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By Katie M. Rak, Robert B. Wynne, and Jeffrey R. Capwell
McGuireWoods, Chicago, IL, Richmond, VA and Charlotte, NC, respectively
The IRS recently issued important updates to its Employee Plans Compliance Resolution System (EPCRS). The updates are contained in Rev. Proc. 2015-27 and Rev. Proc. 2015-28.
EPCRS allows sponsors and administrators of tax-qualified retirement plans and certain other plans, such as §403(b) plans, to correct certain documentary and operational errors that occur as to such plans and thereby preserve the tax-advantaged status of those plans. This BNA Insight highlights the more important modifications made by the revenue procedures and discusses the impact of these modifications on retirement plan sponsors.
Correction of Overpayment Errors
Rev. Proc. 2015-27 clarifies the methods available to correct an overpayment error. Overpayments generally occur when a participant or beneficiary receives a distribution from the plan that exceeds the amount that properly should have been paid to that participant or beneficiary. Previously, correction of an overpayment required the plan sponsor "to take reasonable steps to have the Overpayment returned to the plan." Some plan sponsors have been interpreting that language as requiring that they demand recoupment from the recipient of the full amount of the overpayment. The IRS apparently does not want to encourage strict recoupment actions, particularly in cases where recoupment would cause financial hardship for affected participants and beneficiaries, because overpayment typically results from errors in plan administration for which the participant or beneficiary bore no responsibility.
The new guidelines on overpayment provide greater flexibility by acknowledging that a demand for repayment is not required in all circumstances. As modified by Rev. Proc. 2015-27, EPCRS now provides alternative methods for correcting an overpayment. For example, in lieu of asking for repayment, an employer or another person might make a contribution to the affected plan equal to the amount of the overpayment, plus interest. In addition, correction may in certain cases be accomplished by the plan sponsor adopting a retroactive plan amendment that conforms the plan's language to the manner in which payments were administered. Other correction methods also may be used, provided that they are consistent with the general correction principles for EPCRS.
The IRS has requested comments on whether further modifications should be made to these new guidelines on overpayments. The IRS is interested in whether, and under what circumstances and conditions, correction should require the plan sponsor to make corrective contributions rather than recouping prior overpayments from participants and beneficiaries, and whether there are any unusual circumstances in which full corrective payments to the plan should not be required for overpayments.
Extension of Time to Self-Correct Excess Annual Contributions
Section 415(c) limits the total amount of "annual addition" (principally contributions and forfeiture allocations) that can be allocated annually to a participant's account in a defined contribution plan ($53,000 in 2015). Any excess annual addition can be self-corrected under EPCRS if the plan has established practices and procedures to prevent recurrence.
Rev. Proc. 2015-27 modifies EPCRS to make it clear that a plan meets this condition for self-correction so long as the excess annual contributions for a year are "regularly corrected" by returning elective deferrals to affected participants within 9 1/2 months (previously 2 1/2 months) after the end of the year to which the contributions relate.
Lower Filing Fee for Plan Loan Errors
Errors in structuring or administering loans to participants from their plan account balances can be burdensome to correct because EPCRS generally requires that correction of the faulty loan be made through a filing with the IRS under the Voluntary Correction Program (VCP) in order for the loan not to be treated as a taxable distribution. Under prior rules, the fee for a VCP filing to correct a loan error generally was based on the number of participants in the plan. Thus, a large plan with only a few faulty loans would be required to pay a large filing fee to fix a relatively small error.
Rev. Proc. 2015-17 modifies the filing fee for plans using VCP to correct loan errors by basing the filing fee solely on the number of affected participants. For example, under prior VCP guidelines, a sponsor of a 1,200-participant plan for which the only failure was a plan loan error that affected 45 participants would have been required to pay a fee of $7,500. Under the new fee schedule, the sponsor of that plan would pay a filing fee of only $600.
Correction of Elective Deferral Errors
The second new revenue procedure, Rev. Proc. 2015-28, modifies EPCRS to provide three new safe-harbor correction methods for errors relating to employee elective deferrals in §401(k) and §403(b) plans. These errors (Deferral Errors) include not implementing elective deferrals pursuant to an affirmative election or pursuant to an automatic contribution feature (including an automatic escalation feature) and not affording an employee the opportunity to make an affirmative election because the employee was improperly excluded from the plan.
The new safe-harbor correction methods are intended to respond to concerns that employers are not implementing automatic contribution features because administrative errors often are more common in plans with such features and such errors typically are not discovered until preparation of the Form 5500 annual report. Rev. Proc. 2015-28 also reflects the IRS's response to comments that current EPCRS safe-harbor correction methods for the exclusion of eligible employees, and for failing to implement a salary reduction election, create a windfall for affected employees because under current EPCRS rules such employees receive both their full salary and a 50% corrective contribution.
Deferral Errors Relating to Automatic Contribution Features
If the Deferral Error is the failure to implement an automatic contribution feature for an affected eligible employee, or the failure to implement an affirmative election of an eligible employee who is otherwise subject to an automatic contribution feature, and the error does not extend beyond the end of the 9 1/2-month period after the end of the plan year of the error (generally, the filing deadline for the Form 5500, including automatic extensions), no qualified nonelective contributions (QNECs) are required to be contributed to the plan to correct the error under EPCRS if the following requirements are satisfied:
This correction method also provides an alternative safe-harbor method for calculating earnings. If an affected eligible employee has not affirmatively designated an investment alternative, earnings on the missed contributions may be calculated based on the plan's default investment alternative. However, any cumulative losses reflected in the earnings calculation will not result in a reduction in the required corrective contribution relating to any matching contributions.
This correction method is available only for plans with Deferral Errors relating to automatic contribution features that begin before 2021. The IRS will consider whether to extend this correction method for Deferral Errors beginning in later years. In deciding whether to extend this correction method, the IRS will take into account, among other relevant factors, the extent to which there is an increase in the number of plans implemented with automatic contribution features.
Deferral Errors That Do Not Exceed Three Months
If a Deferral Error occurs for a period that does not exceed three months, no QNECs are required to be contributed to the plan to correct the error under EPCRS if the following requirements are satisfied:
Deferral Errors That Extend Beyond Three Months
If the period of a Deferral Error exceeds three months, but does not extend beyond the last day of the second plan year following the year in which the error occurred (or the conditions for the other safe-harbor correction methods described above are not met), a plan sponsor may correct the error under EPCRS by making contributions equal to 25% of the missed deferral in lieu of the higher QNEC if the following requirements are satisfied:
Other Changes to EPCRS
Rev. Proc. 2015-27 includes a number of other, more limited changes and clarifications to EPCRS. These include expanding eligibility for reduced VCP filing fees if the sole error is to timely pay required minimum distributions; exempting sponsors from having to file determination letter applications in certain cases when correction will be accomplished through adoption of a plan amendment; and extending the period for adopting corrective plan amendments in situations where a determination letter application is required to be filed concurrently with the VCP application. There are also updates to the forms for certain VCP submissions.
Implications and Considerations for Plan Sponsors
The changes to the EPCRS program described above are, on the whole, quite helpful. They not only provide a greater degree of flexibility in structuring corrections, but they also alleviate some of the burdens inherent in certain previously required correction methods. For example, changes to the guidelines for correcting errors in participant loans will in many cases make it much less expensive to correct those errors.
In light of the significant administrative resources that the IRS has invested in the EPCRS program, plan sponsors should be mindful that failure to correct known plan qualification errors using EPCRS comes at the risk of more expensive sanctions if those errors are later identified in an IRS examination of the plan.
For further information, please contact any of the authors, Katie M. Rak, Robert B. Wynne and Jeffrey R. Capwell, or any other member of McGuireWoods' employee benefits team.
For more information, in the Tax Management Portfolios, see Wagner, Bianchi and Cohen, 375 T.M., EPCRS — Plan Correction and Disqualification, and in Tax Practice Series, see ¶5520, Plan Qualification Requirements; ¶5540, Obtaining IRS Approval for Qualified Plans.
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