employee benefits and executive compensation group

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1 Paul W. Holloway Thomas J. Hurley Samuel J. Palisano Christopher M. Potash Mark R. Wilson Leslie E. DesMarteau Lisa G. Pelta Joseph E. Simpson Lori J. Stone Colleen M. Allen Brian S. Bennett Cody R. Braithwaite Diana Clarkson Holl Jesse A. St. Cyr BENEFITS LITIGATION COUNSEL Fred G. Aten, Jr Erika N.D. Stanat Megan K. Dorritie employee benefits and executive compensation group Recognizing and Correcting Retirement Plan Compliance Errors Can Save Time and Money A grammatically correct version of an old adage states, If it s not broken, don t fix it. However, in the highly regulated world of qualified retirement plans (i.e., defined benefit plans, 401(k) plans, and other defined contribution plans), it sometimes can be difficult for an employer that sponsors a qualified retirement plan to recognize when its plan has experienced an error that needs to be fixed. Moreover, if a plan sponsor identifies a compliance error, it can be just as difficult to know how to correct the error in a manner that is acceptable to the Internal Revenue Service ( IRS ) or the Department of Labor ( DOL ), the two principal government agencies with oversight and enforcement responsibilities over qualified retirement plans. Failure to correct compliance errors can result in costly penalties, up to and including plan disqualification (i.e., the immediate taxation by the IRS of all qualified retirement plan assets) or sizeable penalties. To help employers reduce or avoid penalties and liability in the event of an audit, the IRS and DOL have developed certain remedial programs which allow employers to correct plan errors voluntarily before the errors are discovered by the government agencies. Correcting plan errors voluntarily can save employers time and money in the event of a government plan audit. It also helps to provide employees with the confidence that their retirement money will be available when they choose to retire. How does a plan sponsor or plan administrator identify compliance errors? The first step in any qualified retirement plan correction process is to recognize qualification errors when they occur. Some of the most common compliance errors occur when a plan sponsor fails to adopt a legally required amendment to its retirement plan document by a required deadline or when the employer fails to administer its qualified retirement plan in accordance with the terms of its plan document. Other examples of common qualification failures can be found in the Correcting Plan Errors section of the IRS website at under the titles 401(k) Fix-It Guide and A Guide to Common Qualified Plan Requirements. These two online sources can help a plan sponsor learn about and discover qualified plan errors before they are discovered by an IRS auditor.

2 Similarly, the DOL encourages employers to identify and correct any disclosure or fiduciary breaches before it discovers such errors and assesses costly penalties. Failing to submit a timely annual report (i.e., Form 5500) with respect to a qualified retirement plan and failing to remit employee contributions or loan repayments to a qualified retirement plan on a timely basis are two common errors that can be corrected voluntarily under the DOL s remedial programs. For a list of other types of transactions that can be corrected under the DOL s remedial programs, please see the Voluntary Fiduciary Correction Program Fact Sheet available on the DOL s website at Additional information regarding the DOL s compliance programs is available at How does a plan sponsor or plan administrator voluntarily correct compliance errors? The IRS has established the Employee Plans Compliance Resolution System ( EPCRS ) to allow employers to correct qualified retirement plan compliance errors voluntarily. EPCRS includes two voluntary programs, the Self-Correction Program ( SCP ) and the Voluntary Correction Program ( VCP ), as well as a non-voluntary correction program for errors discovered during an audit. The DOL has also established two remedial programs, the Delinquent Filer Voluntary Compliance Program ( DFVCP ) and the Voluntary Fiduciary Correction Program ( VFCP ). Both agencies update these programs from time to time. For example, EPCRS was last updated by the IRS in August This newsletter summarizes the programs as they are currently written. SELF-CORRECTION PROGRAM ( SCP ) SCP permits employers to reasonably and appropriately correct certain plan compliance failures, based on the pre-approved corrections and other general guidance set forth in EPCRS, without paying a penalty fee and without the need to contact the IRS. Accordingly, it is less costly and less formal than VCP. However, since a plan sponsor is not required under SCP to contact the IRS, there is no formal IRS approval of proposed corrective actions. Under SCP, the employer is required only to document the actions that it takes to self-correct compliance failures. The employer will need to provide the self-correction documentation only if the plan is subsequently audited by the IRS. In order to be eligible to self-correct a compliance failure under SCP, a plan sponsor or administrator must have established formal or informal practices and procedures reasonably designed to promote and facilitate overall compliance with applicable Internal Revenue Code requirements. The use of SCP to correct plan compliance failures is limited to certain operational failures, which are defined by EPCRS as compliance failures that arise solely from the failure to follow plan provisions. In general, a plan sponsor can use SCP to correct insignificant operational failures at any time, regardless of when such failures occurred and even if the plan or plan sponsor is under examination (i.e., under IRS investigation). Significant operational failures generally can be corrected under SCP only if such failures are corrected on or before the last 2

3 day of the second plan year in which the failure occurred. Accordingly, in order to be able to take advantage of SCP, it is important for plan sponsors to correct plan compliance failures as soon as possible after they occur. There are several factors involved in determining whether an operational failure is significant or insignificant, so each failure must be assessed on a case-by-case basis. VOLUNTARY CORRECTION PROGRAM ( VCP ) VCP allows a plan sponsor to disclose plan compliance failures in a formal manner to the IRS and propose reasonable and appropriate corrections for such failures based on the preapproved correction methods and other general guidance set forth in EPCRS. If the IRS consents to the plan sponsor s proposed corrections, it will issue a compliance statement. A compliance statement formally approves the plan sponsor s proposed corrections and generally grants the plan sponsor 150 days to complete the proposed corrections. A plan is eligible for formal correction under VCP only if the plan seeking correction and the plan sponsor of the plan are not under examination by the IRS. VCP can be used to correct all plan qualification failures, even egregious plan failures. In addition, as part of the most recent versions of EPCRS guidance, the IRS issued sample forms that are intended to simplify the VCP application process. Those forms are available on the Correcting Plan Errors section of the IRS website. The penalty fee required under VCP generally is based on the number of participants in the affected plan. For example, the current VCP penalty fee for a plan with 101 to 500 participants is $5,000 and the penalty fee for a plan with 501 to 1,000 participants is $8,000. The greatest penalty fee required under VCP (for plans with more than 10,000 participants) is $25,000. In addition, for VCP applications that seek to correct only plan loan errors which affect no more than 25% of the plan sponsor s participants in any year(s) in which the failure occurred, the general VCP penalty fee is reduced by 50%. For example, if a plan has 200 participants and the plan has experienced plan loan failures that require correction under VCP, the applicable penalty fee will be $2,500, so long as no more than 50 plan participants were affected by the errors. Furthermore, a substantially reduced penalty fee of $375 (regardless of the number of plan participants) is available for certain failures to amend a plan in a timely manner for required legal updates. A substantially greater VCP fee is assessed if a failure is determined to be egregious. The IRS has indicated that egregious failures are relatively rare. DELINQUENT FILER VOLUNTARY COMPLIANCE PROGRAM ( DFVCP ) Both the DOL and IRS can assess substantial monetary penalties against a plan administrator or plan sponsor that fails to file a required annual report (i.e., Form 5500). In particular, the DOL can assess a penalty of up to $1,100 per day, with no maximum limit. Similarly, the IRS can assess a separate penalty equal to $25 per day, up to a maximum of $15,000. However, penalties from both agencies can be avoided by filing under DFVCP, since a successful remedial application under DFVCP is accepted by both the DOL and the IRS. Under DFVCP, a plan administrator submits any late annual reports (i.e., Form 5500) to the DOL, together with a penalty fee. The fees for submitting late annual reports under DFVCP are assessed on a per plan basis. For example, the penalty fee for submitting one delinquent annual report for a large plan (i.e., generally, a plan with 100 or more participants) is $2,000. 3

4 However, the largest penalty fee that any plan must pay under DFVCP, regardless of the number of delinquent annual reports submitted under the program, is $4,000. DFVCP also includes reduced penalty amounts and similar penalty fee limits for applications submitted on behalf of small retirement plans (i.e., generally, plans with fewer than 100 participants). A plan administrator is eligible to take advantage of DFVCP at any time prior to the date on which the plan administrator is notified in writing by the DOL of a failure to file a timely Form 5500, even if the plan administrator has received a penalty notice from the IRS. However, plan administrators who file Form 5500-EZ and those who file Form 5500 for certain plans without employees are not eligible to participate in DFVCP. Those employers can, however, request a reduction or waiver of penalties if they can demonstrate reasonable cause for their failure to file. VOLUNTARY FIDUCIARY CORRECTION PROGRAM ( VFCP ) VFCP allows plan administrators and fiduciaries that are not under investigation by the DOL to correct voluntarily the 19 different ERISA violations that are covered by the program. VFCP guidance also includes specific correction procedures for each covered violation. Under VFCP, a plan administrator must identify any ERISA violation(s), determine whether such violation(s), if any, fall within the transactions covered by VFCP, follow the process for correcting the specific violation(s) and file an application with the appropriate DOL regional office for formal approval of the correction. The most common error corrected under VFCP is the failure to remit employee contributions to a qualified plan in a timely manner. In order to correct this error under VFCP, the DOL requires plan administrators to contribute any lost earnings to the plan affected by the error. The DOL has provided a VFCP Online Calculator to determine the amount of lost earnings that must be contributed to an affected plan. The Online Calculator is available on the DOL s website at Please bear in mind that unlike the voluntary IRS programs available under EPCRS, corrective payments made pursuant to VFCP must be made to the affected plan before a VFCP application can be submitted to the DOL. Most correction methods under VFCP require the restoration to the plan of lost earnings or profits. What action should a plan sponsor or plan administrator take to correct compliance errors? Become familiar with IRS and DOL requirements for qualified retirement plans. Periodically conduct an internal audit of your plans to determine whether all legally required amendments have been made and to confirm that the plans have been administered in accordance with the applicable plan documents. Determine the appropriate correction method for any identified compliance errors. If eligible, correct errors in accordance with applicable SCP guidance under EPCRS and document the self-correction. If the failure can be corrected under VFCP, calculate the necessary lost earnings or restoration of profits and contribute such amounts to the plan, and take any other requisite corrective action. 4

5 If your company has failed to file Form 5500 for a particular plan year and the company has not been notified by the DOL or assessed a penalty by the DOL with respect to the failure, prepare the missing Form 5500 or contact your retirement plan s recordkeeper to prepare the missing form. Submit the form under DFVCP. As necessary, make a formal application for correction under VCP or the DOL remedial programs. Please feel free to contact a member of the Employee Benefits & Executive Compensation Group if we can be of any assistance. This publication is provided as a service to clients and friends of Harter Secrest & Emery LLP. It is intended for general information purposes only and should not be considered as legal advice. The contents are neither an exhaustive discussion nor do they purport to cover all developments in the area. The reader should consult with legal counsel to determine how applicable laws relate to specific situations Harter Secrest & Emery LLP 1600 Bausch & Lomb Place Rochester, New York Twelve Fountain Plaza Suite 400 Buffalo, New York Washington Avenue Suite 303 Albany, New York Ridgewood Drive Suite 405 Naples, Florida