Recently, several clients have identified problems with the administration of their 401(k) plans. These operational failures, which are based on the terms of each individual plan, included (1) plan loans that were not properly administered, (2) the failure to recognize that part-time employees may be eligible to participate in the plan, (3) using the improper definition of compensation for employee deferral and company matching purposes, (4) applying improper compensation limits, and (5) the failure to allocate profit sharing contributions to all active and terminated employees. Each employer experienced multiple plan failures over the course of multiple plan years. As a result, all of the affected employers filed a voluntary correction under the Employee Plans Compliance Resolution System ("EPCRS"). The EPCRS program permits plan sponsors to voluntarily correct plan in failures for a limited fee and obtain a compliance statement from the IRS.
In order to voluntarily correct, Masuda Funai filed an application/packet with the Internal Revenue Service ("IRS") that included a detailed description of the method for correcting each failure. Here, each step of the correction method needed to be described, including: the number of employees affected the expected cost of correction, the years involved, and calculations or assumptions that were used to determine the amounts needed for correction. In addition, the method that would be used to locate and notify former employees and beneficiaries and a description of the measures that were implemented to ensure that the same failures will not recur also needed to be considered. Regardless of the number of failures submitted, each employer paid a fixed-compliance fee based on the number of employees reported on the most recent Form 5500. After reviewing the submissions, because the IRS agreed with the firm's correction methodology and explanations, the IRS issued a compliance statement in each case indicating that the IRS would not take any action with respect to the failures that were voluntarily reported.
Because a plan sponsor's failure to administer a 401(k) plan in accordance with the terms of the actual plan document can cause the IRS to disqualify the plan resulting in tax issues for all plan participants and the company, it is important for plan sponsors to periodically audit their plans to ensure compliance. If you identify a plan failure, be sure to call your relationship attorney in order to review whether the error is correctable without reporting it to the IRS or whether it should/must be reported to the IRS to obtain a compliance statement and preserve the tax qualified status of the plan.