Determination Letter: What it is, How it Works

Julia Kagan is a financial/consumer journalist and former senior editor, personal finance, of Investopedia.

David Kindness is a Certified Public Accountant (CPA) and an expert in the fields of financial accounting, corporate and individual tax planning and preparation, and investing and retirement planning. David has helped thousands of clients improve their accounting and financial systems, create budgets, and minimize their taxes.

Ryan Eichler holds a B.S.B.A with a concentration in Finance from Boston University. He has held positions in, and has deep experience with, expense auditing, personal finance, real estate, as well as fact checking & editing.

What Is a Determination Letter?

A determination letter is a formal document issued by the Internal Revenue Service (IRS) that indicates whether or not a company's employee benefit plan has been found to meet the minimum legal requirements for special tax treatment.

Key Takeaways

• A determination letter confirms whether an employee benefit plan is qualified for special tax consideration.
• A request for a determination letter is voluntary, the IRS says, but it warns that checking beforehand is advisable or a plan may be disqualified down the road.
• Determination letters may be issued for all employee pension plans and retirement savings plans, among other benefit programs.

Understanding the Determination Letter

A positive determination letter is needed for retirement benefits plans under two separate sets of regulations:

• The Employee Retirement Income Security Act (ERISA) covers most pension plans, some retirement savings plans, and many health benefits made available to employees of private companies. The Department of Labor is generally responsible for enforcing the requirements of this 1974 law, but the IRS certifies compliance with programs that come with tax benefits for the employer or the employee, or both.
• IRS rules regarding retirement savings plans that are not covered by ERISA.

The determination letter is sent in response to an application from the company to a local IRS office. To paraphrase, the IRS says that submitting a request for a determination letter is voluntary, but don't blame them if the program is disqualified later during an audit.

The act known as ERISA was intended to protect employees from mismanagement of benefits they have been promised. In particular, it assigns fiduciary responsibilities to those who manage and control plan assets and requires companies to establish a grievance and appeals process for disputes over benefits. It sets minimum standards for participation, vesting, benefits accrual, and funding of programs covered by the law.

Notably, pensions awarded by employers who have gotten a positive determination letter are guaranteed by the Pension Benefit Guaranty Corp. (PBGC), a government agency.

What's Covered

A wide range of employee benefits programs is subject to ERISA guidelines. They include medical benefits, death and disability benefits, paid vacation policies, daycare operations, scholarship programs, severance policies, and housing benefits.

Any of these programs that have tax implications for the employer or the employee may need a determination letter from the IRS indicating that its program is in compliance.

The 1974 law known as ERISA was designed to protect employees from any mismanagement of benefits they have been promised by an employer.

With regard to retirement savings programs, some are covered by ERISA and others are not. In general, if the employer directly manages the money and/or reaps the tax benefit, it's covered by ERISA. If the employee manages the money and/or reaps the tax benefit, it's not covered.

• Retirement savings plans that are covered by ERISA include SIMPLE IRAs and SEP IRAs.
• Retirement savings plans that are not covered by ERISA include traditional IRAs and Roth IRAs.

Getting the Determination Letter

If a company offers employee benefits, it must be ERISA compliant. (Government and religious groups are exempt.)

If the determination letter is negative, the IRS will list the shortcomings, along with the necessary action steps that must be taken to comply with ERISA. Once the plan meets all of the requirements, the plan is certified as a qualified plan and is eligible for all of the tax benefits that come with it.

All employee retirement plans, ERISA covered or not, come with plenty of IRS rules and regulations. The IRS provides a comprehensive guide to common qualified plan requirements.