Last week, at the Western Benefits Conference, IRS Commissioner of the Tax Exempt and Government Entities Division, Sunita B. Lough, addressed the conference minutes after the IRS released Ann. 2015-19, 2015-32 IRB. This is the announcement reforming the determination letter process primarily for individually designed plans.
Commissioner Lough explained the rationale for elimination of the determination letter process for individually designed plans other than on plan adoption and termination. She stated that the average time a reviewer takes to determine that a plan is compliant is three hours. This limited time results from the significant number of applications and the shortage of qualified IRS personnel due to budget limitations. Based on a three hour review, the IRS has been issuing, in her view, an opinion letter that would take a law firm tens of hours to review and re-review before a partner’s signature was applied. She finds it to be inappropriate for the IRS to be on the absolute risk when it is hamstrung in this fashion. In other words, the demise of the determination letter program results from a cost/benefit analysis where the Service has determined that it is best to shift the risk of having a compliant plan document to the plan sponsor.
To lessen the risk for the plan sponsor, Commissioner Lough stated that the Service will promulgate model language for all needed qualification amendments. The IRS will also consider amendment by reference as a risk-diminisher for plan sponsors. This latter point is potentially very significant. The IRS has historically taken the position that a plan can only incorporate a provision by reference if the regulations or other guidance specifically allows for it, and the number of provisions that allow for this has been very small. Of course, incorporation by reference only goes so far. If a regulation or other guidance has optional provisions, those will still need to be specified.
Lastly, EPCRS will be available for corrections, but the Commissioner warned that plan sponsors will not be permitted to end-run the lack of a determination letter process by using EPCRS. Since the use of VCP today requires a determination letter, the Commissioner anticipates complying amendments to the Revenue Procedure.
When questioned about the long-standing concerns over interim amendments and how to address those, the Commissioner admitted she was unfamiliar with the issue and promised to look into it.
What does this mean for sponsors of individually designed plans? It means the burden is on them to make sure that plan documents are compliant. The risk of having a non-compliant document will probably be greater than before although it is difficult to anticipate the consequences should a plan fail. Apparently, a good faith effort to comply will go a long way to avoiding disqualification. This will be especially important with interim amendments.
It also probably means that IRS audits will be longer, more expensive, affairs. Auditors will now likely spend significant time reviewing a document for legal compliance since they can no longer rely on their colleagues in the determination letter division to have done that for them. The debates that used to happen on determination letter reviews will now occur on audit, which will only increase the potential stakes of the audit itself. It will also make it more difficult for the auditors to distinguish between the compliance-minded sponsors (who made efforts to obtain determination letters) and those who were not.
What does this mean for drafters of individually designed plans? Without the benefit of a determination letter, the law firms that draft plans are likely litigation targets should the IRS penalize a plan sponsor or, worse yet, disqualify a plan that is not properly drafted. We would expect to see the cost of drafting and restating an individually designed plan to go up to cover the risk that has been shifted from the IRS to the plan sponsors and their law firms.
All in all, this is a bad deal for sponsors of individually designed plans and their document providers. It will likely tend to shift toward greater use of prototype and volume submitter plans which could limit flexibility in plan design. It will increase compliance costs and lead to greater scrutiny on plan audits.