Correction of Plan Errors
Final Internal Revenue Code Section 403(b) regulations which became effective January 1, 2009 require that plan sponsors adopt written 403(b) Plan documents. A 403(b) Plan is a form of defined contribution retirement plan that may only be offered by employers that are tax-exempt entities under Section 501(c)(3) of the Internal Revenue Code or that are public educational organizations and for the benefit of certain clergy members. If a 403(b) Plan sponsor did not adopt a written plan document by December 31, 2009, the sponsor’s 403(b) plan is technically no longer considered to be a qualified tax-deferred retirement plan as of January 1, 2009. The benefit of correcting the written document failure is that all money that has been contributed to the 403(b) Plan will remain tax-deferred and that all investments under the 403(b) Plan will retain their tax-favored status.
To help 403(b) Plan sponsors voluntarily correct any plan document errors, the IRS recently updated its Employee Plans Compliance Resolutions System (referred to as EPCRS). Plan document errors are cured through the voluntary correction program (referred to as VCP) by having the 403(b) Plan sponsor adopt a written plan document that complies with the final regulations, make a VCP submission, and pay a compliance fee based on the number of employees eligible to participate in the 403(b) Plan. To simplify this procedure, the IRS has made available a 403(b) VCP Submission Kit, and to encourage 403(b) Plan sponsors to take advantage of this program, the IRS has reduced the compliance fee by 50% if the VCP filing is made by December 31, 2013.
Correction Due to Loss of Tax-Exempt Status
What happens if a tax-exempt organization becomes ineligible to sponsor a Section 403(b) Plan because it loses its exempt status under Internal Revenue Code Section 501(c)(3)? As an example, loss of tax-exempt status may occur automatically if the organization fails to file an annual Form 990 information return for three consecutive years. It may also lose its exempt status if the IRS revokes or terminates exempt status for other reasons.
To fix that problem, an organization may apply to the IRS for a reinstatement of its tax-exempt status; however, this only works if tax-exempt status was automatically revoked due to failure to file Forms 990. In that case, the IRS may reinstate tax-exempt status retroactively, or it may only reinstate tax-exempt status prospectively.
If an organization loses its tax-exempt status, it must immediately stop making contributions to its 403(b) Plan because it is no longer considered an eligible employer. If, however, contributions were made to the organization’s 403(b) Plan after loss of tax-exempt status and tax–exempt status is not reinstated or is only reinstated prospectively, the 403(b) Plan sponsor may voluntarily correct the eligibility failure through the IRS’s Employee Plans Compliance Resolutions System (EPCRS). The benefit of correcting the employer eligibility failure is that all money that was contributed to the 403(b) Plan while the employer was ineligible to maintain the 403(b) Plan will retain its tax-favored status, all contributions may remain in the applicable annuity contracts and custodial accounts and the organization may avoid potential penalties.
To participate in this voluntary correction program (VCP), the organization must make a VCP submission to the IRS and pay a compliance fee based on the number of employees that were eligible to participate in the 403(b) Plan. To be eligible to correct an employer eligibility failure under VCP, the organization or the 403(b) Plan cannot be under audit by the IRS, all contributions to the 403(b) Plan must have ceased (except where tax-exempt status has already been prospectively reinstated), the 403(b) Plan must have complied with all applicable requirements under the final Section 403(b) regulations and must continue to comply with the distribution rules applicable to 403(b) Plans.
IRS Establishes Pre-Approved Plan Program for 403(b) Plans
On March 28, 2013, the IRS issued Revenue Procedure 2013-22 which establishes a program for the IRS to accept applications for opinion and advisory letters for 403(b) prototype plans and 403(b) volume submitter plans, respectively, starting June 28, 2013. The new program is similar to the pre-approved plan program maintained by the IRS for tax-qualified plans with one significant difference – an employer who adopts a pre-approved 403(b) plan will not be able to apply for an individual determination letter for the 403(b) plan. In addition, the IRS has stated that it is not establishing a determination letter program for individually designed 403(b) plans at this time. Although many large employers will likely continue to use individually-designed 403(b) plans, the program offers employers an alternative to adopting an individually-designed plan to satisfy the written plan requirement under the final regulations issued under Section 403(b) of the Internal Revenue Code.
The IRS has also issued an information package containing samples of 403(b) plan provisions to assist sponsors who are drafting 403(b) prototype plans and 403(b) volume submitter plans with the goal of accelerating the review and approval of these plans. Some of the notes included in the information package reflect requirements that are not included in the final Section 403(b) regulations and have raised questions concerning 403(b) plan administration and compliance. In addition, the information package does not include sample provisions for mandatory employee contributions as a condition of employment, a common feature in many 403(b) plans.
Because there are still a number of unanswered questions and issues that need to be refined, we expect that the IRS will continue to provide guidance concerning the program and the sample provisions.