Updated Employee Plans Compliance Resolution System: Impact on Employer-Sponsored Retirement Plans

IRS Issues Revised Correction Program for Qualified Plans

On December 31, 2012 the Internal Revenue Service (IRS) issued the long anticipated update to its correction program for certain employer-sponsored retirement plans.  The program is known as the Employee Plans Compliance Resolution System or EPCRS.  The revised correction program is set out in Revenue Procedure (Rev. Proc.) 2013-12, which supersedes Rev. Proc. 2008-50.  The revisions include changes and additional guidance with respect to correction methods as well as procedural changes for voluntary correction program (VCP) submissions.  This article discusses these changes with respect to qualified plans.  Through EPCRS, employers who sponsor qualified plans may correct form, operational and demographic failures voluntarily by self-correction, if eligible, or by written submission under the VCP, if eligible, upon payment of the applicable fee. Employers are well-advised to consider periodic compliance reviews to use these voluntary correction methods to avoid the far greater sanctions that apply if the failures are discovered by the IRS on audit.  The VCP fee is based on the number of plan participants and ranges from $750 to $25,000 with reduced fees for certain operational and nonamender failures.  The sanction on audit is negotiated and begins with the maximum amount of tax that the IRS would have collected in the open years if the plan had not been qualified. This includes the tax that results from trust earnings, the loss of employer deductions for plan contributions and income inclusion for participants with respect to contributions and any distributions that were rolled over to another plan or IRA.

Revenue Procedure 2013-12 is generally effective April 1, 2013 but an employer may apply the provisions prior to April 1, 2013.  If so, employers must comply with the new procedural requirements for a VCP submission as described below. Although correction methods are substantially the same, there are some revisions and additional guidance.  Some of the more significant changes are as follows:

• Corrective contributions for excluded employees in 401(k) plans.  Previously all corrective matching contributions and, if the plan used nonelective contributions to satisfy a safe harbor, all corrective nonelective contributions, related to missed deferrals for an excluded employee were required to be made in the form of a qualified nonelective contribution “(QNEC)” which is a nonforfeitable (i.e., fully vested) contribution. 

Except for corrective matching and nonelective contributions used to satisfy the safe harbor requirements under section 401(k)(12) of the Code, contribution in the form of a QNEC is no longer required for corrective matching and nonelective contributions.  Because a QNEC is not required, the corrective contribution may be subject to a vesting schedule – and thus potentially forfeited, in whole or in part, if the participant who received the contribution terminates employment prior to being fully vested. This also means that the elimination of the QNEC requirement applies to nonelective contributions or matching contributions related to missed deferrals under a plan satisfying the qualified automatic contribution arrangement (QACA) safe harbor of section 401(k)(13) of the Code. Under a QACA, safe harbor matching or nonelective contributions may be subject to a two-year vesting requirement. In all cases, however, corrective contributions for missed deferrals (including catch-up contributions) and for after-tax contributions must be made in the form of a QNEC (and thus, immediately 100 percent vested).

New correction guidance regarding missed deferrals is also provided with respect to the improper exclusion of employees under a plan satisfying safe harbor requirements by use of a QACA.  

• Corrective distributions from defined benefit plans.  In the case of a defined benefit plan, a corrective distribution must be increased to take into account the delay in payment.  The EPCRS revisions clarify that the increase is to be determined using the applicable actuarial factors under the terms of the plan that were in effect on the date that the distribution should have been made.
• Overpayments from defined contribution plans.  If a defined contribution plan overpays benefits, in most cases, the plan sponsor must request that the participant return the overpayment to the plan.  Rev. Proc. 2008-50 provided that the participant should repay the overpaid amount with appropriate interest but that the employer was required to make up any amount not repaid by the employee with interest at the plan’s earnings rate.  Rev. Proc. 2013-12 now also requires the plan’s earnings rate to be used for participant repayments.  In addition, if the reason for the overpayment is the lack of a distributable event, the plan sponsor is not required to make a contribution to the plan even if the participant does not repay the overpayment.
• Corrective distributions from forfeitures.  Forfeitures may generally be used for corrective contributions, subject to the plan document providing that forfeitures may be used to reduce employer contributions. However, Rev. Proc. 2013-12 specifically provides that the plan’s forfeiture account cannot be used to provide the QNECs necessary to correct failed actual deferral percentage, actual contribution percentage or multiple use tests.  This is because QNECs used to satisfy these tests must meet the full vesting (and also distribution) requirements when contributed to the plan.
• Code Section 436 correction issues.  Code Section 436 restricts the payment of benefits in certain forms (e.g., lump sums) and benefit accruals under defined benefit plans that do not meet certain funding levels. Rev. Proc. 2013-12 provides guidance on how plans which are subject to such restrictions can correct the failure to comply with the form of payment restriction and also on how corrective distributions and/or amendments may be made to a plan subject to Code section 436 restrictions.

Rev. Proc. 2013-12 also changes some procedural requirements. These include:

• Finding Missing Participants.  The IRS has discontinued the IRS Letter Forwarding Program as a method for finding lost plan participants who are owed retirement plan benefits. Rev. Proc. 2013-12 provides the following methods to locate missing participants should certified mail not result in success: (i) Social Security letter forwarding program; (ii) a commercial locator service; (iii) a credit reporting agency; or (iv) Internet search tools.  Plan sponsors that have received a VCP compliance statement (and for which the correction period has not expired) or are correcting failures under the self-correction procedures of EPCRS, will have until the earlier of May 30, 2013 or 150 days from the date the IRS notifies the plan sponsor that the request to locate the missing participants will not be processed to locate the missing participants by other reasonable action.  
• Fees.  The fees under the new revenue procedure generally remain the same with a few exceptions.  The compliance fee for failure to adopt an amendment required as a condition of a favorable determination letter within the applicable 91-day period is $500, as long as the amendment is adopted within 3 months after the end of the deadline to adopt the amendment. The VCP fee for multiple failures for which reduced fees are applicable is the lesser of the regular fee or the sum of the reduced fees (if applicable).  The fees for nonamender failures discovered during the favorable determination letter process have increased.
• Forms.  The IRS has made additional efforts to streamline the process of filing a VCP application. A revised Appendix C now serves as a model compliance statement as well as a checklist. Schedules similar to the current schedules are also provided.  Use of Appendix C and the schedules are encouraged but not required.  However, effective April 1, 2013, new VCP applications will be required to include Forms 8950 (the application) and 8951 (with respect to the submission fee).  These Forms which were issued on January 18, 2013 must also be used prior to April 1, 2013, if submission is being made under the new Rev. Proc. 2013-12 rather than under Rev. Proc. 2008-50.  If Forms 8950 and 8951 are required but not included, the VCP submission will be considered to be seriously deficient resulting in the return of the submission.  The VCP submissions under Rev. Proc. 2013-12 are now to be  sent to Covington, KY rather than to Washington, DC.

Although Rev. Proc. 2013-12 provides additional guidance, the IRS continues to request comments on certain outstanding issues as they relate to failures with respect to designated Roth contributions, implementation of automatic enrollment (including automatic escalation of the amount deferred) and timely provision of safe harbor notices.

New EPCRS Guidance Expands Possibilities for 403(b) Plans

By Summer Conley and Lori L. Shannon

The IRS will implement the new Employee Plans Compliance Resolution System (EPCRS) rules on April 1, 2013. This new guidance is especially relevant for employers maintaining 403(b) plans.

Under the prior guidance (Rev. Proc. 2008-50), correction was available for 403(b) plans only for an error that violated a statutory requirement. Correction was not provided for an operational failure that violated a plan term but did not violate a statutory requirement or for a document failure. This was due, in part, because the 403(b) regulations that mandated a written plan and other requirements had not gone into effect when Rev. Proc. 2008-80 was released. This left 403(b) plan sponsors without a method to protect their plans if they discovered these errors. The new guidance in Rev. Proc. 2013-12 opens up, to some extent, corrective capabilities for 403(b) plans.

Under Rev. Proc. 2013-12, 403(b) plan sponsors may generally correct failures in the same manner as qualified plans, including errors with respect to plan document failures and failures to administer the plan in accordance with its terms. However, failures that occurred prior to 2009 are still subject to the limitations of the correction guidance under Rev. Proc. 2008-50. Set forth below is a more detailed explanation regarding the new correction procedures as they apply to Plan Document Failures and Operational Failures for 403(b) plans.

Plan Document Failures

Background - Prior to January 1, 2009, there was no written plan document requirement for 403(b) plans under the Internal Revenue Code (Code). This changed effective January 1, 2009, with the issuance of final regulations under Code section 403(b). In IRS Notice 2009-3, the IRS extended the deadline for adoption of a written plan document complying with Code section 403(b) and the regulations to December 31, 2009, provided that the 403(b) plan was maintained in operational compliance during 2009 . In addition, the IRS in Announcement 2009-89 provided for a remedial amendment period for correcting 403(b) plan document failures. The remedial amendment period applies if the plan sponsor adopted a 403(b) plan by December 31, 2009, that was intended to comply with Code section 403(b) and the regulations, and the plan sponsor either has adopted a prototype 403(b) plan that receives a favorable opinion letter from the IRS or applies for an individual determination letter for an individually designed 403(b) plan when that program becomes available. The remedial amendment period during which the plan sponsor can retroactively correct any plan document failures began on January 1, 2010. The IRS has not yet released guidance on the end of this remedial amendment period or on the individual determination letter submission process for 403(b) plans.

Rev. Proc. 2013-12 – As long as the remedial amendment period described in Announcement 2009-89 is applicable, a 403(b) plan will not have a Plan Document Failure during the period beginning on January 1, 2010, and ending on a date to be provided in future guidance, if the Plan Document Failure is corrected during the remedial amendment period by a retroactive plan amendment (i.e., retroactive to January 1, 2010). This is consistent with prior guidance and means no EPCRS submission is required.

If, however, a 403(b) plan sponsor did not timely adopt a written plan document, i.e., by December 31, 2009, the plan sponsor may make a written submission to the Voluntary Compliance Program (VCP) under EPCRS with respect to the document failure. If the plan receives a compliance statement under VCP or if a closing statement is issued as a result of an IRS plan audit, the plan will be treated as if it had been timely adopted for purposes of utilizing the remedial amendment period described in Announcement 2009-89. Neither the compliance statement nor the closing statement constitutes a determination of whether the 403(b) plan is compliant with Code Section 403(b) or the regulations. Like all other 403(b) plans, such plans will have to obtain favorable determination letters if individually designed or rely on favorable opinion letters in the case of pre-approved 403(b) plans to obtain such assurance with respect to document compliance.

Action Items with Respect to Plan Document Failures – 403(b) plan sponsors should consider doing the following:

• Review 403(b) plan documents and contracts to assess compliance.
• If any 403(b) plan document is not compliant with Code Section 403(b) and the regulations thereunder, determine whether the 403(b) plan can be retroactively amended to correct the plan document failure.
• Adopt a pre-approved 403(b) plan that receives a favorable opinion letter from the IRS OR apply for a favorable determination letter for an individually designed 403(b) plan when the program becomes available.
• If the employer did not adopt a 403(b) plan intended to be compliant by December 31, 2009, enter the Voluntary Compliance Program and obtain a compliance statement to treat the 403(b) plan as if it had been adopted timely.

Operational Failures

EPCRS is now available to correct any operational failure (i.e., a failure to follow plan provisions) that occurred on or after January 1, 2009. The correction methods are substantially the same as those used for qualified plans. However, for operational errors that occurred before January 1, 2009, 403(b) plans are limited to those failures included in the definition of 403(b) operational failures in the prior EPCRS guidance (Rev. Proc. 2008-50). The operational failures defined under the prior guidance generally related to specific Code provisions and included failures to satisfy the 401(a)(17) compensation limit, distribution restrictions, required minimum distributions, limits on elective deferrals, and rollover requirements. The failure to follow the plan’s terms alone did not fall under the prior guidance.

Thus, 403(b) plans with any Operational Failures that occurred on or after January 1, 2009, may correct the failures using either the self-correction program or VCP under EPCRS. (Note that in order to use self-correction, the plan sponsor must have practices and procedures that are reasonably designed to promote compliance, and if the failures are significant, self-correction is available only if the plan has a favorable determination letter (this requirement is discussed in the next paragraph). These procedures are only required with respect to failures occurring after December 31, 2009.) However, plan sponsors with errors that occurred before January 1, 2009, are left with the same dilemma when their failures do not fall into one of the 12 specific categories listed in the prior EPCRS guidance.

Favorable Determination Letter – As stated above, self-correction involving significant failures is available only if the plan has a favorable determination letter. Pending additional guidance, a 403(b) plan will be treated as having a favorable determination letter if the employer adopted a written plan document intended to comply with Code section 403(b) and the regulations on or before December 31, 2009 (or the date the plan is established, if later).

Information Sharing Agreements

The new guidance also addresses a failure that results from a vendor contract not being part of a 403(b) plan because an information sharing agreement is not in place for such contract as required by the Code and the regulations. In that case, plan sponsors may use the self-correction program or VCP as applicable and transfer the affected assets to a different vendor with whom contributions are being made and with whom an information sharing agreement is in place. Failure to make such a transfer will result in an ongoing operational failure.

457 Plans

EPCRS is still not officially available for 457 plans. However, in Rev. Proc. 2013-12, the IRS did indicate that governmental entities may submit correction applications for 457(b) plans based on standards that are similar to EPCRS. Generally, the same consideration is not provided for 457(b) plans maintained by tax exempt entities. That being said, the IRS did indicate that even tax exempt entities may be able to submit for correction if a 457(b) plan was mistakenly established for non-highly compensated employees and administered similar to a qualified plan.

Effective Date

The new EPCRS guidance takes effect April 1, 2013. However, plan sponsors may rely on the guidance prior to that date and submit compliance applications accordingly.