Due diligence can avert issues with retirement plans

Employers who run retirement plans should periodically do system-wide due diligence to make corrections. Errors happen, from simple clerical mistakes to systematic failures in the record-keeping system. Whatever the mistake, the key is to fix it quickly through an IRS-accepted method, and to document, document, document.

Accepted correction methods to preserve plan qualifications under the Employee Plans Compliance Resolution System (EPCRS) were a focus of a Grant Thornton LLP webcast. Plan sponsors can use EPCRS to correct mistakes in qualified retirement plans, Section 403(b) plans, simplified employee pension plans, savings incentive match plans for employees and governmental Section 457(b) plans.

The three correction programs within EPCRS follow.

Self-correction program The self-correction program (SCP) is the method plan sponsors prefer, as it is the simplest and involves no fee or IRS notification. It is primarily for operational errors determined to be insignificant through a number of considerations, such as the dollar amount involved or whether other failures happened in the same period. (Plans with more significant operational errors may be eligible to use the SCP, but only if a problem is identified quickly and corrected.) With this method, the sponsor simply figures out the correction, does it and puts a memo in a file indicating what it did, for its own records and in case the IRS shows up later.

For multiple failures or multiple years, the error must be insignificant in the aggregate.

Voluntary correction program The voluntary correction program (VCP) is the default method for non-SCP-eligible failures that are complex or extensive and generally older than two years. These can be document failures (a provision or an absence of a provision that violates qualification rules), a demographic failure (involving general nondiscrimination rules or coverage) or employer eligibility failures (such as adoption of a cash or deferred arrangement or a 403(b) plan by an ineligible employer).

A plan sponsor describes the errors to the IRS and proposes a correction plan. Once the agency approves or adjusts the fix, the sponsor makes the correction, and the IRS issues a compliance statement for the sponsor’s files.

Fees apply and are based on the number of participants. They range from $500 for plans with 20 or fewer participants to $15,000 for plans with more than 10,000 participants.

Audit closing agreement program The audit closing agreement program (audit CAP) is an involuntary program that plan sponsors want to avoid. It applies to errors discovered during an IRS audit and to prior errors not corrected properly under EPCRS. The agency does not look kindly on a plan that had errors and failed to self-correct, so penalties are hefty — often much more than the filing fee for a VCP correction and often in six figures. The IRS considers several factors in determining sanctions, such as steps taken by the plan sponsor to ensure the plan had no failures and steps taken to identify failures.

The maximum payment amount is the monetary amount approximately equal to the tax the agency could collect upon plan disqualification, calculated as the sum for the open taxable years of:
  • Income tax on the trust (Form 1041) plus interest and penalties
  • Income tax resulting from the loss of employer deductions for plan contributions plus interest and penalties
  • Income tax resulting from income inclusion for participants in the plan (Form 1040) plus interest and penalties
  • Tax on plan distributions that have been rolled over to other qualified trusts plus interest and penalties

Special note: The audit CAP sanction is calculated using the size of the plan, not the size of the error. The IRS has broad discretion about the amount it will accept.

Get smart, not in trouble The biggest mistake plan sponsors make is failing to do periodic due diligence and to look beneath the surface even when an error seems minor. They should not think in isolation but review their entire system to uncover an error’s source, the number of participants affected and the earnings or lost earnings associated with an error. The IRS seldom disqualifies plans, but it can. Plan sponsors would be wise to revisit policies and procedures around plan administration to see if changes can be made to catch mistakes sooner or keep them from happening in the first place.

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