New self-correction policy for retirement plans.

A recently released IRS administrative policy on self-correction of pension and profit-sharing plan violations is sure to be embraced by retirement plan sponsors and administrators. This new policy, released Jan. 7,1997, will bring much-sought-after relief from the severe penalties associated with often seemingly insignificant plan defects.

The IRS Administrative Policy Regarding Self-Correction (APRSC) builds on, and replaces, the IRS Administrative Policy Regarding Sanctions (APRS), which was established on Mar. 26, 1991. APRSC is broader in scope and places more emphasis on the self-correction of plan defects. Specifically, the policy eases eligibility requirements for relief, establishes a procedure that plan sponsors can follow to correct their plans in a timely manner, lengthens the list of plan operational violations that may be considered insubstantial (and, therefore, nondisqualifying), and extends relief to Sec. 403(b) tax-sheltered annuity plans.

Background

Over the years, the Service has developed many compliance programs designed to enforce the Code's plan qualification requirements and to promote continued plan qualification. These programs have evolved to meet the needs of employers, participants, examining agents and practitioners.

The first closing agreement program was established Dec. 21, 1990. This program allowed a plan sponsor to correct four specified defects by entering into a closing agreement with the IRS and paying a monetary sanction. Once this was done, the plan was considered qualified with respect to the specific defects corrected. The closing agreement program was expanded on Oct. 9, 1991 to allow for the correction of most plan defects. The APRS established in 1991 allowed plan sponsors to correct, without paying a monetary sanction, a de minimis defect that occurred in a single year in a plan with a compliance history.

Building on the experience gained from the closing agreement program, the Service implemented two voluntary compliance programs, the Voluntary Compliance Resolution (VCR) Program and the Walk-in Closing Agreement Program (Walk-in CAP). The establishment of these two programs allowed the plan sponsor, for the first time, to initiate correction of defects not considered de minimis.

The first voluntary compliance program was established by Rev. Proc. 92-89. This VCR Program was a temporary experimental program, initially scheduled to end after 1993, but now extended indefinitely. Under VCR, a plan sponsor who discovers a defect in a plan intended to qualify under Sec. 401 (a) may pay a fixed compliance fee and work with the IRS to correct the defect. A modified version of VCR, called Standardized VCR Procedure (SVP), was introduced in 1993. Under SVP, the plan sponsor may pay a smaller fixed compliance fee by following the correction procedure established under SVP.

The second voluntary compliance program was established by Rev. Proc. 94-16. This Walk-in CAP allows plan sponsors, whose plans are not eligible for the VCR Program, to correct plan defects and pay sanctions that are ordinarily less (and often substantially less) than an audit CAP sanction.

Eligibility Requirements

APRSC eases the eligibility requirements for relief. Sponsors of retirement plans intended to be qualified under Secs. 401(a) and 403(a) and arrangements described under Sec. 403(b) are eligible to use APRSC to correct operational violations and plan defects. However, APRSC is not available to correct violations resulting from the plan sponsor's failure to amend the plan for law changes (such as the Tax Equity and Fiscal Responsibility Act of 1982, the Retirement Equity Act of 1984 or the Tax Reform Act of 1986). APRSC also is not available to correct exclusive benefit violations relating to the misuse or diversion of plan assets.

To be eligible for APRSC, plan sponsors or administrators must have established practices and procedures reasonably designed to promote and facilitate overall compliance with Sec. 401(a) or 403(b). The plan sponsor may not simply rely on the fact that a formal plan document exists.

The self-correction procedure will not be available to correct any plan violations for any plan year under Employee Plans or Exempt Organizations (EP/EO) examination or pending EP/EO examination. The plan sponsor may not use APRSC to avoid penalties for plan defects discovered under examination.

Self-Correction Procedures

APRSC establishes a procedure that plan sponsors can follow to correct their plans in a timely manner. With APRSC (as with the previous self-correction and voluntary compliance programs), the plan sponsor must completely correct all violations for all years in which the defect existed. The correction method should restore to both current and former participants and their beneficiaries the benefits and rights they would have had if the defect had not occurred. Also, the plan should be restored to the position it would have been in had the defect not occurred. A plan sponsor may use the self-correction procedure as often as needed.

Nondisqualifying Events

APRSC expands the list of nondisqualifying events, which are certain operational violations that may not rise to the level at which it would be productive or consistent with pension policy to pursue the sanction of disqualification (in the case of a Sec. 401 (a) plan) or to recommend loss of the exclusion allowance (in the case of a Sec. 403(b) plan).

Under APRSC, the IRS considers several factors when determining whether or not operational violations are significant and, hence, disqualifying. Some of these factors include: (1) the number of violations that occurred during the period being examined; (2) the percentage of plan assets and contributions involved in the violations; (3) the number of years the violations occurred; (4) the number of participants affected relative to the total number of plan participants; (5) the number of participants affected as a result of the violations relative to the number of participants that could have been affected by the violations; (6) whether corrections were made prior to examination; and (7) the reason for the violations.

Any operational violation (whether or not considered insignificant) corrected by the plan sponsor by the end of the plan year following the plan year in which it occurred is a nondisqualifying event.

Sec. 403(b) Tax-Sheltered Annuity Plans

APRSC brings long-awaited relief to sponsors of Sec. 403(b) tax-sheltered annuity plans. Previous administrative policies failed to address defects and violations related to these increasingly popular retirement plans.

Conclusion

The establishment of APRSC is yet another step in the right direction. The Service is placing increasing emphasis on self-correction of retirement plan defects, rather than the forced correction of plan defects through examinations. The IRS realizes that it is better to work with plan sponsors to correct defects already known by the sponsors, than it is to spend limited time and resources to uncover often insignificant defects of which the sponsor may have been innocently unaware.