Earlier this year, the Internal Revenue Service's (IRS) updated Employee Plans Compliance Resolution System (EPCRS) went into effect. EPCRS provides several procedures under which employers sponsoring retirement plans, e.g., 401(k) plans and 403(b) plans, can correct errors in their retirement plans. Some errors may be corrected without formal submission to the IRS, while others may require formal application and payment of a compliance fee or payment of a negotiated sanction amount. The IRS will not disqualify a retirement plan for an error that is corrected in accordance with EPCRS.
The updated EPCRS provides employers the opportunity to fix incomplete or inaccurate 403(b) plan documents (known as "Plan Document" failures) by making a voluntary submission to the IRS. If the submission is made on or before December 31, employers may pay asignificantly reduced compliance fee.
By way of background, effective January 1, 2009, all employers sponsoring 403(b) plans were required to adopt a written plan document containing specific terms required under the Internal Revenue Code. This requirement was generally met if the employer adopted the written 403(b) plan document no later than December 31, 2009. If on IRS audit, an entity is unable to produce evidence that it properly adopted the written plan document by December 31, 2009, it may have a "Plan Document" failure, even if the document contains all the required terms. A Plan Document failure could result in the 403(b) plan losing its tax-favored status, meaning the employees' ability to accumulate retirement savings is reduced and their current income tax liability increased.
403(b) plans can be maintained only for the benefit of employees of private 501(c)(3) organizations and public schools employees. While any employer is vulnerable to a Plan Document failure, 403(b) plans maintained by governmental entities or by employers whose plans allowed for only voluntary employee contributions are particularly vulnerable, because prior to 2009 these plans were not generally subject to the written plan document requirement.
The EPCRS compliance fee for submissions limited to the failure to timely adopt the 403(b) plan document is reduced by 50 percent,provided the submission is made on or before December 31. For example, if a 403(b) plan has between 101 and 500 participants, the compliance fee for 2013 would be $2,500 rather than $5,000.
Clearly, this $2,500 is a bargain when contrasted with the potential financial exposure for not correcting the Plan Document failure in 2013. First, if the voluntary submission is made after 2013, the compliance fee will double in amount. Second, if not corrected under EPCRS, the Plan Document failure could cause the employer to pay a negotiated sanction amount far in excess of $2,500. To illustrate the potential sanction, the starting point -- assuming just one participant contributing an average of $16,000 per year and paying an effective federal tax rate of 25 percent -- is $12,000. Obviously this amount increases dramatically when all participants are considered. Although the IRS will likely negotiate the sanction amount, it does not typically reduce it below the amount the employer would have paid under a voluntary EPCRS submission.