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Self-Correcting Qualified Retirement and 403(b) Plan Mistakes: New IRS Procedures and Guidance for Plan SponsorsNew IRS Rev. Proc. 2019-19 and 2018-52: Challenges and Opportunities Under the Employment Plans Compliance Resolution System

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TUESDAY, JULY 9, 2019

Presenting a live 90-minute webinar with interactive Q&A

Mark E. Bokert, Partner/Co-Chair, Davis & Gilbert, New York

T. Katuri Kaye, Director, Trucker Huss, San Francisco

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A P R O F E S S I O N A L C O R P O R A T I O N

ERISA AND EMPLOYEE BENEFITS ATTORNEYS

Presented by:

T. Katuri Kaye

Mark E. Bokert

July 9, 2019

Self-Correcting Qualified Retirement and 403(b) Plan Mistakes: New IRS Procedures and Guidance for Plan Sponsors

© Copyright Trucker Huss, APC | One Embarcadero Center, 12th Floor, San Francisco, California 94111 Telephone: 415-788-3111 | Facsimile: 415-421-2017 | www.truckerhuss.com

A P R O F E S S I O N A L C O R P O R A T I O N

ERISA AND EMPLOYEE BENEFITS ATTORNEYS

OUTLINE

I. EPCRS Overview

II. SCP Overview and Expansion under Updated EPCRS

III. Case Studies

IV. SCP Best Practices for ERISA Practitioners


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I. THE EMPLOYEE PLANS COMPLIANCE RESOLUTIONS SYSTEM

(EPCRS)


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EPCRS

A tax-qualified retirement plan or 403(b) plan must satisfy requirements set forth in the Internal Revenue Code (Code) to qualify for favorable tax treatment

A plan that fails in this regard is said to have incurred a “disqualifying defect”


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EPCRS

The Employee Plans Compliance Resolution System (EPCRS) is an Internal Revenue Service (IRS) program that allows retirement plan sponsors to correct disqualifying defects with respect to their retirement plans

Most recent version: Revenue Procedure 2019-19 (https://www.irs.gov/pub/irs-drop/rp-19-19.pdf)

> Became effective on April 19, 2019

> Restates the rules of previous versions of EPCRS

> Significantly expands the types of disqualifying defects that may be corrected under the Self-Correction Program (SCP) component of EPCRS

If a plan sponsor corrects in accordance with EPCRS, the IRS will not treat the plan as failing to meet the qualification requirements of the Code


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https://www.irs.gov/pub/irs-drop/rp-19-19.pdf

Correction Programs Under EPCRS

Voluntary Correction Program(VCP)

> IRS involvement and must pay fee

> Fix almost anything

> Must do before IRS audit

> Streamlined option

Audit Closing Agreement Program (Audit CAP)

> IRS has caught you

> Can be expensive

> But, better than

disqualification

Self-Correction Program (SCP)

> Free, other than the costs of correction

> No need to file with IRS

> Few guarantees

> Limited to certain types of

defects

In all cases, to avoid disqualification, participants must be made whole


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Qualification Failures under EPCRS

Operational failure:

> Failure to follow the plan’s terms

Plan document failure:

> Plan provision (or lack thereof) that violates the Code

Demographic failure:

> Failure of the Code’s coverage, nondiscrimination, and/or participation requirements (that’s not an operational failure)

Employer eligibility failure:

> Employer not eligible to adopt the plan

• Examples: Government employer can’t establish a 401(k) plan; For-profit entity can’t establish a 403(b) plan


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How Do You Correct under EPCRS?

EPCRS contains pre-approved, safe harbor correction methods

If you use a listed method to correct a listed mistake, you have reliance that it was a valid correction

In absence of a safe harbor correction method, the plan sponsor needs to correct in a reasonable and appropriate manner

> Use the Code, Treasury Regulations, and EPCRS’s general correction principles as a guide

> Correct nondiscrimination testing failures by giving money to non-highly compensated employees (NCHEs)

> Keep the money in the plan rather than reverting to the employer

> Do not create another failure


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Lost Earnings under EPCRS

Corrective contributions, allocations or distributions should be adjusted for earnings

> Don’t have to adjust for losses, but permitted

Methods for determining earnings:

> Generally use actual earnings based on the employees’ investment choices;

> Reasonable estimates of investment returns; or

> If not reasonable to make an estimate, a reasonable interest rate must be used


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Effect of Examination under EPCRS

VCP is not available

SCP is only available to:

> Correct insignificant operational failures while the plan or plan sponsor is under examination

> Complete the correction of significant operational failures that were substantially completed before the plan or plan sponsor was under examination


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EPCRS Practice Tip

General rule: The further you go away from EPCRS’s pre-approved list of safe harbor corrections, the more you want to use VCP (versus SCP)


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II. THE SELF-CORRECTION PROGRAM (SCP)


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SCP

Are you eligible for SCP?

> Applicable to operational failures and certain plan document failures (new modification)

> The plan must have in place (at time of failure) practices and procedures reasonably designed to facilitate overall compliance with the qualified plan rules


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SCP

Are you eligible for SCP?

> Significant failures:

• Must be corrected by end of second plan year after year of the defect, and before notice of an IRS exam

• Must have a favorable determination letter or equivalent

> Insignificant failures:

• Not subject to the 2-year rule or the favorable letter requirements

• May be corrected at any time


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Significant vs. Insignificant Failures under SCP

Significance is determined based on a facts and circumstances analysis

EPCRS lists 7 non-conclusive factors that may be considered in determining that a failure is insignificant

The IRS plans to provide additional examples illustrating whether an operational failure is insignificant (new modification)

> The additional examples will be provided at www.IRS.gov

> It is expected that a link to these examples will appear on the “Correcting Plan Errors” webpage


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http://www.irs.gov/

SCP – What Has Changed?

The availability of self-correction has expanded in the following three areas:

> Operational failures;

> Plan document failures; and

> Plan loan failures


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Operational Failures

A common disqualifying defect is the failure to operate the tax-qualified plan or 403(b) in accordance with its written terms

Such operational failures often times result in participants receiving higher benefits than were called for under the terms of the plan document

Under the prior version of EPCRS, plans could use SCP to correct an operational failure by a plan amendment, in order to conform the terms of the plan to the plan’s prior operations, only with respect to the following types of operational failures:

> 401(a)(17) failures

> Limited hardship distribution failures and plan loan failures

> Early inclusion of otherwise eligible employee failures

(Retro amendment for these three types of failures still available under new version of EPCRS)


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Operational Failures

Under the new version of EPCRS, if the plan sponsor is willing to provide for the higher benefit, operational failures can now generally be corrected with a retroactive conforming amendment through SCP

A retroactive conforming amendment through SCP is only available if:

> The amendment results in an increase in a benefit, right or feature (BRF) under the plan;

> The increased BRF is available to all employees eligible to participate in the plan;

> Providing the increased BRF does not violate any other qualification requirement (such as Code sections 401(a)(4),410(b),411(d)(6), etc.); and

> The correction is permitted under the Code and satisfies the correction principles of EPCRS


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Plan Document Failures

Under the prior version of EPCRS:

> The failure to timely amend a plan document for changes in the law or regulations could only be corrected by filing a VCP application and paying a user fee

> Additionally, if this type of defect was discovered in the context of an IRS audit or a determination letter application review, it could only be corrected if a monetary sanction was paid (unchanged by new version of EPCRS)


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Plan Document Failures

Under the new version of EPCRS:

> Self-correction of a plan document failure under a tax-qualified plan or 403(b) plan is available by retroactively adopting the required amendment, if

• With respect to an individually designed plan, the plan has a favorable determination letter, or

• With respect to a pre-approved plan, the plan has a favorable opinion or advisory letter for the most recently expired 6-year remedial amendment cycle; and

• The corrective amendment is adopted no later than the close of the second plan year following the plan year in which the amendment should have been adopted


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Plan Loan Failures – Defaulted Loans

The new version of EPCRS (similar to the old version of EPCRS) allows for the correction of a plan loan operational error resulting from failure to repay the loan in accordance with the plan’s terms (i.e., a defaulted loan)

Under EPCRS, a deemed taxable distribution may be avoided as long as the defaulted loan is corrected by either:

> Re-amortizing the outstanding loan balance over the remaining period of the loan or by the end of the maximum period under Code section 72(p)(2)(B);

> Making a single corrective “catch-up” payment; or

> A combination of these correction methods

If the default is not corrected in this manner, it is corrected by treating it as a deemed distribution


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Plan Loan Failures – Defaulted Loans

What’s new under the new version of EPCRS?

> A tax-qualified plan or 403(b) plan is now able to self-correct this type of plan loan failure without having to report the failure as a deemed taxable distribution to the participant

• This is significant, because under the old rules, the only way to correct a defaulted loan without tax consequences to the participant was by filing under the VCP and paying a user fee

> Any deemed distribution may be reported and recognized in the participant’s current tax year rather than the year of the original default

• This is significant, because under the old rules, the deemed distribution would have been required to be recognized in the year of the original default unless a VCP filing was made, which included a specific request for current recognition of the deemed distribution


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DOL on Defaulted Plan Loans

The Department of Labor (DOL) takes the position that the failure of a “plan official” to properly withhold “a number of loan repayments” based on administrative or systems processing errors is a breach of fiduciary responsibilities. (See section 7.3(b) of the Voluntary Fiduciary Correction Program (VFCP))

Additionally, the DOL will not issue a no-action letter in the case of a defaulted plan loan unless a VCP filing is made with the IRS and the IRS issues a compliance statement


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Defaulted Loans

Practice tip: Until the DOL changes its position, plan sponsors may still want to consider a VCP filing (and then a subsequent VFCP filing depending on the circumstances and the implications for a fiduciary breach)


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Plan Loan Failures – Spousal Consent

Under the new version of EPCRS, it is now possible to self-correct the failure to obtain spousal consent to a participant loan

Correction is completed by notifying the spouse to whom participant was married at time of the loan and obtaining his or her retroactive consent

If spousal consent is not obtained, then the correction must be effected through negotiation with the IRS (in the context of either a VCP filing or Audit CAP)


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Plan Loan Failures – Excessive Number

Under the new version of EPCRS, a tax-qualified plan or 403(b) plan may now self-correct an operational failure that occurs as a result of permitting a participant to obtain a number of plan loans that exceeds the number permitted by the plan’s terms

SCP is available to adopt a retroactive conforming amendment to the plan to increase the number of loans allowed, provided that the amendment:

> Cannot violate the qualification requirements of Code section 401(a);

> Satisfies the requirements of Code section 72(p); and

> Plan loans (including plan loans in excess of the number permitted under the terms of the plan) must be available to either all participants, or solely to one or more participants who are classified as NHCEs


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III. SCP CASE STUDIES UNDER

EXPANDED EPCRS


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Case Study #1 – Correcting Operational Failures under New SCP Rules

XYZ 401(k) Plan, based on a pre-approved document, has long provided that the definition of compensation for employee deferral purposes excludes certain overtime and commissions pay

In 2018, the XYZ Plan document is restated and the new adoption agreement inadvertently fails to check the box to exclude overtime and commissions pay from compensation

In operation, the employer does not take overtime and commissions pay into account for 401(k) deferral purposes during 2018 and the first two quarters of 2019

In July 2019, the employer discovers that its operation did not match the terms of the XYZ 401(k) Plan during the period of 2018 through June 2019

> Can the resulting operational failure be corrected under SCP?


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Case Study #1 – Correcting Operational Failures under the New SCP Rules

Answer: Maybe

> Are the basic SCP eligibility requirements satisfied?

> Does the addition of overtime and commissions pay represent an increase in a benefit, right or feature (BRF), as contemplated by Section 4.05(2) of Rev. Proc. 2019-19?

> Assuming that it does amount to an increase in a BRF, can it be corrected under SCP if it were subjected to a condition? That is, would the SCP requirement that the increase must apply to all eligible employees be satisfied here?


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Case Study #1 – Correcting Operational Failures under the New SCP Rules

Assuming that the inclusion of overtime and commissions pay in the definition of 401(k) compensation does amount to an increase in a BRF, by what date would the corrective amendment need to be signed?

What should be the effective date of the amendment?

What if instead of failing to check the box to exclude overtime and commissions pay, the restatement document failed to check the box for age 59.5 in-service distributions and/or matching contributions? Would the case for SCP be easier in these situations? Would it make a difference if both operational failures existed at the same time?


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Case Study #2 – Correcting Plan Document Failures under the New SCP Rules

Pre-approved defined contribution plans will begin the updating process for the third pre-approved plan during a 2-year window, which is expected to open in the summer of 2020 and run until the summer of 2022. The third cycle will formally end on January 31, 2023

XYZ Company timely adopted a pre-approved 401(k) plan effective January 1, 2014

The XYZ 401 (k) Plan was timely amended by April 30, 2016 for the second 6-year cycle and is due to be updated for the third cycle during the 2-year restatement window in the summer of 2022

In February of 2023, XYZ Company discovered that it missed the summer 2022 deadline for the third cycle restatement

> Can the resulting plan document failure be corrected under SCP?


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Case Study #2 – Correcting Plan Document Failures under the New SCP Rules

Answer: Unfortunately, No

In order to self-correct a plan document failure under the new SCP rules, a pre- approved plan must have a favorable opinion or advisory letter “... issued with respect to the most recently expired six-year remedial amendment cycle”

As of February 1, 2023, the XYZ 401(k) Plan will no longer have a favorable opinion or advisory letter with respect to the most recently expired cycle

The deadline to self-correct this document failure would have been January 31, 2023

After that date, a VCP filing must be made to correct the plan document failure


36

Case Study #3 – Correcting Plan Loan Failures under the New SCP Rules

Participant A takes a $5,000 loan from her account under the XYZ 403(b) Plan effective April 1, 2019

The loan terms provide for repayment through level amortization payments over a 5-year period (the maximum period under Code section 72(p)(2)(B))

XYZ Non-Profit, Org. mistakenly does not set up payroll withholding to commence her loan repayments

As a result, Participant A’s loan goes into default on October 1, 2019

XYZ Non-Profit, Org. discovers the failure on October 15, 2019

> Can the resulting plan loan failure be corrected under SCP?


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Case Study #3 – Correcting Plan Loan Failures under the New SCP Rules

Answer: Yes

Once discovered, XYZ Non-Profit, Org. must inform Participant A of the failure and her correction options

Here, Participant A consents to re-amortizing the loan over the remainder of the 5-year repayment period (the maximum period under Code section 72(p)(2)(B))

Additionally, XYZ Non-Profit, Org. pays the additional interest that accrued from April 1, 2019 through the date withholding actually commenced (October 31, 2019)

No VCP application is required to avoid treating a properly re-amortized loan as a deemed distribution


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IV. SCP BEST PRACTICES


39

Helpful Hints

How can I maximize protection under SCP?

> On a regular basis (at least annually), employers should review procedures and documentation to determine if there are any potential qualification failures

> If an issue is discovered, correct it as soon as possible

> Use SCP if available for correction of any operational, plan loan and/or plan document failures

> Additional consideration should be given towards self-correcting plan loans vs. going through VCP

> Although the types of failures that may be self-corrected have expanded, the parameters for self-correction mustcontinue to be satisfied


40

Contact

T. Katuri Kaye, Esq.Trucker Huss, APC

15821 Ventura Blvd., Suite 510Los Angeles, CA 91436

(415) 788-3111

[email protected]

www.truckerhuss.com


41


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Disclaimer

These materials have been prepared by Trucker Huss, APC for

informational purposes only and constitute neither legal nor tax advice

Transmission of the information is not intended to create, and receipt does not constitute, an attorney-client relationship

Anyone viewing this presentation should not act upon this information without first seeking professional counsel

In response to IRS rules of practice, we hereby inform you that any federal tax advice contained in this writing, unless specifically stated otherwise, is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding tax-related penalties or (2) promoting, marketing or recommending to another party any tax-related transaction(s) or matter(s) addressed herein

Overview of ERISA Fiduciary Responsibilities

Strafford Webinar

Self-Correcting Qualified Retirement and 403(b) Plan Mistakes:

New IRS Procedures and Guidance for Plan Sponsors

July 9, 2019

Mark E. Bokert

T. Katuri Kaye

VOLUNTARY CORRECTION WITH IRS

APPROVAL (VCP)

A Plan Sponsor, at any time before audit, may pay

a limited fee and receive the IRS's approval for

correction of a Qualified Plan, 403(b) Plan, SEP, or

SIMPLE IRA Plan failure.

» VCP provides general procedures for correction of all

Qualification Failures: Operational, Plan Document,

Demographic, and Employer Eligibility. VCP also available for

the correction of plan loan failures.

Self-Correcting Qualified Retirement and 403(b) Plan Mistakes44

--SIGNIFICANT FAILURES

Generally, VCP is used for the correction of:

» Significant Operational failures (unless you are correcting

before the end of the second plan year following the year in

which the failure occurs, in which case use SCP).

» Plan Document failures that are not eligible for SCP.

» Demographic failures.

» Employer Eligibility failures.


-- PLAN AMENDMENTS

VCP may be used to correct Plan Document,

Demographic, and Operational Failures by plan

amendment:

» This includes correcting an Operational Failure by plan

amendment to conform the terms of the plan with the plan’s

prior operation.

» Any amendment must comply with applicable Code

requirements.


--EGREGIOUS FAILURES

Unlike SCP, VCP is available to correct egregious

failures. However, the IRS reserves the right to

impose a sanction that may be larger than the usual

user fee.

» An egregious failure would include any case in which a plan

sponsor recognized that the action taken would constitute a

failure and either involves a substantial number of participants

or involves participants who are predominantly highly

compensated employees.


--EXCISE TAXES

Some plan failures cause a participant or the plan

sponsor to be liable for an excise tax or additional

taxes. In your VCP submission, you can ask that

the IRS not pursue these taxes. Examples:

» Non-deductible contributions (§ 4972)

» RMD excise tax (§ 4974)

» Excess contributions (§§ 4979, 4973)

» 10% additional tax (§ 72(t))


--USER FEE

VCP fees based on net plan assets (effective for

submissions made on or after January 1, 2019):

Net assets User fee

$0 to $500,000 $1,500

Over $500,000 to $10,000,000 $3,000

Over $10,000,000 $3,500


--CORRECTION PRINCIPLES

The general correction principles that apply to SCP

also apply to VCP:

» Full correction should be made

» Benefits should be restored

» Keep assets in plan

» Provide benefits to NHCEs

» Be consistent with the IRC



The are several exceptions to the full correction

principle:

» Unreasonable or not feasible

» Reasonable estimates are necessary

» Distribution of small amounts ($75 or less)

» Recovery of small overpayments ($100 or less)

» Lost participants

» Small excess allocations ($100 or less)



The EPCRS revenue procedure offers general

guidance on how to correct common failures and

includes details on some correction methods that

are acceptable. Under VCP, you may propose an

alternative correction method if either:

» The EPCRS Rev. Proc. doesn’t describe an approved

correction method for your failure.

» You prefer to use a different correction method that is

reasonable and appropriate.


--NEW PROCEDURES

New procedures apply for VCP applications:

» Applicant creates a pay.gov account.

» If the plan sponsor authorizes an attorney to sign and file the

VCP on its behalf, a cover letter with a signed penalty-of-

perjury declaration must accompany the submission.

» The Form 8950, Application for Voluntary Correction Program

Submission, will now be completed directly on the pay.gov

website.

» Pay the user fee using a credit or debit card or electronically

from a checking or savings account.


--NEW PROCEDURES

New procedures continued:

» All VCP submission documents (model forms, failure

explanations, correction computations, plan documents, etc.)

must be converted into one PDF file and uploaded to pay.gov.

If the file exceeds 15 megabytes in size, the excess must be

faxed to a dedicated IRS VCP fax number.

» After the plan sponsor files a VCP submission, the system

automatically generates a payment confirmation. The

“pay.gov Tracking ID” on the receipt serves as the IRS control

number for the submission. The IRS no longer issues a

separate acknowledgment letter confirming receipt of the

submission.


--IRS REVIEW

IRS will review the failures and correction methods

identified. They will not look for other failures.

» If IRS needs more information, they will contact you.

» If the IRS approves the proposed correction, they will send

you a compliance statement stating that the approved

correction must be completed within 150 days.

» If they do not approve the proposed correction method, they

will work with you to find an acceptable correction.

» If agreement cannot be reached, the IRS will not issue a

compliance statement or refund any user fees.

» IRS will generally not audit your plan while considering your

VCP submission.


AUDIT CLOSING AGREEMENT

PROGRAM (CAP)

If your plan is audited by the IRS and the IRS

discovers a failure:

» IRS and plan sponsor enter into a contract called a “Closing

Agreement” to correct the problem.

» Sponsor pays a sanction to the IRS. Sanction is based on a

percentage of the tax that would apply if the plan were

disqualified (“Maximum Payment Amount”).

» Procedure requires that the sanction not be excessive and

bear a reasonable relationship to the nature, extent, severity

of the failure.

» Problem: “excessive” and “reasonable” are undefined.


--MAXIMUM PAYMENT AMOUNT

The consequences of disqualification are severe:

» Employer deductions lost

» Trust is taxable

» Employees taxed on contributions during disqualified years

once vested


--SANCTION FACTORS

The factors that the IRS will consider when

determining the appropriate sanction:

» The steps taken by the Plan Sponsor to ensure that the plan

had no failures.

» The steps taken by the Plan Sponsor to identify failures that

may have occurred.

» The extent to which correction had progressed before the

examination was initiated, including full correction.

» The number and type of employees affected by the failure.

» Whether the failure is solely an Employer Eligibility failure.


--SANCTION FACTORS

Sanction factors continued:

» The number of non-highly compensated employees who

would be adversely affected if the plan were not treated as

qualified.

» Whether the failure is a failure to satisfy the requirements of §

401(a)(4), 401(a)(26), or 410(b).

» The period over which the failure occurred.

» The reason for the failure (for example, data errors such as

errors in transcription of data).


BEST PRACTICES

You may find plan mistakes via an internal audit, or

when your adviser or a third-party administrator

reviews the plan’s written document and its

operations.

See IRS Fix-It Guides for common failures and

suggested ways to find and correct them for

different types of plans.


BEST PRACTICES

Weighing the benefits of SCP v. VCP:

» If you can self-correct, is there any reason to use VCP?

» Cost-benefit analysis includes cost of VCP user fee, cost of

service-provider fees, internal costs of gathering information

and correcting.


BEST PRACTICES

Correct the failures after you file the VCP

submission:

» The compliance statement includes a 150-day deadline by

which you must complete all corrective actions. If you correct

the failures before you submit, you may have to undo the

correction if the IRS doesn’t approve the method you used.

» Keep records – including your compliance statement and the

documents that prove corrections were completed before the

deadline.


BEST PRACTICES

Anonymous Submitter:

» Advantages: if you don’t like IRS’s correction requirements,

you can revoke your submission.

» Disadvantages: you may be audited (audit is suspended if

you disclose your plan name). If you are audited while an

anonymous VCP submission is pending, CAP applies.


BEST PRACTICES

Credibility is important so be honest when dealing

with the IRS:

» That does not mean that you should offer all information,

regardless of what is asked.

» But don’t be caught in a lie or a material misstatement.

» Don’t characterize yourself as a “bad actor.”


CASE STUDY– PLAN DOCUMENT

FAILURE

Client maintained a 403(b) plan since 1999. There

is no formal plan document.

» Prepare a restated written Plan Document and Summary Plan

Description, retroactive back to January 1, 2009, that

complies with the final regulations under the Internal Revenue

Code Section 403(b) and other legislation.

» Review the operational practices of the plan in order to

prepare the above noted plan document.

» Prepare a VCP submission of the above noted plan document

in order to bring the plan document into compliance with

federal tax law and preserve the Plan’s tax-favored status.


CASE STUDY – DEMOGRAPHIC

FAILURES

Client made “ad hoc” employer contributions to plan

from 2009-2019. In 2011, only participants who

voluntarily contributed to the plan received an

employer contribution. No non-discrimination

testing was ever performed. No data for 2009,

2010.

» Test plan for compliance with 402(g), 410(b), 415 each year.

» Run 401(a)(4) general test for every year except 2011.

» Run ACP test for 2011.

» File VCP for any failures and ask for mercy with regard to

2009 and 2010.


CASE STUDY – NON-EPCRS

Client failed to file IRS Form 5500 for 10 years and

deposited employee elective deferrals late.

» Identify the contributions deposited beyond the regulatory

deadline, calculate the lost earnings due the participants.

» Deposit and allocate lost earnings to the affected participants

for each late deposit.

» File a Form 5330 with the IRS for each affected year to pay

the excise taxes.

» Request DOL approval of the correction via the Voluntary

Fiduciary Correction Program (VFCP).

» File 5500s under Delinquent Filer Voluntary Compliance

Program (DFVCP).


THANK YOU

Mark E. Bokert, Partner/Co-Chair

Davis & Gilbert

[email protected]

Overview of ERISA Fiduciary Responsibilities68

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