On May 4, the IRS issued Notice 2023-36 inviting the public to submit recommendations for its 2023-2024 Priority Guidance Plan. While the IRS has its hands full due to the over 90 changes to retirement plan law contained in the SECURE 2.0 legislation enacted last December, I believe one particular provision needs guidance as soon as possible, the new expansion of self-correction under the Employee Plans Compliance Resolution System (EPCRS) for eligible inadvertent failures.
Old Rules of Self-Correction.
EPCRS includes a Self-Correction Program (SCP) through which plan sponsors can self-correct certain types of errors without the need to make a submission to the IRS to obtain approval. It currently classifies operational failures as either insignificant or significant. An insignificant operational failure may be corrected at any time. A significant operational failure must be corrected by the end of the third plan year after the plan year in which the failure occurred.
Whether a failure is insignificant (or significant) is based on the relevant facts and circumstances. EPCRS identifies 7 factors to be applied in making the determination. These are: 1) Whether other failures occurred during the plan year; 2) The percentage of plan assets and contributions involved in the failure; 3) The number of years the failure occurred; 4) The number of participants affected relative to the total number of participants; 5) The number of participants affected relative to the number of participants who could have been affected; 6) Whether the correction was made within a reasonable time after discovery of the failure; and 7) The reason for the failure (e.g., data transcription error or minor math error, etc.).
I have always been fairly critical of this regime for determining significance principally because the EPCRS Rev. Proc. doesn’t clearly show how one should apply the factors or how many factors a sponsor must meet to conclude the failure is insignificant. It does state the no single factor is determinative. The Rev. Proc. then only applies the factors through examples concluding whether the failure was significant or not. However, each example applies no more than 2 factors. Therefore, for close cases, the sponsor needs to decide whether to self-correct and risk the possibility that the IRS could disagree, that the failure qualified for self-correction. The alternative would be to file under the Voluntary Correction Program (VCP), pay a user fee to the IRS, and wait for a compliance statement from the IRS stating it would not disqualify the plan based on the identified failures, if corrected as proposed. Often, the more expensive VCP route would be chosen by the sponsor to get assurance.
SECURE 2.0 Expansion.
SECURE 2.0 generally states that unless otherwise provided in the Internal Revenue Code, regulations, or other Treasury guidance, any “eligible inadvertent failure” to comply with the rules for tax favored status by certain plans may be self-corrected under EPCRS as set forth in Rev. Proc. 2021–30, (or any successor guidance). Self-correction is not available if such failure was identified by the Secretary of the Treasury prior to any actions which demonstrate a specific commitment to implement a self-correction with respect to such failure; or the self-correction is not completed within a reasonable period after such failure is identified by the plan sponsor. Provided self-correction is available under the above criteria, an eligible inadvertent failure, may be corrected at any time. The plans whose inadvertent eligible failures may be so self-corrected are qualified retirement plans (401(k), profit sharing, pension), 403(b) plans, SEPs, SIMPLE IRA plans and IRAs.
What Is An “Eligible Inadvertent Failure?
An eligible inadvertent failure is defined as a failure that occurs despite the existence of practices and procedures which: 1) satisfy the standards set forth in EPCRS, or 2) satisfy similar standards in the case of an individual retirement plan. EPCRS requires that the plan have established practices and procedures (formal or informal) reasonably designed to promote and facilitate overall compliance in form and operation with applicable Code requirements and these established procedures must be in place and routinely followed. Additionally, the failure is not eligible if it is egregious, relates to the diversion or misuse of plan assets, or is directly or indirectly related to an abusive tax avoidance transaction.
Just reading the above demonstrates that the language of the statute uses many terms that need to be better defined through guidance. What action is sufficient to show a specific commitment to implement self-correction? For example, if a sponsor discovers that a number of employees weren’t automatically enrolled when they should have been and is in the process of calculating the correction amounts when audited by the IRS, is that sufficient? How specific do practices and procedures need to be? Can a sponsor have practices and procedures in place to amend the plan for any required changes in the law so that a failure to timely amend can be self-corrected as an eligible inadvertent failure? What practices and procedures do IRAs need? What is a reasonable period to complete the correction? Currently, if an operational failure is insignificant, there is no time period, will that standard go away? If an operational failure is significant, is completing correction after 3 years unreasonable? Will the significant/insignificant dichotomy go away? What is an egregious inadvertent failure?
The new self-correction provision of SECURE 2.0 is effective upon enactment. While Congress directed the IRS to revise the EPCRS Rev. Proc. within 2 years of enactment, guidance is needed well before then. Hopefully, such guidance will “fill in the blanks” that the statute created to give plan sponsors and practitioners clearer parameters of the new program. Additionally, hopefully it will have brighter lines than the 7 factors of significance under the current SCP.