Posted on

The Brave New World of Self-Correction

With apologies to Aldous Huxley, it is fair to say that SECURE 2.0 has ushered in a brave new world of self-correction for plan sponsors with plan qualification failures.  This post focuses on self-correction of operational failures; i.e., failures to operate plans in accordance with their written terms.

SECURE 2.0 comprises Division T of the Consolidated Appropriations Act, 2023, and Section 305 of that Division expanded the Employee Plans Compliance Resolution System (EPCRS) to permit self-correction of any inadvertent failure to comply with the rules applicable to qualified plans, Section 403(b) plans, SIMPLE or SEPs, except in the event that either (a) the IRS identifies the failure prior to the plan sponsor having taken actions demonstrating a specific commitment to self-correct the failure; or (b) the plan sponsor fails to self-correct the error within a reasonable period after identifying the failure.   SECURE 2.0 expressly provides that if neither of these disqualifying factors exist, the self-correction time period for an eligible inadvertent failure is “indefinite and has no last day.”  

Contrast this with pre-SECURE 2.0 rules for self-correction of operational errors, as follows:

  • “Insignificant” operational errors could be self-corrected at any time, including while the plan or plan sponsor was under examination; and
  • “Significant” operational errors were required to be substantially corrected within three years of the error occurring.

In order to determine whether or not an operational error was significant or insignificant, plan sponsors needed to consult a list of criteria set forth in EPCRS, most recently contained in Revenue Procedure 2021-30, § 8.02.  They include factors such as the percentage of plan assets and contributions involved in the error relative to total plan assets, the number of participants affected relative to total plan participants, the number of years in which the error occurred, and several others.  SECURE 2.0 has rendered the criteria obsolete, with one exception:  whether correction was made within a reasonable time after discovery of the error.  As mentioned, SECURE 2.0 retained this criterion for self-correction.

Certain other pre-SECURE 2.0 criteria for self-correction remain under the post-SECURE 2.0 expansion:

  • To be eligible to self-correct an inadvertent error, the plan sponsor must maintain practices and procedures that are generally designed to promote and facilitate overall compliance with the applicable IRS requirements.  A plan error must have occurred despite the existence of such practices and procedures (such as a failure to apply them in a specific instance) and not as a result of their absence. 
  • Self-correction remains unavailable to correct an egregious error such as a plan feature or design that exclusively benefits highly-compensated employees.
  • Lastly, self-correction must be able to be accomplished in a manner that conforms to the general principles that apply to corrections under the Internal Revenue Code and related guidance, including EPCRS Revenue Procedures.

Plan sponsors and advisers will need further specific direction from IRS in order to navigate the new self-correction landscape.  Guidance will come in the form of an updated EPCRS Revenue Procedure, which SECURE 2.0 directs IRS to issue by December 29, 2024.  Hopefully additional written guidance will be available before that deadline.  Among the more pressing questions for plan sponsors are the following:

  1. What comprises an “eligible inadvertent failure” and the degree to which inadvertence relates to the criteria of pre-existing practices and procedure for proper plan administration.
  2. With respect to timing of discovery of an error by IRS, what is meant by steps that demonstrate a specific commitment to implement self-correction?  Is it enough to have identified the error and outlined the means of correction or must actual correction have commenced, such as deposit or refund of amounts and earnings?
  3. What is meant by completing self-correction within a reasonable time after discovery of the error?  Will the pre-SECURE 2.0 rules about substantial completion remain relevant?  These rules made reference to completion of correction with respect to at least 65 percent of affected participants within the three-year correction period, or alternatively to complete correction within 120 days after the end of the applicable correction period, so long as completion efforts were diligently pursued during the original time period for correction. Rev. Proc. 2021-30, §9.03.
  4. How closely must the proposed correction method conform to existing EPCRS correction methods, or otherwise conform to correction principles under the Code, in order to be eligible for self-correction?  How narrowly or broadly will IRS interpret these pre-existing correction standards?
  5. To what degree is preparation of a self-correction memorandum recommended or required? Our prior post identified creation of a self-correction memo as best practices to document self-correction in anticipation of an IRS audit or merger or acquisition due diligence process. It would be helpful to hear from IRS on this front.

Additional direction from IRS will also be welcome with regard to self-correction of plan loan failures, which was specifically expanded under SECURE 2.0, and self-correction of plan document errors through retroactive amendment, which was last expanded under the prior iteration of the EPCRS Revenue Procedure, Rev. Proc. 2019-19.   

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. © 2023 Christine P. Roberts, all rights reserved.
Photo credit: Galen Crout, Unsplash

Posted on

The Unsung Importance of Self-Correction Memos

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


Posted on

Will New IRS Funding Increase Plan Audits?

The Inflation Reduction Act, H.R. 5376 stands poised for passage in the House and includes almost $80 billion in new funding for the Internal Revenue Service, of which almost $46 billion is allocated to “enforcement,” including determination and collection of taxes, legal and litigation support. What is not clear at this juncture is how much of that massive amount of new funding will trickle down to the Tax Exempt and Government Entities Division, which has oversight over retirement plans, the employers that sponsor retirement plans, and IRAs. IRS Commissioner Chuck Rettig has stated in letters to both houses of Congress that the rates of auditing households making under $400,000 per year will not increase despite the new funding, but that the resources will enable “meaningful, impactful examinations of large corporate and high-net-worth taxpayers.” Whether this includes examinations of large corporate and high-net-worth taxpayer retirement plans and IRAs is uncertain.

A breakdown of the new IRS funding, which is set forth in Title I, Subtitle A, Part 3 of the Act, is set forth below.

Section 10301. Enhancement of Internal Revenue Service Resources.

It seems hard to imagine that some portion of the enforcement budget won’t ultimately increase plan audit activity. The IRS only recently announced a new plan enforcement initiative in the form of a 90-day Pre-Examination Compliance Pilot program (click on June 3, 2022 to display the program announcement). Under this new program, IRS will send a letter to a plan sponsor notifying them that their retirement plan has been selected for an examination. The letter gives the plan sponsor a 90-day window of time to review their plan’s documentation, and operations, for compliance with applicable law. If errors are noted, they may be eligible for self-correction under the terms of Revenue Procedure 2021-30. Errors that are not eligible for self-correction can be corrected under a closing agreement, with the Voluntary Correction Program fee structure forming a basis to determine the sanction amount that the IRS will impose. If the plan sponsor fails to respond to the IRS within 90 days of the letter, the IRS will contact the sponsor to schedule an exam. Since this audit initiative starts with a simple letter, there would now seem to be ample funds at IRS to pursue this agenda – in fact, postage is one of the expressly sanctioned expenses under Operations Support. Even without a specific funding line-item for TE/GE, plan sponsors should be on their guard in this new era of IRS funding.

The author thanks Peter Gulia, Fiduciary Guidance Counsel, and other colleagues at the Benefitslink Message Boards for sharing their thoughts about the new IRS funding.

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:  Mathieu Stern, Unsplash

Posted on

The Slippery Slope of SEP and SIMPLE Notification Duties

As the June 30, 2022 CalSavers deadline bears down on employers with five or more California employees, many small employers may be giving thought to adopting a simplified retirement plan, whether a SEP or SIMPLE IRA.  Establishment of one of these types of plans is a permissible alternative to participating in CalSavers.  There are circumstances where these types of plans are a good fit.  However, each of these types of plans imposes participation notification duties that employers often overlook, and noncompliance can put the tax-sanctioned status of the whole arrangement at risk. Below we summarize the relevant rules.

Simplified Employee Pension (SEP) Notification Duties

IRS Form 5305 is often used to establish a SEP.  A plan set up via Form 5305 is considered adopted when eligible employees have been provided with:

  • a copy of the completed, signed, and dated Form 5305-SEP, including the Instructions to Employer and Information to Employee sections;
  • a statement to the effect that IRAs other than the IRA(s) into which employer contributions will be made may yield different rates of return and may have different terms concerning, among other things, transfers and withdrawals of funds from the IRA;
  • a statement that notice of any amendment to the SEP, a copy of the amendment and a written explanation of its effects, will be provided within 30 days of the effective date of any such amendment; and
  • a statement that the employer will provide written notice of contributions made to the plan, by the later of (a) January 31 of the year following the year in which the contribution is made, or (b) the date that is 30 days after the date the contribution is made.  This notice duty may be met by reporting the SEP contribution on eligible employees’ Form W-2 for a given year.  Failure to provide the notice of contribution may subject the employer to a $50 penalty per failure unless the failure is due to reasonable cause. 

This information must be provided thereafter to each new employee who becomes eligible under the SEP.

Additional disclosure duties apply if you are using a prototype SEP arrangement, rather than Form 5305-SEP, including special disclosures for plans under which contributions are integrated with Social Security.  Providing eligible employees with a copy of the SEP agreement will meet many of the disclosure requirements, but employers should check with the prototype SEP sponsor to confirm that they will timely supply your business with all necessary additional disclosures.  Annual contribution reporting through Form W-2 is the same. 

Savings Incentive Match Plan for Employees (SIMPLE IRAs)

Notification duties under a SIMPLE plan are more complicated than under a SEP due to the employee elective deferral feature.  Also, there are two model SIMPLE forms in use, Form 5304-SIMPLE and Form 5305-SIMPLE.  Form 5304-SIMPLE is used when all IRAs are established with a single designated financial institution, and Form 5305-SIMPLE is used when participants select their own IRA provider.

For an existing SIMPLE IRA plan, eligible employees must receive a Summary Description and Notification to Eligible Employees before the start of a 60-day election period.  Since all SIMPLE plans must be on a calendar plan year, including those set up using Forms 5304- or 5305-SIMPLE, the plan year must be the calendar year.  Therefore the 60-day election period runs from November 2 through December 31, and the notice must be provided before November 2 each year.   Provision of a current copy of the completed Form 5304-SIMPLE or 5305-SIMPLE, with instructions, will satisfy both disclosure duties if Article VI – Procedures for Withdrawals, is completed.  When Form 5304-SIMPLE is in use, the custodian or trustee may provide the Article VI information directly to the employees; employers should confirm that the custodian/trustee is timely meeting this disclosure duty, however. 

For a new SIMPLE IRA plan or for a new hire who becomes eligible, the Model Salary Reduction Agreement that comprises part of Forms 5304- and 5305-SIMPLE must be provided prior to the 60-day period that includes either the date the employee becomes eligible or the day before.  The employee must be able to commence elective deferrals as soon as they become eligible, regardless of whether the 60-day period has ended, but no earlier than the plan’s effective date.  Certain special notification and election period rules apply when an employee becomes an eligible employee other than at the beginning of a calendar year, including when an employee is rehired during a plan year. 

How to Deal with SEP and SIMPLE Mishaps

If you have not timely met your SEP notification duties as outlined above, you should consult an ERISA attorney.

If you have not timely met your SIMPLE-IRA plan notification duties as outlined above, you can fix the problem by following the steps outlined in the SIMPLE IRA Plan Fix-It Guide.  Self-correction may be an option if you had practices and procedures in place to timely provide the notice but failed to follow them, and other pre-requisites to self-correction have been met.  Otherwise, you may need to use the Voluntary Correction Program to fix the problem.  This will generally require the involvement of an ERISA attorney.

In addition to notification duties, SIMPLE plans are subject to rules regarding timing of deposit of employees’ elective deferrals.  Elective deferrals must be deposited with the IRA custodian or trustee within the 30-day period following the last day of the month in which the amounts otherwise would have been payable in cash to employees.

If elective deferrals are not timely deposited, the Department of Labor (DOL) may have to be contacted to correct the problem.  Why is this necessary?   To avoid potential employer liability for civil penalties, and in some cases involving missed or late elective deferrals, criminal penalties. 

Special rules, not addressed above, may apply to plan documents not established using the IRS forms mentioned in this post.

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:  Nico Smit, Unsplash

Posted on

Five Good Reasons to Correct Retirement Plan Errors

If your business sponsors a Section 401(k) or other retirement plan, it is governed by a lengthy plan document, often a separate trust agreement or custodial account agreement, and multiple other documents (salary deferral agreements, loan policy statement, investment policy statement, etc.)  Not surprisingly, most plan sponsors get something wrong somewhere along the way, whether with respect to the plan document, or operation of the plan.  Below are five reasons why taking prompt action to correct plan errors is in the best interests of your business, and your employees.   

  1. To preserve the tax-qualified status of your plan.

Contributions to your plan are deductible to your business and excluded from your employees’ taxable compensation (i.e., are “tax-qualified”) because the plan document, and operation of the plan, conform to certain requirements under the Internal Revenue Code.  Under the Employee Plans Compliance Resolution System or EPCRS, the Internal Revenue Service permits plan sponsors to voluntarily correct a wide range of errors that, if left uncorrected, could result in a loss of the plan’s tax-qualified status and subject plan assets to taxation.   There are costs associated with participating in the EPCRS, including amounts that may be owed to the plan, attorneys’ fees, and program fees, but they are usually only a fraction of the potential expense of plan disqualification. 

  1. To correct prohibited transactions.

While the IRS monitors the tax-advantaged status of benefit plans, the Department of Labor policies the actions of plan fiduciaries, both with respect to plan assets, and in fulfilling reporting and disclosure duties.  When salary deferrals and loan repayments are withheld from employees’ pay and not promptly deposited in the plan’s trust account, the Department of Labor essentially views this as an interest free loan, by the employer, of employee money.  Technically speaking, it is a “prohibited transaction” that requires correction under the DOL’s Voluntary Fiduciary Correction Program.  Uncorrected prohibited transactions, if discovered on audit, can result in civil monetary penalties to the fiduciaries, and also triggers excise taxes payable to the Internal Revenue Service.  Prohibited transactions also must be disclosed on the annual Form 5500 Return/Report, potentially alerting the Department of Labor to initiate further inquiry or audit.  Timely participation in VFCP eliminates the fiduciary penalties and offers alternatives to payment of the excise taxes in some circumstances (e.g., if the same amount is paid to the plan). 

  1. To minimize penalties in the event of a plan audit.

The IRS, on audit, may assess penalties for uncorrected errors in plan documentation and operation, that can reach many thousands of dollars, on top of the amounts owed to the plan in order to correct operational errors.  And, as mentioned, prohibited transactions trigger potential civil monetary penalties.  Participation in IRS and DOL voluntary correction programs protects plan sponsors from these potential large assessments.  Whatever the cost of taking part in the voluntary program, whether it be costs of corrective contributions and earnings, attorneys fees, and the program fee, it is a quantifiable cost and one that is much smaller than the cost of correcting under the supervision of the IRS or DOL.

  1. To ensure the saleability of your business.

Plan sponsors sometimes think that their uncorrected plan errors are only at risk of discovery if they are audited, and point to low levels of IRS and DOL audit activity as proof that they can safely play “audit roulette.”  However they are forgetting that, if they want to sell their business – particularly stock sales – or merge with another business, the due diligence process preceding the transaction will likely require them to identify any errors in plan documentation or operation within a 3 year or longer period.  An unresolved plan error could derail the transaction, or at best require correction under terms and conditions that are not as favorable, to the plan sponsor, as self-correction would have been.  If you envision your business as a purchase target or merger partner in the future you owe it to yourself to make sure that plan errors are corrected promptly and in advance of any due diligence inquiries. 

  1. Because it’s the right thing to do.

Your retirement plan document is a contract you have entered into for the benefit of plan participants and beneficiaries and you should take it as seriously as any contract you enter into with a third party.  It spells out the right way to do things, for the most part, and the IRS and DOL self-correction programs are there to minimize the downside when plan documentation or operation falls short of perfection.  Whether your goal is to sell your business without a hitch, or glide through an IRS or DOL audit with a minimum of fuss, fixing plan errors promptly is the right choice every time.

The above information is a brief summary of legal issues 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. © 2021 Christine P. Roberts, all rights reserved.

Photo credit:  Sasun Bughdaryan, Unsplash

Posted on

IRS Plays Musical Chairs With Voluntary Correction Programs

Section 401(k) and other retirement plans are notoriously complicated to operate and no plan sponsor gets it 100% correct, 100% of the time. When problems arise, plan sponsors may correct certain errors – technically “failures” — under an IRS program called the Employee Plans Compliance Resolution System, or EPCRS. Failures corrected this way cannot later be the basis for revoking the tax-qualified status of the plan, or imposing other tax penalties or interest. EPCRS is set forth in a Revenue Procedure that the IRS updates every few years. On July 16, 2021 the IRS published the latest EPCRS upgrade in Revenue Procedure 2021-30, in which, like musical chairs, some ground is gained while some is taken away. Below is a summary of some of the key changes.

Expansion of Self-Correction Period

Under the Self Correction Program, a plan sponsor may at any time, without IRS review or approval, correct “insignificant” failures in the way a plan has been operated (operational failures), and failures relating to plan documentation such as missed amendment deadlines (plan document failures). Further, a plan sponsor may self-correct “significant” failures of these types, provided that the significant failure is identified and fixed within a set “correction period.”

In the past, the correction period ended on the last day of the second plan year following the plan year for which the failure occurred. The EPCRS upgrade adds a whole additional year to the correction period. Now, self-correction of significant failures may be made by the end of the third plan year following the plan year in which the failure occurred. Thus, a plan sponsor with a calendar plan year and a significant operational error occurring in 2018 will have until the end of 2021 to correct the error.

There are two follow-on effects of this extension:

  • The three-year self-correction period for significant operational failures does not begin to run until after the statutory correction period for ADP and ACP testing failures, which is the 12-month period following the close of the plan year for which the test was failed. In effect there is four years to correct these errors – the original statutory period of 12 months, followed by the three plan year self-correction period.
  • For errors involving a failure to offer or implement elective deferrals, corrective contributions equal to 50% of what would have been deferred generally must be made to the plan. That percentage is reduced to 25% of what would have been contributed if certain requirements are met, including that the period during which the error occurred lasted more than three months, but not longer than the self-correction period for significant failures. That period has now been extended a year, from two to three plan years.

Plan sponsors wishing to use the Self-Correction Program should be mindful not just of the correction period deadline, but of several other pre-requisites. First, the plan sponsor must have established compliance practices and procedures in place, and the error must have arisen due to a lapse in their normal application. Plan document failures may only be self-corrected if a “favorable letter” for the plan exists. The plan sponsor must also assess a number of facts and circumstances in order to determine whether the failure is “insignificant” or “significant.” For those seeking more information, the IRS provides helpful online guidance on Self-Correction (but the two-year correction period had yet to be updated as of the date of this post), as well as Self-Correction FAQs.

Anonymous VCP Repealed after 2021

In addition to Self-Correction, EPCRS includes the Voluntary Compliance Program (VCP), which involves an online submission, IRS approval of the proposed correction method, and payment of a VCP fee. Normally the name of the plan sponsor and the plan involved are revealed in the VCP submission process. However the IRS has for some years maintained an Anonymous VCP process, particularly for plan sponsors whose proposed corrections do not fit within the preapproved or “safe harbor” methods outlined in EPCRS. In Anonymous VCP, a representative of the plan sponsor, such as a law firm, files the submission without identifying the plan sponsor or plan. If the IRS approves the proposed correction, the plan sponsor reveals is identity and the process converts to a conventional VCP submission. If the IRS rejects the proposed correction method, the plan sponsor remains anonymous and has the option of later participating in regular VCP with an alternative proposed correction.

For reasons that it does not explain, the IRS is retiring Anonymous VCP and will not accept any more Anonymous VCP submissions after December 31, 2021. In its place the IRS is introducing a new program effective January 1, 2022, which it refers to as an “anonymous, no-fee VCP pre-submission conference.” This new program is intended for proposed corrections that fall outside the safe-harbor correction methods set forth in Appendices A and B to the EPCRS Revenue Procedure. The VCP pre-submission conference is available only if the plan sponsor is eligible for and intends to submit a conventional VCP submission. Following a VCP pre-submission conference, the IRS will provide oral feedback on the failures and proposed correction method that is “advisory only, is not binding on the IRS.” The IRS will only confirm in writing that a VCP pre-submission conference took place but will not appear to provide anything substantive in writing about what was discussed.

VCP pre-submission conferences are held only at the discretion of the IRS and “as time permits.” Given limited IRS funding and significant understaffing in recent years, one wonders how widely and promptly available this program will be. It is also unclear whether or not the introduction of the VCP pre-submission conference means that VCP coordinators at IRS will no longer informally discuss proposed corrections with attorneys and other practitioners, as has been the practice in the past.

Other Changes

  • EPCRS generally requires full correction of operational errors, but makes an exception for certain de minimis amounts. Effective July 16, 2021, the de minimis threshold increases from $100 to $250, and erroneous contributions (plus earnings) of $250 or less will not need to be pulled from a participant’s account or recouped after distribution to a participant.
  • In the past, when a participant received a lump sum distribution of a more than de minimis amount (“Overpayment”), the plan was required to seek recoupment in a lump sum repayment. Now, repayment in installments is also an option. For defined benefit plans, the Revenue Procedure describes certain conditions under which recoupment of Overpayments may be avoided altogether.
  • The Revenue Procedure restores a safe harbor correction method for failures arising from automatic contribution arrangements, which had expired on December 31, 2020. The new expiration date is December 31, 2023; until then no corrective contributions are required for certain automatic contribution failures that do not extend beyond 9 ½ months following the end of the plan year of the failure. Other correction criteria apply including provision of written notice to affected employees.
  • The Revenue Procedure substantially liberalizes self-correction of certain operational failures through a plan amendment that retroactively reflects how a plan has been operated. Such retroactive amendments must increase benefits, rights or features under the plan, rather than reduce them. In the past it has been required that the benefit increase or enhancement apply to all eligible participants under the plan, which made many proposed corrections unaffordable. The new Revenue Procedure lifts the universality requirement, so that a retroactive amendment may increase benefits only for those participants affected by the operational error. This will make this form of correction much more flexible and attainable for plan sponsors.

Photo credit: Federica Campanaro, Unsplash

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. © 2021 Christine P. Roberts, all rights reserved.

Posted on

IRS Lists Solo 401(k) Plans as Audit Target

If your business sponsors a “solo 401(k)” plan, it may be in the crosshairs of the Internal Revenue Service.  The Service’s TE/GE (Tax Exempt and Government Entities) division has identified one-participant 401(k) plans as among its current audit initiatives.  In its web posting announcing the initiative, TE/GE states:  “[t]he focus of this strategy is to review one-participant 401(k) plans to determine if there are operational or qualification failures, income and excise tax adjustments, or plan document violations.”

By way of background, a solo 401(k) plan is a traditional 401(k) plan covering a 100% business owner with no employees, or that person and their spouse.  As this handy IRS info page describes, solo 401(k) plans are subject to the same rules and requirements as any other 401(k) plan, however because no common law employees participate, you do not have to worry about minimum coverage and nondiscrimination testing, top heavy rules, or most of the requirements of Title I of ERISA.  Solo 401(k) plans can be a great fit for some businesses, but those that stray outside the strict eligibility requirements for these plans have potentially high exposure to correction costs and sanctions in an audit setting.    

Below we list some common solo 401(k) compliance pitfalls.   If you are a solo 401(k) sponsor, check your plan design and operations to determine if these might be issues for you.  Take steps now to correct any compliance failures through use of EPCRS and other voluntary compliance programs, where applicable, so that, if an IRS audit does occur, it is resolved without incident.

  1. Employees Eligible for Benefits: One of the most frequent errors with solo 401(k) plans is that they lose their solo status when the business sponsoring them acquires employees, and the employees work the necessary number of hours required for eligibility under the plan.  (These generally cannot exceed 1,000 hours in a year of service.)  This will trigger application of minimum coverage, nondiscrimination, and top heavy rules, as well as ERISA reporting and disclosure requirements (Summary Plan Description, Form 5500-SF, etc.).  Failure to meet requirements under any of these sets of rules will be fodder for the IRS in an audit setting.  Business owners who need employees should probably avoid solo 401(k) plans unless they can be certain that the employees’ work hours never reach or exceed 1,000 hours in a year.   
  2. Controlled Group/Affiliated Service Group: This issue is related to the first in that, if the business that sponsors the solo 401(k) plan is under common control with a business that has common law employees, the answer to the question “who is the employer” — and who has employees — will be both businesses under common control, not just the business that sponsors the solo 401(k).  Generally, solo 401(k) status will be lost as a result.  The same potential coverage, testing, and top-heavy issues listed above can apply. Potentially, employees of the other business could be eligible for benefits under the (formerly) solo plan.
  3. Form 5500 Filing Duties: Solo 401(k) plans are exempt from filing Form 5500-EZ so long as plan assets remain under $250,000.  If plan assets exceed this threshold and a Form 5500-EZ is not filed, significant penalties could be assessed by IRS and by Department of Labor.  Participation in the Department of Labor Penalty Relief Program for Form 5500-EZ Late Filers should be considered in such instances. 
  4. Exceeding Contribution and Deduction Limits: The contribution and deduction limits that apply to group 401(k) plans apply to a solo 401(k) plan.  Employee salary deferrals cannot exceed the applicable dollar limit under Internal Revenue Code (“Code”) § 402(g) ($19,500 in 2021, plus $6,500 for those 50 and older).  The 415(c) limit equal to the lesser of 100% of compensation or $58,000 (in 2021) applies (and is increased by the age 50 catch-up limit, for a total of $64,500).  The maximum Code § 404(a) deduction of 25% of eligible plan compensation also applies, but in general the 415(c) limit will be reached first.  Failure to observe any of these dollar limits could be picked up on audit.
  5. Plan Document Errors: Businesses that sponsor a solo 401(k) need to update their plan document periodically to comply with the law just like any plan sponsor, meeting the adoption deadlines for preapproved plan remedial amendment cycles (the next one falls on July 31, 2022). Voluntary plan amendments also have to be properly documented and timely adopted.  Failure to meet these document requirements may be able to be corrected under EPCRS. 

The above information is provided for general informational purposes only and does not create an attorney-client relationship between the author and the reader. Readers should not apply the information to any specific factual situation other than on the advice of an attorney engaged specifically for that or a related purpose. © 2021 Christine P. Roberts, all rights reserved.

Photo Credit:  Markus Spiske, Unsplash

Posted on

IRS Questionnaire Sent to College, University Plans Does Not Put Plans “Under Examination” but EPCRS Availability Remains Unclear

The IRS Employee Plans Compliance Unit (“EPCU”) is in the process of sending over 300 written questionnaires to a random sample of small, medium, and large institutes of higher education, including private and public colleges, universities, and trade and vocational schools. The questionnaire – on IRS Form 886-A – contains 18 separate questions but mainly focuses on one issue: whether the organization’s Section 403(b) plan satisfies the “universal availability” requirement. Under that rule, if one employee has the opportunity to defer a portion of salary under the plan, then generally all employees must be offered the same opportunity. (Very limited exceptions apply.) The questionnaire seeks to identify plans that are not making the deferral opportunity universally available, either because the limited exceptions are misapplied, or the employer imposes additional conditions on deferring that are not permitted under law. A number of the questions refer specifically to exclusion of groups of employees unique to educational organizations, such as medical residents, and different categories of instructors, professors or lecturers. An IRS announcement on the project as well as links to the questionnaire, instructions for filling out same, and a glossary of terms, can be found here.

Organizations have 25 days to complete and return the questionnaire by fax, mail or e-mail. Upon review of the questionnaire, the IRS will either deem a plan to be compliant and issue a “closing letter,” or will request additional information from the organization. If a problem is found the IRS will work with the organization to correct it, for instance by making fully vested employer contributions to restore the lost opportunity to make tax deferrals in prior plan years. (Generally the employer contribution requirement is equal to half of the deferral the employee would have made (the “lost opportunity” cost), but specific correction methods are not set forth in the questionnaire or in the IRS announcement of the program. Correction methods will be specified in a follow-up letter sent to organizations whose initial responses require follow-up.

Receipt of the questionnaire will not mean that a plan sponsor is “Under Examination” and thus barred from using the Voluntary Correction Program under the Employee Plans Compliance Resolution System (“EPCRS”) to correct 403(b) operational errors currently identified in EPCRS (for instance, failure timely to implement an employee’s salary deferral election). This was confirmed by the IRS, with regard to a similar 401(k) questionnaire project, in a recent issue of Employee Plans News. That said, the current version of EPCRS, set forth in Revenue Procedure 2008-50, does not provide as many corrections for Section 403(b) plans as are available to other types of qualified plans, largely because Rev. Proc. 2008-50 was drafted before Section 403(b) plans were required to be set forth in writing. For instance, VCP is not available for sponsors that lack a written Section 403(b) plan document or that have failed to operate the plan in accordance with its written terms, nor is it available for employer eligibility failures. The IRS is expected later this year to release an updated version of EPCRS that covers Section 403(b) corrections in greater detail. However, it is not known whether or not the new Revenue Procedure will contain relief for sponsors that failed to timely put a plan document in place or failed to operate a plan in accordance with its written terms.

Tax-exempt employers who receive a questionnaire strongly are advised to consult with their professional tax advisors before submitting a response to the IRS. An incorrect response – or an accurate response – could trigger potential contribution and tax liability on a significant scale, and the availability of EPCRS is uncertain. Such discoveries are better made – and resolutions discussed – with private advisors before the IRS is part of the conversation. If additional time to complete the questionnaire is necessary, employers should request it of the IRS before reaching the 25-day deadline.