Plan Sponsors (and advisors) beware - the IRS continues to signal an increased focus on good internal controls, especially with respect to plan document compliance and responsiveness to document production requests. As discussed below, plan sponsors can take a few simple steps now to review and adjust their own internal policies and processes to mitigate these risks.
Qualified retirement plans such as 401(k) plans must navigate a dizzying myriad of rules and regulations to maintain their tax favored and tax exempt status, including (but not limited to), having and following an up-to-date plan document. Because nearly every plan fails in some way to attain the level of perfection required by the law, the Internal Revenue Service offers plan sponsors the opportunity to “voluntarily correct” certain compliance errors through its “Employee Plans Compliance Resolution System (“EPCRS”) at a reduced cost (as compared to the cost of plan disqualification¹ ). The IRS regularly updates the EPCRS system, in some cases expanding the availability of corrections and in others, contracting them. The IRS also just publicly announced tougher enforcement guidelines for document requests for plans under audit.
The Good News
Revenue Procedure 2016-51 updates the EPCRS system to account for the elimination of the favorable determination letter program that took effect earlier this year. It also incorporates the less restrictive correction methods for overpayments and elective deferral failures that were each announced earlier this year and specifically clarifies that there is flexibility in recovering overpayments from plan participants in certain cases. (Some plan sponsors apparently incorrectly believed that EPCRS required collection efforts against poor, elderly widows, etc.)
The Bad News (and some further good news)
First, the bad news: although the changes that take effect to the EPCRS system on January 1 are mostly technical and favorable, there are a few surprises buried in the new Revenue Procedure’s 56,000+ words. They include the following:
a.Elimination of self-correction as an option for “egregious failures”
2. VCP Changes:
a. Elimination of a combined VCP as a method of obtaining approval of plan document language changes
b. Elimination of the 50% refund in a withdrawn “John Doe” VCP
3. Audit CAP Changes:
Elimination of the Maximum Payment Amount (an approximation of the tax that could be collected if a plan were disqualified) as the primary factor in negotiating the sanction under Audit CAP
Addition of new factors for consideration in the negotiation of document failures under Audit Cap including:
i. whether the plan is the subject of a favorable IRS letter;
ii. the internal controls implemented by the Plan Sponsor to ensure the timely adoption of required amendments;
iii. the extent to which the Plan Sponsor had adopted a timely plan amendment which later is found not to satisfy the qualification requirements of the Code;
iv. the extent to which the Plan Sponsor had otherwise adopted applicable amendments published annually by the IRS; and
v. the extent to which the Plan Sponsor had reasonably determined that a provision on its required amendments list was not applicable to the plan.
c. Adding the tax that could be collected on defaulted loans to the Maximum Payment Amount in Audit CAP.
d. Changing the method of determining the sanction for plan document failures found through the determination letter process.
4. Imposing a new sanction on certain SEP or SIMPLE Plan failures.
And, a little more bad news– document requests will be strictly enforced. In addition to the recent changes to EPCRS, the IRS also just updated its own internal enforcement procedures to require very prompt plan sponsor responses to document requests during audits and examinations. Although extensions of the time required to produce documents can be granted under the new regime, these will be much more limited and less discretionary than in the past. Failure to produce the documents requested in a timely manner will result in an IRS summons.
But, there is some good news -for most plan sponsors, a few simple steps can help. These include the following:
1. Locate and organize your plan documents. Although it sounds simple, this is often the first step we help clients with when we are first retained. Plan documents can be complex, with multiple interrelated components (adoption agreements, base plan documents, IRS opinion letters, amendments and summary plan descriptions.) For plans other than very new plans, there should be multiple versions as laws have changed necessitating plan restatements. Copies should be signed and timely adopted.
2. Double-check your plan’s document compliance. The burden of proof is nearly always on the taxpayer. Even if you “think” your plan is compliant, given the IRS’s new focus, it would be wise to have your document compliance reviewed by an expert. Even in large, “well-run” companies, document compliance is a problem, sometimes merely because no one can find signed copies of the plan documents that once existed and sometimes because they never existed. Be sure the “expert” you are relying on for this purpose is giving you an opinion on which you can rely (hint – check your service agreement).
3. Create a policy/procedure/process/internal control to keep your plan document compliant. At a minimum, there needs to be an annual review, but in some cases, plan amendments must be adopted mid-year, so it is important to be aware of the types of changes and situations that can require mid-year amendments and act accordingly. See, e.g., the article below regarding year-end deadlines.
4. Follow the policy/procedure/process/internal control that you created in Step 3above. Part of the policy needs to be a method to confirm the policy is being followed, e.g. an annual report to the plan committee.
5. Review your plan design against plan operations. Failure to follow the terms of a perfect document is itself a disqualifying failure.
6. Address document issues and other potential operational failures as soon as you become aware of them. The sooner a problem is addressed, the more likely it can be self-corrected, the less likely the plan is to be under examination and the less it likely will cost.
See Revenue Procedure 2016-51 (https://www.irs.gov/pub/irs-drop/rp-16-51.pdf) (effective January 1, 2017) and the recent IRS announcement found here https://www.irs.gov/pub/foia/ig/spder/tege-04-1116-0028.pdf (effective April 1, 2017) or contact us for more information.
© Boutwell Fay LLP 2016, All Rights Reserved. This handout is for information purposes only, and may constitute attorney advertising. It should not be construed as legal advice and does not create an attorney-client relationship. If you have questions or would like our advice with respect to any of this information, please contact us. The information contained in this article is effective as of November 30, 2016.