When a plan is disqualified, the employee must immediately pay taxes on contributions to the extent that those contributions are guaranteed. A plan distribution that has been disqualified cannot be tax-deferred transferred to another work plan or to an IRA. Worse, a plan can be retroactively disqualified if the plan defect occurred in a previous year. This means that employers and employees are likely to have to file amended returns to reflect the tax effects of disqualification from previous years.
Penalties could also be imposed for not reporting income in those previous years. And while the IRS generally cannot go back more than three years (six years if there was a substantial understatement of income) to collect taxes from a previous year, the IRS could require those closed years to be corrected if an employer seeks to requalify its plan. For employers If your retirement plan is disqualified, your deductions for plan contributions may be restricted and delayed. Once a plan is disqualified, different rules apply about how much an employer can deduct for plan contributions and when deductions are allowed.
Unlike contributions to a qualified plan, contributions to a trust for non-exempt employees cannot be deducted until the contributions are included in employee gross income. Employers that sponsor a defined benefit plan (or another plan that doesn't maintain separate accounts for each employee) can't deduct any contributions.