Oops! How do I make it right? IRS Correction Program Options for Common Plan Errors

Posted by Maria Hurd, CPA

Disclaimer: All blog posts are valid as of the date published.

IRS Correction Programs - 401k Audit

In a highly regulated industry with complicated rules that always have exceptions (except when the exception does not apply) it is inevitable that sooner or later a failure to follow the plan document will take place. Such operational errors can be corrected through the IRS Employee Plan Compliance Resolution System (EPCRS) in one of three ways:

1-Self-Correction Program (SCP)

Recognizing that certain errors are common, the EPCRS program offers pre-approved ways for plan sponsors to self-correct insignificant errors at any time, and significant errors by the last day of the second plan year after the error occurred, or by the last day of the third year in the case of ADP/ACP test violations.

2- Voluntary Compliance Program (VCP) Submission to the IRS Requesting Approval for a Specific Correction Method

When a significant error is not timely corrected, the plan sponsor would like to deviate from a pre-approved correction method, or the error is not correctable under SCP (such as participant loan violations) the plan sponsor should submit a VCP application, which requires the payment of a fee. VCP applications can be done anonymously to avoid a commitment, but the IRS will not delay an audit if an anonymous VCP application is in progress, as opposed to a regular submission.

3- Audit Closing Agreement Program (Audit CAP)

If the error is discovered during an IRS audit, the plan sponsor will pay a sanction greater than the VCP fee. Understandably, the goal of the IRS is to encourage self-correction and self-reporting under VCP, so the sanction amount is meant to dissuade taxpayers from taking a risk that the error may never be caught.

When a plan error is identified, the plan sponsor and its service providers must make several determinations:

4- Employee Plan Voluntary Closing Agreement Program

Plan sponsors seeking a closing agreement to resolve retirement plan errors that are not eligible for correction under EPCRS, such as excise tax, deductibility, or funding violations can make a request for approval of a correction that they suggest, and propose a sanction to the IRS through the Employee Plan Voluntary Closing Agreement for which there is more detail on the IRS website.

Self-Correction vs. VCP

Is the error insignificant?

The first step is to determine whether the error is insignificant based on a number of subjective factors including:

  • The number of participants affected as a percentage of the plan
  • The correction amount per participant
  • The percentage of plan assets of the correction involved
  • The number of years that the error took place
  • The contribution amount as a percentage of annual contributions
  • The reason that the error occurred

If the error can be deemed to be insignificant, it is eligible for self-correction at any time if:

  • The plan has a favorable determination letter or equivalent
  • The plan sponsor has established practices and procedures (formal or informal) reasonably designed to promote and facilitate overall compliance with the law
  • The plan is not under examination by the IRS

The correction of significant errors not corrected by the last day of the second year after the error is made, correction methods that are not pre-approved by the EPCRS program, and errors not eligible for self-correction (such as loan violations) should be submitted for approval through a VCP application.

For a discussion of VCP fees, please refer to our blog titled, All Good Things Come to an End: A Tale of Significant Changes in VCP Fees Affecting Small Benefit Plans.

Making Participants Whole: Does Materiality Play a Role?

As one would expect, both the IRS and the DOL favor participants and expect corrections to put them in the position they would have been in had the error not taken place. However, the regulators recognize that there are practical aspects to plan corrections and that sometimes, there is a need to make estimates. As such, there are certain permitted exceptions to full correction of plan errors. For example:

  • Corrective distributions of $75 or less
  • Distributions for which the costs of delivery are higher than the distribution amount
  • Recovery of overpayments to participants of $100 or less

Note that the exceptions to full correction eliminate the need to make de minimis distributions or eliminate the requirement to recover funds from a participant who erroneously received an overpayment.   If the participant who is owed an omitted contribution is still employed by the company, the IRS would likely prefer that a restitution be deposited, even if an estimate has to be made to complete the correction in a cost-effective manner. For example, an employer that misses a series of elective deferral deposits into the plan can assume that all missed contributions would have been made on the midpoint of the plan year, or portion of the plan year in which the omission occurred. This method is a practical alternative to computing up to 52 separate interest calculations. In this case, the results of an exact calculation would not be significantly different than those of an estimated contribution date in the midpoint of the omission period. To make the participants whole, interest must generally be allocated to their accounts when a correction requires an additional deposit.

In the end, plan errors are likely to occur and the vast majority of plan sponsors  prefers to restore participant accounts to the position they would have been in had the mistake not been made. Administratively, the Self-Correction Program tends to be the favored method over a more costly and time consuming VCP application, but when the errors are significant, or stray from the pre-approved methods, the peace of mind of an official IRS approval can be what an employer needs. Careful consideration must be given to all the options.

Contact Us

If you have questions or seek additional information on this subject, please contact our Employee Benefit Plan Team.

Maria T. Hurd, CPA
Retirement Plan Audit Services

Chris J. Ciminera, CPA, QKA
Manager – Accounting & Auditing

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