EPCRS Part I - Directly Resolving Plan Problems Avannesh K. Bhagat, IRS Robert M. Richter, J.D., LL.M., VP, FIS Relius Robert Richter, J.D., LL.M., Vice President, FIS Robert M. Richter, J.D., LL.M. is a Vice President with SunGard Relius in Jacksonville, Florida. Robert manages the consulting department and is instrumental in authoring and supporting SunGard Corbel's retirement plan documents. He is a frequent lecturer and author on matters involving qualified retirement plans and cafeteria plans. He has held numerous positions within the American Society of Pension Professionals and Actuaries (ASPPA), including President from October 2011 to October 2012. Robert is a Fellow of the American College of Employee Benefits Counsel and is a member of the National Institute of Pension Administrators (NIPA), the Florida Bar, and other organizations. Robert received a B.S., with a major in Finance, from the University of Florida, a J.D. from Florida State University, and an LL.M. in taxation from the University of Florida. 1
Avaneesh Bhagat, Group Manager, IRS Avaneesh is the Group Manager for the Voluntary Compliance Group in El Monte, California. His responsibilities include assisting with the resolution of applications made under VCP, assisting with the development of the revenue procedure relating to the correction programs for qualified plans, providing information on correction programs, and responding to inquiries relating to plan corrections and potential VCP applications. Avaneesh has worked with the examination, determination letter and voluntary compliance functions of the IRS' Employee Plans Division since 1988. EPCRS: GENERAL PRINCIPLES AND TERMS 2
EPCRS Employee Plans Compliance Resolution System (EPCRS) Rev. Proc. 2016-51 Consolidates prior updates (e.g., Rev. Procs. 2015-27 and 2015-28) Updated to reflect changes in the determination letter program for individually designed plans Changed sanctions to user fees Four Types of Qualification Errors Plan Document Failure Terms of plan not qualified Failure to timely adopt interim amendment/ restatement Demographic Failure Failure to satisfy IRC 410(b) or 401(a)(26) 3
Four Types of Qualification Errors Employer Eligibility Failure Not eligible to establish type of plan (e.g., governmental 401(k) or ineligible for 403(b)) Operational Failure Not following the terms of the plan (i.e., usually everything else you encounter) Other than prohibited transactions and exclusive benefit violations Consequences of Disqualification Taxation (EPCRS defines as Maximum Payment Amount) Employer deductions lost if no inclusion in employee income Trust is taxable (earnings may be taxable) Employees taxed on amounts not subject to risk of forfeiture Exception: If sole failure is IRC 410(b) coverage or 401(a)(26) participation failure, then only HCEs taxable 4
How Do You Correct? EPCRS contains pre-approved correction methods Following these methods is safe Otherwise, find reasonable, appropriate method Use IRC, Regulations and EPCRS as a guide The farther you get from pre-approved methods, the more beneficial it is to ask for IRS approval Correction Principles Must correct all taxable years (even if closed) Restore plan and participants to position they would have been in had the failure not occurred Should be reasonable and appropriate Consistent with IRC (don t create another violation) Provide benefits to NHCEs Keep assets in plan Consideration of other agencies (e.g., DOL on abandoned plans) 5
Exceptions to Full Correction Unreasonable or not feasible (tough one to apply) Reasonable estimates are necessary (e.g., earnings) Distribution of small amounts ($75 or less) Recovery of small overpayments ($100 or less) Lost participants Small excess allocations ($100 or less) Lost Earnings Corrective contributions, allocations or distributions must be adjusted for earnings Don t have to adjust for losses, but can Assume that the date on which the earnings begin: Date on which contribution/forfeiture would have been allocated to the participant s account For salary deferrals and after-tax contributions, assume mid-point of plan year (or period of exclusion) 6
Lost Earnings Methods for determining earnings: Generally use actual earnings based on EE s investment choices Reasonable estimates of investment returns Multiple investment options option w/highest rate of return (if most EEs are NHCEs) If EE has no investment selections average of all investment options Can the DOL s online VFCP calculator be used? EPCRS Structure Three correction procedures: Self correction procedure ( SCP ) Insignificant errors: anytime Significant errors: time limited Voluntary submissions to IRS ( VCP ) Cannot be under examination Audit Closing Agreement Program ( CAP ) 7
Self-Correction Program (SCP) Advantages of SCP No IRS involvement Deemed IRS reliance on corrections if following corrections in Appendices A and B Lower costs (fees and time) 8
Disadvantages of SCP Uncertainty as to eligibility Significant vs. insignificant Practices and procedures Uncertainty as to corrections if not covered in Appendices A or B SCP Eligibility SCP is only available for Operational Errors No plan document failures (2 limited exceptions) No demographic failures No employer eligibility failures No waivers of taxes (e.g., loan defaults or excise taxes for late RMDs) Not available for orphan plans 9
Practices and Procedures SCP only available if plan has practices and procedures reasonably designed to promote compliance Plan document is not enough Generally should be in place before the failure Operational failure should have occurred because of oversight or mistake in applying procedures Exception for Certain 415 Failures Exception to having practices and procedures for plans that provide for elective deferrals and nonelective employer contributions that are not matching contributions Permissible to have regular corrections for IRC 415(c) violations by refunding deferrals Must refund deferrals within 9 ½ (used to be 2 ½) months after the end of the plan s limitation year Allows refund of deferrals even though employer nonelective contribution was made after the participant deferred 10
SCP Eligibility SCP cannot be used for egregious failures Plan only covers HCEs Plan provides benefits to owners under a collective bargaining agreement but there was no good-faith bargaining between employee representatives and the employer Plan provides benefits to HCEs that are several times the 415 limits SCP cannot be used if abusive tax avoidance transaction SCP cannot be used to correct significant failures in SEPS/SARSEPS and SIMPLE Plans Insignificant vs. Significant Failures Insignificant operational failures can be corrected at any time Even if the plan is under audit by the IRS Significant operational failures are subject to additional conditions (time limits and must have a favorable letter on plan document) 11
What is Insignificant? Factors to consider: Have other failures occurred? What % of plan assets and contributions are involved?* How many years were affected? How many participants were affected (as % of total in plan and as % of those who could have been affected)?* Was correction made within a reasonable time after discovery? Why did the failure happen? *Do not interpret these factors to exclude small businesses What is Significant? Anything that is not insignificant Significant failures must be substantially corrected during the Correction Period Correction Period: General rule: last day of 2nd plan year following year of occurrence ADP/ACP: last day of 3rd plan year following year for which testing is failed If plan comes under IRS examination then correction period ends unless correction substantially completed 12
Example from Rev. Proc. 50 employees are at 415(c) limit for the year 18 had 415 excess ranging from $1K - $9K Total excess = $150K Total employer contribution for the year = $3.5 Million Significant failure Affects 36% of those who could have been affected 4% of total contribution was in error Example from Rev. Proc. Public school has 403(b) plan for its 200 employees The following errors occurred in the same year: Former employee should have received an additional RMD of $278 Impermissible hardship distribution of $2,500 was made to an another employee Another participant had an IRC 402(g) excess of $1,000 In the aggregate, these failures are insignificant 13
Favorable Letter A plan must have a favorable letter to be able to use SCP to correct significant failures Favorable Letter means: For IDPs, a letter (does not need to be current) For pre-approved plans, a current letter For 403(b) plans, plan that was timely adopted and conforms, in good-faith, to final 403(b) regulations SCP Eligibility Cannot use SCP if correction involves corrective plan amendment 4 limited exceptions: Loans/hardships (this is 1 and 2) - Plan permitted loans/hardships but did not include language permitting loans/hardships Early inclusion of otherwise eligible employees provided included EEs are primarily NHCEs If primarily HCEs, must use VCP to correct by amendment SCP may be available if making distributions/forfeitures Conforming amendment to a stated correction under Appendix B E.g., IRC 401(a)(17) failure or ADP test failure and plan does not permit QNECs 14
Corrections 2 General Guide for EPCRS Correction Start with IRS-approved corrections Rev. Proc. 2016-51 (Appendices A & B) Use those corrections unless there is a reason not to do so Too impractical Too expensive Very unpopular to rank-and-file Check out informal IRS guidance that is available IRS answers to Q&As What other practitioners have experienced 15
Appendix A (Rev. Proc. 2016-51) Failure to provide top-heavy minimum Failure to satisfy ADP/ACP test Failure to satisfy 402(g) Exclusion of an eligible employee RMD failure Appendix A (Rev. Proc. 2016-51) Failure to obtain spousal consent where needed Failure to satisfy IRC 415 limits in DC plan Orphan plans 16
Appendix B (Rev. Proc. 2016-51) ADP/ACP test failures (adds the one-to-one method) Exclusion of eligible employee (adds expansion of correction for partial year exclusion and reallocation method for nonelective contributions) Vesting failures Appendix B (Rev. Proc. 2016-51) IRC 415(b) failures (overpayments from a DB plan) IRC 415(c) failures (adds forfeiture for terminated employee and return of overpayment method) Other overpayments IRC 401(a)(17) failures Correction by amendment (IRC 401(a)(17) failures; hardship and loan failures; early inclusion of otherwise eligible employee) 17
SCP Exceptions Only 4 exceptions where SCP permits plan amendment: Loans/hardships (this is 1 and 2) - Plan permitted loans/hardships but did not include language permitting loans/hardships Early inclusion of otherwise eligible employees provided included EEs are primarily NHCEs If primarily HCEs, must use VCP to correct by amendment SCP may be available if making distributions/forfeitures Conforming amendment to a stated correction under Appendix B E.g., if failed ADP test or 401(a)(17) and plan does not permit QNECs, then amendment may be made Other Corrections Allowed Appendices A & B are safe harbor correction methods Other corrections are permitted But you never know if the correction is acceptable to the IRS unless you file under VCP 18
What if SCP Cannot be Used? Option 1: VCP Option 2: Correct with no filing Option 3: Don t correct EPCRS Part I - Directly Resolving Plan Problems Avannesh K. Bhagat, IRS Robert M. Richter, J.D., LL.M., VP, FIS Relius 19