5500 with respect to their qualified plan. What Form 5500 would a Puerto Rico only-plan covering only the company owner file?

One participant plans may satisfy their filing obligation under the code by filing Form 5500-SF electronically under EFast-2 in place of Form 5500 EC, which is a paper form.  You must file Form 5500 EC for a retirement plan if the plan is the one participant plan that is required to file an annual return and you're not eligible or choose not to file the annual return electronically on Form 5500 SF.

For more information on whether you're required to file the Form 5500 EC or you choose the 5500-SF, you can go to the under Forms and Publications and you'll find the instructions for filing Forms 5500 EC and an explanation of the requirements of who has to file this form.

For information on the e-fast filing system or on how can you approach or how can you do this filing, since this is a system operated by Department of Labor, you will be able to find information at

I will go move into another question that I have here:  now that the transfers in minimum coverage testing relief allowed in Revenue Ruling 2008-40 has expired for plans now using a group trust, how can a practitioner resolve a problem with a dual qualified plan that can no longer meet US qualification rules as a result of the demographic shift?

For example, if a plan can no longer meet both coverage and non-discrimination in the US and Puerto Rico,  can similarly relief via a tax free spin off to a separate Puerto Rico qualified trust be requested as part of the VC filing?  Could this be added to a future EPCRS revenue procedure?

Basically, the answer to that is the transitional relief has run for transfer from all dual qualified plans, except those who already invest in a good trust. For a plan that didn't take  part of that, the result is that the plan might be able to correct through EPCRS and might correct the qualification problems but it can't be a correction for the replicates, the favorable tax treatment under  2008-40.

If you want to look up further questions and there we re some questions which were given to us, there is information, if you go to and enter on the search engine Puerto Rico retirement plans, you'll find a lot of information and publications that the IRS has published for your information. I believe that's all that we have time for today.

Charlie:   With that, I want to thank everybody for joining us and for those of you who have sent in questions that I mentioned before, we'll do our best to respond individually and answer all your questions. Once again, thank you very much for joining our conference.