ERISA law is complicated, so it’s easy for plan sponsors and their advisors to make mistakes unintentionally. Luckily, the IRS recognizes this. They know that it is in everyone’s best interest for plan sponsors to remedy their mistakes on their own initiative as soon as they are discovered.
The IRS has put together a system so that reasonable and appropriate corrections can be made to avoid plan disqualification. This system is called the Employee Plans Compliance Resolution System (EPCRS) and consists of three different programs:
The Self-Correction Program (SCP) allows a plan sponsor to correct operational plan failures without contacting the IRS or paying any fee. Operational plan failures occur when the written terms of the plan are not followed. It is not an option for correcting problems with the plan document itself, such as the failure to keep it current.
To be eligible, the plan sponsor or administrator needs to have established practices and procedures, either formal or informal. These practices and procedures must be designed to promote and facilitate overall compliance with the law. Just having a plan document is not enough and does not constitute evidence of established procedures. If a 403(b) sponsor determines that they are not eligible to maintain a 403(b) plan, they cannot use the SCP.
An insignificant operational error can be self-corrected at any time to preserve the tax-favored status of the plan. There are no application or reporting requirements. However, significant operational failures must be corrected within two years of the end of the plan year in which the failure occurred. All facts and circumstances must be considered when evaluating the significance of plan failures. Only qualified plans may use the SCP to correct significant errors, SIMPLE IRAs and SEP plans are not eligible.
To self-correct under the SCP, plan sponsors must complete the following four steps:
- Ascertain eligibility to self-correct.
- Make necessary corrections so that plan participants are in the position they would have been in if the failure had not occurred.
- Document the steps taken to correct the error. This is important in case of an audit.
- Adjust administrative procedures to ensure the mistake does not recur.
Voluntary Correction Program
With the Voluntary Correction Program (VCP), anytime before an audit a plan sponsor can pay a fee and receive IRS approval for correction of plan failures. The VCP is commonly used to correct mistakes with the language in the plan document or how the plan has been run. It is used for mistakes ineligible to be corrected with the SCP or if the plan sponsor wants documentation of IRS approval of their corrections. To use the VCP, the plan sponsor first makes a submission to the IRS that:
- Includes completed Forms 8950 and 8951
- Identifies the mistakes
- Proposes corrections using the general correction principles found in Revenue Procedure 2016-51, section 6
- Proposes changes to its administrative procedures so that the mistakes do not recur
- Pays a compliance fee
- May include Form 14568, Model VCP Compliance Statement, and Forms 14568-A through 14568-I
- Acknowledgment letter to assist applicants making a VCP submission
Once the submission is received and reviewed, the IRS will issue a Compliance Statement detailing mistakes identified by the plan sponsor and the IRS-approved correction methods. The plan sponsor then has 150 days to make the necessary corrections. While the IRS is processing the submission, the plan is generally safe from an audit, though exceptions do occur.
The steps in using the VCP are:
- Find the failures that need to be corrected.
- Submit the above information along with payment of the fee.
- Make corrections within the specified time period.
- Keep all records with your plan document.
Audit Closing Agreement Program
The Audit Closing Agreement Program (Audit CAP) is used when a plan is already under an audit. The plan sponsor enters into a Closing Agreement with the IRS but first, makes all necessary corrections in order to preserve their tax-favored status. They have to pay a sanction that is directly related to the amount of tax benefits preserved, which they negotiate with the IRS. The sanction is determined based on facts and circumstances including:
- The presence of internal controls designed to ensure that the plan had no failures or that such failures were identified and corrected in a timely manner
- Number of affected employees
- Impact on non-highly compensated employees
- Whether the failure is demographic or employer eligibility
- The length of time the failure occurred
- The reason for the failure
There are legal maximum limits for the sanction amount so that it is not excessive. The sanction must bear a reasonable relationship to the nature, extent, and severity of the failures. It must, however, be more than the fee paid under the VCP.
How I Can Help
If you have clients with retirement plans that need corrections, you need to ensure that all facts and circumstances are considered and the correction method resembles one already provided for in the Internal Revenue Code. This can be time-consuming and require specialized knowledge. I can help your clients determine their eligibility for these IRS programs and assist them in making corrections compliant with the Internal Revenue Code. Email me today at firstname.lastname@example.org so we can discuss your client’s needs and how we can help them preserve the tax-favored status of their retirement plan.
About Kenny Phan
Kenny Phan is a Managing Partner at FinancialFocus Retirement Plan Services, a 3(16) fiduciary. He works as a pension specialist who partners with financial professionals to design and implement pension plans. His area of expertise is customized defined benefit, defined contribution, and 401(k) plans. Serving financial advisors and businesses in the greater Phoenix area, he is supported by FinancialFocus Retirement Plan Services. Together, they provide comprehensive plan design consultation, administration, document installation, compliance testing, as well as IRS and DOL reporting for qualified retirement plans.