United States: New IRS Corrections Guidance Puts A Premium On Careful Qualified Plan Drafting

On September 29, 2016, the Internal Revenue Service (IRS) issued Revenue Procedure 2016-51 (Rev. Proc. 2016-51), which updates the Employee Plans Compliance Resolution System (EPCRS) and changes how sanctions will be determined if a qualified plan error is found during an audit or the determination letter process (the Audit Closing Agreement Program or "Audit CAP" portion of EPCRS). Rev Proc. 2016-51 is effective on January 1, 2017 and consolidates other recent IRS guidance, but falls far short of expectations for an expanded corrections program for retroactive corrective amendments in light of the absence of an ongoing determination letter program for most qualified plans.

Except for the winding up of the last of the Cycle A individually-designed plan applications, the determination letter program is now limited to individually designed new plans, individually designed terminating plans, volume submitter plans with individually designed language and special circumstances to be announced in the future.

In light of the suspension of the cyclical determination letter program for most qualified plans, it is more important than ever to closely monitor legally-required plan language changes and deadlines, and to attend to careful drafting. If a legally-required amendment is late or inadequate, the likelihood that it will not be caught until either the plan is audited or a determination letter is submitted upon plan termination increases. This could result in much higher sanctions than otherwise would have been the case under the prior system, when most errors were identified and corrected within the cyclical determination letter process and within acceptable amendment timeframes.

Audit CAP – Negotiation of Sanctions

Under Rev. Proc. 2016-51, Audit CAP sanctions will no longer simply be a negotiated percentage of the maximum payment amount. Instead, the sanctions will be a negotiated amount that is determined based on all of the facts and circumstances. The maximum payment amount is now de-emphasized and is one of the facts and circumstances considered, instead of the starting point for negotiations. In some cases, this approach may lead to more flexibility and lower sanctions.

At a minimum, the sanction will not be less than the user fee that would have been paid if the plan had submitted a VCP filing to correct the failure.

Audit CAP - Negotiation of Sanctions - Nonamender Failures

Rev. Proc. 2016-51 contains new factors that will be considered in the negotiation of the Audit CAP sanction for a failure to adopt legally required qualified plan amendments timely, or for other legally inadequate or disqualifying Plan language (a "Nonamender Failure"). In addition to the facts and circumstances discussed above, the following factors will be taken into account:

  • whether the plan had received a favorable determination letter;
  • the internal controls implemented by the plan sponsor to ensure the timely adoption of required amendments;
  • the extent to which the plan sponsor had adopted a timely plan amendment which later is found not to satisfy the qualification requirements of the Internal Revenue Code;
  • the extent to which the plan sponsor had otherwise adopted applicable amendments identified on the Required Amendments List published annually by the IRS; and
  • the extent to which the plan sponsor had reasonably determined that a provision on the Required Amendments List was not applicable to the plan.

Audit CAP - Negotiation of Sanctions - Nonamender Failures Discovered During Determination Letter Process

If the only failure discovered during the determination letter process (which is now very limited and may not occur until plan termination) is a Nonamender Failure, the sanction will be 150% or 250% of what the VCP user fee would have been for the plan had the failure been voluntarily identified by the plan sponsor in a VCP filing, and will depend upon how late the required qualifying amendment was adopted.

This sanction may be negotiated, however, and reduced based upon the facts and circumstances. The sanction may also be increased if the Nonamender Failure is "egregious." If the IRS finds the failure to be egregious, the general Audit Cap sanction rules will apply.

VCP – Higher Sanctions – Egregious Failures

Rev. Proc. 2016-51 also provides that the standard VCP user fee may be increased in the case of egregious failures. A failure is egregious if the IRS concludes that the parties responsible for the qualified plan knew that their actions would constitute a failure, and the failure either involved a substantial number of participants or predominantly highly compensated participants.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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