October 4, 2016Client Alert

IRS’s Correction Program Retooled and Revamped

Last week, the Internal Revenue Service (IRS) issued a new Revenue Procedure (2016-51), which is intended to be a comprehensive overhaul of its Employee Plans Compliance Resolution System (EPCRS). Sponsors of tax-qualified retirement plans (including 401(k), 403(b), pension, cash balance, SEP, and simple plans) have historically relied on EPCRS to correct failures to comply with one or more applicable Internal Revenue Code requirements, either by virtue of faulty plan documentation, errors in operation, and/or failure to meet certain discrimination testing requirements. These failures are referred to respectively as documentary, operational, and demographic failures in EPCRS. At the most basic level, EPCRS encourages those maintaining retirement plans to voluntarily and timely identify and correct documentary, operational, and demographic failures. Making a correction under EPCRS allows employers to correct errors for a reduced fee or, in some circumstances, for no fee at all.

The basic three-component structure of EPCRS is retained: (1) Self-correction program with no filing fee or sanction (SCP); (2) Voluntary correction program with a filing fee and a pre-established sanction (VCP); and (3) Audit closing agreement program for correction of failures identified by the IRS on audit with payment of a negotiated sanction (Audit CAP).

However, there are some significant changes, including:

  • Adapting the program to clarify how and when determination letters need to be filed with VCP applications: This is particularly important given the “demise” of the ongoing determination letter program. In most cases, the IRS no longer requires a determination letter application to be filed with a VCP application.
  • Adopting a revised approach for determining Audit CAP sanctions: The “worst case scenario” (or Maximum Payment Amount) will no longer be the starting place of negotiations. Rather, it will be one factor, considered with all other relevant factors in determining the assessed sanction. Not surprisingly, the IRS stated that, in general, the sanction will not be less than the VCP user fee applicable to the plan. This is obviously designed to encourage use of SCP and VCP rather than waiting for the IRS to discover an error on audit.
  • Relaxing the sanction for failing to timely adopt an amendment that is quickly corrected: Generally, such a failure that is corrected within three months after the expiration of the remedial amendment period will only be $750, regardless of number of plan participants.
  • Incorporating changes made by recent EPRCS guidance to relax the rules on the collection of overpayments and correction of a failure to timely implement elective deferral elections, in automatic contribution plans and otherwise.
  • Adding a new rule designed to handle “egregious failures”: Notably, the IRS has now reserved the right to impose a sanction higher than the pre-established VCP user fee for egregious failures that are submitted for correction under the VCP.

Overall, the changes in the revised EPCRS program are welcome, particularly in light of the sunset of the ongoing individually-designed determination letter program at the end of the current cycle. That said, the basic EPCRS rule remains the same—timely and efficient identification and correction of failures will yield the best result for the plan sponsor and potentially provide the best protection to participating employees.

While public comments are being accepted, the new EPCRS revenue procedure will become effective January 1, 2017. Any failures currently undergoing correction that will not be completed by year end should be reviewed under the new guidance for possible refinements to approach, filing fee, etc. Similarly, future failures identified and/or corrected will need to be corrected under the revised program.

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