Legal Bulletins

Sponsors of retirement plans face a myriad of complex and ever-changing rules pertaining to their plans. The traditional way in which the Internal Revenue Service has enforced these rules has been through the threat of audit with the ultimate sanction of plan disqualification. However, when violations have been found during an audit, the IRS has been reluctant to disqualify a plan because of the negative consequences disqualification would have on rank-and-file employees.

For these reasons, starting in the 1990's, the IRS began developing a more practical approach to plan compliance through programs designed to provide plan sponsors with an incentive to correct problems on their own, and imposing stiff penalties, short of plan disqualification, when IRS audits uncover problems that have not been corrected. Over time, the IRS has fine-tuned these voluntary correction programs to make them more sponsor-friendly. For example, the IRS has identified a number of common plan errors and has described acceptable correction methods for those errors.

Sometimes the best alternative for an employer confronted with a retirement plan problem is to do nothing and risk an IRS audit. However, many problems can be resolved through the IRS correction program with limited risk and minimal expense.

The IRS Employee Plans Compliance Resolution System ("EPCRS"), consists of three separate programs.

The Self-Correction Program ("SCP"), allows sponsors to correct certain "operational failures" without even notifying the IRS or paying any fee. An "operational failure" is one that arises from the failure to follow plan provisions. The ability to use SCP depends on whether the operational failure is "insignificant" or "significant." If the failure is insignificant, it can be corrected at any time. If it is significant, it must be corrected by the last day of the second plan year following the plan year in which it occurred (not the plan year in which it was discovered). The IRS guidance provides that whether a failure is significant or insignificant is a "facts and circumstances" determination. The guidance lists several factors that the IRS considers relevant in making that determination. Although SCP is available for a wide variety of plan violations, it is not available for "egregious" violations.

The second EPCRS program, the Voluntary Correction Program ("VCP"), allows sponsors to notify the IRS of plan violations, propose a correction method, and receive IRS approval of the correction. If the sponsor complies with the IRS-approved correction method within a certain period of time, the IRS will not take further action against the plan for the identified problem. VCP is generally used when correction is unavailable under SCP (e.g., because it is too late to fix a "significant" operational failure or because the failure is "egregious").

VCP is available not only for "operational failures," but also for "demographic" and "plan document" failures. A "demographic failure" is a failure to comply with nondiscrimination or minimum coverage rules, while a "plan document failure" is either a plan provision (or the absence of a plan provision) that violates the tax rules or a plan that has not been timely amended under IRS deadlines. A sponsor using VCP must make a formal submission with the IRS and pay a fee ranging from $750 to $25,000 depending on the number of participants. The IRS has generally been flexible in approving the VCP filer's proposed correction method. However, there is always a risk that the IRS will insist on a correction that is unacceptable to the VCP filer. In that case, the VCP fee will be forfeited and the IRS may refer the case for further examination.

The third program under EPCRS is the Correction on Audit Program ("Audit CAP"). If the IRS audits a plan and discovers a defect, Audit CAP allows the sponsor to correct the defect and pay a negotiated penalty (generally much higher than any VCP fee) without having the plan disqualified.

Other governmental agencies have taken their cue from the IRS and established correction programs. The Department of Labor has two such programs. The first is the Voluntary Fiduciary Correction Program ("VFCP"), which allows a plan fiduciary to receive DOL approval for correction of certain breaches of fiduciary duty (e.g., delinquent transmittal of participant contributions to the plan trust and certain prohibited transactions). The second is the Delinquent Filer Voluntary Correction program ("DFVC"), which allows retirement and welfare plan sponsors who fail to file timely annual reports (Form 5500) to voluntarily file those reports and pay reduced penalties. Finally, the Pension Benefit Guaranty Corporation has established a voluntary correction program for defined benefit plan sponsors who fail to provide a timely notice of the plan's under-funded status to participants.