IRS Updates Correction Program for Qualified Plans

October 23, 2008

The Internal Revenue Service (“IRS”) recently issued revised procedures for its Employee Plans Compliance Resolution System (“EPCRS”). The updated procedures are designed to be more user-friendly and recognize some of the practical realities of plan administration.

Revenue Procedure 2008-50 (“Rev. Proc. 2008-50”) is the first major update to EPCRS in more than two years and supersedes Revenue Procedure 2006-27. Rev. Proc. 2008-50 continues a trend of supplementing existing EPCRS relief and streamlining correction procedures. Rev. Proc. 2008-50 is effective January 1, 2009, but its provisions may be applied now.

EPCRS Programs

EPCRS is a collection of three programs for correcting errors in the form and operation of qualified plans. These three programs are the Self-Correction Program (“SCP”), Voluntary Correction Program (“VCP”), and “Audit CAP.”

  • SCP is a means of correcting operational failures without involving the IRS. To use SCP, an employer corrects the failure as specified by IRS procedures and then documents the correction in a detailed memorandum. Failures that can be corrected by SCP are divided into “insignificant” failures, which can be corrected at any time, and “significant” failures, which must be corrected within a certain time period.
  • VCP requires filing an application to seek IRS approval of the correction and the payment of a user fee. The advantage of VCP is that it can be used to correct a broader range of failures than SCP, including plan document problems and “significant” failures not corrected within SCP’s required time period.
  • Audit CAP is an IRS-initiated program that applies to plans under examination. Audit CAP involves taking IRS-approved corrective actions, paying a negotiated penalty and entering a closing agreement with the IRS.

Regardless of which program an employer uses, EPCRS generally requires full correction of the failure, which means that the impacted participants and the plan must be made whole.

Correction of Common Failures

Under Rev. Proc. 2008-50, the IRS has offered additional relief and guidance on the correction of failures that are common among 401(k) plans. For example, EPCRS now provides guidance on how to correct exclusions from catch-up contributions where eligible employees were denied the opportunity to make deferrals. Exclusions from catch-up contributions may be corrected through an employer contribution equal to 25 percent of the catch-up contribution limit for the year in which the employee was excluded plus applicable matching contributions and missed earnings.

EPCRS is now consistent with the final Internal Revenue Code (“Code”) Section 415 regulations. In particular, EPCRS now provides that matching contributions or non-elective contributions (plus any earnings) that are forfeited because they would constitute excess annual additions should be placed in a suspense account. The suspense account is then used to offset employer contributions in the current year and succeeding years. The suspense account must be adjusted for earnings, and as long as the suspense account maintains unallocated amounts, the employer may only make elective deferrals to the plan.

Rev. Proc. 2008-50 also makes important changes regarding the correction of plan loan failures. The revised EPCRS provides specific guidance on how to report deemed distributions on Form 1099-R where the employer desires specific treatment (e.g., reporting in the year of correction, not the year of failure). EPCRS now also permits defaulted loans with terms less than the maximum permitted (usually five years) to be reamortized over the remaining portion of the maximum permissible term. Although corrections of plan loan failures must still be made using VCP, Rev. Proc. 2008-50 reduces the VCP fee by 50 percent for filings that involve only a loan failure and do not affect more than 25 percent of participants.

Simplified Correction Procedures

Calculating appropriate earnings is often a problem when correcting a plan failure. When it is not possible to make a precise calculation of the correction amount that the participant actually would have received, EPCRS allows reasonable estimates. In a welcomed clarification, Rev. Proc. 2008-50 expressly permits use of the Department of Labor’s online earnings calculator to determine a reasonable interest rate to estimate investment results.

Another small but welcome change in Rev. Proc. 2008-50 is an increase in the de minimis threshold for corrections to distributions. Employers need not make distributions of $75 or less per participant if the cost of the distribution would exceed the amount the participant receives.

The updated EPCRS also includes some important excise tax relief for certain distributions. For example, overpayments that are rolled into an IRA are subject to an excise tax. However, the IRS has the discretion to not impose this excise tax going forward if an overpayment plus applicable earnings is returned to the plan from the IRA by the recipient. Rev. Proc. 2008-50 also contains limited relief from excise taxes associated with premature distributions and the failure to make minimum required distributions.

Liberalized Self-Correction Program Standards

SCP is the most desirable EPCRS correction program, as it does not require any IRS filing or fee. The recent revisions to EPCRS further liberalize the use of SCP by extending the period for self-correction. The general rule continues to be that self-corrections of “significant” operational failures must be substantially complete by the end of the second plan year after the plan year in which the failure occurred (i.e., the “correction period”). The revised EPCRS considers a correction to be “substantially complete” at two points:

  • When the correction is made during the correction period for as little as 65 percent of the affected participants with the remaining corrections made in a diligent manner; or
  • When an employer has initiated a correction during the correction period in a way that shows the employer is committed to completing the correction as expeditiously as practicable and the correction is completed within 120 days after the end of the correction period.

Rev. Proc. 2008-50 also permits employers to use SCP to correct certain operational failures through plan amendments as long as the plan’s determination letter application is submitted before the end of its applicable remedial amendment period. Certain Code Section 401(a)(17) compensation limit violations and errors involving the early inclusion of certain eligible employees may be corrected in this manner. Plan amendments under SCP can also be used to provide for hardship distributions or loans where such distributions were made but no plan provision authorizing them existed.

Streamlined Voluntary Correction Program Applications

Where a VCP filing is still necessary, the revised EPCRS makes filings for many common failures easier. Streamlined application procedures are available for failures such as certain late amendments, plan loans, employer eligibility, excess elective deferrals and minimum required distributions. According to IRS representatives, a streamlined application often can be processed in a matter of weeks, rather than the six to nine months common with other VCP applications. For situations that require a regular VCP filing not covered by the streamlined application, Rev. Proc. 2008-50 also includes an updated model application that should speed processing.

Periodically reviewing plan administration and procedures, and annually reviewing plan documentation and updating as necessary, are still the keys to ensuring that a qualified plan maintains its tax-advantaged status. But when an error occurs requiring IRS involvement, the updated EPCRS should generally make it simpler and faster to get a plan back into legal compliance.

For further information or help analyzing the impact of the revised EPCRS procedures or addressing errors that may occur in the administration of qualified plans, please contact any member of the McGuireWoods Employee Benefits or Labor & Employment teams.