When a retirement plan is disqualified, the plan's trust loses its tax-exempt status and must file Form 1041, United States Income Tax Return for Estates and Trusts (InstructionsPDF) and pay income tax on the trust's earnings. Tax legislation and administrative details that may seem trivial or irrelevant can actually be critical to maintaining a plan's qualification. If a plan loses their eligibility status, each participant pays taxes on the value of their benefits acquired after the date of disqualification. This can result in large (and completely unexpected) tax obligations for participants.
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 to 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.