Correcting Plan Errors Using IRS Voluntary Correction Programs

Transcription

1 Presents Correcting Plan Errors Using IRS Voluntary Correction Programs February 26, 2015 Misty A. Leon

2 Today s Agenda IRS Compliance Initiatives Qualified Plan Failure Categories Operational Failure Plan Document Failure Demographic Failure Employer Eligibility Failure Overview of EPCRS SCP VCP Audit CAP Correction Tips Open EPCRS Questions Slide No. 2

3 IRS Compliance and Audit Initiatives EP Compliance Unit (EPCU) Develops compliance projects and pinpoints areas of potential non-compliance Current projects include: o o o o Non-governmental 457(b) plans and 403(b) plans Diversification of employer securities by defined contribution plans Puerto Rico plan compliance See Compliance-Unit-(EPCU) Prior projects include 401(k) Compliance Check Questionnaire Employee Plans Team Audit (EPTA) Focuses on plans with at least 2,500 participants Slide No. 3

4 IRS Compliance Programs Focus on encouraging proactive identification and correction of errors by plan sponsors Top Ten Issues for 403(b)/457 plans, defined benefit plans, and multiemployer plans Tips-Compliance-Activities-Plan-Type Fix-it guides for 401(k) plans, SIMPLE IRAs, and SARSEPS Common-Problems-Real-Solutions Descriptions of Common Plan Mistakes Common-Plan-Mistakes EPCRS Overview Slide No. 4

5 Qualified Plan Failure Categories Operational Failure: Failure to follow plan provisions Ex: Making hardship distributions not provided for under the plan Also a potential ERISA fiduciary issue Plan Document Failure: Plan provision violates Code requirements Ex: Late adoption of required interim amendments Demographic Failure: Failure to satisfy nondiscrimination or minimum coverage requirements (401(a)(4), 401(a)(26), or 410(b)) Excludes failures that are also Operational or Employer Eligibility Failures Employer Eligibility Failure: Plan adopted by an ineligible employer Ex: New 401(k) plan adopted by a governmental employer Slide No. 5

6 Overview of Correction Programs Employee Plans Compliance Resolution System (EPCRS) Self-Correction Program (SCP) Voluntary Correction Program (VCP) Audit Closing Agreement Program (Audit CAP) Programs available for qualified plans under Code 401(a), 403(b) plans, SEPs, SARSEPs, and SIMPLE IRAs Submissions on 457(b) plans accepted on a provisional basis and reviewed under standards similar to EPCRS, outside of the program No acceptance of submissions involving the form of the written plan (ex: nonamender issues) Self-correction may be available for certain governmental plan errors Slide No. 6

7 Benefits of Using EPCRS Maintain qualified status of Code 401(a) plans Ensure continued compliance for other eligible plans Income tax relief under Code 72(p) for loans and excise tax relief for certain errors Mistakes happen, but proactive identification and correction of errors serves a number of purposes: Potential elimination or reduction of agency sanctions Identification of errors before they become an ongoing problem Initiation of correction before data becomes stale and former employees move on Limits on use of EPCRS (and other voluntary correction programs) once an agency audit has been initiated Slide No. 7

8 Eligibility Restrictions No VCP relief if plan or plan sponsor is already under examination Limited availability for SCP: o Insignificant operational failures o Significant operational failures only if the correction has already been completed or substantially completed To correct a significant operational failure under SCP, a qualified plan or 403(b) plan must be the subject of a favorable determination letter Special rules also apply for SEPs and SIMPLE IRAs SCP requires prior adoption of reasonable practices and procedures Slide No. 8

9 EPCRS Eligibility Chart SCP Insignificant SCP Significant VCP Audit CAP Qualified Failures Operational Operational All All Egregious Errors No No Yes Yes Plan Exclusions None IRAs None None Favorable Letter Required Established Procedures Required No Yes No No Yes Yes No No Under Examination Yes No No Yes Slide No. 9

10 General EPCRS Correction Principles Full correction required, for all affected participants and beneficiaries and for all taxable years (whether closed or not) Restore the plan and affected participants to the position they would have been in had the failure not occurred Use reasonable and appropriate methodology Use methodology already provided for in the Code, regulations, or other guidance, to the extent available Keep plan assets in the plan unless the law requires otherwise Avoid violating other Code requirements Apply consistent methodology for all operational failures of the same type during a plan year Look to the plan terms at the time of the failure (except for plan amendment corrections) Slide No. 10

11 Limited Exceptions to Full Correction Corrective distributions of $75 or less not required if the reasonable direct processing and delivery costs exceed the amount of the distribution Does not apply to corrective contributions (where the participant has a plan account) Excess amounts of $100 or less need not be distributed or forfeited Overpayments totaling $100 or less need not be requested from payee and no required notification of lost tax-free rollover treatment However, reasonable actions must be taken to locate all current and former participants and beneficiaries Slide No. 11

12 Earnings Methodology For a defined contribution plan, adjust corrective allocations for earnings and forfeitures that would have applied in the absence of the error Adjustment is made from the date of the failure through the date of full correction May require earnings on earnings calculations Precise calculations based on plan data (e.g., actual investment results) generally required Reasonable estimates permitted if precise calculations not feasible o Ex: Data held by prior recordkeeper that declines to cooperate Use of DOL s Voluntary Fiduciary Correction Program Online Calculator deemed to be reasonable Slide No. 12

13 Self-Correction Program (SCP) No IRS fees or filing required Limited to operational failures Distinguishes between insignificant and significant failures Follow general EPCRS correction principles Maintain records to fully document the correction Change administrative practices to prevent similar errors in the future Slide No. 13

14 Significant vs. Insignificant Failures Factors to consider include: Occurrence of other failures during relevant time period Percentage of plan assets and contributions involved Number of years over which the failure occurred Number of affected participants relative to the total number of plan participants Number of affected participants relative to the number of participants who could have been affected Reasonable timing on correction after failure discovered Reason for the failure (e.g., transcription of data, transposition of numbers, or minor arithmetic errors) Slide No. 14

15 Significant vs. Insignificant Failures (cont d) No single factor is determinative Factors involving plan assets, contributions, and affected participants involved are not intended to preclude small businesses from participating Where a plan has had multiple operational failures in a single year or failures occurring in more than one year, the failures must be insignificant in the aggregate Slide No. 15

16 Example Employer established a qualified profit-sharing plan (Plan A) Plan A has 250 participants in a year, 50 of whom were subject to Code 415 limits in 2011 ($49,000) In 2014, it is discovered that contributions made with respect to 18 of the 50 participants exceeded Code 415 limits during 2011 Employer contributed $3.5 million to the plan for 2011 The amount of the 415 excesses ranged from $1,000 to $9,000 in each case and totaled $150,000 The IRS says this failure is significant, taking into account the number of participants affected relative to the total number of participants that could have been affected and the monetary amount of the failure relative to the total employer contribution Slide No. 16

17 Self-Correction of Significant Failures Permitted if the correction is completed or substantially completed by the end of a required correction period Generally requires correction by the last day of the second plan year following the one in which the failure occurred Certain extensions for failure to satisfy ADP and ACP nondiscrimination requirements, transferred asset situations, and where a plan sponsor is taking action to locate lost participants Correction period generally cuts off once the plan or plan sponsor is under examination for a plan year in which the failure occurred Substantial completion will generally require reasonably prompt and diligent action on behalf of the plan sponsor (see Rev. Proc , Section 9.04) Slide No. 17

18 Voluntary Correction Program (VCP) Filing fee and formal submission required Requires IRS approval Correction must be completed within 150 days Applies to all types of qualification failures (e.g., operational, plan document, demographic, and employer eligibility) Certain failures eligible for streamlined relief Lower fees may apply Check the box forms expedite submission process Slide No. 18

19 General VCP Fees Number of Participants Source: Revenue Procedure , Section 12 Fee 20 or fewer $ to 50 1, to 100 2, to 500 5, to 1,000 8,000 1,001 to 5,000 15,000 5,001 to 10,000 20,000 Over 10,000 25,000 Slide No. 19

20 Special VCP Fee Rules Reduced fees for certain failures involving minimum distribution requirements and loans Limits on number/percentage of participants involved The failure must be the only one described in the submission Nonamender failures: $375 if the submission contains only a failure to adopt timely good faith amendments, interim amendments, or amendments required to implement optional law changes and the submission is made within the remedial amendment period that applies to the late amendment Otherwise, the general fee is reduced by 50% if the failure is submitted within one year of expiration of the applicable remedial amendment period $500 for late adoption of an amendment upon which a determination letter is conditioned, if adoption occurs within three months of the deadline Fees may be waived in the IRS discretion for a terminating orphan plan Special rules apply to group submissions, SEPs and SIMPLE IRAs, and egregious or intentional failures Slide No. 20

21 Assembling the Submission Form 8951, with the VCP check attached to the front of the form Also include a photocopy of the check Signed Form 8950 (Application for VCP) Form 2848 (Power of Attorney) or 8821 (Tax Information Authorization) Required narrative information including description of the failure(s), an explanation of how and why the failure occurred, and a description of the correction methodology Appendix C Part I (Form 14568); Model Compliance Statement that can be used to report any failure Appendix C Part II Schedules 1-9 (Forms A - I); can be used for streamlined corrections, regardless of whether Model Compliance Statement is used Include any required information and enclosures Slide No. 21

22 Assembling the Submission (cont d) Appendix D Acknowledgement Letter Copy of opinion, advisory, or determination letter (if applicable) Copy of relevant plan document language or plan document (if applicable) Any other relevant items Determination letter application, if applicable, including all required documentation Include additional copies of plan documents/amendments as needed Slide No. 22

23 VCP Streamlined Submissions Eligible Failures Nonamender (Interim and Certain Discretionary) Plan Loans Employer Eligibility Missed Corrective Distributions for Elective Deferrals Exceeding the Code 402(g) Limit ($18,000 for 2015) Minimum Required Distributions Slide No. 23

24 VCP Streamlined Submissions (cont d) Eligible Failures (continued) Correction of Operational Failures by Plan Amendment o 401(a)(17) Compensation Limit ($265,000 in 2015) o o Hardship Distributions or Plan Loans Not Provided for by the Plan Early Inclusion of Otherwise Eligible Employee Failure to Timely Adopt a 403(b) Plan Certain Failures made by SEPs, SARSEPs, and SIMPLE IRAs Slide No. 24

25 Example 1 Inadvertent Exclusion of Eligible Employee from 401(k) Plan During 2014, 30 new employees were not offered the opportunity to participate in the plan in accordance with its terms Operational failure resulting in missed elective deferral opportunity and missed matching contribution Assume matching contribution is 100% of first 3% of compensation contributed to plan Assume average deferral percentage of active plan participants is 4% Slide No. 25

26 Example 1 Resolution Employer must make the following corrective contributions to the plan on behalf of each inadvertently excluded employee: 50% of the employee s missed deferral amount (4% of the participant s compensation in this case), plus 100% of the 3% matching contribution the participants would have received if they had contributed the full deemed missed deferral amount (i.e., 4% of compensation) to the plan, plus Any lost earnings through the date such earnings are restored to the plan o Calculate from the date on which contributions of the same type were made, OR o Use the midpoint of the plan year (or portion of the plan year, as applicable), OR o Use the first day of the plan year (or portion of the plan year, as applicable) and divide the applicable earnings rate in half See Rev. Proc , Section 6.02(4)(a), App. A, Section.05, App. B, Sections 2.02 and 3.01 Special rule for partial year exclusion if the employee has the opportunity to make elective deferrals for at least the last nine months of the plan year (Rev. Proc , App. B, Section 2.02(1)) Slide No. 26

27 Example 2 Hardship Distribution Errors Over the course of several years, 401(k) plan participants were permitted to take hardship distributions from the plan. The distributions fully complied with IRS restrictions on such distributions and participant requests were treated consistently. However, there was no plan term actually providing for such distributions to be made. Operational failure with two possible resolutions Slide No. 27

28 Example 2 Resolution Option 1 Amend the plan retroactively to provide for hardship distributions Correction by plan amendment is permitted under SCP if the facts and circumstances indicate the error qualifies for self-correction The amendment should be identified as having been adopted pursuant to SCP and submitted as part of the plan s next determination letter application Determination letter application has to be submitted during the plan s next on-cycle year or, if earlier, in connection with the plan s termination IRS must ultimately issue a favorable determination letter on the plan See Rev. Proc , Section 9.03 If self-correction is not available under the SCP factors, a streamlined correction is available under Appendix C, Part II, Schedule 9 (Rev. Proc , App. B, Section 2.02(1)) Slide No. 28

29 Example 2 Resolution Option 2 If the plan sponsor does not want to retroactively amend the plan to provide for the hardship distributions, they would be treated as overpayments Plan sponsor must ask the recipients to repay the distributions If the recipients do not comply, the EPCRS procedures indicate that the employer (or another party) must restore an overpayment to the plan Plan sponsors may be surprised at this result, where the participant has arguably not been harmed, however, the plan s terms have been violated when the overpayment remains outstanding See Rev. Proc , App. B, Section 2.05 Slide No. 29

30 A Note on Hardship Distributions Examples of hardship distribution errors recently reviewed by the IRS: Distributions made for car repairs, fees to hire tutor of school-aged child, or to cover costs of home remodeling projects/restorations Distribution to prevent eviction from a primary residence which was a Chevrolet van Distribution for the purchase of a primary residence which was a small building with a garage door The IRS did not consider any of these to be safe harbor hardship distributions Underscores the importance of obtaining adequate documentation of hardship events from a participant before making a distribution Slide No. 30

31 Nonamender Corrections Fees and submission rules vary based on circumstances such as the type of amendment and whether the remedial amendment period for the late amendment has expired If the failure involves only good faith, interim, or discretionary amendments and the corrective amendment is adopted before expiration of the remedial amendment period, a $375 fee and streamlined submission under Appendix C, Part II, Schedule 1 generally applies Other nonamender failures reported on Appendix C, Part II, Schedule 2 (with higher applicable fees) Rev. Proc. Section 6.05 addresses when a determination letter application is required or permitted to be submitted with a nonamender VCP Review these rules carefully for each situation Slide No. 31

32 Audit CAP Correction Audit CAP ( Closing Agreement Program ) Applies to plan failures uncovered upon IRS plan audit VCP not available SCP relief limited Correction Procedures Apply correction principles that make participants whole Plan sponsor and IRS agree on correction method, with a written agreement ultimately signed by plan sponsor and IRS Sanction paid to IRS negotiated percentage of Maximum Payment Amount Slide No. 32

33 General Nonamender Sanctions Under Audit CAP Number of Participants Late GUST or 401(a)(9) Amendment Late EGTRRA Amendment Late HEART Act Amendment Compare with General VCP Fee 20 or fewer $ 3,500 $3,000 $ 2,500 $ to 50 7,000 6,000 5,000 1, to ,500 9,000 7,500 2, to ,500 15,000 12,500 5, to 1,000 24,500 21,000 17,500 8,000 1,001 to 5,000 35,000 30,000 25,000 15,000 5,001 to 10,000 45,500 39,000 32,500 20,000 Over 10,000 56,000 48,000 40,000 25,000 Source: Revenue Procedure , Section Slide No. 33

34 VCP Correction Tips Use the IRS Fill-In Model Submission forms Available at: Errors--Fill-in-VCP-Submission-Documents Submit documents in the recommended order Carefully review correction methodology against IRS procedures and examples The IRS has indicated informally that it does reject submissions that are grossly incomplete Slide No. 34

35 Common IRS Complaints Use of incorrect schedules and/or submission of incorrect fees for nonamender failures Fee amounts and whether Schedule 1 and/or 2 applies depends on adoption date of corrective amendment(s) Sponsors of pre-approved plans should report late adoption of an EGTRRA restatement on Schedule 2 (if adopted after 4/30/2010 for a defined contribution plan or 4/30/2012 for a defined benefit plan); use Schedule 1 for late adoption of PPA, HEART, and WRERA amendments at this time Failure to adequately describe late interim amendments Need more than a general reference to an IRS cumulative list or Code provision Failure to include signed copies of late interim amendments or a copy of the restated plan, with appropriate indication of where the corrective amendment can be found Slide No. 35

36 Common IRS Complaints (cont d) Failure to include a copy of the plan document in affect prior to adoption of corrective amendments, as required Failure to include sample calculations that demonstrate each aspect of the proposed correction method Ex: loan-related submission includes the loan s original amortization schedule, but not a re-amortized schedule developed as part of the correction Slide No. 36

37 Locating Missing Participants The Social Security Administration and IRS have discontinued certain letter forwarding programs previously available to locate missing participants Suggested alternative options: Commercial locator services Credit reporting agencies Internet search tools (e.g., Google, etc.) Social media websites Slide No. 37

38 Potential Reporting Implications of Correction Certain operational and other failures may need to be reported on a plan s financial statements Generally depends on materiality and/or whether the error is a prohibited transaction Certain prohibited transaction reporting also required on Form 5500 Ex: Untimely remittance of participant contributions to plan trust Once an error has been reported, plan sponsor should be mindful of timely correction (if not already completed) Slide No. 38

39 Best Practices to Prevent or Minimize Errors Read the plan document and be aware of its terms Actively monitor service providers and confirm they are performing necessary tasks Follow up on any participant complaints Investigate any discrepancies identified by staff, auditors, service providers, etc. Regular internal audits to identify potential errors, evaluate necessary changes to procedures, and minimize potential correction costs Make sure review process includes independent parties and experts as needed, to ensure an impartial, thorough review Slide No. 39

40 Open EPCRS Questions Approved methods for correcting the failure to implement plan automatic enrollment and automatic escalation provisions What is the appropriate deemed missed deferral amount (i.e., can you assume that the participant would have contributed at the automatic enrollment/escalation percentage)? Approved methods for correcting the failure to timely provide required ADP/ACP safe harbor notices Correction of Roth contribution issues: Participant s contribution incorrectly designated as pre-tax Correction of failure to notify participant of Roth deferral opportunity Slide No. 40

41 Slide No. 41 Questions??