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:
- 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.
- 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?
- 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.
- 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?
- 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.
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