In December 1996, the IRS adopted the Administrative Policy Regarding Self-Correction ("APRSC"), an extraordinary policy allowing self-correction, without penalty, for certain operational failures that would otherwise subject a plan to disqualification. Yet, despite it's importance, despite the sea-change of attitude it reflects, very little was written about the APRSC. APRSC quietly joined other programs, such as VCR, SVCR, and walk-in CAP, as part of the alphabet-soup of reduced sanction programs the IRS has adopted to avoid the severity of punishment of plan disqualification.
Then, in March 1998, in Revenue Procedure 98-22, the IRS has consolidated these programs under one heading, a coordinated Employee Plans Compliance Resolution System ("EPCRS"). In addition, IRS has provided more guidance, less uncertainty, and lower sanction amounts, for plans making corrections.
Underlying Principles
EPCRS is based on the concepts that
1) plan sponsors should be encouraged to establish policies and procedures to ensure that plans are operated in accordance with qualification requirements,
2) sponsors should maintain plan documents in compliance with qualification requirements,
3) sponsors should make voluntary and timely correction of plan defects, because timely correction protects participants by providing them with their expected retirement benefits, and avoids the adverse effects of plan disqualification,
4) voluntary compliance is promoted by providing for limited fees for approved corrections, and
5) sanctions, when imposed, should be reasonable in light of the nature, extent, and severity of the violation.
Overview of Programs
Self-correction (APRSC): A sponsor that has established compliance practices and procedures may correct insignificant operational failures at any time. A sponsor, if it has a favorable determination letter, may correct significant operational failures within two years of the failure. If the plan qualifies to use APRSC, no fee or sanction is paid and the IRS is not notified.
(The plan sponsor may face a difficult decision in determining whether a correction qualifies under APRSC, since a later IRS determination that a failure was not "insignificant", or that the plan's established compliance practices were not adequate, might cause an APRSC correction to fail. If there is question about the eligibility to use APRSC, some plans will opt for VCR, at higher cost, to guarantee that the correction will "stick".)
Voluntary Compliance Resolution (VCR): Plans that are not currently under examination can correct operational failures with IRS approval. VCR fees are based on plan size, from $500 for a plan with less than 1,000 participants and less than $500,000 in assets, to $10,000 for a plan with 10,000 or more participants.
Standardized VCR Procedure: SVP can be used for correcting one of eight specific operational failures, using the specific correction procedure allowed under the program. The SVC fee is $350.
Walk-in CAP (Closing Agreement Program): Plan document and demographic failures, as well as operational failures that are not eligible for VCR or APRSC, can be corrected under the walk-in CAP program. A plan can apply for Walk-in CAP on a John Doe basis, and only identify itself after getting IRS approval for the corrections.[See my July Newsletter... it appears that John Doe CAP will NOT be available in the future..] Correction fees are negotiated, based on the nature and severity of the failure. The Rev Proc includes a range of fees for this program, which can be as low as the VCR fee described above, or as high as $2,000 for a plan with 10 participants, or $70,000 for a plan with over 1,000 participants, but it seems that the negotiated fee ("the presumptive amount") will be in the middle of the range, in most cases. If the failures are egregious, the fee is still "negotiable", but the maximum fee is increased to 40% of the "maximum payment amount", generally the maximum tax that would be collected from the plan, the participants, and the employers, should the plan be disqualified.
Audit CAP is available for all types of qualification failures found on examination that can't be corrected under APRSC. The Audit CAP sanction is a negotiated percentage of the maximum payment amount, (the "maximum tax" described above), but should not be excessive, and should bear a reasonable relationship to the nature, extent, and severity of the failure. The Rev Proc provides that corrections made before an IRS examination, even for failures that can't be corrected under APRSC, VCR or Walk-in CAP, will be an important factor in reducing the sanctions imposed under Audit CAP. Where existing administrative procedures are inadequate for operating the plan in conformity with qualification requirements, the Audit CAP closing agreement may require adoption of certain improved control procedures.
Nature of Corrections
Corrections should be full corrections with respect to all participants and beneficiaries, resulting in full restoration of benefits as if the failure had not occurred. The correction, in general, should keep assets in the plan. Reasonable action must be taken to locate lost participants and beneficiaries. Corrective distributions of $20 or less per participant can be waived, if the cost of processing and delivering the distribution would exceed the amount of the distribution.
What Do Trustees Need to Know?
Plan disqualification is too severe a punishment for most errors. These programs make reasonable alternatives available, if the plan qualifies to use them, but that depends on finding the errors timely, and making full correction.
The lesson in these programs is clear. The IRS wants plan sponsors to actively enforce compliance with qualification provisions of the plan, by establishing a system of internal controls and procedures that continually test for compliance.
If your plan is examined, and if you've made a correction under APRSC, you can expect the IRS agent to consider whether you are eligible to use APRSC, and he will ask for proof that such self-policing procedures are in place. However, there's little guidance as to what procedures would be sufficient. The plan document, alone, is not enough evidence of an "established procedure". It seems clear, also, that the annual financial statement audit will not be enough to satisfy this need.
Depending on the size of the plan, appropriate procedures could range from the use of forms and checklists that document your staff's compliance with the rules, to a periodic "compliance audit" involving your internal and outside auditors, as well as your actuary and attorney. Discuss with your outside professionals whether your current procedures are sufficient to detect operational failures in time for correction under APRSC.
Ask how procedures can be improved. If you need further guidance, or want to consider a periodic compliance audit, we can help.
