IRS Updates Voluntary Correction Program for Retirement Plans (June 12, 2006)

The Internal Revenue Service (IRS) recently issued Revenue Procedure 2006-27, updating and expanding the Employee Plans Compliance Resolution System (EPCRS).  The newly revised EPCRS expands the types of errors (‘qualification failures’) in the design or administration of tax-qualified retirement plans that sponsors may correct.  It also provides new correction methods.  Plan sponsors that do not use EPCRS to correct qualification failures risk losing the favorable tax-qualified status of their plan.

Background

The new Revenue Procedure retains the existing structure of EPCRS, which is comprised of the following three correction programs:

• Self-Correction Program (SCP) - used to correct certain insignificant qualification failures without having to notify the IRS or pay any fee or sanction;

• Voluntary Correction Program (VCP) - allows the plan sponsor to pay a relatively modest fee and apply to the IRS for approval of corrections at any time before an IRS audit; and

• Audit Closing Agreement Program (Audit CAP) - permits the plan sponsor to correct a qualification failure that has been identified upon IRS audit and pay a sanction based on the nature, extent and severity of the failure.

Participant Loan Corrections 

For the first time, EPCRS now allows a plan sponsor to correct some plan loan problems, without having to declare the loan a deemed distribution and report the distribution on Form 1099-R.  A plan sponsor now may apply under VCP to correct any of the following participant loan errors:

• Loans exceeding the statutory loan amount (generally the lesser of $50,000 or 50 percent of the participant’s account balance).  This error may be corrected by repaying the excess loan amount and reamortizing the loan balance over the remaining period of the original loan, not to exceed the statutory maximum period (generally 5 years).

• Loans failing to satisfy the level amortization requirement or the maximum period requirement.  This error may be corrected by reamortizing the loan balance in accordance with these requirements based on the original loan date.

• Loans in default because of the participant’s failure to repay.  This error may be corrected by requiring the participant to pay a lump sum to make up for the missed repayments, by reamortizing the loan balance over the remaining term of the loan, or by a combination of these methods. 

The participant is generally responsible for paying the corrective payment.  However, to the extent that an employer is responsible for failure to repay, the employer must pay a portion of the corrective payment equal to the interest that accumulates as a result of the failure. 

Failure to Include an Eligible Employee in a 401(k) Plan

Under the prior version of EPCRS, the method for failure to include an eligible employee in a 401(k) plan was for the employer to make (i) a qualified nonelective contribution (QNEC) equal to the average deferral percentage (ADP) for the type of employee (highly compensated or non-highly compensated) multiplied by the employee’s compensation, and (ii) if applicable, a QNEC equal to the average contribution percentage (ACP) for the type of employee (highly compensated or non-highly compensated) multiplied by the employee’s compensation. 

The new EPCRS specifies a different procedure, which is based on the “lost opportunity cost” to make elective deferrals.  For elective deferral contributions, the employer is required to make a QNEC equal to only 50% of the ADP for the type of employee (highly compensated or non-highly compensated) multiplied by the employee’s compensation.  If the plan provides for matching contributions, then the employer must make a QNEC equal to the matching contribution that the employee would have received had the employee made a deferral based on the full amount of missed deferrals (not just 50%).  With respect to employee after-tax contributions, the employer must make a QNEC equal to only 40% of the ACP for the type of employee (highly compensated or non-highly compensated) multiplied by the employee’s compensation. 

New correction methods also apply for a safe harbor 401(k) plan.  If the safe harbor is a 3% non-elective contribution, then the missed elective deferral is deemed to be 3% of compensation.  Therefore, the employer must contribute 50% of the deemed 3% elective deferral, plus the 3% safe harbor contribution.  If the safe harbor is based on the matching formula, then the missed elective deferral is deemed to be the greater of 3% or the maximum deferral percentage for which the plan provides a matching contribution. 

Failure to Obtain Spousal Consent 

If a plan that is subject to the qualified joint and survivor annuity rules failed to obtain the necessary spousal consent, under the prior version of EPCRS the plan sponsor could seek to obtain spousal consent, or have the participant repay the distribution and receive a qualified joint and survivor annuity.  The new EPCRS provides an additional correction method.  If the plan cannot obtain spousal consent, the plan may offer the spouse the choice between a survivor annuity benefit or a single-sum payment equal to the actuarial present value of that survivor annuity benefit. 

Other Issues Covered under the New EPCRS 

The new EPCRS also includes: (i) an updated schedule of user fees, (ii) a streamlined procedure for certain failures to adopt required amendments on time, (iii) guidance on the availability of VCP and Audit CAP to ‘orphan’ plans, (iv) waiver of excise tax in certain scenarios, (v) guidance on determination letter requirements, and (vi) guidance on correcting abusive tax avoidance transactions. 

Effective Date 

Revenue Procedure 2006-27 was released on May 5, 2006 and generally becomes effective September 1, 2006, with certain provisions effective May 30, 2006. Prior to September 1, 2006, plan sponsors may elect to follow the new EPCRS under Revenue Procedure 2006-27.

If you have any questions regarding this alert or other Employee Benefits Law related issues, please contact one of our Employee Benefits attorneys.

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