The Internal Revenue Service (IRS) recently expanded self-correction opportunities under its Employee Plans Compliance Resolution System (EPCRS) in Revenue Procedure 2019-19, which was effective as of April 19, 2019. EPCRS permits plan sponsors to correct certain failures in the documentation and operation of qualified retirement plans. There are three methods under EPCRS of correcting plan failures—self-correction by the plan sponsor, requesting approval from the IRS through a submission under the voluntary correction program (VCP), and the audit closing agreement program (Audit CAP), which applies to failures identified by the IRS on audit. Self-correction is preferred as it allows plan sponsors to remedy certain plan failures without the costs, fees, or sanctions associated with VCP and Audit CAP.
This latest revision to EPCRS is welcome news to plan sponsors because it permits self-correction of certain additional (and quite common) failures related to plan loans, documents, and operations. The following is a summary of these additional self-correction opportunities that were not previously available.
Plan Loans Failures
The revised EPCRS expands self-correction of plan loan failures as follows:
- Reporting of deemed distributions
Deemed distribution may now be reported in the year of correction instead of the year of the failure. This helps plan participants avoid the inconvenience and cost of amending prior tax returns.
- Defaulted loan
When a plan loan is not repaid on a timely basis, it is defaulted and results in the outstanding loan balance being reported as a taxable distribution to the participant. Prior to the expanded EPCRS, plan sponsors had to submit a request to the IRS under VCP to correct the tax implications of a loan default. Now, EPCRS allows the plan sponsor to avoid reporting the loan repayment failure as a taxable distribution by self-correcting the missed plan loan payments by providing a single lump-sum payment, reamortizing the outstanding loan balance, or a combination of the two. However, if the maximum permitted repayment period for the defaulted loan (e.g., five years for general purpose loans) has expired, then self-correction is not available.
Additionally, the IRS notes that the U.S. Department of Labor (DOL) will not issue a “no-action letter” with respect to loan defaults that are self-corrected. Accordingly, plan sponsors concerned with correcting an eligible fiduciary violation resulting from a plan loan failure (e.g., failure by the plan sponsor to properly withhold loan repayments) should still consider correcting through VCP if they wish to take advantage of the DOL’s Voluntary Fiduciary Correction Program.
- Failure to obtain spousal consent for a plan loan as required by plan terms
Some qualified plans require spousal consent be obtained before a participant may elect a plan loan. Where spousal consent was required and not obtained, plan sponsors may self-correct by notifying the affected participant and the participant’s spouse and obtaining spousal consent for the plan loan. If the spouse does not consent, however, then self-correction is not available.
- Number of plan loans to a participant exceeds the number of loans permitted by written plan terms
Where a participant was inadvertently permitted to take plan loans that exceed the number of loans allowed by the plan’s terms, the plan sponsor may make a retroactive plan amendment to increase the number of permitted loans. In order to make use of this correction method (i) the amendment must comply with Sections 401(a) and 72(p) of the Internal Revenue Code (the code); and (ii) the plan loans, including those in excess of the plan’s terms, must be available to either all participants or only to one or more non-highly compensated employees.
Plan Document Failures
Plan sponsors can also use self-correction for certain plan document failures, such as a failure to adopt good faith or interim amendments. Self-correction is not permitted for a failure to timely adopt a qualified plan or written 403(b) plan document in the first place. It also does not apply to the failure to adopt a discretionary amendment, for example, an amendment to permit after-tax contributions or to change the definition of deferral compensation.
Self-corrections of plan document failures may be made if the plan has a favorable IRS determination or opinion letter. Furthermore, because a plan document failure is always deemed a significant failure, the corrective plan amendment must be adopted by no later than the last day of the second plan year following the plan year in which the failure occurred.
Operational Failures
Prior to the latest update of EPCRS, plan sponsors were limited in their ability to self-correct operational failures using a retroactive plan amendment to only a handful of specifically enumerated circumstances. Under the expanded program, self-correction can be used to correct operational failures by adopting retroactive plan amendments to conform the plan terms to the plan operations if:
- the amendment would result in an increase of a benefit, right, or feature;
- the increase is provided to all eligible employees under the plan; and
- the increase is permitted under the code and satisfies the general correction principles of EPCRS.
Significance of a Failure
Under EPCRS, whether a failure is deemed significant or not (a fact and circumstances determination) can impact the plan sponsors' ability to self-correct. If a failure is deemed insignificant, the IRS permits self-correction at any time. Significant failures, however, generally must be corrected no later than the end of the second plan year following the plan year in which they occurred. (As noted earlier, plan document failures are deemed significant failures.) The updated EPCRS states that the IRS will make available additional examples illustrating whether a failure is significant or not on its “Correcting Plan Errors” webpage.
