In Revenue Procedure 2019-19, the Internal Revenue Service (IRS) significantly expanded the availability of the Self-Correction Program (SCP) that plan sponsors may use to self-correct failures in their qualified retirement and/or 403(b) plans under the IRS Employee Plans Compliance Resolution System (EPCRS). For the first time, SCP may now be used to correct certain plan document failures, certain operational failures by plan amendment, and the most common participant loan failures. Sponsors of tax-qualified retirement and 403(b) plans should take note of the new self-correction options to ensure they do not miss opportunities to maintain their plan’s qualification in the most timely and cost-efficient manner.

Background

Over the past 30 years, in the course of the evolution of EPCRS, the IRS has created and expanded opportunities for the sponsors of tax-qualified retirement plans to correct certain problems that, without correction, would risk the qualification of such plans. There are three different correction programs available under EPCRS:

• SCP, which requires no submission to the IRS and no fee;
• Voluntary Correction Program (VCP), which does require a submission to the IRS and the payment of a fee based on the size of the plan; and
• Closing Agreement Program (Audit CAP), which applies to the correction of problems identified in the course of an IRS plan audit. Fees for resolving problems through Audit CAP are negotiated with the IRS and are generally more costly than the fee would have been to resolve the problem under VCP.

Correcting Plan Document Failures under SCP

A “Plan Document Failure” (defined in Revenue Procedure 2019-19) occurs when a provision of the plan on its face violates Section 401(a) or 403(b) of the Internal Revenue Code (Code). This type of failure most often arises when a plan sponsor fails to timely adopt an amendment required as a result of a change in law. A plan sponsor may correct a Plan Document Failure under EPCRS by adopting an amendment to retroactively revise the terms of the plan.

Previously, in order to make such a correction, the plan sponsor had to utilize the more costly VCP program. Under the new rules, a Plan Document Failure may now be corrected under SCP if the following requirements are met:

• Determination Letter. As of the date of the correction, the plan is subject to a favorable determination letter. For this purpose, a 403(b) plan is generally treated as subject to a favorable determination letter if a written plan document has been timely adopted.
• Correction Deadline. The correction must be completed by the last day of the second plan year following the plan year in which the failure occurred.
• Not Under Examination. The correction must be completed before the plan comes under examination by the IRS for the year in which the failure occurred.

Correcting Operational Failures by Plan Amendment under SCP

An “Operational Failure” (defined in Revenue Procedure 2019-19) occurs when a plan is not operated in accordance with its terms. Most Operational Failures are corrected under EPCRS by taking actions to put the plan and affected participants in the same position (as much as possible) that they would have been in had the terms of the plan been followed. However, because undoing past actions may not always be practicable or in the best interests of the plan and the affected participants, EPCRS also permits certain Operational Failures to be corrected by an amendment of the plan to retroactively revise its terms in order to conform to the operation of the plan. Previously, correcting operational errors with a retroactive plan amendment required a plan sponsor to utilize VCP.

Under the new rules, for an Operational Failure to be eligible for correction by plan amendment under SCP, the general eligibility requirements for SCP must first be satisfied. The application of these requirements generally depends on whether the failure is “insignificant” or “significant.” If the failure is insignificant, it may be corrected at any time even after the plan comes under examination by the IRS and even if the Operational Failure is discovered on examination. If the failure is significant, the correction (i) must be substantially completed by the last day of the second plan year following the plan year in which the failure occurred, and (ii) must be completed before the plan comes under examination by the IRS for the year in which the failure occurred.

If the generally eligibility requirements are satisfied, the following specific conditions must also be met for an Operational Failure to be eligible for correction by plan amendment under SCP:

• the plan amendment would result in an increase of a benefit, right, or feature available to the plan participants;
• the increase in the benefit, right, or feature is available to all participants; and
• providing the increase in the benefit, right, or feature is permitted under the Code and satisfies the general correction principles under EPCRS.

If all of the above conditions are met, an Operational Failure may be corrected by plan amendment under SCP if it falls within one of the following categories:

• Code Section 401(a)(17) Failure. A “Code Section 401(a)(17) Failure” (defined in Revenue Procedure 2019-19) occurs when a plan takes into account an employee’s compensation over a limit specified in the plan for purposes of allocating contributions. This failure may be corrected through a plan amendment to retroactively allocate additional contributions to employees for whom the failure did not occur.
• Hardship Distribution Failure. For this purpose, a “Hardship Distribution Failure” (defined in Revenue Procedure 2019-19) occurs when a plan makes a hardship distribution to a participant but the plan document does not allow for hardship distributions. This failure may be corrected through a plan amendment to retroactively provide for the hardship distribution that was made.
• Plan Loan Failure. For this purpose, a plan loan failure occurs when (i) the plan makes loans to participants but the plan document does not provide for loans, or (ii) when the plan makes a number of loans to a participant that exceeds the amount of loans that may be made to a participant under the plan document. This failure may be corrected by a plan amendment to retroactively provide for the loans that were made, but only if the loans were available to all participants or just certain participants who were non-highly compensated employees.
• Early Inclusion of Otherwise Eligible Employee Failure. This type of operational failure occurs when the plan includes an otherwise eligible employee who either (i) has not completed the plan’s minimum age or service requirements, or (ii) has completed the plan’s minimum age or service requirements but became a participant in the plan earlier than the entry date specified in the plan. Such a failure may be corrected by a plan amendment to retroactively change the eligibility or entry date generally or just for the affected employees, but only if the majority of the employees affected are non-highly compensated employees.

Correcting Plan Loan Failures under SCP

There are many different types of plan loan failures, including, for example, failures that arise when administrative errors (such as payroll issues) inadvertently result in missed payments and eventually default of a participant loan. Under the previous rules, a plan sponsor had to utilize VCP to resolve any plan loan problems.

Under the new rules, the following plan loan failures may now be corrected under SCP:

• Defaulted Loans. Defaulted participant loans may be corrected under SCP in the same manner they are corrected under VCP. The failures may be corrected by (i) making a single payment equal to the missed payments (plus interest); (ii) reamortizing the outstanding balance of the loan (including interest) over a period up to the remaining maximum period for the loan; or (iii) a combination of (i) and (ii). In general, any interest due should be paid by the plan sponsor and should equal the greater of the interest rate for the loan or the rate of return under the plan for the applicable time period.
  • Reporting on Form 1099-R. If a defaulted participant loan cannot be corrected using the method above (e.g., because the maximum repayment period for the loan has expired), a distribution is deemed to have occurred in the year of the default and generally must be reported to the affected participant on Form 1099-R for such year. However, the IRS had permitted plan sponsors to report the distribution to the participant in the current year if the plan sponsor applied for such relief under VCP or Audit CAP. Now, a deemed distribution for a defaulted loan may be reported to the participant on Form 1099-R for the current year without having to apply under VCP or Audit CAP.
• Failure to Obtain Spousal Consent. A failure to obtain spousal consent may be corrected under SCP by notifying the affected participant and spouse and obtaining the spouse’s consent.
• Failure to Abide by Limitation on the Number of Plan Loans Permitted. As described above, when the number of loans provided to a participant exceeds the number of loans provided under the terms of the plan, the failure may be corrected by a plan amendment retroactively revising the terms of the plan.

Other loan failures not described above remain ineligible for correction under SCP, but they may still be corrected only under VCP or Audit CAP. These failures include loans of amounts that exceed the maximum amount established by the Code and loans with terms that do not satisfy Code requirements.

Considerations When Using SCP

Plan sponsors who have identified problems that may be corrected under SCP should be careful not to assume that correcting the issue under SCP is always the best or only approach. To be certain, if SCP is available, it will most often be the most appropriate and efficient method of correcting a failure. However, plan sponsors should be mindful that they will inherently have less assurance that a failure has been completely and appropriately corrected in the eyes of the IRS when it is corrected under SCP instead of VCP, in which each submission culminates in a compliance statement being issued by the IRS. Additionally, in regards to participant loan failures that may be corrected under SCP, the Department of Labor has advised the IRS that it will only issue no-action letters for such failures under its Voluntary Fiduciary Correction Program if the failure is corrected under VCP.

In light of the above, plan sponsors should continue to evaluate the benefits and limitations of all of the  correction programs available to them under EPCRS based on the scope and nature of the particular problem that is identified.