Voluntary Corrections for Qualified Plans
October 2009 Newsletter
Given the complex nature of administering qualified retirement plans in accordance with ever-changing pension law, mistakes are inevitable. When the IRS discovers plan mistakes through audit, the plan risks being disqualified which results in severe consequences to the plan sponsor and participants.
Fortunately, the IRS recognizes that mistakes are a fact of life and has responded by developing voluntary error resolution programs. It has also posted on its web site the top ten failures reported through these resolution programs. Since the IRS recently announced its intent to conduct more audits this year, plan sponsors should become aware of the more common types of compliance problems and, if found in their plans, voluntarily correct errors by using the IRS correction programs rather than take a chance that an audit will reveal the mistakes.
In order to reap tax advantages, qualified plans are responsible for complying with complex IRS requirements. Failure to meet these requirements can lead to plan disqualification which results in severe consequences including:
To create awareness of common errors that may result in plan disqualification, the IRS has released the following list of the top ten failures found in the Voluntary Correction Program.
Plan sponsors who uncover plan qualification failures, such as those listed above, should promptly take advantage of the IRS's Employee Plans Compliance Resolution System.
EPCRS is a series of correction programs that can be used by plan sponsors to correct common plan failures and bring the plan back in compliance. "I'm from the government and I'm here to help" is actually true in this case! These programs may be used to correct qualification failures which generally fall into three categories:
The IRS has provided pre-approved methods for correcting many types of common failures. The typical correction method is to put the plan and participants in the position they would have been had the plan been administered correctly. This may require additional contributions (plus earnings) for certain participants. In some cases, the failure can be corrected by a retroactive amendment to the plan. Below is an overview of the three EPCRS programs.
SCP allows qualified plan sponsors to correct operational failures without filing with the IRS or paying a penalty tax. The program allows the correction of both insignificant defects as well as, in limited circumstances, significant defects. SCP cannot be utilized for demographic and plan document failures or if the failure is egregious. The plan must have established practices and procedures (formal or informal) designed to promote overall plan compliance.
Plan sponsors should document the steps that were taken for fixing the failure in case they are later asked to justify their actions and should also put administrative procedures in place so the mistake does not happen again.Insignificant Corrections
Generally, in order for a correction to be considered insignificant, it must be an isolated incident, and the plan must otherwise have a history of compliance in all other areas. Several factors need to be analyzed to determine if the correction is deemed insignificant including the number of errors that occurred, the percentage of plan assets and contributions involved in the error and the number of plan participants affected.
Insignificant defects can be corrected at any time following discovery. Also, SCP can be utilized for insignificant defects even if the plan is already under examination by the IRS.
To be eligible to utilize SCP for a significant operational failure, the plan must have a current determination letter or, in the case of a pre-approved plan, an opinion letter. For significant corrections, SCP is not available if the plan is already under examination by the IRS.
Significant failure correction must be completed, or substantially completed, by the end of the second plan year following the plan year in which the error occurred.
Defects that are not eligible for SCP, such as significant operational defects beyond the two-year correction period, plan document failures or demographic failures, may be corrected using VCP. This program is not available if the plan is already under examination by the IRS.
The plan sponsor submits an application to the IRS outlining the failures and proposed correction methods and also pays a fee based on the number of participants. The IRS reviews the application and issues a Compliance Statement setting forth the agreed terms of correction.
If a plan sponsor is hesitant about disclosing plan failures to the IRS, a John Doe submission can be filed which allows the plan sponsor to propose a correction to the IRS anonymously. After a correction method is agreed upon in writing, the plan and plan sponsor are then identified.
Audit CAP is available for problems that were not corrected voluntarily but instead were discovered during an IRS audit. By utilizing Audit CAP, the plan avoids the consequences of disqualification. In addition to correcting plan defects, the plan sponsor must pay a penalty equal to a percentage of the amount of tax that would have been due if the plan were disqualified. The fee is generally negotiated based on the severity of the failure.
Because of the severe penalties associated with plan disqualification, plan sponsors should be aware of and on the lookout for common plan failures. Frequent internal audits of all aspects of plan administration can quite possibly prevent insignificant defects from becoming significant.
If the plan sponsor discovers any instance of noncompliance, the plan's advisors should be consulted to help determine the appropriate correction method. Fortunately, there are several EPCRS programs available for voluntarily correcting plan failures. The least expensive way to correct defects is to discover them early and before the IRS.
This newsletter is intended to provide general information on matters of interest in the area of qualified retirement plans and is distributed with the understanding that the publisher and distributor are not rendering legal, tax or other professional advice. Readers should not act or rely on any information in this newsletter without first seeking the advice of an independent tax advisor such as an attorney or CPA.