On December 31, 2012 the Internal Revenue Service (IRS) issued the long anticipated update to its correction program for certain employer-sponsored retirement plans. The program is known as the Employee Plans Compliance Resolution System or EPCRS. The revised correction program is set out in Revenue Procedure (Rev. Proc.) 2013-12, which supersedes Rev. Proc. 2008-50. The revisions include changes and additional guidance with respect to correction methods as well as procedural changes for voluntary correction program (VCP) submissions. This article discusses these changes with respect to qualified plans. Through EPCRS, employers who sponsor qualified plans may correct form, operational and demographic failures voluntarily by self-correction, if eligible, or by written submission under the VCP, if eligible, upon payment of the applicable fee. Employers are well-advised to consider periodic compliance reviews to use these voluntary correction methods to avoid the far greater sanctions that apply if the failures are discovered by the IRS on audit. The VCP fee is based on the number of plan participants and ranges from $750 to $25,000 with reduced fees for certain operational and nonamender failures. The sanction on audit is negotiated and begins with the maximum amount of tax that the IRS would have collected in the open years if the plan had not been qualified. This includes the tax that results from trust earnings, the loss of employer deductions for plan contributions and income inclusion for participants with respect to contributions and any distributions that were rolled over to another plan or IRA.
Revenue Procedure 2013-12 is generally effective April 1, 2013 but an employer may apply the provisions prior to April 1, 2013. If so, employers must comply with the new procedural requirements for a VCP submission as described below. Although correction methods are substantially the same, there are some revisions and additional guidance. Some of the more significant changes are as follows:
- Corrective contributions for excluded employees in 401(k) plans. Previously all corrective matching contributions and, if the plan used nonelective contributions to satisfy a safe harbor, all corrective nonelective contributions, related to missed deferrals for an excluded employee were required to be made in the form of a qualified nonelective contribution “(QNEC)” which is a nonforfeitable (i.e., fully vested) contribution.
Except for corrective matching and nonelective contributions used to satisfy the safe harbor requirements under section 401(k)(12) of the Code, contribution in the form of a QNEC is no longer required for corrective matching and nonelective contributions. Because a QNEC is not required, the corrective contribution may be subject to a vesting schedule – and thus potentially forfeited, in whole or in part, if the participant who received the contribution terminates employment prior to being fully vested. This also means that the elimination of the QNEC requirement applies to nonelective contributions or matching contributions related to missed deferrals under a plan satisfying the qualified automatic contribution arrangement (QACA) safe harbor of section 401(k)(13) of the Code. Under a QACA, safe harbor matching or nonelective contributions may be subject to a two-year vesting requirement. In all cases, however, corrective contributions for missed deferrals (including catch-up contributions) and for after-tax contributions must be made in the form of a QNEC (and thus, immediately 100 percent vested).
New correction guidance regarding missed deferrals is also provided with respect to the improper exclusion of employees under a plan satisfying safe harbor requirements by use of a QACA.
- Corrective distributions from defined benefit plans. In the case of a defined benefit plan, a corrective distribution must be increased to take into account the delay in payment. The EPCRS revisions clarify that the increase is to be determined using the applicable actuarial factors under the terms of the plan that were in effect on the date that the distribution should have been made.
- Overpayments from defined contribution plans. If a defined contribution plan overpays benefits, in most cases, the plan sponsor must request that the participant return the overpayment to the plan. Rev. Proc. 2008-50 provided that the participant should repay the overpaid amount with appropriate interest but that the employer was required to make up any amount not repaid by the employee with interest at the plan’s earnings rate. Rev. Proc. 2013-12 now also requires the plan’s earnings rate to be used for participant repayments. In addition, if the reason for the overpayment is the lack of a distributable event, the plan sponsor is not required to make a contribution to the plan even if the participant does not repay the overpayment.
- Corrective distributions from forfeitures. Forfeitures may generally be used for corrective contributions, subject to the plan document providing that forfeitures may be used to reduce employer contributions. However, Rev. Proc. 2013-12 specifically provides that the plan’s forfeiture account cannot be used to provide the QNECs necessary to correct failed actual deferral percentage, actual contribution percentage or multiple use tests. This is because QNECs used to satisfy these tests must meet the full vesting (and also distribution) requirements when contributed to the plan.
- Code Section 436 correction issues. Code Section 436 restricts the payment of benefits in certain forms (e.g., lump sums) and benefit accruals under defined benefit plans that do not meet certain funding levels. Rev. Proc. 2013-12 provides guidance on how plans which are subject to such restrictions can correct the failure to comply with the form of payment restriction and also on how corrective distributions and/or amendments may be made to a plan subject to Code section 436 restrictions.
Rev. Proc. 2013-12 also changes some procedural requirements. These include:
- Finding Missing Participants. The IRS has discontinued the IRS Letter Forwarding Program as a method for finding lost plan participants who are owed retirement plan benefits. Rev. Proc. 2013-12 provides the following methods to locate missing participants should certified mail not result in success: (i) Social Security letter forwarding program; (ii) a commercial locator service; (iii) a credit reporting agency; or (iv) Internet search tools. Plan sponsors that have received a VCP compliance statement (and for which the correction period has not expired) or are correcting failures under the self-correction procedures of EPCRS, will have until the earlier of May 30, 2013 or 150 days from the date the IRS notifies the plan sponsor that the request to locate the missing participants will not be processed to locate the missing participants by other reasonable action.
- Fees. The fees under the new revenue procedure generally remain the same with a few exceptions. The compliance fee for failure to adopt an amendment required as a condition of a favorable determination letter within the applicable 91-day period is $500, as long as the amendment is adopted within 3 months after the end of the deadline to adopt the amendment. The VCP fee for multiple failures for which reduced fees are applicable is the lesser of the regular fee or the sum of the reduced fees (if applicable). The fees for nonamender failures discovered during the favorable determination letter process have increased.
- Forms. The IRS has made additional efforts to streamline the process of filing a VCP application. A revised Appendix C now serves as a model compliance statement as well as a checklist. Schedules similar to the current schedules are also provided. Use of Appendix C and the schedules are encouraged but not required. However, effective April 1, 2013, new VCP applications will be required to include Forms 8950 (the application) and 8951 (with respect to the submission fee). These Forms which were issued on January 18, 2013 must also be used prior to April 1, 2013, if submission is being made under the new Rev. Proc. 2013-12 rather than under Rev. Proc. 2008-50. If Forms 8950 and 8951 are required but not included, the VCP submission will be considered to be seriously deficient resulting in the return of the submission. The VCP submissions under Rev. Proc. 2013-12 are now to be sent to Covington, KY rather than to Washington, DC.
Although Rev. Proc. 2013-12 provides additional guidance, the IRS continues to request comments on certain outstanding issues as they relate to failures with respect to designated Roth contributions, implementation of automatic enrollment (including automatic escalation of the amount deferred) and timely provision of safe harbor notices.