When Bad Things Happen To Good Plans: IRS Enhances Plan Correction Methods
The Employee Plans Compliance Resolution System (“EPCRS”) is a program offered by the IRS that allows plan sponsors to correct retirement plan compliance violations on a voluntary basis. Plan sponsors whose plans experience operational errors or mistakes can avail themselves of EPCRS and pay a penalty that is a fraction of the penalty that would otherwise be assessed if the defect is discovered under an IRS audit. In some cases, if the defect qualifies for self-correction without IRS approval, the sanction or penalty can be entirely avoided.
EPCRS continues to improve as a very beneficial tool for plan sponsors who desire to maintain legal compliance in a complex regulatory environment. Most recently, the IRS published two new Revenue Procedures, which serve to further entice plan sponsors to utilize EPCRS by expanding the program and lowering the cost of certain corrections. The opportunity to correct certain defects in accordance with the Revenue Procedures is available immediately. This article provides a brief summary of the more pertinent enhancements to EPCRS offered by the Revenue Procedures.
Employee Elective Deferral (401(k)) Contributions
A common plan error is the failure on the part of the plan sponsor to accurately honor the salary deferral election of eligible employees in a 401(k) plan. Before the issuance of the Revenue Procedures, the permitted corrective measure under EPCRS was for the plan sponsor to contribute 50% of the amount that should have been contributed and the full matching contribution that would have been contributed if the participant’s election had been followed. These corrective contributions were adjusted for earnings.
The justification by the IRS for requiring the 50% contribution in lieu of the elective deferral is that even though the participant received the cash amount that should have been deferred, the participant was deprived of the tax deferred savings opportunity. Recognizing that the 50% could be considered a “wind-fall” for the participant, the Revenue Procedures provide that if the correct deferral amount begins not later than the first payroll after a three month period after the failure first occurred, only the corrective matching contribution is required. If the correction is made after three months, the corrective percentage for missed deferrals is 25% rather than 50%. In order to be eligible for the lower 25% correction percentage, the following conditions apply:
- The participant election must be followed not later than the first payroll after the second year following the year the failure occurred or, if the plan sponsor is notified by the employee, the first payroll made after the month of the notification;
- The corrective contribution must be made before the last day of the second plan year after the year of the failure and, in no case, after the plan or plan sponsor is under examination by the IRS; and
- Corrective contributions for missed matching contributions are made in accordance with existing EPCRS rules and all corrective contributions are adjusted for earnings.
Regardless of whether the correction is made within the first 3 months or the second year following the initial failure, notice of the failure must be provided to the employee no later than 45 days after the date the correct deferrals begin.
Recognizing that automatic enrollment errors are common, the Revenue Procedures provide significant relief with respect to the available correction method for failure by a plan sponsor to implement a plan’s automatic contribution feature. The Revenue Procedures provide that where the failure to implement a plan’s automatic contribution feature does not extend beyond 9½ months after the end of the plan year during which the failure occurs, no corrective contribution is required to be made by the plan sponsor if:
- The correct deferrals begin no later than the end of the 9½ month period after the end of the plan year in which the failure first occurred or the first payroll date after the end of the month the plan sponsor is notified of the failure by the affected employee;
- Notice of the failure is provided to the affected employee no later than 45 days after the date the correct deferral amount begins; and
- Corrective contributions for missed matching contributions are made in accordance with the existing EPCRS rules and all corrective contributions are adjusted for earnings.
The Revenue Procedures include several other revisions to the correction methods including an extended period to correct excess annual additions, reduced sanctions for required minimum distribution and participant loan violations under certain conditions, clarification regarding the plan sponsor’s duty to collect excess distributions, a new permitted method for calculating lost earnings in some situations and a variety of procedural changes.
The revisions to EPCRS by the recently released Revenue Procedures provide an impetus to plan sponsors to utilize the IRS voluntary correction program and to make the corrections sooner rather than later. By catching errors within the stated timeframes, plan sponsors can significantly reduce the cost of correction. The regulatory environment surrounding retirement plans is vast and complex; however, when errors occur, prompt correction can serve to significantly reduce and eliminate further costs and financial exposure. If you have questions regarding the IRS plan correction program, please feel free to contact one of our employee benefits lawyers or your McGrath North attorney.