In a tight labor market, a 401(k) plan (or other tax-favored retirement plan such as a 403(b) plan) is not really viewed as optional for most employers. And in a growing number of states, some sort of retirement plan must be offered by employers (e.g., the CalSavers law in California). But 401(k) plans are complicated pieces of machinery, with many moving parts and many ways to break down. The risk of making a mistake, even an inadvertent mistake, is high. The potential costs of that mistake (plan disqualification) are even higher.
To its credit, the Internal Revenue Service has offered some form of voluntary correction program since at least 1996 and has continually updated and improved the opportunities for self-correction. However, the now well-known Employee Plans Compliance Resolution System (“EPCRS”) (Revenue Procedure 2021-30), which often required a filing with the IRS to implement a correction, became a victim of its own success with long waiting periods (1-2 years being not unusual) to get a compliance statement. For many plan sponsors, the requirement to file a VCP application for a known error and method of correction that fell just outside of the relatively short window of time for self-correction just seemed like a high price to pay to offer a tax-qualified plan.
Under Secure 2.0, the opportunities to self-correct “inadvertent” errors in both qualified plans (and now also IRA based plans) have now been expanded. The new Secure 2.0 legislation is thousands of pages long and uses the word “inadvertent” just 17 times – 15 of those references are found in the new rules for correcting plan errors and overpayments. For more information on the new rules for correcting overpayments, see Secure 2.0 Makes Big Changes to Recoupment of Overpayments.
Self-Correction Under Secure 2.0
Let’s unpack this: section 305 of the Secure Act 2.0 provides generally as follows:
· Except as otherwise provided in the Internal Revenue Code of 1986, regulations, or other guidance of general applicability prescribed by the Secretary of the Treasury (emphasis added);
· Any eligible inadvertent failure to comply with the rules applicable under section 401(a), 403(a), 403(b), 408(p), or 408(k) 13 of such Code may be self-corrected under Revenue Procedure 2021–30, or any successor ‘‘EPCRS’’ guidance)(emphasis added);
· Self-correction is not available to the extent that (1) such failure was identified by the Secretary prior to any actions which demonstrate a specific commitment to implement a self-correction with respect to such failure, or (2) the self-correction is not completed within a reasonable period after such failure is identified;
· For purposes of self-correction of an eligible inadvertent failure, the correction period is indefinite and has no last day, other than with respect to failures identified by the Secretary prior to any actions which demonstrate a specific commitment to implement a self-correction with respect to such failure, or with respect to a self-correction that is not completed within a reasonable period, as described in the preceding sentence.
So, what is an “eligible inadvertent failure”? Secure 2.0 answers that question as follows: except for any failure which is egregious, relates to the diversion or misuse of plan assets, or is directly or indirectly related to an abusive tax avoidance transaction, the term ‘‘eligible inadvertent failure’’ means a failure that occurs despite the existence of practices and procedures which— (A) satisfy the standards set forth in section 4.04 of Revenue Procedure 2021–30 (or any successor guidance), or (B) satisfy similar standards in the case of an individual retirement plan. Section 4.04 of Revenue Procedure 2021-30 requires that the plan have established practices and procedures (formal or informal) reasonably designed to promote and facilitate overall compliance in form and operation with applicable Code requirements and these established procedures must have been in place and routinely followed.
Secure 2.0 also adds specific opportunities to self-correct loan and other failures.
What does this mean for plan corrections going forward?
· First, Secure 2.0 offers the IRS the opportunity to carve out certain failures from self-correction through regulatory or other guidance. Until that guidance is issued, the industry can only speculate about what is or is not covered by Secure 2.0’s new self-correction rules.
· Second, it is not clear what is meant by “actions which demonstrate a specific commitment to implement a self-correction” with respect to such failure, or (2) what is a “reasonable period” to implement such correction after a failure is identified.
· Third, it has never been clear what level of established practices and procedures (formal or informal) satisfies Section 4.04 of Revenue Procedure 2021-30 (or its predecessors).
· Finally, it is not clear what types of failures are “egregious.”
In several sections of Secure 2.0, Congress specifically directed the IRS to issue guidance. This includes guidance about correction methods for inadvertent failures as well as a rewrite of Revenue Procedure 2021-30 within the next 2 years. Hopefully, the IRS and Treasury will issue at least some soft guidance promptly and additional guidance as they are able. Absent that guidance, plan sponsors will want to carefully assess the risks and benefits of self-correction and may still file an application for a compliance statement under the voluntary correction program (“VCP”) where more certainty is needed. In the meantime, another possibility is to take a fix now, possibly file later approach, by implementing and documenting eligibility for and the adequacy of a self-correction (perhaps supported by an opinion of counsel) but calendaring a reconsideration of that approach once guidance is issued and some of the above issues are hopefully cleared up.
Secure 2.0 has opened up both new opportunities and new challenges in the self-correction of failures in tax-qualified retirement plans. We will discuss these issues in more detail in our upcoming webinar on this topic: Secure 2.0 Corrections - EPCRS/Overpayments Thursday, April 27, 2023, from 11:00am to 12:00pm. Register by clicking the button below.