Small Pension Plans

After discovering that some highly paid professionals were reaping huge tax deductions by making extremely large contributions to their pension plans, the Internal Revenue Service (IRS) began in 1989 a nationwide audit of small defined benefit pension plans--those with one to five participants. IRS concluded that in many cases large tax deductions were being taken on the basis of unreasonably conservative actuarial assumptions used in calculating allowable pension contributions. Many taxpayers and their accountants complained that IRS was merely trying to generate federal revenues at the expense of small businesses. This report analyzes the impact of the IRS audit program on small business sponsors of defined benefit pension plans. GAO examines the validity of the complaints about IRS' reasons for undertaking the audit program, identifies whom the program targeted, and determines whether IRS considered taxpayer facts and circumstances before substituting its own actuarial assumptions.

GAO found that: (1) IRS initiated its small pension plan audit program to identify abusive tax practices; (2) IRS did not address issues and questions needing immediate resolution when it initiated the program or provide definitive guidance for examining defined benefit plans; (3) in July 1991, IRS implemented the Actuarial Resolutions Program to provide taxpayers with an opportunity for quick resolution of their cases; (4) IRS data showed that most audited plan returns were those of highly paid professionals; (5) in many cases, IRS did not find sufficient evidence to support lower interest rate or retirement age assumptions; and (6) IRS may be unable to support its assumptions for computing allowable pension contributions.