By now you’ve probably read that the IRS has expanded the failures that can be self-corrected under the Employee Plans Compliance Resolution System (EPCRS) as set forth in Rev. Proc. 2019-19 issued April 19, 2019. This development comes on the heels of the IRS changing how user fees are determined under the Voluntary Correction Program (VCP) from a participant-based fee to an asset-based fee. See, Plan Mistakes are Now More Costly to Correct. The expansion will help smaller employers with significant plan assets save money by permitting certain failures to be corrected without filing under VCP and paying a user fee.
Failures that can now be self-corrected include: certain plan document failures caught by the end of the second plan year after the plan year in which the failure occurred; retroactive plan amendments to correct an operational failure by conforming the plan document to its actual operation; and certain plan loan failures.
Plan document failures. If a plan would no longer be considered a qualified plan or 403(b) plan because it failed to timely adopt a good faith amendment or interim amendment required by law, this failure can be self-corrected if discovered early enough. The employer must adopt the necessary amendment by the end of the second plan year following the plan year in which the amendment was required to be adopted. The plan must already have a letter indicating it is tax favored to be eligible for self-correction. A failure to originally adopt a plan timely cannot be self-corrected.
Operational failures. If a plan was operated with respect to benefits, rights, and features contrary to the provisions of its plan document, such an operational failure can be self-corrected by adopting a retroactive plan amendment to conform the document to the operation. The amendment must increase the benefit, right or feature for all eligible employees and otherwise be permitted under the Internal Revenue Code and satisfy EPCRS correction principles. An example, would be a plan that in operation has been permitting in-service distributions at age 59 ½ when the document does not provide for such. This could be self-corrected by a retroactive amendment permitting such distributions for all employees.
Loans. Loan issues have historically been the number one cause for correction under EPCRS. Now certain loan failures can be self-corrected. If a loan was made from a plan that requires spousal consent for such a distribution, but such consent was not obtained, it can be self-corrected by notifying the Participant and spouse and obtaining written consent of the spouse currently. If one or more participants has exceeded the number of loans permitted for a Participant under the plan document, the plan can be retroactively amended to conform to the operation as self-correction.
Likewise, where a participant defaults on making timely payments on a plan loan can now be self-corrected. The failure can be for any reason, including the employer’s failure to start payroll deduction timely. The default can be corrected by: the Participant making a single sum payment of the missed payments to “catch up”; by re-amortizing the outstanding balance over the remaining term of the loan; or a combination of the two. In all of these cases of self-correcting loans, there is no deemed distribution to the Participant and no Form 1099-R need be issued.
It is important to note, that participant loans are allowed as an exception to the prohibited transaction rules. Therefore, if a loan fails to meet the requirements for the exception, a prohibited transaction has occurred. However, the sponsoring employer and other plan fiduciaries cannot obtain the Department of Labor’s blessing on the correction through a no-action letter stating it will not pursue penalties or legal action for fiduciary breaches because currently it will only accept corrections made through VCP under its Voluntary Fiduciary Correction Program. It remains to be seen whether this will change.
Documenting the self-correction.
Expanded self-correction is beneficial given how measuring user fees based on plan assets tends to increase the cost of correction for plans with a small amount of participants but significant assets. Of course, these are not the only failures that can be self-corrected. Significant operational failures can still be self-corrected by the end of the second plan year in which the failure occurred. Likewise, insignificant operational failures can still be self-corrected at any time. However, the overarching issue with self-correction is that the employer sponsoring the plan is never completely certain that on audit of the plan, the auditing IRS agent will agree that the matter was eligible for self-correction and properly self-corrected. In such case, the agent may attempt to require the employer enter the Audit Closing Agreement Program to maintain the qualified status of the plan where the employer will have to pay a substantial penalty. This is quite different than VCP where the plan sponsor receives a compliance statement from the IRS agreeing not to disqualify the plan, if the corrections are timely made pursuant to the VCP submission.
That said, Employers taking advantage of any self-correction should prepare appropriate documentation regarding the correction so that they can defend it if the plan were audited. Employers should prepare and keep detailed records reflecting the Employer’s action relating to the self-correction including resolutions or meeting minutes recording: the issue; its eligibility for self-correction; the employer decision to self-correct; the number of participants affected; the dollars involved; and the employer action taken. These documents should be kept with the employer records of business action such as a corporate book as well as with the plan documents. Detailed documents showing the actual correction should also be created and kept. For example, if an amendment was adopted, a signed copy of the amendment should be included. If a loan agreement’s payment schedule is changed, this should be documented with an amendment to the loan agreement and both included. If payments were made and accounts adjusted, documents demonstrating this should be included. I also recommend that all the correction documents be kept in their own separate “self-correction” file that can be easily found and reviewed without sifting through several other documents. A memorandum summarizing the entire correction is also a good idea so when years have passed it can easily be determined how the issue was corrected.
These steps will help defend the self-correction should it ever be challenged by the IRS.