No More IRS Determination Letters New Strategies for Plan Sponsors

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1 Tax Management Compensation Planning Journal TM Reproduced with permission from Tax Management Compensation Planning Journal, Vol. 45, 8, p. 214, 08/04/2017. Copyright 2017 by The Bureau of National Affairs, Inc. ( ) No More IRS Determination Letters New Strategies for Plan Sponsors By Thomas W. Meagher, Esq. * and Meghan M. Lynch, Esq. ** * Thomas W. Meagher is a Senior Partner in Aon Hewitt s Retirement and Investment Practice in Somerset, N.J. Tom is responsible for legal consulting and compliance services regarding the design of qualified and nonqualified plans on behalf of major employers. Tom has significant experience in counseling clients regarding executive compensation and benefits, including plan design and funding, and postretirement health funding arrangements, including VEBAs and 401(h) accounts. Tom s practice has had a particular emphasis on compliance consulting-related matters as they may impact the compensation and benefit programs of restructuring companies in the context of reorganizations, divestitures, and mergers and acquisitions. ** Meghan M. Lynch is an associate partner with Aon Hewitt s Retirement and Investment Legal Consulting and Compliance practice in Washington D.C. Meghan specializes in qualified and nonqualified retirement plans and international retirement consulting. Meghan received her J.D. and LL.M. in Employee Benefits from The John Marshall Law School in Chicago, Illinois. Meghan is a member of the American Bar Association and served as Assistant Vice-Chair to the Subcommittee on Exempt Organization and Governmental Plans. INTRODUCTION The plan sponsor world is presently going through a major adjustment now that the Internal Revenue Service has ended the determination letter program for ongoing, individually designed plans. While this is certainly a major development for qualified plan sponsors, all is not lost. The objective of this article is to reacquaint the reader with the events that led up to the current situation and identify possible strategies for employers to consider in an effort to confirm and protect the tax-exempt status of their qualified plans. Before we describe the current state of play, some readers may be wondering why they should be concerned about the qualified status of their retirement plans. While most qualified retirement plans will have received a determination letter within the past five years, those letters will become more and more out of date as the years pass. From a plan sponsor standpoint, there will be a continuing need to confirm and perhaps demonstrate that their retirement plans are qualified. This qualified status is important on a number of fronts, including providing a basis for the plan sponsor to deduct plan contributions at the time that they are made (up to certain limits) and supporting the plan sponsor s withholding and tax reporting obligations. Qualified status will also be important for a number of plan sponsor transactions, including the ability to invest plan assets in certain investment products, to represent the qualified status of the plan for various merger and acquisition transactions, to respond to any internal audit findings, and to permit an existing qualified plan to be merged with another qualified plan. Participants also benefit from the qualified status of the plan in terms of tax-deferred savings opportunities and the ability to avoid immediate taxation upon a plan distribution by rolling over the plan distribution to an individual retirement account or another eligible retirement plan. For these reasons, among others, plan sponsors (and the plan s fiduciaries) will need to develop support for the position that their retirement plans are qualified under the Internal Revenue Code. The ability of a plan sponsor to rely on its last IRS determination letter will lessen with each passing year, particularly following future statutory, regulatory, or design changes impacting the plan, and that may call into question how comfortable the plan sponsor is (or will be) in treating the plan as qualified. We will discuss possible strategies for plan sponsors to consider in an effort to develop their position that the plan is qualified notwithstanding the inability to obtain a favorable IRS determination letter in the future. CURRENT STATE OF PLAY At the outset, it may be helpful to discuss what remains of the IRS determination letter program and 2017 Tax Management Inc., a subsidiary of The Bureau of National Affairs, Inc. 1

2 how it may apply to individually designed and preapproved plans. Individually Designed Plans. In Rev. Proc , the IRS announced extensive changes to the determination letter program. Among the changes announced was the elimination of the 5-year remedial amendment cycle for determination letters for individually designed plans beginning on January 1, However, the IRS permitted determination letters to continue to be submitted for Cycle A plans (plans where the employer identification number for the plan sponsor ends in 1 or 6 ). 1 In announcing these changes, the IRS agreed to continue issuing determination letters for initial plan qualification (plans for which no prior determination letter had been received), plan terminations, and additional events based on future IRS guidance. 2 Pre-Approved Plans. In an effort to encourage the use of pre-approved plans, the IRS has recently issued guidance intended to encourage the use of such preapproved plans. Under the new Opinion Letter program, there will no longer be a distinction between master and prototype and volume submitter plans. Rather, plans will be classified as either standardized or nonstandardized plans. In view of the pre-approved nature of these plans, they may be more attractive to plan sponsors that prefer the comfort of having an IRS Opinion Letter over the benefits of a customized plan. 3 Ongoing IRS Support. In order to assist plan sponsors in maintaining a qualified retirement plan, the IRS requested comments on how it could facilitate compliance by plan sponsors in the absence of the IRS determination letter process. 4 In reaching out to the plan sponsor community, the IRS suggested that it might expand the use of incorporation by reference as a technique for plan sponsors to ensure compliance with statutory or regulatory requirements. In addition, the IRS suggested that plan sponsors be permitted to exclude plan provisions or amendments that are not applicable or not yet applicable to the plan. Further, the IRS noted that it may undertake additional efforts to ease the transition from an individually designed plan to a pre-approved plan. Possible Future Expansion of Determination Letters. In addressing possible situations for which it might expand the issuance of determination letters, the IRS noted that such circumstances may include significant law changes, new approaches to plan design, and the inability of certain types of plans to convert to pre-approved (i.e., standardized or nonstandardized) plan documents. In addition, the IRS noted that its future case load and resources available will be significant factors in deciding if and when to consider certain amended plans or types of amendments in plans under the determination letter program. Most recently, the IRS indicated that the only determination letter applications for individually designed plans that will be accepted during calendar year 2017 (other than for Cycle A plans as described above) are applications for initial plan qualification and qualification upon plan termination. 5 HOW DO I KNOW IF MY RETIREMENT PLAN IS QUALIFIED? In evaluating how best to determine a retirement plan s qualified status, plan sponsors and fiduciaries must be mindful that the determination of a plan s qualified status is not limited solely to the terms of the written plan document, but rather also includes the administration of the plan. Although the IRS has limited the situations in which it will issue determination letters (at least for 2017), plan sponsors will receive some support from the IRS regarding qualified plans. In Rev. Proc , the IRS announced its intent to provide annual guidance to plan sponsors to assist them in maintaining the qualified status of their retirement plans from both a document and an operational standpoint. Plan Document. In order for a plan document to meet the qualification requirements of the I.R.C., the form of the document must be up-to-date with all legal and technical requirements and must align with the operation of the plan. In reviewing the retirement plan document for purposes of assessing whether the qualification requirements of the I.R.C. have been sat- 1 Rev. Proc , I.R.B. 54. See Rev. Proc , I.R.B. 136, Rev. Proc , , I.R.B. 146, In Rev. Proc , 4.03(3), the IRS indicated that consideration will be given annually to whether determination letter applications will be accepted for individually designed plans in specified circumstances other than for initial qualification and qualification upon plan termination. 3 In Rev. Proc , I.R.B. 92, the IRS announced that it was combining the master and prototype and volume submitter plan programs and replacing them with a single Opinion Letter program. The purposes of the consolidation was to simplify the process for issuing opinion letters as to the form of the plan document, increasing the types of plans eligible for pre-approved status, and to provide for greater flexibility in the design of preapproved plans. 4 Announcement , I.R.B In this Announcement, the IRS requested comments on ways in which the Department of the Treasury and the IRS could improve compliance with plan qualification requirements by making it easier for plan sponsors to satisfy requirements for qualified plan documents, particularly in light of the changes to the determination letter program described in Rev. Proc Rev. Proc , 8.04; Rev. Proc , Part II, Tax Management Inc., a subsidiary of The Bureau of National Affairs, Inc.

3 isfied, plan sponsors have a number of resources available to them. While many plans may have received a favorable IRS determination letter over the last five years, there will likely be discretionary plan design modifications, legislative and regulatory updates, or changes in plan administration since that letter was issued. While many of these events will likely have necessitated some changes to the plan document, the last received favorable determination letter will not be reliable or determinative of the plan s qualified status as it relates to the form of the document (to the extent modified). Moreover, the plan sponsor will not be able to have the IRS validate that the plan document continues to comply with the qualification requirements of the I.R.C. as a result of such written changes. Nonetheless, there are several alternatives for plan sponsors to manage the risk associated with the end of the IRS determination letter program and the limited ability to rely on an existing determination letter, as described more fully below. Reliance on Determination Letter for Unchanged Plan Terms. In issuing recent guidance, the IRS has noted that a plan sponsor that maintains a qualified plan for which a favorable determination letter has been issued may not continue to rely on the determination letter with respect to a plan provision that is subsequently amended or that is subsequently affected by a change in law. It follows, however, that a plan sponsor may continue to rely on a determination letter with respect to plan provisions that are not amended or affected by a change in law. 6 Thus, for example, depending on plan design and on future legislative and regulatory changes, plan sponsors may be able to continue to rely on their existing determination letters for most material plan features that have remained unchanged since the last determination letter. Reliance on IRS Required Amendments List. The Required Amendments List is the annual list issued by the IRS of all the amendments for which an individually designed plan must be amended to retain its qualified plan status. The IRS indicated that it will publish the Required Amendments List after October 1 of each year. Generally, plan sponsors must adopt any Required Amendments List item by the end of the second calendar year following the year the Required Amendments List is published. For example, for plans with calendar plan years, amendments for items on the 2016 Required Amendments List generally must be adopted by December 31, Discretionary amendments to a plan other than a governmental plan will still be required by the end of the plan year in which the plan amendment is operationally put into 6 Rev. Proc , (setting forth the degree of reliance that may be placed on existing determination letters). effect. 7 The Required Amendments List is intended to guide plan sponsors with respect to plan amendments that may be required during the course of a year in response to statutory or regulatory changes. (This list, of course, relates only to statutory or regulatory changes; plan sponsors would be on their own in terms of ensuring plan document compliance surrounding any discretionary design changes or changes to administrative practices.) As promised, the IRS issued (on December 27, 2016) Notice , which sets forth the 2016 Required Amendments List (the only listed required amendment involves certain collectively bargained defined benefit plans). 8 Independent Review of Plan Terms. As the time from the date of the last favorable determination letter increases, plan sponsors will likely become increasingly concerned about their ability to rely on the most recent determination letter. This concern will increase to the extent that the plan sponsor has made material changes in plan design, or if there have been significant regulatory changes impacting the plan terms. As a consequence, plan sponsors should consider having their plan documents reviewed to confirm that their plans continue to satisfy the qualification requirements of the I.R.C. Such a review may be undertaken by in-house legal counsel, outside counsel, or consulting firms experienced with qualified plan documents. In some cases, it may be advisable to consider having individuals conduct the review who were not involved in the drafting or operation of the most recent plan document. This may be beneficial in that an independent reviewer would not necessarily be committed to positions that the incumbent advisor may have taken when drafting the plan terms. In addition, an independent reviewer will more likely replicate the type of review that the IRS would undertake, for example, as part of a plan audit; an independent reviewer or IRS examiner each would have had no prior experience or familiarity with the plan document. It may also be possible (and perhaps more efficient) for a firm with whom the plan sponsor has a continuing relationship involving the plan to undertake the review, provided that the reviewing firm assigns individuals to conduct the review who were not involved directly with the plan and can examine the plan terms independent of the usual team. Plan Administration and Related Operations. While most plan sponsors have relied on the IRS de- 7 Rev. Proc , 8. 8 The most recent Required Amendment List provided for amendments to certain collectively bargained defined benefit plans to provide for restrictions on accelerated distributions from underfunded single-employer plans in employer bankruptcy under 436. Notice , I.R.B All section references are to the Internal Revenue Code of 1986, as amended, and the regulations thereunder, unless otherwise specified Tax Management Inc., a subsidiary of The Bureau of National Affairs, Inc. 3

4 9 Reg (a)(2), (a)(3)(iii); Rev. Proc , I.R.B. 465, 5.01(2)(b). 10 Although this article focuses on the cessation of the IRS s 5-year remedial amendment cycle for determination letters, ERISA also requires plan fiduciaries to administer the plan in accordance with its terms. Section 404(a)(1)(D) of ERISA expressly states that plan fiduciaries are required to administer the plan in accordance with the documents and instruments governing the plan. termination letter to indicate that a plan is qualified, some may not have fully appreciated the importance of the second component of plan qualification that the plan must be operated in accordance with the I.R.C. requirements and plan terms. 9 Although a written plan document may be compliant with applicable requirements as to form, quite often the plan administration does not conform to the terms of the plan in all respects, or there is turnover within a client organization that results in differing interpretations of plan provisions and changes in plan administration. When plan administration does not align with the plan provisions, the plan is noncompliant and may be violating one or more provisions of the I.R.C. and the Employee Retirement Income Security Act of 1974, as amended (ERISA). 10 To the extent that a plan is not properly administered, such shortcomings can adversely affect the qualified status of the plan. While this potential issue existed even when the IRS was issuing determination letters, there is now a heightened awareness of operational failures and their impact on plan qualification. For this reason, plan sponsors may want to review plan operations (in addition to the written terms of the plan document) before determining (and representing to others) that the plan remains qualified. Ongoing Plan Operations. Plan sponsors may administer their qualified plans using internal resources, third-party administrators, or a combination of both. In all of these situations, there is a possibility that plan terms will not always be followed in actual operation. As noted above, this may be due to a variety of reasons, including lack of strong controls, changes in administrative systems or personnel, mergers involving the plan, new statutory or regulatory requirements, or changes in plan design. While an inadvertent error can always occur (e.g., a date of hire may have been miscoded), the goal is to establish plan controls that will mitigate the risk of an operational failure. Operational Compliance List. The IRS announced its intent to issue an annual Operational Compliance List. To assist employers, the IRS intends to identify in that List any changes in qualification requirements that are effective during a calendar year. For 2017, the IRS identified a number of operational requirements that a plan must follow, to the extent applicable, in order to maintain the plan s qualified status. The IRS noted that the List is not intended to be a comprehensive list of every item of IRS guidance or new legislation for a year that could affect a particular plan. Thus, it continues to be incumbent on plan sponsors to identify operational issues that may need to be addressed during the course of the year with respect to their qualified retirement plans. 11 PLAN DOCUMENT ISSUES In preparing this article, we have identified some of the more common plan document issues that plan sponsors can expect to encounter when examining their defined contribution or defined benefit plans. While all plans are different, there are certain plan terms that consistently come to the attention of reviewers that may require clarification or substantive changes in order to conform to applicable provisions of the I.R.C. or other technical pronouncements from regulatory agencies. Late Amendments. One of the most common plan document errors that are identified during an IRS audit or a third-party compliance review is a plan sponsor s failure to adopt a required plan amendment by its due date. Late amendments may include a nonamendment failure or a failure to adopt good faith amendments, as well as a failure to timely adopt interim amendments. 12 Late amendments can include the failure to amend an existing plan provision or the absence of a plan provision that may violate the qualification requirements of the I.R.C. This error can be due to various reasons, including miscommunication between those drafting the amendment and those responsible for its adoption, misinterpretation of the timing of the amendment, or possible turnover in the organization responsible for moving the amendment forward. This type of error is so common that the IRS has created a streamlined process to facilitate correction under the IRS Employee Plans Compliance Resolution System (EPCRS). 11 See Rev. Proc , 10. The Operational Compliance List identifies matters that involve either mandatory or discretionary plan amendments depending on the particular plan, and contain other significant guidance that affects daily plan operations; the IRS noted that the Operational Compliance List will not be published in the Internal Revenue Bulletin. For 2017, for example, the Operational Compliance List includes, among other things, the requirements that plans be administered in accordance with the proposed regulations regarding QNECs and QMACs, operational compliance with the extension of temporary nondiscrimination relief for closed defined benefit pension plans, compliance with final regulations regarding partial annuity distribution options for defined benefit pension plans, final regulations regarding cash balance/hybrid plans, and the application of benefit restrictions for certain defined benefit plans. See operational-compliance-list. 12 See, e.g., Rev. Proc , 5.01(2)(a) Tax Management Inc., a subsidiary of The Bureau of National Affairs, Inc.

5 Corporate Transactions. Another common plan document error relates to corporate transactions. These plan document errors can be due to the evolving transaction details, timing of the corporate actions, or miscommunication as to the intent of the parties. Moreover, many sponsors look for opportunities to consolidate the management and fiduciary responsibilities involving plans that are acquired in a transaction. Plan mergers must observe the anti-cutback rules so as not to reduce or eliminate protected benefits of either of the plans to be merged. 13 Other Plan Document Issues. While every plan is different, and drafting issues will surely vary from plan to plan, not all plan document issues present qualification concerns. Nonetheless, a review of the plan document and clarification of noncompliant or ambiguous terms is a valuable undertaking. Some of the more common issues that we have encountered include a failure to update plan language to address the Supreme Court s recent decisions regarding Defense of Marriage Act requirements, 14 new cash balance plan guidance, 15 discretionary design and operational changes, as well as a failure to provide for or properly describe required actuarial adjustments. 16 PLAN OPERATIONAL ISSUES In preparing this article, we have identified some of the more common administrative and operational issues that plan sponsors can expect to encounter when examining their defined contribution or defined benefit plans. If the plan sponsor has not examined its plan administration recently, it is very possible that one or more of these plan features is not being administered properly and, thus, the plan may not be following the qualification requirements of the I.R.C (d)(6). 14 See, e.g., United States v. Windsor, 570 U.S. 12, 2013 BL (2013) (Federal Defense of Marriage Act struck down insofar as it barred federal government from treating same-sex marriages as valid even when lawful in state where marriage was performed) and Obergefell v. Hodges, 135 S. Ct. 2584, 2015 BL (2015) (Fourteenth Amendment requires states to license marriage between two people of same sex and to recognize marriage between two people of the same sex when their marriage was lawfully licensed and performed out-of-state). 15 Reg (b)(5) See, e.g., 401(a)(25); Rev. Rul , C.B Common Plan Errors Potentially Impacting Qualified Defined Contribution Plans While operational issues can arise in even the most well written and administered plans, they can be due to any number of reasons; some failures may represent deficiencies in controls, while others may be simply inadvertent errors. For defined contribution plans, particularly those involving qualified cash or deferred arrangements, operational errors have become so predictable that the IRS has issued a list of what it considers to be some of the most common mistakes involving 401(k) plans. 17 Eligible Compensation One of the most common areas of operational noncompliance relates to a failure to calculate properly a participant s compensation for plan benefit purposes. In our experience, payroll and benefit departments are not always aligned in terms of applying the plan terms to the different forms of compensation that may be generated during the course of the plan year. With the sophisticated payroll systems in place today, employers may have hundreds of payroll codes covering everything from standard base rate of pay to spot awards, leaves of absence payments, overtime, incentive awards, or commissions. In reviewing the plan document (which may have a fairly generic definition of eligible compensation), the level of detail provided for eligible compensation may not approach the specificity typically found within a payroll department and payroll system. This disconnect can result in a number of operational failures covering everything from incorrect plan contributions by the employee, incorrect matching or nonelective contributions by the employer, and ultimately incorrect plan distributions. The operational issues may be further exacerbated in view of the fact that many plan sponsors may not appreciate the fact that the definition of compensation used for determining benefits or contributions may be quite different from the definition that should be used for determining highly compensated employees and for conducting nondiscrimination testing. ADP/ACP Operational Failures These testing failures can occur due to the misapplication of the definition(s) of compensation under the plan, misclassification of employees, calculation errors, or unanticipated changes to the employee population due to a corporate transaction. While the plan document may lay out the testing requirements in excruciating detail, a periodic review of the administrative procedures surrounding these tests and the data relied upon is useful to ensure compliance and to avoid any correction efforts potentially spanning multiple years. From a practical standpoint, a targeted, current year review of testing data may allow plan sponsors to project test results with greater accuracy 17 See A Guide to Common Qualified Plan Requirements, IRS (last updated Oct. 28, 2016), available at retirement-plans/a-guide-to-common-qualified-plan-requirements Tax Management Inc., a subsidiary of The Bureau of National Affairs, Inc. 5

6 and quickly identify administrative errors or deficiencies in controls well in advance of the compliance issue becoming systemic and adversely affecting the annual nondiscrimination testing results. 18 Required Minimum Distributions Section 401(a)(9) requires that plans commence distributions of participant account balances on or before a participant s required beginning date. Generally, the required beginning date for a participant is April 1 of the year following the later of the year in which the participant reaches age or the year in which the participant retires. IRS auditors have consistently identified this as an audit issue, because this requirement necessitates diligent administration with regard to monitoring participants ages and retirement elections. Despite the plan sponsor s (and their thirdparty administrator s) best efforts, for any number of reasons, plan benefits do not always commence as of these required beginning dates, resulting in a qualification error and operational noncompliance. Furthermore, individual participants and their beneficiaries may incur adverse tax consequences by reason of the non-payment. Plan sponsors (or participants) will need to take specific steps with regard to their annual federal income tax filings to address this operational failure. 19 Plan Loans Plan loans in both form and operation are a persistent thorn in the side of plan sponsors and represent low hanging fruit for the IRS during an examination. While the written terms of the plan may be above reproach, there are multiple ways for a plan loan program to fall out of compliance. For example, the amount of the loan may not be calculated correctly, particularly if there has been more than one 18 To the extent that IRS examination agents examine a defined contribution plan s ADP/ACP testing in a manner consistent with guidance from the IRS Internal Revenue Manual (IRM), they also may want to verify compliance with other nondiscrimination testing and minimum coverage requirements of the I.R.C. See I.R.M (relating to employee contributions and matching contributions). 19 Section 4974 provides for an excise tax equal to 50% of the amount by which such minimum required distribution exceeds the amount actually distributed during the taxable year. The excise tax is to be imposed on the plan participant to the extent that the participant has not received a required minimum distribution in a timely fashion. When the failure to provide a required minimum distribution occurs (which is often far more frequent than plan sponsors would like), the IRS EPCRS program provides a mechanism to take appropriate corrective action based on a streamlined filing for a reduced user fee. See Rev. Proc , 6.09(2). In appropriate cases, the IRS will waive the excise tax under 4974 applicable to plan participants or beneficiaries. loan during the loan period. 20 Similarly, the term of the loan (particularly if there have been any intervening events such as military leaves) may not be properly followed in terms of level amortization, and participants loan defaults and the operational requirements surrounding the timing of deemed distributions and related tax reporting can also be problematic and lead to operational failures. Other Requirements of Interest to IRS on Examination In terms of plan operations, defined contribution plans have a number of moving parts and can be quite complex to administer. In reviewing a defined contribution plan for operational compliance, we often try to replicate the issues likely to be examined by an IRS examiner. For this reason, careful attention should be paid to sampling data that might be requested by the IRS in addition to the above, these data requests can involve such things as verifying compliance with 401(a)(17) and 415 limits and application of the controlled group rules often a trap for the unwary. 21 Common Plan Errors Potentially Impacting Qualified Defined Benefit Plans As with defined contribution plans, plan errors and identified deficiencies in defined benefit plan controls can arise quite often (and can involve significantly larger amounts). These operational failures, however, may be less obvious to plan sponsors and their plan administrators that do not have the same day-to-day activity with their defined benefit plan participants as they do with their defined contribution plan participants. Some of the more common operational issues arising with defined benefit plans that result in potential operational or administrative noncompliance are described below. From a plan sponsor standpoint, these operational issues should be periodically examined to confirm operational compliance. 20 Plan compliance issues surrounding loan amounts continue to be an area of frustration for plan sponsors. In a recent Memorandum for Employee Plans (EP) Examinations Employees, the IRS Tax Exempt and Government Entities Division noted that if, during an examination, it is determined that a qualified plan made two or more loans to the same participant during a 1-year period, the IRS auditor is permitted to determine if the plan computed the highest outstanding balance in one of two ways each of which may result in a significantly different amount available for a loan, yet either of which is deemed compliant. Available at 21 See, e.g., I.R.M (relating to 415(b) limits applicable to defined benefit plans) Tax Management Inc., a subsidiary of The Bureau of National Affairs, Inc.

7 Required Minimum Distributions As with qualified defined contribution plans, 401(a)(9) requires that qualified defined benefit plans commence distributions of benefits on or before a participant s required beginning date. Furthermore, as noted above, once a failure to commence required minimum distributions is discovered, plan sponsors will normally want to take action to correct the failure and eliminate the potential excise tax due from the participant for failure to commence timely payments. Late Commencement of Pension Benefits One of the areas that the IRS is likely to scrutinize because of consistent failures is plan administration relating to the late commencement of benefits. In our experience, many plans may not provide for a suspension of benefits notice 22 to participants who continue in employment beyond the plan s normal retirement age. Under those circumstances, the plan may need to provide additional, post-normal retirement age actuarial increases. (These issues can become even more complex for a cash balance plan where there is a need to credit interest or provide an actuarial increase for participants whose benefit commencement is deferred beyond normal retirement age.) Unfortunately, it is also not uncommon for plans that reference a suspension of benefits notice to fail to provide such notice and also fail to provide the required actuarial increases for late commencement. Not until payments are to commence does the plan sponsor discover that either the suspension of benefits notice was not provided, or that the plan had no provision for a suspension of benefits notice and, therefore, had to adjust the participant s benefits for nonpayment of benefits during service following normal retirement age. 23 Grandfathered Plan Formulas In our experience, plans that have grandfathered plan formulas (i.e., benefit formulas from a prior plan design or merged plan) can introduce a fair amount of complexity to the calculation of a plan benefit. The history surrounding the grandfathered plan formula can contribute to possible calculation errors. This may be due to any number of reasons, including inaccurate or incomplete data, misinterpretation of plan formulas, improper comparisons between multiple formulas (e.g., providing the greater of two benefit formulas), or use of incorrect actuarial assumptions. Having sample benefit calculations reviewed by an experienced actuary or plan administration professional can lead to identification of many issues involving plan interpretation and data integrity and should be an integral part of any compliance review. Unchecked legacy plan provisions can lead to years of noncompliance and potentially significant operational failures. Section 401(h) Accounts While some pension plans may have established 401(h) accounts for the funding of postretirement health benefits, the administration of the 401(h) account is not always well understood. Since compliance with 401(h) rules is a qualification requirement, it is important that these accounts be properly administered. 24 While most plan sponsors intend to exclude key employees from the 401(h) account (and many plan documents explicitly provide for such exclusion), administrative systems are not always as finely tuned as may be needed for purposes of excluding key employees from 401(h) account reimbursements. Compliance problems can be quickly magnified to the extent that a plan sponsor pays key employees from the 401(h) account 415(l) requires that contributions allocated to the account of a key employee within a 401(h) account be treated as an annual addition to the plan sponsor s defined contribution plan, thereby reducing the amount that the key employee could have received under such defined contribution plan for the year and potentially lead- 22 ERISA 203(a)(3)(B) provides that the right to the participant s accrued pension benefit is not treated as forfeitable solely if a pension plan suspends the payment of benefits during certain periods of re-employment that occur after an employee has begun to receive benefits. In order to suspend benefits permissibly, plan sponsors must notify the affected employee that his or her benefits are suspended. See 29 C.F.R From a compliance standpoint, plan sponsors, upon discovering that their plan document does not provide for a suspension of benefits notice, may want to amend the plan to add such a feature so as to avoid noncompliance issues in the future. While such an amendment would be helpful, the ability to apply the suspension of benefit rules retroactively to benefits already accrued may not be possible. In Central Laborers Pension Fund v. Heinz, 541 U.S. 739, 32 EBC 2313 (2004), aff g 303 F.3d 802, 28 EBC 2505 (7th Cir. 2002), the U.S. Supreme Court held that a plan cannot attach new conditions to benefits that a participant has already earned/accrued. This reasoning would prevent the prospective suspension notice from eliminating post-normal retirement age actuarial increases for benefits already accrued. Newly added conditions may be viewed as a cutback under ERISA 204(g) and I.R.C. 411(d)(6). Prospective application to newly accrued benefits may be possible but may introduce additional administrative complexity. 24 Section 401(h) provides that a separate account must be established to the extent that postretirement health benefits are to be paid for a key employee (within the meaning of 416(i)) and his or her spouse and dependents; while postretirement health assets may be commingled with pension assets for investment purposes, such postretirement health benefits may only be payable from the key employee s separate account. For this reason, most employers will draft the plan s 401(h) account so that it excludes key employees from reimbursement from the 401(h) account. See Reg Tax Management Inc., a subsidiary of The Bureau of National Affairs, Inc. 7

8 ing to additional compliance issues for the defined contribution plan. 25 Distributions of Small Amounts Many defined benefit plans provide for mandatory payments to former participants to the extent that the present value of the nonforfeitable accrued benefit does not exceed $5, Despite these plan provisions, many plan sponsors fail to identify these participants and do not always make such payments on a timely basis in accordance with the plan terms. While that is viewed as a deficiency in plan controls and an operational failure, the timely payment of small pension amounts is also a helpful de-risking strategy and can save plan sponsors on Pension Benefit Guaranty Corporation (PBGC) premiums once the participants have been cashed out of the plan. Other Requirements of Interest to IRS on Examination For the individually designed plan, there may be various unusual features or requirements that may impact plan administration and compliance. Thus, depending on the plan design, it is likely that any unique design features should also be examined in an effort to confirm operational compliance, including the impact of such unique designs on nondiscrimination testing requirements (h)(6), 415(l) (a)(11). 27 The IRS Tax Exempt and Government Entities Division, Employee Plans Rulings and Agreements Office ordinarily will not issue private letter rulings on matters involving a plan s qualified status under 401 through 420 and 4975(e)(7). These matters are generally handled by the Employee Plans Determinations program pursuant to Rev. Proc and Rev. Proc , subject to the limitations discussed above. STRATEGIES FOR PLAN SPONSORS TO CONSIDER IN THE ABSENCE OF IRS DETERMINATION LETTERS With the cessation of the IRS s cyclical determination letter program for individually designed plans (other than for initial qualification or for terminating plans), employers have been left with few alternatives to confirm their retirement plan s qualified status. While some practitioners have suggested possible alternatives, these approaches generally do not appear viable or practical under existing guidance. The alternative approaches that have been considered (but largely rejected) include requesting a private letter ruling regarding the qualified status of the plan, 27 filing a declaratory judgment action in Tax Court seeking a determination as to the plan s qualified status, 28 or attempting to rely on compliance statements issued under EPCRS. 29 Third-Party Reviews In the wake of the end of the IRS determination letter program for ongoing individually designed plans, plan sponsors may look to specialists to assess their plans qualified status. One alternative for plan sponsors is to engage a third party to perform an independent review of the plan document and related plan operations similar to the review that would be undertaken by the IRS in the course of a determination letter application or examination upon audit. These reviews may be used to verify that the plan document is up-to-date with all legal and technical requirements as well as appropriately administered with respect to any prior transaction activity, plan changes, or other operational considerations. While the ability to obtain regulatory support for a plan s qualified status is limited, the importance of maintaining qualified status is important to plan sponsors, plan fiduciaries, and employees. 30 We believe that an operational review will be increasingly important in the post-irs determination letter environment. Plan sponsors can no longer simply represent in any relevant situation (e.g., in connection with a merger and acquisition transaction or for reporting purposes) that they have an IRS determination letter and be satisfied that their plan document is 28 Section A declaratory judgment relating to qualification of certain retirement plans generally will require an actual controversy involving the initial or continuing qualification of a retirement plan, and challenges under this rule may be impractical in view of the time and effort that may be required and the likely reaction of the IRS to the taxpayer pursuing such an approach. 29 The compliance statement issued under the Voluntary Correction Program (VCP) of EPCRS only addresses the failures identified in the submission, the terms of correction (including any revision of administrative procedures), and the time period within which proposed corrections must be implemented (including any changes in administrative procedures). The compliance statement also provides that the IRS will not treat the plan as failing to satisfy the applicable requirements of the I.R.C. on account of the failures described in the compliance statement if the conditions of the compliance statement are satisfied. The reliance provided by a compliance statement is limited to the specific failures and specified years, and does not provide reliance for any other failure or year. Rev. Proc , 6.05(a), ERISA requires plan fiduciaries to ensure that the plan is administered in accordance with its terms, and plan fiduciaries may be personally liable for losses resulting from a breach of fiduciary duties. See ERISA 404(a)(1)(D) (fiduciaries must discharge their duties with respect to plan solely in interest of participants and beneficiaries and in accordance with the documents and instruments governing the plan insofar as such documents and instruments are consistent with the provisions of [ERISA]. ). See also ERISA Tax Management Inc., a subsidiary of The Bureau of National Affairs, Inc.

9 qualified. Rather, plan sponsors will more likely be expected to indicate that they reasonably believe that the plan is qualified; such a statement may include (or be expected to include) a representation by the plan sponsor that, to the best of its knowledge, both the plan document and related plan administration are compliant with the I.R.C. It may be difficult for a plan sponsor to make such a representation in financial papers or merger and acquisition transactions if it has not undertaken some level of current review of its plan document and plan operations. Practical Considerations Involving Third-Party Reviews In the experience of the authors, no plan is perfect, and it is unlikely that we will ever encounter a plan that is flawlessly written or administered in compliance with the plan document at all times. While there can always be one-off issues that can arise, the goal of the compliance review is to identify significant plan document issues and systemic operational issues that indicate that there is a deficiency in controls, or that there has been an interpretation of the plan that is inconsistent with plan provisions, I.R.C. requirements, or the expectations of the plan sponsor when designing the plan. Moreover, such a third-party review can prove quite helpful from a plan governance and ERISA fiduciary standpoint in documenting the processes and procedures that are (or should be) in place, and identifying areas that may benefit from more closely watched controls (e.g., ensuring that there has been development and conformance with investment policy statements, delegations of authority, and committee charters). 31 In the context of an IRS examination on audit, a plan sponsor will be notified that their plan(s) have been selected for IRS examination upon receipt of an IRS letter. See IRS Examination Process Guide, available at ep-examination-process-guide-section-3-initiation-of-anexamination. For more detail surrounding specific plans and IRS audit techniques, the IRS Internal Revenue Manual provides guidelines to examination agents and is a useful tool for plan sponsors and practitioners. Issues of Interest to the IRS and DOL While the IRS and Department of Labor (DOL) each has the ability to get the attention of plan sponsors when it chooses to audit a plan or its sponsor, 31 the plan sponsor can mitigate the risk of that agency s expanding its inquiry to the extent that the plan sponsor has completed an operational review and addressed any identified issues. IRS and DOL examiners may limit the scope of the audit if the examiner observes readily available documentation, strong processes in place, and disciplined procedures with respect to ongoing plan administration. It will be far easier for a plan sponsor to address IRS and DOL inquiries if it has previously examined and gathered all the relevant plan documentation (plan restatements, amendments, or required notices) and can address all related plan activity. This advance work will generally go a long way to satisfying the IRS or DOL auditor that the plan has generally operated in accordance with its terms. Confirm Most Recent Determination Letter Plan Compliance Date From our perspective, plan sponsors should begin the process by noting which plan document and amendment(s) are covered by their most recent determination letter and the number of plan changes since such letter was issued statutory, regulatory, administrative, or design related. To the extent that there has been a significant amount of activity from the issuance of the determination letter, a review of the plan (or at least those provisions impacted by any changes) are necessary from both a document and an operational perspective. Retain an Experienced Advisor In order to identify operational deficiencies, it is critical that the plan sponsor (or plan fiduciaries) retain an organization that has the capabilities to evaluate the operations of the plan from an actuarial, investment, administrative, tax and ERISA, nondiscrimination testing, and data integrity standpoint. While there are several organizations that may have these collective capabilities, it is not necessary that all such areas be reviewed at the same time or as part of the same engagement. Targeted Reviews Plan fiduciaries may choose to select certain areas (targets) that they believe are at risk with respect to operational compliance and revisit other operational areas at a later time. However they choose to proceed, it is important that the fiduciaries work with an organization that can evaluate these items with both a technical and practical lens this type of review should rely on an experienced compliance team that recognizes that there is more than one approach to compliance. (We anticipate that many of these reviews and related findings will rely on positions identified by the IRS during previous audits, prior determination letter applications, VCP submissions, and in future guidance). Availability of Plan Data Plan data is the life blood of an operational review. We often hear that plan sponsor staffs are too 2017 Tax Management Inc., a subsidiary of The Bureau of National Affairs, Inc. 9

10 thinly stretched to support a compliance review. While the independent reviewer will need to access certain data, including copies of required notices, election forms, and participant details, this information can often be developed without a significant time commitment by the plan sponsor s staff. In many cases, plan sponsors can simply facilitate the independent third party s interaction with the plan s recordkeeper. In our experience, for example, most defined contribution plan recordkeepers will provide the reviewing organization with administrative access to the plan recordkeeping system. This access will permit the reviewing organization to go directly into the participant data for purposes of sampling various plan transactions, e.g., participant loans, hardship withdrawals, and plan distributions. This is particularly helpful to a plan sponsor s Human Resources/Benefits Departments that has limited resources to devote to these reviews. While defined benefit plan systems do not necessarily provide the same type of access (in view of the different benefit calculation processes that may be in place and recordkeeping methods), reviewing organizations should be able to obtain much of the necessary information directly from other service providers. Focus of Review on Internal Procedures and Controls While plan sponsors will want to identify any issues of noncompliance, they should be most interested in having their plan controls evaluated and any shortcomings or deficiencies in controls addressed. As noted above, plans will always have some operational noncompliance; having strong controls in place (and following them) will mitigate much of the risk associated with operational noncompliance and permit plan sponsors to avoid future noncompliance. Such controls also demonstrate strong plan governance a topic often considered during the review of participant claims and appeals and in response to government audits or examinations. Develop Correction Methodology If errors are identified during the review, a correction methodology should be established. Corrections may relate to the plan document or plan operation, both of which may be addressed in the IRS VCP process or self-corrected. To the extent that the corrections involve operational issues, the IRS VCP procedures require the applicant to address procedures in place and process improvements so as to mitigate the risk of similar operational failures recurring. Correction process changes may include a change to internal procedures or third-party administrator systems, or the introduction of additional safeguards. The independent reviewing organization should be able to determine appropriate methods of correction whether that involves a change to plan controls, selfcorrection, or a VCP submission under EPCRS to address any document or operational failures. Pre-Approved Plans It is noteworthy that the IRS has encouraged the use of pre-approved plan documents for which the IRS s new Opinion Letter program applies. To the extent that one of these pre-approved plans is adopted, the need for a plan document review will be significantly reduced; in many cases, the review of a preapproved plan document may be limited to, among other things, confirming that required amendments have been timely adopted and that appropriate provisions have been selected. The migration to a pre-approved plan may be another strategy for plan sponsors to consider. While ongoing individually designed plans are for the most part precluded from obtaining an IRS determination letter, pre-approved plans are eligible to participate in the IRS s recently modified Opinion Letter program. Over time, larger employers may choose to move toward these plans for the comfort of having IRS approval of the plan document and forgo any advantages of an individually designed plan. (It is noteworthy that the IRS has recognized that the need to retain legacy benefits has been an impediment to employers considering converting from an individually designed plan to a pre-approved plan. In Rev. Proc , the IRS and Treasury Department requested comments as to the effect that appending legacy benefit formulas to the pre-approved plan document may have on a plan s reliance on an IRS-issued Opinion Letter.) 32 Payment of Compliance Reviews from Plan Assets Many employers may be interested in conducting a compliance review with respect to the qualified status of their plans but may have budgetary constraints. Moreover, the cost of such reviews may not have been included in the Human Resources/Benefits/Legal Department budget for the year. While the fees can vary depending on the size of the plan (in terms of the number of active, retired, and terminated vested participants to be sampled), the number of plan years involved, and the number of review areas to be examined, some employers may consider using plan assets to pay for such a review. While the decision to use 32 Rev. Proc Tax Management Inc., a subsidiary of The Bureau of National Affairs, Inc.