The Internal Revenue Service (IRS) modifies and updates plan qualification correction programs, making many relatively minor, but also a few important, changes.  Revenue Procedure 2013-12 (12/31/12) is the first overhaul of the Employee Plans Compliance Resolution System (EPCRS) since 2008 and continues an evolutionary process that stretches back to 1992.  The EPCRS is the IRS' program for correcting violations of the retirement plan qualification rules as an alternative to the drastic course of disqualifying erring plans.  The new Rev. Proc. includes some significant expansions of the scope of EPCRS, particularly in its availability to §403(b) tax-sheltered annuity and custodial account plans maintained by public schools and §501(c)(3) tax-exempt organizations, as well as a number of lesser modifications.  The IRS’s summary of the changes takes up over four pages.  Most of them are of interest only when the specific situation that they address happens to arise.

The new Rev. Proc. takes effect as of April 1, 2013.  Until then, plan sponsors have a choice between following its predecessor, Rev. Proc. 2008-50, or voluntarily complying with the new rules.  Because almost all of the changes are liberalizations, the latter will probably be the choice whenever it makes a difference.

Overall, the structure of EPCRS has not changed.  It still consists of three separate parts:

  1. Self-Correction Program (SCP):  Qualification defects that stem from differences between what the plan document requires and how the plan operates in practice often may be corrected without filing anything with the IRS or paying any penalty.  The deadline for self-correcting “significant” failures is the end of the second plan year after the year in which the violation occurred.  The initiation of an IRS audit of the plan cuts off this period, unless the correction has already been substantially completed.  Insignificant failures may be self-corrected at any time.  Self-correction is useful in the many situations in which both the violation and the correction method are cut-and-dried, leaving little risk that a subsequent IRS audit would question the approach taken.  Self-correction is not available for non-operational lapses, such as the employer’s ineligibility to maintain the plan, a failure to adopt required plan amendments, or “discriminatory” plan coverage.  It can, however, be used to deal with such issues as uncorrected ADP/ACP test failures in 401(k) plans, the exclusion of eligible employees from a plan, premature distributions, overpayments or underpayments of benefits, etc.
  2. Voluntary Correction Program with IRS Approval (VCP):  Any failure that is not “egregious” can be corrected by using VCP, so long as the plan is not under IRS audit at the time of submission, the employer pays a monetary sanction, and the IRS and the employer can agree on a correction method.  The compliance fee is based on the number of plan participants and ranges from $750 if there are fewer than 20 participants to $25,000 for more than 10,000 participants, though reduced amounts are charged for some violations.
  3. Audit Closing Agreement Program (Audit CAP):  Audit CAP is the IRS’s term for resolving qualification defects discovered in the course of an audit of a plan.  The monetary sanctions are potentially draconian.  They are almost always abated substantially, but the IRS often demands $50,000 or more for even relatively minor faults.

The EPCRS programs are open to qualified plans, §403(b) plans, simplified employee pensions (IRC, §408(k)) and SIMPLE IRA plans (IRC, §408(p)).  Nonqualified deferred compensation plans are not eligible, though the new Rev. Proc. announces that the IRS in some cases will enter into closing agreements along the same lines to correct violations by §457(b) deferred compensation plans maintained by governmental employers.  EPCRS cannot be utilized in other instances, such as to remedy a nonqualified plan’s noncompliance with §409A.

Like its predecessor, Rev. Proc. 2013-12 consists of a set of definitions, eligibility rules and general correction principles, followed by two appendices detailing acceptable correction methods for a variety of failures and several more appendices addressing VCP submission procedures.  The list of correction methods is not exclusive and does not cover every issue that can be dealt with through EPCRS.  Plan sponsors are free to propose alternatives, and the IRS frequently agrees to them.

The main procedural innovation in Rev. Proc. 2013-12 is the creation of new Forms 8950 and 8951 for VCP submissions, which replace the largely free-form applications of the past.  The use of these forms will be mandatory from April 1st onward.  Until then, they are optional.  If used, they must be sent to the new VCP mailing address.  (The old address is reserved for submissions under Rev. Proc. 2008-50.)

Another procedural change is a reduction in the number of circumstances in which a VCP submission or Audit CAP settlement must be accompanied by an application for a new determination letter (DL) concerning the plan’s qualified status.  Under the new rules, a DL application is needed only in two cases:  i) if the defect was a failure to adopt an amendment required for continued plan qualification, or ii) the correction includes the adoption of an individually designed plan amendment (except for an amendment whose sole effect is to expand coverage or benefits in order to eliminate prohibited discrimination), and the submission is made during a period when the plan could submit a standard “on-cycle” DL application.  In all other situations, the plan sponsor must wait until its DL cycle comes around (once every five years for individually designed plans and once every six years for master, prototype and volume submitter plans), to get an updated letter.

Substantively, there are a few significant additions and modifications:

  • The guidance concerning §403(b) plans has been much enlarged and clarified.  The aim was to harmonize qualified plan and 403(b) corrections to the maximum extent feasible.  Previously, EPCRS covered 403(b) plans to only a limited extent.
  • EPCRS now takes into account IRC §436, which limits benefit increases, lump sum and other accelerated distributions, payment of shutdown benefits and benefit accrual in defined benefit plans that are less than 80% funded.  Aside from providing a standard method for correcting §436 violations, Rev. Proc. 2013-12 imposes special requirements when the correction of some other defect necessitates an accelerated distribution or a benefit increase:  The plan sponsor must make a contribution equal to the amount that §436 would otherwise prohibit the plan from distributing or, in the case of a plan amendment, the resulting increase in the plan’s funding target.
  • When a correction requires belated contributions to participants’ accounts (e. g., when additional contributions are made to remedy prohibited discrimination), the earnings credited to the contribution may be negative if a timely contribution would have had a negative return.  This point was previously unclear.
  • Because the IRS no longer allows plans to use its letter forwarding program to search for lost participants, the Rev. Proc. describes other steps that must be taken where a correction requires the payment of additional benefits and the recipient cannot be found at his/her last known address.  Suggested methods include “the Social Security letter forwarding program, a commercial locator service, a credit reporting agency, or Internet search tools," with the admonition that, “Depending on the facts and circumstances, the use of more than one of these additional search methods may be appropriate.”  In practice, if Internet searches fail to bear fruit, a commercial locator service is the only one of these methods that has much chance of success.

Employers and practitioners contemplating the use of EPCRS may find it helpful to download the index to Rev. Proc. 2013-12, a road map to the document’s scattered and sometimes disorderly provisions.

Caution:  Rev. Proc. 2013-12’s introductory material contains an imprecise statement worth noting, lest it mislead plan sponsors that are self-correcting failures to allow eligible employees to make §401(k) elective deferrals.  Supposedly, the new Rev. Proc. 

Revis[es] Appendix A, section .05, and related examples in Appendix B to provide that, in some cases, a matching contribution owed to a participant may be made in the form of a corrective employer matching contribution, instead of a QNEC [qualified nonelective contribution, which must be 100% vested and is subject to the same distribution restrictions as an elective deferral], so that the corrective employer matching contribution would be subject to the vesting schedule [and distribution rules] under the plan that [apply] to employer matching contributions.

Actual scrutiny of the text finds only one situation to which this rule clearly applies:  where a 401(k) plan makes use of the automatic enrollment safe harbor in IRC §401(k)(13) and fails to give participants the opportunity to opt out of automatic deferrals or change the deferral percentage.  It may also be available if participants are improperly excluded from making catch-up contributions that would have been eligible for matching.  (The text of the Rev. Proc. and the example in Appendix B are contradictory.)  Both of those cases are extremely rare.  In all others, the Rev. Proc. specifies that corrections for insufficient matching contributions must take the form of QNEC’s.  The reasons for carving out only two narrow exceptions are neither stated nor self-evident.

Continuing the Amara-CIGNA saga, district court orders reformation of plan and additional benefit accruals.  Two years ago, the US Supreme Court held, in CIGNA Corporation v. Amara, 131 S. Ct. 1866 (2011), that courts have no authority to revise the terms of ERISA-covered plans to reflect statements in the summary plan description (SPD) that conflict with the plan document.  The Court’s opinion did not leave matters at that, though.  The opinion also included a discussion of forms of equitable relief that might be available to participants who were aggrieved by SPD errors.

Amara then went back to the district court, which has now decided (Amara v. CIGNA Corporation, 2012 US Dist. LEXIS 180355 (D. Conn. December 20, 2012)) that it had the right remedy the first time and needed only to reformulate its rationale.  The opinion is at odds with a number of courts that have treated the court’s discussion on the Law of Equity as dictum and not as a warrant for an expansion of judicial power to rewrite private pension contracts.  (The Department of Labor (DOL) has submitted briefs arguing for the latter result.)

The case arose out of the conversion of CIGNA’s traditional pension plan into a cash balance plan.  The amended plan credited each participant with an “opening balance."  It also provided that no one’s actual benefit could be less than his/her accrued benefit as of the date of the conversion.  Hence, participants would always receive the greater of i) the frozen pre-conversion benefit or ii) the sum of the opening balance and contributions and earnings subsequently credited to their cash balance accounts.  The alternative to this transition rule would have been to have no opening balance and instead pay participants the sum of the pre-conversion benefit and post-conversion additions to their accounts.  For reasons that need not be detailed here, the latter technique (A+B) is more generous than the former (wear-away) to participants who leave before the plan’s normal retirement age (and has since been made mandatory for cash balance conversions).

The plaintiffs in Amara asserted that various documents distributed by CIGNA left them with the misapprehension that they would be entitled to A+B benefits.  In the original case, the district court agreed and directed that benefits be calculated in that manner, as CIGNA’s communications supposedly promised, without regard to the terms of the plan document.  The US Supreme Court reversed this holding.

On remand, the district court adhered to its original order, relying on two equitable doctrines:  reformation of contract and surcharge.  "Reformation" allows a court to revise a contract to reflect the mutual intent of the parties or to protect a party that was induced to enter into a contract through fraudulent misrepresentation of its terms.  "Surcharge" makes the beneficiaries of a trust whole when trust assets are misused and gives the trust the right to recover any unjust enrichment by a fiduciary.

On both counts, Judge Arterton's argument is not persuasive.  She found that CIGNA’s statements about how benefits would be calculated post-conversion were “fraudulent” in the rather special sense that equity courts give to that adjective but ignored the other predicate of reformation:  that the fraud has induced the other party to enter into the contract.  In this instance, the participants’ consent to the amendment was not required, because CIGNA had the right to amend the plan unilaterally.  Fraudulent inducement was simply impossible.  CIGNA had a duty, of course, to inform participants about the amendment, but that duty sprang from ERISA, and, as the US Supreme Court held, reformation was not a permissible sanction for carrying out that duty inadequately.

The argument for surcharge is also unpersuasive.  Unless the plan could first be reformed, the participants received exactly the benefits promised, and CIGNA (whose supposed unjust enrichment consisted of the lower cost of wear-away), received exactly the economic result to which it was entitled.

The last time around, the 2nd Circuit Court of Appeals summarily affirmed the district court judgment without issuing an opinion.  One can expect it to pay more attention when the next appeal arrives.

DOL officials question use of online VFCP calculator in corrections of late deposits of elective deferrals.  At a meeting with members of the American Bar Association’s Joint Committee on Employee Benefits (held May, 2012 but reported on only recently), DOL representatives were asked whether a company that realized it had deposited §401(k) elective deferrals late could simply deposit them and add interest determined using the DOL’s online calculator for the VFCP, without filing a VFCP application.  (Forgoing VFCP does mean that the employer must file Form 5330 with the IRS and pay a penalty tax, but the tax is minuscule if the correction is made fairly promptly.)

The DOL’s answer was “no”:  It does not recognize self-correction, unless the earnings credited to the late contribution are identical to what a timely one would have garnered.  Therefore, it will not promise not to take enforcement action against employers that do exactly what VFCP would require but do not take the time and trouble to enter the program formally.  Because a VFCP filing is often time-consuming and expensive when compared to the magnitude of the violations, that answer was somewhat disappointing, though not entirely a surprise.

In practice, the vast majority of elective deferral delinquencies are self-corrected, and the vast majority of those corrections undoubtedly make use of the online calculator.  The alternative is to choose some interest rate that has no official sanction at all or to calculate, for each affected participant, what his actual return would have been if the deposit had been timely.  When, it is typically the case, the lapse is a few days or a couple of weeks, the last calculation has a very poor cost-to-benefit ratio.  Where, however, the delinquent deposits are significantly large or late, there now may be an additional reason to consider VFCP.