IRS Voluntary Compliance Program - Correcting Plan Failures

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In order for a retirement plan to be treated as a qualified retirement plan and enjoy the benefits of such status (contributions deductible to employer, employees not taxable on contributions until distributed, employees not taxable on appreciation of investments), the plan must meet all of the requirements set forth in the Internal Revenue Code.  Some of these requirements relate to the form of the plan.  That is, the plan must contain certain provisions mandated by the IRC.  Other requirements related to the operation of the plan.  That is, the plan must operate in accordance with the terms of the plan and with the IRC.  Failure to operate a plan in accordance with terms and the IRC could lead to the plan being disqualified.  In this event all of the plan contributions could be considered as taxable income to the plan participants.

Operating and maintaining a qualified retirement plan can be quite complex.  It is not unusual for a plan to suffer an operational failure.  Some of these failures are minor and infrequent.  Other failures may be more serious or egregious.   To encourage employers to correct plan failures and give employers comfort that the correction will be acceptable to the IRS, the IRS has a program (set forth in Revenue Procedure 2013-12) that outlines how certain plan failures can be corrected.

Under Revenue Procedure 2013-12, depending on the type of plan failure involved, there are three possible ways that the plan failure might be corrected. These correction methods include:

Self-correction (SCP). A Plan Sponsor that has established compliance practices and procedures may, at any time without paying any fee or sanction, correct insignificant Operational Failures under a Qualified Plan, a 403(b) Plan, a SEP, or a SIMPLE IRA Plan. For a SEP or SIMPLE IRA Plan, however, SCP is available only if the SEP or SIMPLE IRA Plan is established and maintained on a document approved by the Service. In the case of a Qualified Plan that is the subject of a favorable determination letter from the Service or in the case of a 403(b) Plan, the Plan Sponsor generally may correct even significant Operational Failures without payment of any fee or sanction if the correction is made within certain time periods.

Voluntary correction with Service approval (VCP). A Plan Sponsor, at any time before audit, may pay a limited fee and receive the Service’s approval for correction of a Qualified Plan, 403(b) Plan, SEP, or SIMPLE IRA Plan failure. Under VCP, there are special procedures for Anonymous Submissions and group submissions.

Correction on audit (Audit CAP). If a failure (other than a failure corrected through SCP or VCP) is identified on audit, the Plan Sponsor may correct the failure and pay a sanction. The sanction imposed will bear a reasonable relationship to the nature, extent, and severity of the failure, taking into account the extent to which correction occurred before audit.

Whether a plan failure may be self-corrected, or corrected under the VCP program or must be corrected under the Audit CAP program depends on the type of failure, the frequency and the significance of the failure, and whether the failure was self-reported or discovered on audit.  The more often the failure, the more participants involved, the more plan years involved, and discovery of the error on audit reduce the chances the failure can be self-corrected (or even fixed under the VCP program).

If your retirement plan has suffered an operational failure, call or email Jeff Senney to discuss how the plan can be corrected at Jsenney@pselaw.com or 937-223-1130.



AND ONE MORE THING.  A frequent plan failure involves plan loans not being administered in compliance with the terms of the plan or the IRC.   The IRS does not currently recognize self-correction as a permitted correction method for a plan loan failure.  As a result, a plan loan failure must be corrected under the IRS’s VCP.  If the plan loan failure is not so corrected, the IRS requires the loan amount to be treated as a taxable distribution and reported on IRS Form 1099-R.  The IRS also requires the employer to pay the applicable income tax withholding related to such deemed distribution.   There might be other applicable penalties as well.  Call Jeff Senney to discuss any questions you have about correcting retirement plan operating failures at 937-223-1130 or Jsenney@pselaw.com.