United States: IRS Updates Voluntary Correction Program for Retirement Plans

On May 5, 2006, the Internal Revenue Service ("IRS") issued Revenue Procedure 2006-27, which updates and expands the IRS’s voluntary correction program under which sponsors of tax-qualified retirement plans can correct certain errors without losing tax-qualification status. The updated correction program, known as the Employee Plans Compliance Resolution System ("EPCRS"), allows for greater ease of use and more flexibility in the correction process, especially with regard to correcting the most common qualified plan errors, such as plan loan errors and mistakenly excluded employees.

Revenue Procedure 2006-27 generally becomes effective September 1, 2006, although some rules become effective May 30, 2006 and plan sponsors may apply any of the revised procedures as of May 30, 2006.

EPCRS allows sponsors of tax-favored retirement plans to correct certain operational, plan document, demographic, and employer eligibility errors. By voluntarily correcting under EPCRS, plan sponsors can correct the errors without losing tax-favored status, and in some cases, the IRS need not even be informed of the error and correction. EPCRS offers a graduated series of fees and sanctions as further incentive for plan sponsors to timely correct failures. The limited fees provided under EPCRS are predictable, thus reducing uncertainty about potential tax liability for both plan sponsors and participants.

EPCRS consists of three correction program components: the Self-Correction Program ("SCP"), the Voluntary Correction Program ("VCP"), and the Audit Closing Agreement Program ("Audit CAP"). Failures in a qualified plan, a 403(b) plan, SEP or SIMPLE IRA plan may be corrected under one or more of these programs.

• SCP may be used only for correction of operational failures. With respect to qualified plans and 403(b) plans, SCP is generally available to correct both significant and insignificant operational failures; with respect to SEPs and SIMPLE IRA plans, SCP may be used to correct insignificant operational failures only. Corrections made in accordance with SCP procedures generally do not require IRS notification or payment of any fee or sanction.

• VCP provides general procedures for correction of all plan qualification failures, and may be used to correct plan failures at any time before an audit. Plan sponsors must submit an application to the IRS for approval, accompanied by the specified correction fee. Special procedures exist under VCP for anonymous submissions and group submissions.

• Audit CAP is available for correction of any plan failure that has not been corrected under SCP or VCP, and has been identified on IRS audit. The correction will require payment of a sanction based on the nature, extent and severity of the failure being corrected.

Plan sponsors who do not voluntarily correct plan failures under EPCRS may lose tax-favored status for their plans, or pay a significant sanction under Audit CAP, if the problems are discovered upon IRS audit.

Revenue Procedure 2006-27 revises EPCRS in a number of substantive and procedural ways. One important point emphasized in the new rules is that EPCRS is not available to correct plan failures in cases where either the plan or the plan sponsor have been a party to an abusive tax avoidance transaction ("ATAT") and the plan failure is directly or indirectly related to the ATAT. VCP submissions are now required to disclose any ATATs to which the plan or plan sponsor has been a party, whether or not it was related to the plan, and while ATATs that are not related to the failure will not prevent a VCP correction, they may result in a referral of the plan for audit.

Key changes were made to correction methods for the following plan failures:

• Plan Loan Failures – The revised EPCRS includes correction methods for plan loan errors timely corrected through VCP, where none had existed before. Under the new rules, the participant in receipt of the plan loan must pay the corrective amount, with the employer paying any portion representing additional interest.

• Plan loans in violation of IRC provisions relating to maximum amounts that may be borrowed may be corrected by repaying the excess amount and reamortizing the remaining balance over the remaining loan period.
• Plan loans in violation of IRC provisions relating to maximum loan terms and level amortization requirements may be corrected by reamortizing the loan balance over a compliant loan term.
• Defaults on plan loans may be corrected by either making a lump-sum payment of the missed loan repayments, by reamortizing the outstanding loan balance, or by a combination of both.
• Plan loan failures that otherwise would be treated as deemed distributions need not be reported on Form 1099-R, if corrected.
• Plans that contain no provisions permitting participant loans but that allow plan loans in operation may be corrected by a retroactive plan amendment.

• Exclusion of Otherwise Eligible Employees – The correction method for plans that have erroneously excluded an eligible employee from a 401(k) plan is revised to reduce the amount of the replacement qualified nonelective contributions ("QNEC") that the plan sponsor must contribute for missed deferrals and for missed after-tax contributions. Additionally, correction methods are established for safe harbor plans.

• Spousal Consent Errors – The revised EPCRS provides an alternative correction method for plans that allow distribution in the form of a spousal survivor annuity but failed to obtain spousal consent with respect to a different form of benefit elected by a participant. Plan sponsors may offer the spouse a choice between the existing correction method, which is a survivor annuity, and the new alternative, which is a lump-sum payment equal to the survivor annuity’s actuarial present value.

• Failure to Timely Amend for Changes to the Law – Plans that have failed to timely adopt good-faith amendments for EGTRRA, conform to minimum distribution rules under Section 401(a)(9) of the Internal Revenue Code, or adopt interim amendments required for changes to the law related to the new 5-year remedial amendment cycle rules, may now correct these errors in a more streamlined and less expensive manner, by submitting a greatly simplified VCP submission and a $375 fee for each year of failure. Only plans that are not under audit and plans and plan sponsors that have not been a party to an ATAT may take advantage of this relief.

• Non-amender Fee Schedule – A plan that has failed to timely amend for changes to the law and is discovered by the IRS during a review for a determination letter may be corrected under Audit CAP. Fees for such correction depend on plan size and on which law was overlooked. A fee schedule that has been in place unofficially will be formally incorporated into EPCRS, effective May 30, 2006. The fees are higher if the non-amender failure is discovered in audit, instead of during the determination letter review process.

Other noteworthy revisions include:

• Expansion of VCP and Audit CAP to terminating abandoned plans and, in appropriate circumstances, excepting such plans from the full correction requirement and permitting a waiver of the VCP fee;

• Treatment of a plan that corrects failures in accordance with the requirements of EPCRS as having satisfied qualification requirements for purposes of the FICA and FUTA taxes;

• Revision of requirements for submitting a determination letter application when correcting certain qualification failures by plan amendment;

• Clarification of submission procedures for anonymous and group submissions under VCP; and

• Reduction of the general compliance fee for SEPs and SIMPLE IRAs, and specified reduction of the compliance fee for a plan where the sole failure is the failure to satisfy the minimum distribution rules for 50 or fewer employees.

The IRS expects to update the EPCRS revenue procedure from time to time, and has invited the public to comment on and suggest improvements to the system.

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Revenue Procedure 2006-27

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