In Part 1 of this article (see To VCP or Not to VCP? Part 1 in Benefits News, April 2017) we discussed the importance of correcting qualified plan failures as soon as practicable. When correcting a qualified plan failure under EPCRS, plan sponsors may have more than one option, with the primary options being: self-correction (“SCP”) or voluntary correction with IRS approval (“VCP”). This article discusses the considerations of using either SCP or VCP.
Limitations of Self-Correction
If a plan meets the basic eligibility requirements for SCP (see Self-Correction of Operational Defects in a Qualified Retirement Plan, August 2016), the plan sponsor will also need to consider the following limitations under SCP:
Limitations on Timing: Insignificant failures can be self-corrected at any time. If a failure, or a series of failures, is not insignificant, SCP is only available if the correction is made within a limited period. That limited period generally ends on the last day of the second plan year following the plan year in which the failure occurred. For example, if a calendar year plan experienced a significant failure in April 2015, the last day to correct that failure under SCP would be December 31, 2017. For a more detailed discussion of the eligibility requirements for SCP and what factors are used to determine if a failure is significant or insignificant, see our previous article on this topic at the link provided above.
No Retroactive Plan Amendments: When correcting a qualification failure, in some instances a retroactive amendment is either the required correction (such as where the defect is the timely adoption of required amendments to the plan) or the desired correction (such as when the plan was not operated according to its written terms but there is documentation establishing that the operation of the plan was consistent with the plan sponsor’s intent and the participants’ understanding). With very limited exceptions, correction by retroactive amendments under SCP is not permitted.
Limited to Failures and Corrections Described in the Latest Revenue Procedure: When correcting under SCP, the IRS will not be issuing a compliance statement – the plan sponsor is taking the risk that the correction is either not eligible for SCP or is not properly corrected. However, the IRS does publish certain “safe harbor” correction methods that can be used when correcting under either SCP or VCP (see, e.g. Rev. Proc. 2016-51). The more creative or customized the correction method used, the higher the risk that the correction is not sufficient to satisfy the requirements of EPCRS.
Note – even if a failure is eligible for SCP, VCP is still always available for confirmation of the correction. A risk-averse plan sponsor may want to consider a VCP submission for peace of mind or other reasons (e.g., the plan sponsor is publicly traded).
Advantages of Filing a VCP
There are several advantages to filing a VCP:
Cost: VCP provides a fixed filing fee, based upon the number of participants in the plan, and there is no penalty to negotiate the actual correction. While there are additional upfront costs such as the cost of legal advice and/or tpa or recordkeeper fees to prepare the submission, the IRS position is that when negotiating a sanction in an audit, the sanction should be more than the costs of filing a VCP and in nearly all cases the costs of the VCP will be much lower than the cost of plan disqualification (see 401(k) Retirement Plan Disqualification, June 2016.)
Insurance Coverage: Fiduciary or other liability policies may cover some of the costs of a VCP, such as the VCP fee. If an error is discovered, it is important for a plan sponsor to promptly review all applicable policies and be aware of the conditions for coverage of the costs of a VCP. Frequently these policies require the plan sponsor to report the potential claim within a short time frame following its discovery.
Flexibility: When filing a VCP submission, a plan sponsor may propose and negotiate a creative correction method that may be different than the published correction method, or obtain IRS approval for simplifying assumptions and earnings calculation methods.
Special Situations: Similarly, special situations can also be handled under VCP, where there is some ability to negotiate special circumstances such as business hardship, loss or unavailability of plan records or unreasonableness of full correction.
Retroactive Amendments: While retroactive amendments are sometimes the required correction and can only be corrected under VCP, there are also situations where documents demonstrate that the intentions of a plan sponsor and the understanding of plan participants are both contrary to a plan term but consistent with the operation of the plan. Retroactive amendments may be permitted under VCP, potentially eliminating or reducing the need for corrective contributions from the plan sponsor.
Audit Protection: Once a plan receives a compliance statement from the IRS, the plan has audit protection on the failures covered by the compliance statement. In addition, unless the VCP was filed anonymously (see Part I of this article for more information on anonymous submissions), that audit protection applies as soon as the VCP is filed (assuming a compliance statement is eventually issued).
Disadvantages of Filing a VCP
The primary disadvantages of filing a VCP are:
Costs. Filing a VCP requires payment of a user fee and plan sponsors also incur the cost of preparing and filing of the submission (however much of the same documentation and effort is required for SCP, as the plan sponsor and its advisors must still calculate the error and correction and document that the correction was made)
Time. IRS often takes 6 months to a year from the filing date to respond to a VCP. Negotiations can then continue over an extended period before a compliance statement is issued.
Failure to agree. Although rare, there may be situations where no agreement can be reached with the IRS and for this reason, a worst-case scenario should always be analyzed and prepared for before a VCP is filed. If a plan sponsor finds a worst-case scenario unacceptable, an anonymous filing can be considered.
There is much to consider when deciding how to correct a qualified plan failure, and in many cases self-correction is the right choice. Each situation must be carefully reviewed before making a business decision, considering the facts and circumstances of the failure and the plan sponsor, as well as the options available.
If you are dealing with a qualification failure and would like assistance with determining how best to correct the situation, the attorneys of Boutwell Fay have significant experience in this area and are available to help you.
© Boutwell Fay LLP 2017, 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 June 30, 2017.