The Internal Revenue Service (IRS) made important changes to the Employee Plans Compliance Resolution System (EPCRS) in Revenue Procedure 2021-30 that are helpful for plan sponsors as they expand the ability of plan sponsors to self-correct certain operational failures. The IRS also requested comments on Revenue Procedure 2021-30 so there may be more changes to come.
The IRS expanded plan sponsors’ ability to self-correct operational failures through retroactive amendment. These include insignificant operational failures or significant operational failures that are corrected within the required time period (see “Extension of Deadline to Self-Correct Significant Operational Failures” below for more information about this time period). Insignificant operational failures are those failures that are insignificant based upon the applicable facts and circumstances. EPCRS identifies certain factors that may be relevant in determining whether an operational failure is insignificant, including (1) the reason for the failure and occurrence of other failures; (2) the relative amount of plan assets/contributions involved; (3) the duration of failure and timing of correction; and (4) the number of participants affected (relative to those who could have been affected and to the plan population). A significant operational failure is everything else, i.e., a failure that does not constitute an insignificant operational failure under the factors described above.
In a previous EPCRS update, the IRS provided plan sponsors with the opportunity to self-correct operational failures through a retroactive plan amendment if the following requirements were met: (1) the plan amendment would result in an increase of a benefit, right, or feature; (2) the increased benefit, right, or feature would be available to all eligible employees; and (3) providing the increase in the benefit, right, or feature is otherwise permitted under the Internal Revenue Code and the general principles of EPCRS. The second requirement sometimes proved to be challenging for plan sponsors to satisfy because operational failures and resulting corrections oftentimes did not impact each and every plan participant. In addition, the requirement made it difficult to correct significant operational failures as it may be unlikely that all plan participants would be impacted by a plan provision within the required time period for correction of significant operational failures. Now, in this EPCRS update, the IRS eliminated that second requirement. This change will make it easier for plan sponsors to self-correct operational failures through retroactive amendment without having to go through the voluntary correction program (VCP).
As part of this update, the IRS also specifically indicated that overpayments (discussed below) may be corrected by adopting a retroactive amendment reflecting the plan’s operation (again, provided that the retroactive amendment satisfies requirements (1) and (3) above).
While self-correction of operational errors through retroactive amendment is still limited to amendments that increase benefits for all affected employees, the IRS’s change expands the instances in which this correction approach may be available. A common example of this type of error is where a plan sponsor historically includes a particular element of compensation in the plan’s definition of eligible earnings (e.g., modest “spot bonuses” or achievement awards paid to some (but not all) employees) even though the plan document’s definition of earnings does not include the element of compensation. Before this recent change to EPCRS, the retroactive amendment approach would not be available because the increase in benefits would not be available to all participants. Now, the plan sponsor could choose to correct through retroactive amendment by amending the plan retroactively to include the element of compensation in the plan’s definition of earnings for affected participants.
The IRS has amended EPCRS several times over the last six years to make it easier for plan sponsors to correct operational failures involving overpayments from retirement plans and to reduce the perceived burden on affected participants and beneficiaries. For example, the IRS previously updated EPCRS to permit a plan sponsor to correct erroneous overpayments without demanding repayment from the participant or beneficiary receiving the overpayment (referred to as “overpayment recipients”). But while the plan sponsor was no longer required to demand repayment from the overpayment recipient, the plan sponsor generally was still required to “make the plan whole” for the overpayments by making an out-of-pocket contribution to the plan in the amount of the overpayment.
EPCRS is now amended to provide even more flexibility for the correction of overpayments in the following ways:
Flexibility in Repayment Options. Plan sponsors may now provide overpayment recipients with the option of how they would like to repay overpayments (installments or reduction of future payments rather than a single lump sum). If the reduction of future payments method is selected and the actual amount returned is insufficient (for example, the recipient dies before the overpayment and interest is returned), the plan sponsor is not required to make up the difference. This flexibility in repayment options is available for overpayments involving both defined benefit and defined contribution retirement plans.
Funding Exception Correction Method for Defined Benefit Plans. For overpayment scenarios involving a single employer defined benefit pension plan, if the plan’s adjusted funding target attainment percentage (AFTAP) is at least 100% at the date of correction, no corrective payments are required from the plan sponsor or the overpayment recipient. For a multiple employer pension plan, no corrective payments are required from the plan sponsor or the overpayment recipient if the plan’s most recent annual funding certification states that the plan is not in critical, critical and declining, or endangered status at the time of correction. However, for both types of pension plans, if the overpayment recipient is receiving ongoing payments that are in excess of the amount permitted under the terms of the plan, future payments must be reduced to the correct amount permitted under the terms of the plan.
Contribution Credit Method for Defined Benefit Plans. The plan sponsor can offset/reduce (but not below zero) the amount of the overpayment that needs to be repaid to the plan by any “contribution credits.” Contribution credits include (1) the increase in the plan’s minimum funding requirements due to the overpayment (calculated between the year in which the overpayments were taken into account for funding purposes and the year the corrected payments were taken into account); and (2) contributions made by the plan sponsor to the plan after the first overpayment that were over and above the contributions required by the minimum funding requirements set forth in the Internal Revenue Code. Contributions are not treated as contribution credits for these purposes if the contributions (1) are added to the prefunding balance (unless an election was made to apply these contributions to reduce it); (2) are made to remove or avoid benefit restrictions imposed pursuant to Section 436 of the Internal Revenue Code, withdrawal liability payments, and contributions to multiemployer plans; or (3) were made to correct other failures. If the contribution credits completely offset the overpayments, the plan sponsor does not need to make any further corrections (i.e., there is no need to recoup overpayments from overpayment recipients and no need to make any other contributions to make the plan whole). If there is still a net overpayment after applying the offset/reduction for contribution credits, then the net overpayment must be corrected in accordance with EPCRS’s general procedures for correcting overpayments, but with some additional modifications as described below. In either case, if the overpayment recipient is receiving ongoing payments that are in excess of the amount permitted under the terms of the plan, future payments must be reduced to the correct amount permitted under the terms of the plan. The additional modifications for recoupments of net overpayments after application of the contribution credit approach are as follows:
Increase in De Minimis Overpayment Threshold. The IRS increased the de minimis overpayment threshold from $100 to $250. If the overpayment amount does not exceed $250, a plan sponsor has no obligation to correct the overpayment or provide written notice to the recipient that the overpayment is not eligible for rollover.
These revised overpayment correction procedures provide additional flexibility to plan sponsors in the correction of overpayment failures, particularly as it relates to the requirement for plan sponsors to contribute make-whole payments to defined benefit plans. Plan sponsors had noted that the repayment requirement in the defined benefit plan context is perhaps unnecessary, as plan sponsors regularly make contributions to defined benefit plans in order to satisfy minimum funding requirements. The updated changes regarding defined benefit plan overpayments demonstrate that the IRS heard plan sponsors’ concerns and is now providing sensible alternatives that forgo the make-whole contributions. Given ongoing funding relief, many reasonably well-funded plans may have an AFTAP of 100% or more and be able to apply the funding exception correction method. Other plans may be able to apply the contribution credit method to avoid or reduce the obligation to contribute make-whole payments to the plan, but, as noted above, there are more rules and requirements associated with the contribution credit method and it may be more complicated to apply.
Under the current IRS correction procedures, plan sponsors were permitted to make VCP submissions on an anonymous basis (i.e., with all of the plan sponsor’s identifying information redacted, to be provided to the IRS once the submission was approved). However, unlike a regular VCP, the plan sponsor does not have audit protection for the failures identified in the anonymous VCP. Effective January 1, 2022, the IRS will no longer accept anonymous VCP submissions. Instead, the IRS may allow anonymous VCP presubmission conferences. There is no fee to request or participate in these conferences.
The anonymous VCP submission conferences “are held only at the discretion of the IRS, and as time permits,” and a conference may only be requested (1) for matters otherwise eligible for a compliance statement; (2) for matters that do not have a safe harbor correction provided under EPCRS; and (3) by plan sponsors who are eligible for VCP. Further, the request for the VCP submission conference also requires submission of extensive information similar to what is required to make the actual VCP submission, including (1) the Form 8950; (2) a description of the failures (all relevant facts including timing, reasons for failures, types of affected participants); (3) a description of the method of correction; (4) copies of relevant plan documents and amendments; and (5) “any other information the IRS would need to evaluate the request.” Lastly, the IRS will only give oral feedback (written confirmation will only indicate that the conference took place), which is not binding on the IRS and cannot be relied on to obtain relief under EPCRS.
It is not yet entirely clear how well the anonymous VCP presubmission process may work—for example, will the IRS exercise its discretion not to schedule a conference for a requesting plan sponsor? Will the IRS provide useful oral feedback as part of the conferences? Because of these uncertainties, plan sponsors that have been considering an anonymous VCP may wish to file soon, before the opportunity is no longer available.
While plan sponsors can self-correct so-called “insignificant” operational failures at any time, the IRS places time limits around when plan sponsors can correct “significant” operational failures. Factors relevant to whether a failure is insignificant or significant are described in the first section of this LawFlash. Previously, self-correction of significant operational failures was required to be substantially completed by the last day of the second plan year following the plan year in which the failure occurred. The IRS extended this deadline by another year to the last day of the third plan year following the plan year of the failure.
In previous updates to EPCRS, the IRS provided a safe harbor for correction of missed deferral failures for employees subject to an automatic contribution feature. Under the safe harbor, no qualified nonelective contribution was required to make up for missed deferrals of an employee subject to the automatic contribution feature if the affected employee was enrolled within 9½ months after the end of the plan year in which the affected employee should have been initially enrolled, provided that the employer makes missed matching contributions and provides a notice with certain required content to the employee within 45 days of the date correct deferrals begin. This safe harbor correction method was scheduled to sunset on December 31, 2020, but the IRS has now extended this sunset to December 31, 2023.
The continued availability of this correction method is a beneficial change for plan sponsors that have adopted or plan to adopt an automatic enrollment feature. The extension of this correction method is consistent with the general trend seen in the SECURE Act of encouraging plan sponsors to adopt automatic enrollment features. Recent legislative proposals have proposed extending the safe harbor, so there may be more to come.
In addition to these changes, the updated EPCRS makes a number of other smaller changes, including increasing the de minimis threshold (under which correction is not required) for distribution or forfeiture of excess contributions from $100 to $250 and requiring Audit Cap sanctions to be paid via pay.gov (same method as paying VCP fees) rather than by check.
If you would like more information or have questions about the updates to the EPCRS program, please contact the authors, your Morgan Lewis contacts, or any of the following lawyers:
Amy Pocino Kelly
R. Randall Tracht