Occasionally qualified plan administrators discover that their plans have incurred an operational error.  The Internal Revenue Service (“IRS”) recognizes that it needs the help of plan administrators to police the administration of qualified plans and has correspondingly published guidance to help plan administrators take appropriate corrective action where necessary.

IRS Correction Alternatives

Revenue Procedure 2016-51, known as the Employee Plans Compliance Resolution System (“EPCRS”) provides guidance to plan sponsors regarding how to correct plan failures.

Self-Correct:  EPCRS provides that a plan sponsor may, paying no fee or sanction, correct certain operational plan failures in a qualified plan if the correction is substantially completed by the last day of the second plan year following the plan year in which the failure occurred and in certain other circumstances as described below.  This method is known as self-correction.

Voluntary Correction Program:  EPCRS also offers a Voluntary Correction Program (“VCP”) through which a plan sponsor, at any time before audit, may pay a fee and receive the IRS’s approval for correction of an error.  VCP requires a written application to the IRS and a filing fee of between $500 and $3,500 (depending on the assets in the plan.)  (For more information about filing fees, see Jackson Lewis’s prior blog here.  Plan administrators must determine whether that correction can be self-corrected or whether it must be included in the VCP.

  • The first step in the analysis is to determine whether the error can be self-corrected by the last day of the second plan year following the plan year in which the failure occurred.
  • Next, a plan administrator should analyze whether the error was “significant” in which case it requires a VCP.  If an error was “insignificant”, it can be self-corrected.  The factors to be considered in determining whether a failure under a plan is insignificant are set forth below.  No single factor is determinative.
    1. Whether other failures occurred during the period being examined (for this purpose, a failure is not considered to have occurred more than once merely because more than one participant is affected by the failure);
    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 in the plan;
    5. The number of participants affected because of the failure relative to the number of participants who could have been affected by the failure;
    6. Whether correction was made within a reasonable time after discovery of the failure; and
    7. The reason for the failure (for example, data errors such as errors in the transcription of data, the transposition of numbers, or minor arithmetic errors).

 

Approval of a VCP filing often takes between three and twelve months.

No Correction – Audit CAP:  If no correction is performed regarding an error and the failure is later identified in an IRS audit, the plan sponsor will have to correct the failure at that time and pay a sanction.  The IRS guidance regarding the amount of the sanction states, “the sanction imposed will bear a reasonable relationship to the nature, extent, and severity of the failure, taking into account the extent to which correction occurred before audit.”  The IRS generally takes the position that the tax could be as high as the fees that would be paid if the plan were disqualified (which depends on the amount of assets in the plan) and negotiates from there.

 

Please contact Natalie Nathanson or your local Jackson Lewis Employee Benefits attorney to discuss whether your 401(k) plan must take corrective action.