Voluntary compliance programs for qualified retirement plans.

Favorable tax treatment is available for retirement plans that meet statutory qualification requirements. In the 22 years since ERISA was enacted, these qualification rules have become increasingly technical. Although plan sponsors are generally careful to keep plan documents up to date for new qualification requirements, many sponsors and their advisers have found instances in which their plans are not in compliance with one or more qualification requirements.

Prior to the introduction of voluntary compliance programs by the IRS in the early 1990s, the unfortunate result of operational defects was possible disqualification of the plan's tax-favored status. Pardy because plan disqualification negatively affects both highly compensated and rank-and-file employees, disqualification was applied only in the most extreme cases.

To encourage voluntary compliance by plan sponsors and provide greater uniformity of enforcement among Service key districts, voluntary compliance programs were started. These programs were the Closing Agreement Program (CAP) in 1990, Administrative Policy Regarding Sanctions (APRS) in 1991 and Voluntary Compliance Resolution (VCR) in 1992. Although the costs, procedures and types of eligible defects vary under each program, the overall goals include preserving an impaired plan's qualified status, correcting the defects to make affected participants "whole" and reasonably ensuring that the same or similar defects no longer occur in a plan's operation.

These programs were recently modified and consolidated in Rev. Proc. 98-22, effective Sept. 1, 1998.

Each program covered under Rev. Proc. 98-22 has different goals, requirements and results. In some cases, a plan sponsor has to follow the appropriate program outlined in Rev. Proc. 98-22, based on its ability to meet eligibility requirements. However, in some cases, different programs provide more favorable results in different areas. While the correction of a defect is required in each program, the sanction or required fee may differ greatly, depending on which program is chosen. Therefore, practitioners should be familiar with each program, to be able to place their client's plan under the program that provides the best opportunity for the results desired.

The only program that does not require filing with the IRS is Administrative Policy Regarding Self-Correction (APRSC). (This program was formerly known as APRS.) APRSC offers relief from disqualification only for operational plan defects that satisfy certain criteria, and provides no relief for form defects or for violations of the exclusive benefit rule (relating to the misuse or diversion of plan assets). Under APRSC, a plan sponsor or administrator must have established practices or procedures reasonably designed to promote and facilitate overall compliance with Sec. 401(a) requirements. It must also be shown that these procedures are "routinely" followed, but that, due to an oversight or mistake or because of an inadequacy in the procedures, an operational violation occurred.

To be eligible for relief under APRSC, a plan sponsor must make full correction of all violations for all years in which the defects existed. The correction should restore current and former participants or beneficiaries (as well as the plan) to the position they would have been in had the defect not occurred. The correction procedures outlined in Rev. Proc. 98-22 consider when the operational defect occurred, the type of plan document and whether a current determination letter has been received. The "significance" of the violation is considered in determining whether an operational defect must be corrected within the two-year period described.

One of the most beneficial aspects of APRSC is that no sanction or fee is required. Rather, all that is required is retroactive and prospective correction of the defect. Additionally, as an informal program, the Service does not have to be informed of the plan sponsor's use of the program unless later questioned. Of course, a disadvantage is that, unlike VCR and CAP, the plan sponsor and adviser do not have the comfort of knowing the IRS has approved the eligibility of the defect and the corrective procedures.

The VCR program involves a filing with the IRS National Office, in which the defect, proposed correction procedures and other relevant information are reviewed. The Service then issues a letter indicating whether the corrective procedures are acceptable. The most common types of defects that have been corrected through the VCR program include excess annual additions under Sec. 415, incorrect Sec. 401(k) actual deferral percentage and Sec. 401 (m) actual contribution percentage testing, Sec. 416 top-heavy violations and missing Sec. 401(a)(9) required minimum distributions.

An important eligibility requirement for consideration under the VCR program provides that an employee plan must not be under examination. The second eligibility requirement for consideration provides that the defect(s) must be operational in nature. Also, plans with operational violations that are egregious are not eligible for consideration under VCR. If a plan files under VCR and it is determined that the violations are egregious, the plan sponsor is given 60 days to voluntarily request CAP consideration. Also, the VCR program is not available to sponsors that diverted or misused plan assets. The third eligibility requirement is that a current favorable determination letter must have been issued.

Along with a filing under VCR, the employer must also submit a user fee. The fee is based on the number of participants and the amount of assets in the plan. It ranges from $500 to $10,000, and is generally refunded if the IRS determines that the plan is ineligible for VCR.

When a defect cannot be corrected through APRSC or VCR, the voluntary CAP is generally available. IRS key district offices administer voluntary CAP, as well as involuntary CAE Voluntary CAP is initiated by the plan sponsor, while involuntary CAP may be proposed by the Service following an examination, as an alternative to plan disqualification.

The eligibility requirements for voluntary CAP include the failure to follow a plan's terms and to satisfy the qualification requirements in either form or operation. This includes failure to timely amend the plan for changes made by the Taxpayer' Relief Act of 1986. If a plan is eligible under the VCR program, it is generally not eligible under the voluntary CAP program. Egregious violations, for example, will be eligible for consideration only under voluntary CAP.

Unlike VCR, which requires a user fee, voluntary CAP requires a sanction. This sanction is a negotiated amount between the plan sponsor and the key district office. Under Rev. Proc. 98-22, the sanction imposed will generally fall within a specified range depending on the number of affected plan participants. The "presumptive amount" contained in the ranges varies from $2,000 to $35,000. Determining whether the sanction in the voluntary CAP program should be above or below the presumptive amount depends on the nature, extent and severity of the defect.

In summary, the consolidation of the APRSC, VCR and CAP programs under Rev. Proc. 98-22 should facilitate practitioners' ability to advise clients on correcting potential qualification defects in their retirement plans. Choosing the appropriate program, based on the facts and circumstances of a defect, is critical to its successful resolution.

From David S. Horvath, CPA, Oak Brook, IL.