Self-correction of operational errors arising in qualified retirement plans is a critical means for plan sponsors to retain their plans’ tax-qualified status. Self-correction has been promoted by the Internal Revenue Service as part of the Employee Plans Compliance Resolution System, or EPCRS, for approximately twenty years, but the rules for self-correction have evolved over that time period, and some essential requirements of self-correction are still little understood. One recommended component of self-correction that can tend to be overlooked is preparation of a self-correction memo. Below I describe what a self-correction memo is, and why preparing one is “best practices” – even if EPCRS does not mandate it.
By way of background, the Self-Correction Program or SCP is one of three component programs of EPCRS available to sponsors of qualified plans, 403(b) plans, SEP or SIMPLE IRA plans. (EPCRS is set forth in a Revenue Procedure that is updated periodically; the current version is Revenue Procedure 2021-30. The other component programs are Voluntary Correction Program or VCP, and the Audit Closing Agreement or Audit CAP.) SCP is available for operational failures (failure to operate a plan in accordance with its written terms) and plan document failures (such as failure to timely adopt a required plan amendment). With regard to operational failures, SCP divides them into two categories: “significant” operational failures, and “insignificant” operational failures. Plan document failures are always treated as significant. Insignificant operational failures are eligible for self-correction at any time. Significant operational failures are eligible for self-correction only if the corrections are both discovered and substantially completed by the last day of the third plan year following the plan year for which the failure occurred. Whether or not an operational failure is significant depends upon a number of criteria that are set forth in Revenue Procedure 2021-30, Section 8.02, including the number of affected participants, versus the total number of participants in the plan as of the Plan’s last filed Form 5500, and the amount involved in the operational failure, versus the total assets in the plan per the last-filed Form 5500. SEP and SIMPLE IRA plans may only self-correct insignificant operational errors.
Other requirements of SCP are as follows:
- To correct a document failure or a significant operational failure, the qualified plan in question must be the subject of a favorable determination letter (for an individually designed plan) or must be a pre-approved plan that is the subject of a favorable opinion or advisory letter.
- In addition, the plan sponsor or plan administrator must have established practices and procedure (formal or informal) that are reasonably designed to promote and facilitate overall compliance with Internal Revenue Code requirements, both in form and operation. This may take the form of annual plan administration procedures or guidelines; the plan document alone will not suffice. For SCP to be available, the procedures must have been in place and routinely followed, and the error must have occurred through an oversight or mistake in applying them. This component of SCP is also often overlooked.
What is a Self-Correction Memo?
A self-correction memo is a written memorandum, ideally signed and dated by a representative of the plan sponsor, that does all of the following: (a) describes a plan sponsor’s eligibility to use SCP; (b) describes the operational or document failure(s) and the method(s) of correction; (c) addresses whether or not the error was significant and if so whether it was substantially corrected within the necessary time period; and (d) assembles, as exhibits, all documentation of the error and its correction. Paragraph headings for a self-correction memo for an operational failure may include the following:
- A description of the operational failure
- The date that the plan sponsor discovered the operational failure
- The fact that a favorable letter is in place
- A description of the plan sponsor’s established practices and procedures for compliance with the Internal Revenue Code
- A summary of any changes to the plan’s administrative practices designed to prevent the failure from reoccurring
- A determination that operational errors were insignificant, or significant, following the criteria set forth in Revenue Procedure 2021-30, Section 8.02
- The correction methodology, with citations to approved EPCRS correction methods, if appropriate
- The number of affected participants relevant to the number of total participants
- The manner in which affected participants were notified of the correction
- A recitation of the actual corrections, including dates and amounts, or attached documentation proving same
- The bases on which the plan sponsor determined the operational failure to be insignificant, if applicable
- If the operational error was significant, the dates on which the correction period began and ended
- If the correction involved transferred assets (which increases the time available for correction), the date of the merger, acquisition, or other similar transaction in which the assets were transferred.
Confirming that your operational failure is eligible for self-correction — and preparing the self-correction memo itself – will often require the guiding hand of an ERISA attorney.
Why is a Self-Correction Memo “Best Practices”?
That is a good question, and there is a common-sense answer. There is nothing in the Revenue Procedure 2021-30 specifically requiring that a self-correction memo be created, but it is best practices because it provides ready proof that the plan sponsor qualified for self-correction and completed all correction steps in accordance with EPCRS. Operational and document failures must be disclosed in a plan audit or during due diligence related to a merger or acquisition involving the plan sponsor. Having a self-correction memo and exhibits to hand in such an event is vastly preferable to simply asserting that self-correction was pursued, without being able to prove that SCP was both available to the plan sponsor, and properly completed within the necessary time period. The listing of recommended topics to cover, above, indicates the volume and specificity of information that is required to take advantage of self-correction. Trying to compile this information under the time pressures of a plan audit or due diligence process, when the information may be difficult to locate or reproduce, is a recipe for failure. It is far preferable to document your self-correction process with a memo as you go along, not unlike cleaning up the kitchen as you cook. You’ll thank yourself later.
The above information is a brief summary of legal developments that is provided for general guidance only and does not create an attorney-client relationship between the author and the reader. Readers are encouraged to seek individualized legal advice in regard to any particular factual situation. © 2022 Christine P. Roberts, all rights reserved.
Photo credit: Dimitri Karastelev, Unsplash
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