On July 16, 2021, the IRS issued Revenue Procedure 2021-30, updating its Employee Plans Compliance Resolution System (“EPCRS”), which permits retirement plan sponsors and administrators to correct compliance failures that may adversely impact the tax-qualified status of their defined contribution (including 403(b)) and defined benefit plans. Rev. Proc. 2021-30 includes numerous highly anticipated (and mostly welcome) updates to the IRS correction procedures, including two new correction methods for defined benefit plan overpayments, an increase in certain de minimis correction thresholds, elimination of the ability to make an anonymous submission under the program, and the expansion of the Self-Correction Program (“SCP”) with respect to the use of retroactive plan amendments. Unless otherwise noted below, the changes to EPCRS are effective July 16, 2021.
Correction of Plan Overpayments
Undoubtedly, the most significant changes to EPCRS relate to the correction of plan overpayments. Several years ago, the IRS updated EPCRS to set forth the methods that could be used by a plan sponsor to correct a plan overpayment. Generally, these options included the return of overpayment method, a “make-whole” contribution by the plan sponsor for the amount of the overpayment (adjusted for earnings) or, in some cases, a retroactive plan amendment. For several years, the IRS has been considering additional changes relating to the recoupment of overpayments. The hope has been that any update would address when it may not be necessary to recoup an overpayment from a participant. Happily, the Revenue Procedure has been revised and reformatted to include helpful clarifications relating to the long-standing return of overpayment method, as well as two new correction methods that plan sponsors may use to correct defined benefit plan overpayments.
Return of Overpayment Method (Applicable to DC and DB Plans)
Under Revenue Procedure 2019-19, the prior iteration of EPCRS, plan sponsors may generally correct overpayments from defined contribution plans (including 403(b) plans) and defined benefit plans by using the return of overpayment correction method. Under this method, the plan sponsor takes reasonable steps to have the amount of the overpayment, adjusted for earnings at the plan’s earnings rate, returned to the plan by the participant. If the amount returned to the plan is less than the overpayment, adjusted for earnings, then the plan sponsor must contribute the difference to the plan unless the overpayment only occurred because the distribution was made in the absence of a distributable event and the amount of the distribution was otherwise consistent with the plan’s terms. The plan sponsor must also notify the participant that the amount of the overpayment was not eligible for tax-free rollover.
Rev. Proc. 2021-30 expands upon the return of overpayment correction method, providing that plan sponsors may give the recipient of an overpayment a choice of how they would like to repay. Specifically in the context of defined benefit plans, plan sponsors may allow overpayment recipients to repay as follows:
- As a single, lump sum payment,
- Through an installment agreement (provided the overpayment recipient is not a “disqualified person” or an owner-employee), OR-
- By having future periodic benefit payments reduced by an amount necessary to recoup the amount of the overpayment, if applicable. Note that under this option a spouse’s survivor benefit may not be reduced to recoup the overpayment, even if the overpayment amount has not been fully recouped during the participant’s lifetime.
Note, if the amount repaid to the plan by the overpayment recipient as a lump sum payment or through an installment agreement is less than the amount of the overpayment adjusted for earnings, the plan sponsor must contribute the difference to the plan. This “make-whole” rule, however, does not apply if future periodic benefit payments are reduced to recoup the amount of the overpayment, even if the participant dies, for example, before the entire amount of the overpayment has been recouped.
Revenue Procedure 2021-30 does allow plan sponsors of defined contribution plans to give overpayment recipients a choice as to the method of repayment, but does not point directly to the specific repayment methods permitted for defined benefit plans. We would expect the IRS to interpret this ability to choose in the defined contribution space to include similar methods as described for defined benefit plans, as appropriate.
For both defined benefit and defined contribution plans, the new Revenue Procedure retains language indicating that other appropriate correction methods (presumably those not detailed therein) may be used to correct an overpayment.
New Correction Methods for Overpayments (Applicable to DB Plans)
Revenue Procedure 2021-30 adds two new correction methods that employers may use when correcting overpayments from a defined benefit plan: (1) the funding exception correction method and (2) the contribution credit correction method. As described in more detail below, these new correction methods reduce the amounts necessary for plan sponsors to recoup from participants or to contribute to the plan to make the plan “whole” when overpayment errors occur.
Note, these two new correction methods may not be used if the overpayment is associated with a failure to satisfy a statutory limit, such as Code Sections 401(a)(17), 415(b) and 436, and may also not be used to correct an overpayment made to a disqualified person or an owner-employee.
The Funding Exception Correction Method
As its name suggests, this new correction method is generally tied to a defined benefit plan’s adjusted funding target attainment percentage, or “AFTAP.” Specifically, no corrective payment to the plan (by either the recipient of the overpayment or the plan sponsor) is necessary if, in the case of a plan subject to Code Section 436, the plan’s certified or presumed AFTAP applicable at the time of correction is equal to at least 100% (or, in the case of a multiemployer plan, the plan’s most recent annual funding certification indicates that the plan is not in critical, critical and declining, or endangered status, determined at the date of correction). If these requirements are met, then for purposes of EPCRS:
- No further corrective payments from any party are required,
- Reductions to future benefit payments to the recipient of an overpayment (or the spouse or beneficiary of an overpayment recipient) to recoup the amount of an overpayment are not permitted, and
- Corrective payments from the recipient of an overpayment (or the spouse or beneficiary of an overpayment recipient) are not permitted.
Future benefit payments must be reduced, however, to the correct benefit payment amount, if applicable.
“Contribution Credit” Correction Method
This new correction method limits the amount of an overpayment that is required to be repaid to a plan. Under this method, the amount of an overpayment that must be repaid to the plan is equal to the amount of the overpayment reduced (but not below zero) by a “contribution credit” that is equal to the following:
- The cumulative increase in the plan’s minimum funding requirements attributable to the overpayments (including the increase attributable to the overstatement of liabilities, whether funded through cash contributions or through the use of a funding standard carryover balance, prefunding balance, or funding standard account credit balance), beginning with (1) the plan year for which the overpayments are taken into account for funding purposes, through (2) the end of the plan year preceding the plan year for which the corrected benefit payment amount is taken into account for funding purposes; AND
- Certain additional contributions in excess of minimum funding requirements paid to the plan after the first of the overpayments was made.
If, after applying the contribution credit, the amount of the overpayment is reduced to zero, then (1) no further corrective payments from any party are required, (2) no further reductions to future benefit payments to the recipient of an overpayment (or their spouse or beneficiary) are permitted, and (3) no corrective payments from the recipient of an overpayment (or their spouse or beneficiary) are permitted.
If a net amount of an overpayment remains after applying the contribution credit, the plan sponsor must made a contribution to the plan of the remaining amount or take action to recoup the remaining amount from the overpayment recipient. The amount may be recouped from the overpayment recipient using a method described above (i.e., single sum payment, installments, reduction of future benefit payments), but additional special rules apply when recouping a net overpayment after applying the contribution credit. Also, when requesting a repayment of that net overpayment from a recipient, the plan sponsor must provide the recipient of the overpayment with a special written notice that includes information about the overpayment and about the three repayment options available to the recipient. If the recipient does not choose a repayment option within a reasonable period of time (deemed to be at least 30 days), then the notice must explain that the default repayment option will be the adjustment of future payments, provided the recipient is entitled to future payments under the plan, or a single sum payment if not entitled to future payments. Note, this notice requirement does not appear to apply when providing a recipient with options for repayment under the general repayment of overpayment correction method described above.
In order to be eligible to use the contribution credit correction method, the plan may not have a funding deficiency or an unpaid minimum required contribution as of the end of the last plan year before the plan year for which the plan sponsor takes into account the corrected benefit payment amount for funding purposes (taking into account contributions made after the end of the plan year that are credited to that plan year).
Additional Correction Principles for Overpayments
Revenue Procedure 2021-30 provides that when correcting overpayments, the following correction rules/principles apply (some of these are not new):
- If periodic payments are involved, any future benefit payments must be reduced to the correct benefit payment amount (i.e., plan sponsors must “stop the bleeding”).
- Generally, the plan sponsor must notify the recipient of the overpayment (in writing) that the amount of the overpayment is not an eligible rollover distribution (i.e., is not eligible for tax-free rollover), even if the recipient of the overpayment is not required to repay the amount of the overpayment under the applicable correction methods described above.
- In many circumstances, with a few exceptions, if the overpayment is not repaid, the plan sponsor must make the plan whole. For example, if a net overpayment amount remains after the contribution credit from (2) above is applied and the participant does not repay the overpayment amount, the plan sponsor must reimburse the plan for the remaining amount of the overpayment (adjusted for earnings).
Other Meaningful Updates to EPCRS
Increase in De Minimis Threshold
A welcome change in Rev. Proc. 2021-30 is an increase to the de minimis threshold that applies to plan overpayments and excess amounts (e.g., excess employee or employer contributions) from $100 to $250. For example, if the total amount of a plan overpayment is $250 or less (after adjustment for earnings), the plan sponsor is not required to seek return of the overpayment from the participant, or notify the participant that the overpayment was not eligible for tax-free rollover. Note, however, plan sponsors must still notify participants that overpayment amounts resulting from exceeding a statutory limit are not eligible for favorable tax treatment.
Replacement of Anonymous VCP Submissions with New Procedures
Effective January 1, 2022, the anonymous VCP submission procedures are eliminated, and replaced with new pre-submission procedures. Under the new pre-submission procedures, beginning January 1, 2022, plan sponsors may request (at no fee) an anonymous, pre-submission meeting with the IRS regarding issues for correction under VCP when their requested correction methods are not any of the safe harbor correction methods described in the EPCRS guidance.
Correction of Operational Issues via Plan Amendment
Revenue Procedure 2021-30 further expands the correction of operational errors by plan amendment under the IRS’ Self-Correction Program (“SCP”). Previously, the IRS had expanded the SCP to allow for the correction of certain operational failures via a retroactive plan amendment under the following conditions:
- The corrective amendment must result in an increase of a participant’s benefit, right or feature;
- The increase in benefit, right or feature is provided to all employees eligible to participate in the plan;
- The increase in benefit, right or feature (a) was permitted under IRS rules and (b) satisfied certain applicable correction principles under Revenue Procedure 2019-19.
With respect to the second requirement above, the IRS’ prior informal position was that all employees eligible to participate in the plan really meant every single employee eligible to participate, making this a difficult requirement to meet. In many cases, an error only occurs with respect to a subset of participants in a plan and not all employees eligible to participate (e.g., erroneous exclusion of overtime wages from the definition of compensation only affects non-exempt employees eligible for overtime). In Rev. Proc. 2021-30, the IRS completely eliminated the requirement that the increase in benefit, right or feature must be provided to all eligible employees, thus making it easier to retroactively amend a plan under SCP without having to file an application under VCP in these circumstances.
Extension of SCP Correction Period for Significant Failures
Historically, plans have had until the last day of second plan year following the plan year for which a significant operational or plan document failure occurred to self-correct under the SCP. Rev. Proc. 2021-30 extends this correction period by an additional year, until the last day of the third plan year following the plan year for which the failure occurred. The change to this SCP correction period also results in an extension of the deadline for self-correcting certain elective deferral failures (under the special safe harbor correction method) lasting more than three months but not longer than the SCP correction period for significant failures.
Extension of Sunset Safe Harbor Correction Method
Revenue Procedure 2015-28 added a safe harbor correction for certain automatic contributions failures that generally were corrected by the end of the 9½ month period after the end of the plan year when the failure first occurred. Under the safe harbor correction, a plan sponsor was not required to make-up missed employee contributions (pre-tax or Roth) if the plan had an automatic enrollment feature and certain other requirements, including a 45-day notice, were met. Unfortunately, under Rev. Proc. 2015-28 and subsequent EPCRS Revenue Procedures (including Rev. Proc. 2019-19), this special correction option was available only for failures that began on or before December 31, 2020. Revenue Procedure 2021-30 extends this correction method by an additional three years, so this safe harbor may continue to be used for failures that begin on or before December 31, 2023. This extension is retroactively effective back to January 1, 2021.