In this issue of The Benefits Professional Report, attorneys Leslie A. Klein and William F. Lee from the law firm Sonnenschein Nath & Rosenthal continue their analysis of the Employee Plans Compliance Resolution System and the remedial programs available to employers and practitioners. For service providers, knowledge of IRS remedial program options combined with competent legal counsel to provide guidance is of significant value.
We hope you find this discussion of the Administrative Policy Regarding Self-Correction informative and useful.
The Employee Plans Compliance Resolution System ("EPCRS") as set forth in Revenue Procedure 98-22, I.R.B. 1998-11, permits a plan sponsor to self-correct certain plan failures without IRS approval under the Administrative Policy Regarding Self-Correction ("APRSC"). APRSC offers relief from disqualification only for operational failures which satisfy certain criteria. APRSC is not available for plan document failures, demographic defects, egregious failures or for the misuse or diversion of plan assets. APRSC allows a plan sponsor to correct operational failures without having to pay a sanction or notify the IRS.
Under APRSC, a plan sponsor is permitted to self-correct "insignificant" operational failures even if the plan is under examination by the IRS. The factors to be considered in determining whether an operational failure is "insignificant" include, but are not limited to, the following: (1) whether the failure occurred during the period being examined; (2) the percentage of plan assets and contributions involved in the plan failure; (3) the number of years in which the failure occurred; (4) the number of participants affected by the failure relative to the total number of participants in the plan; (5) the number of participants affected as a result of the failure relative to the number of participants who could have been affected by the failure; (6) whether the correction was made within a reasonable time after its discovery; and (7) the reason for the failure (e.g., an error in the transcription of data, the transposition of numbers, or minor arithmetic errors). No one factor is determinative. If the plan has more than one operational failure in a single plan year or has an operational failure or operational failures that have occurred over the course of several plan years, such operational failures will be eligible for correction under APRSC for insignificant violations if all of the operational failures are insignificant in the aggregate.
A plan sponsor may also correct "significant" operational failures provided that the correction is completed or substantially completed by the last day of the "correction period" set forth in Revenue Procedure 98-22. Generally, the correction period for an operational failure is the last day of the second plan year following the plan year in which the operational failure occurred. In the case of a failure to satisfy the requirements of the ADP or the ACP test, the plan year that includes the last day for correction under Sections 401(k)(8) or 401(m)(4) (that is, the end of the year after the plan year for which the test is run) is treated as the plan year in which the operational failure occurred. Thus, the correction period for ADP or ACP failures is effectively three years after the year the plan failed the ADP or the ACP test.
The two-year correction period will be extended if the employer has taken reasonable and timely steps to correct the failure within the correction period, even if the correction has not been completed. An operational failure is considered "substantially completed" by the last day of the correction period if either (1) the plan sponsor was reasonably prompt in identifying the defect and initiating correction in a manner that demonstrates a commitment to completing correction of the operational failure as expeditiously as is practicable and the plan sponsor completes correction within 90 days after the last day of the correction period or (2) the defect has been corrected with respect to 85 percent of the affected participants during the correction period and the plan sponsor completes correction in a "diligent manner." The correction period, however, will end on the first date the plan is "under examination" (i.e., audited ) for that plan year.
APRSC is only available for correcting "significant" operational failures where the plan is the subject of a current favorable determination letter. In order to be eligible for APRSC, the plan sponsor or administrator must have established practices and procedures (formal or informal) reasonably designed to promote and facilitate overall compliance with the requirements of Sections 401(a) of the Internal Revenue Code. Finally, to be eligible for relief under APRSC, the plan sponsor must make full correction of all violations for all years in which the defects exist. The correction should restore both current and former participants (and beneficiaries), as well as the plan, to the position they would have been in if the failure had not occurred.
One of the most beneficial aspects of APRSC is that no sanction or fee must be paid to the IRS. Rather, all that is required is retroactive and prospective correction of the failure. Additionally, as an informal program, the IRS need not be informed of the plan sponsor's use of the program unless subsequently questioned. This eliminates the concern of plan sponsors that voluntarily coming forward to disclose operational failures will increase the chance of an audit. One of the disadvantages of using APRSC, however, is the risk that by correcting an operational failure, the plan has created additional qualification failures that a compliance statement or closing agreement would normally cover. Moreover, even with APRSC, practical uncertainties persist. For example, whether a qualification failure is "insignificant" under APRSC is not a question that can often be answered with absolute certainty. This is partly because that while APRSC provides certain factors to consider in making this determination, these factors are not exclusive, but rather form only part of what ultimately is a facts and circumstances test. The examples provided in APRSC of insignificant errors are rather limited in scope, and would suggest rather modest usefulness of this avenue of relief under APRSC. It is also not clear in light of the enumerated factors whether a defect which a plan sponsor believes to have corrected but actually was not corrected can qualify as an insignificant defect under APRSC.
Retroactive plan amendments to cure operational failures are not permitted under APRSC. The IRS should consider allowing retroactive amendments to cure certain operational failures, such as the making of hardship distributions or plan loans to nonhighly compensated employees without proper authority under the plan, allowing ineligible nonhighly compensated employees to participate in a Section 401(k) plan, or when the plan sponsor contributes a greater percentage of covered compensation then the plan permitted (without violating the Section 404 or the Section 415 limits). It is doubtful that allowing plan sponsors to correct these commonplace operational failures by means of an amendment in the context of APRSC would have the effect of undermining the IRS's determination letter program.
In light of these ambiguities or limitations surrounding the application of APRSC, employers may opt to use the APRSC program to correct some of the minor or generic defects described in Rev. Procedures 98-22 and 99-31. However, many employers will still use VCR or the Walk-in CAP where the availability of relief under APRSC is uncertain or the correction method chosen by the employer is not clear-cut. Perhaps additional guidance in interpreting some of the requirements of APRSC will make the program more reliable and useful to both practitioners and employers.
Copyright 1999 by Professional Practice Insurance Brokers, Inc., a Hilb, Rogal & Hamilton Company. Reprinted with permission from The Benefits Professional Update, September 1999 (vol I, issue II).