The Internal Revenue Service

This is a series based on questions from the AICPA
tax certificate of educational achievement (CEA) courses.

Small Business Tax Solutions

Q. In January 1997, the Internal Revenue Service announced a new procedure—the administrative policy regarding self-correction (APRSC)—for qualified retirement plans. Are all such plans included in the program?

A. Unfortunately, some plans will be excluded from the APRSC program, as described below.

The new policy—part of IRS Field Directive on the Administrative Policy Regarding Self-Correction —will allow retirement plan administrators to correct operational mistakes and prevent them from turning into disqualification problems. The policy signals a change in IRS procedures regarding a plans ongoing qualification after a disqualifying event. The IRS recognizes that the rules for qualified plan operations are complex and that plan administrators can—and do—make mistakes. Administrators now have the right to fix problems that violate the Internal Revenue Code, Treasury regulations, current legislation or the terms of the plan before the IRS enforces compliance through a plan examination or disqualifies a plan as the result of an audit. Unlike other IRS programs, there is no need to notify the agency about the error or the correction.

Before APRSC, plan administrators and sponsors had two choices to correct a violation.

  1. They could apply to one of three formal IRS correction programs:
    • Voluntary compliance resolution (VCR).
    • Simplified VCR program (SVP).
    • Closing agreement program (CAP).
  2. "Insignificant and isolated" problems could be corrected under the administrative policy regarding sanctions (APRS).

Each formal program required an IRS filing and a fee. While APRS let plan administrators make certain limited corrections without an IRS filing, the correction had to put any affected participant in the same position he or she would have been in had the error not occurred. In addition, APRS could be used to correct only minor, one-time errors; most operational problems tend to be repetitive. For example, if the plan did not make required distributions under IRC section 401(a)(9), then it had multiple violations if two or more people were required to receive a distribution.

The new policy is designed to encourage compliance by making corrections easier. APRSC generally is available for all operational violations found and corrected within the plan year following the violation year. APRSC also may be used to correct insignificant violations detected after this period. As a result, most operational violations that previously could be corrected only under VCR, SVP and CAP may now be self-corrected—even when they are significant and repetitive. The new program also may be used by sponsors of tax-sheltered annuity plans under IRC section 403(b).

Some plan violations may not be covered under APRSC:

  • Form defects . These are violations that can be corrected only by plan amendments, such as failing to make required amendments before the end of the remedial amendment period.
  • "Demographic" defects that lead to disqualification . These are IRC violations, including a violation of section 401(a)(26) or section 410(b), caused by a change in the demographic make-up of the employers workforce, such as increased staffing levels, that can be cured only by a plan amendment.
  • Exclusive benefit violations . These relate to the misuse or diversion of plan assets, for example by a business owner who uses the assets to operate his or her business or some other use that is not for the exclusive benefit of plan participants. Typically, the Department of Labor has jurisdiction.

To be eligible for APRSC, a plan administrator must have established practices and procedures that demonstrate a reasonable effort to comply with the plan and the IRC. The violation in question must have resulted from an oversight or mistake in applying these procedures. This suggests that all administrative activities such as determining eligibility or allocating contributions should follow a written checklist. In addition, the correction must be made for all years, including those for which the statute of limitations would otherwise not be required.

Although the IRS has not yet provided specific procedures for correcting an error, it has said it may be beneficial for plans to look at the VCR programs correction methods. The IRS intends to publish a list of correction methods used in CAP and VCR as a guideline for making corrections under APRSC. Until there is more guidance, plan administrators must take steps that can be shown to put participants where they would have been had the mistake not occurred. For example, if a sponsor omitted an employee in the prior years allocation, the employer must make a make-up contribution, plus investment earnings attributable to that contribution. The plan administrator should clearly document the correction, including a review of possible violations in prior years.

The IRS release makes clear that any failure to follow the plan terms is an operational violation that can lead to disqualification. There is no de minimis exception. Thus, violations that otherwise satisfy the IRC are still a disqualifying event. For example, failure to allocate contributions according to the plan is an operational violation, even when the allocation complies with the IRC.

Self-correction is available only if a plan is covered under a current IRS letter. For an individually designed or volume submitter plan (a plan that has received preapproval from the key IRS district office), a determination letter satisfies this requirement. For master or prototype plans, an opinion letter issued to the prototype sponsor is satisfactory; for regional prototype plans, it is a notification letter to the prototype sponsor.

Prototype plans come in two formats. A nonstandardized plan must be submitted to the IRS for an individual to rely on the prototype sponsors letter. A standardized plan usually does not need IRS approval; it can rely on the sponsors IRS approval and need not file for a separate determination letter. Standardized plans have become popular with employers looking for an inexpensive way to adopt new plans or to amend existing plans. The IRS approval given a prototype sponsor is transferred to the adopting employer and thus the plan becomes eligible for APRSC only when four requirements are met:

  1. Employers that currently maintain or have ever maintained a qualified plan covering the same participants cannot rely on the standardized plans opinion letter unless the two plans are part of a paired plan from the same prototype sponsor.
  2. When a standardized plan document is used to amend an existing plan, it must not result in an anticutback violation. That is, the restatement must provide for all protected benefits from the original plan. In some cases, a standardized plan may have a limited number of options, making violations of this criteria common.
  3. The plan must cover all employees of the employer, including members of a controlled group. The plan may not exclude any component of compensation.
  4. The adopting employer cannot change any wording in the prototype document unless specifically provided for in the adoption agreement.

If a plan fails to meet any of these criteria, it wont necessarily become disqualified, but the employer may be prevented from using APRSC to correct violations. Currently, there is no guidance on the IRSs intentions when it says that, to be eligible for APRSC, a plan must be covered by a "current" IRS letter. Does it mean every plan amendment must be submitted? While companies must wait for more clarification, it seems logical to conclude the prototype sponsors letter must be current with legislation or any major elective plan amendment.

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