Publication: Journal of Pension Benefits
Date/Volume/Issue: Autumn 2023, Vol. 31, No. 1
This column discusses Notice 2023-43 issued by the IRS on May 25, 2023, which provides interim guidance on interpretation and application of Section 305 of SECURE 2.0, which is effective while the updated EPCRS procedure is pending.
IRS Notice 2023-43: Welcome to Immediate Use of
SECURE 2.0 Self-Corrections
By: Adrienne I. Moore, Esq.
Those of us involved in plan correction work welcomed Section 305 of the SECURE 2.0 Act with open arms. This Section modified the rules for correcting compliance errors, significantly expanding the Employee Plans Compliance Resolution System (EPCRS), the formal correction procedure provided by the Internal Revenue Service (IRS), to resolve most qualification failures in retirement plans.
As with most legislation, however, Section 305 left many details to be resolved by the agency, including whether the positive changes from the law were effective immediately, or if they awaited the legally mandated IRS updates to the correction procedures. Knowing the size of the current burden on the IRS due to the many changes in SECURE and SECURE 2.0, as well as other challenges faced by the Service, we wince when we think about when the new procedures likely will be issued.
Fortunately, the IRS pleasantly surprised us with a stopgap measure. Although the revised procedure for plan corrections is still on the drawing board, the IRS issued Notice 2023-43 (Notice) on May 25, 2023. The Notice provides interim guidance on interpretation and application Section 305, which is effective while the updated EPCRS procedure is pending.
What the Notice Provides
The Notice gave us two pieces of important and welcome news. First, where SECURE 2.0 did not specifically state the effective date of Section 305, the Notice authorizes the use of the Section 305
changes immediately for qualified plan corrections. [Notice Section I] Therefore, we can now self-correct more types of failures and the permissible correction period is longer than before in many cases. Second, the Notice authorizes the more lenient self-correction process to be used for failures that occurred before SECURE 2.0 was enacted. [Notice Q&A-8]
The Notice also provided additional guidance about permissible self-correction of failures, so that practitioners can now confidently rely on the SECURE 2.0 changes. Practitioners particularly are welcoming the Notice’s guidance on how to self-correct loan failures. The Notice also provides more expansive correction possibilities than what was available under EPCRS, and authorizes self correction of failures, such as coverage failures, that previously required IRS filings and intervention.
What Exactly Did the SECURE 2.0 Section 305 Changes Entail?
EPCRS, the current version of which is found in Revenue Procedure 2021-30, contains three distinct correction programs: (1) the self-correction program (SCP), (2) the Voluntary Correction Program (VCP), and (3) the Audit Closing Agreement Program (Audit CAP). Audit CAP is the correction method for plans that have errors discovered during an IRS examination. [EPCRS § 13] VCP is the formal method of correction that requires the plan sponsor to file a submission (which includes a user fee payment) with the IRS for approval. [EPCRS § 10] SCP permits plan sponsors or administrators to fix plan failures without involving the IRS. [EPCRS §§ 8, 9] If a plan can use SCP, it is almost always less expensive than VCP, and does not necessitate confessing one’s sins to the IRS. Historically, a plan sponsor could use SCP only for certain types of failures and, if the failure was significant, correction had to occur within three years of the plan year in which the failure occurred. [EPCRS § 9.02]
Section 305 of the SECURE 2.0 Act gives plan sponsors and practitioners a phenomenal gift: the correction of most eligible inadvertent failures (EIFs) through SCP, regardless of the type of failure or the time during which it occurred. Therefore, it makes SCP more accessible, thereby reducing the cost and time needed to make many corrections. At a time when plan compliance keeps getting more and more complex and expensive, this is a welcome change that can help an employer keep plan costs within an acceptable range.
Here are the Details …
When Is the Notice Effective?
The Notice was effective immediately upon its issuance, that is, as of May 25, 2023. The IRS provided that plan sponsors may rely on the Notice until a new EPCRS procedure is issued (at which point the Notice will become obsolete). [Notice Section V] The Notice confirms that insignificant failures may still be self-corrected even if the plan is under examination by the IRS (as is currently permitted under EPCRS). Further, the Notice can be used immediately by plans to demonstrate that EIFs that were self-corrected before the Notice was issued but in reliance on SECURE 2.0 were handled appropriately. [EPCRS § 4.02, Notice Q&A-5] In particular, plan sponsors were permitted to apply a good faith, reasonable interpretation of Section 305 in self-correcting failures before the Notice was issued. [Notice Section V] If those good faith efforts align with the Notice’s requirements, correction is deemed to have been completed using a reasonable interpretation of the law.
What Is an Eligible Inadvertent Failure?
An EIF is a failure that occurs despite the existence of practices and procedures that satisfy the standards set forth in EPCRS. [SECURE 2.0 Act § 305(a)] An EIF cannot be egregious, relate to the diversion or misuse of plan assets, or directly or indirectly relate to an abusive tax avoidance transaction. [SECURE 2.0 Act § 305(e)]
This is a significant broadening of the errors that may be self-corrected. There are four types of failures covered by EPCRS: (1) operational failures (not administering the plan according to its terms); (2) document failures (not keeping the plan document up to date with legal changes); (3) demographic failures (failure of nondiscrimination testing, coverage, or plan participation rules based on the demographics of the employee group); and (4) eligible employer failures (when an employer sponsors a plan of a type that it is not permitted to have, such as governmental entities that erroneously adopt 401(k) plans or non-501(c)(3) nonprofits that mistakenly adopt 403(b) plans). Under EPCRS pre-SECURE 2.0, only the first two types of failures were self-correctable (and not all document failures were eligible for self-correction). Therefore, the expansion of EIFs into the other types of failures is huge.
Existing Practices and Procedures
EPCRS has always required, as a condition of self-correction, that a plan sponsor have practices and procedures reasonably designed to ensure compliance of the plan operations with the plan and the law. [EPCRS § 4.04] This requirement, however, is even more critical now, because such practices and procedures must be demonstrated as part of the process, as will be noted below. [Notice Q&A-1]
This may be a harbinger of deeper IRS dives into how plan sponsors take responsibility for operating their own plans. The IRS has been clear in the past in soft guidance and speeches that it expects the employer to fulfill its obligations to the plan in a responsible fashion, and not just blindly rely on service providers, particularly if the employer is solely responsible for that area of plan operations. Now, the IRS wants to see that the employer is taking the plan’s operations seriously. No one is sure yet what this means on a practical basis, but smart sponsors and their service providers should be thinking about how to comply.
Revised Timing for Self-Correction
As noted above, EPCRS historically limited the time during which errors that were significant needed to be corrected. Section 305 provides that an EIF may be self-corrected at any time before the IRS identifies it, and, even then, self-correction may still be permitted if the plan sponsor has demonstrated a “specific commitment to implement a self-correction” with respect to the EIF. [SECURE 2.0 Act § 305(a)]
The rules require, however, that the correction be completed within a reasonable period after the EIF is identified. The burden, therefore, falls not on catching and correcting the error during a specific time period after the error occurred, but getting to it before the IRS does, committing to get it fixed once the misstep is found, and correcting it reasonably quickly.
While this may seem to encourage dawdling, it really should not. First, you never know when the IRS will knock on the door, and dragging one’s heels certainly tempts fate in that regard. Second, it is almost axiomatic that, the longer a failure goes uncorrected, the more expensive the correction becomes. If dollar amounts are involved, the plan sponsor usually must make up earnings, and that can mount up faster than one might think. The broader correction timing should not be taken for granted.
When Is a Failure “Identified” by the IRS?
A failure is considered to have been “identified by the IRS” if the plan or plan sponsor comes under IRS examination in accordance with EPCRS Section 5.08. [Notice Q&A-4] This EPCRS section provides that “under IRS examination” means that a plan is under an Employee Plans examination, the plan sponsor is under an Exempt Organizations examination, or the plan is under criminal investigation by the IRS. An examination of the plan sponsor’s corporate tax filing, then, would not constitute being “under examination.” Perhaps even more importantly, this definition does not include compliance checks from the IRS. Therefore, these will not block a plan sponsor from SCP, nor will investigations of the plan by the Department of Labor (DOL).
It is important to note, however, that “identification” does not require the IRS agent conducting the examination to actually identify a specific failure to take self-correction of that failure off the table. The initiation of an examination alone means any outstanding failure is deemed to be identified by the IRS.
This restriction on self-correction applies only to significant failures. Self-correction of insignificant failures when the plan is under examination was permitted under EPCRS, and the Notice explicitly provides that this availability continues to exist. [Notice Q&A-5] To make use of SCP during an IRS examination, the failure will need to be eligible for self-correction under the stricter SCP requirements (for example, it must be insignificant, as determined using the factors presented in EPCRS). [EPCRS §§8.01, 8.02]
What Is a “Specific Commitment to Implement” a Self-Correction?
Whether a plan sponsor has made a specific correction commitment is a facts and circumstances determination that the employer is “actively pursuing correction.” [Notice Q&A-6] It appears from the Notice that both a specific identification of a failure and action toward correcting that failure is needed.
So, what does that entail? A facts and circumstances determination, of course, is a subjective analysis. The Notice tells us that undertaking a general compliance audit or having a general statement of intent to correct errors when they are found doesn’t cut it.
We considered the following and came up with our opinion of whether it constitutes a specific commitment:
- If a plan sponsor is concerned that the plan is generally out of compliance in some respects and hires someone to engage in a compliance review, that is likely not a “specific commitment,” as no failure has yet been identified.
- Undergoing the independent CPA audit required for the Form 5500 filing is also not a specific commitment to implement a self-correction.
- Finding an error and retaining a professional for the purpose of helping correct the error likely does constitute a specific commitment to implement the correction, assuming that action is taken within a reasonable time to start the process. Therefore, if a third-party administrator (TPA) identifies a failure during the annual administration and advises the plan sponsor of correction options, a direction from the plan sponsor to the TPA to carry out the corrective action (whether that be calculating amounts owed or overpaid, preparing missing amendments, etc.) likely demonstrates a specific commitment to implement the correction.
Needless to say, there is a wide gap between not knowing that an error exists and finishing the correction. Where in that range is the “specific commitment”? It will likely depend on the attitude of an IRS reviewer who is examining the plan, coupled with the strength of the arguments the plan sponsor is able to make to support that decisive action has been initiated. Recordkeeping will become incredibly important for this piece. Plan sponsors and their service providers must keep track of the exact dates that failures are first identified and what corrective action is taken (and when) to be able to demonstrate that self-correction began before the IRS identified the failure.
What Is “Correction Within a Reasonable Period”?
The definition of a reasonable period is again a facts and circumstances determination, although the Notice provides a safe harbor: any EIF that is corrected by the last day of the 18th month following when it is identified is presumed to have been completed in a reasonable period. [Notice Q&A-7] Note that the timing depends, not on when the error occurred, but when it is discovered by the plan sponsor. This is another reason why it is important to carefully document when EIFs are first identified. This will allow plan sponsors to demonstrate to the IRS that correction was completed within a reasonable period (or that a reasonable period is ongoing, should an IRS examination intervene, and the plan sponsor is now arguing that there has been a specific commitment to self-correct).
There is a separate safe harbor for employer eligibility failures. In that case, correction is presumed to have occurred within a reasonable period after identification of the failure if all contributions to the improper plan have ceased no later than the last day of the sixth month following when the failure is identified.
Self-Correcting Loan Failures
The Notice acknowledges that SECURE 2.0 removed the remaining restrictions on self-correcting certain loan failures (in particular, limitations on correcting loan defaults and on correcting loans that were defective from issuance). [Notice Q&A-1]
Generally, the permissible correction method under EPCRS for a loan in default is to either make a lum sum payment of the amount in arrears or to re-amortize the loan over the remaining portion of the five-year period. [EPCRS § 6.07(3)(d)] While the Notice is not explicit on this point, it appears that lump sum repayment after the five-year period has expired still does not avoid the participant having to claim the remaining balance on the loan as income in the year of correction.
Noncompliant participant loans are not just tax problems, but also ERISA violations. In particular, noncompliant loans may be prohibited transactions. SECURE 2.0 specifically overrides the DOL’s position that VCP or the use of its program, the Voluntary Fiduciary Correction Program, is needed to ensure that a defaulted loan is not a prohibited transaction. The language of the law does not appear to require a modification of DOL procedures for this to be so. Therefore, it appears that correction under EPCRS will suffice to salve the ERISA wound entirely.
What Conditions Apply to Self-Correction of EIFs?
Any self-correction of an EIF must satisfy certain requirements in Q&A-3 of the Notice:
- As noted earlier, the plan sponsor must have established practices and procedures reasonably designed to promote and facilitate overall compliance. Does this mean that the sponsor must have a specific procedure to address the specific task for which the failure occurred? Probably not. What it appears the IRS is seeking is some reasonable indication that the plan sponsor takes compliance with the law seriously and that it is positioning itself to handle the plan properly. Just hiring a TPA and considering one’s responsibility completed—the pension version of “set it and forget it”—is likely not sufficient.
- The plan sponsor must apply the general correction principles and rules in Section 6 of EPCRS. Section 6 dictates, among other things, that a correction method should restore the plan to the position in which it would have been had the failure not occurred, be reasonable and appropriate for the particular failure, and match or align with other correction methods provided for in EPCRS.
The Notice reiterates that the correction methods provided in EPCRS Appendices A and B are not required but are deemed to be reasonable and appropriate. [Notice Q&A-1(4)] The IRS is clear, however, that correction methods that are specifically prohibited under EPCRS cannot be used (although certain previously prohibited corrections have been modified or expressly permitted by the Notice).
Can Self-Correction Be Used to Eliminate Taxes?
No. If an EIF involves excise taxes or additional taxes, a plan sponsor will still need to file a VCP (or a Voluntary Closing Agreement Program) application to get a waiver of such taxes or to correct the tax issue.
What Still Cannot Be Self-Corrected?
Failures that are not eligible for self-correction and for which the plan sponsor must resort to VCP to fully correct include: [Notice Q&A-2]
- A failure to adopt an initial written plan. This includes a failure to document a Section 403(b) plan in 2009, and likely also applies to a failure to adopt a salary deferral provision before deferrals begin, as required by Treasury Regulation Section 1.401(k)- 1(a)(3)(iii)(A).
What if the nonadopter is a related employer (that is, a member of a controlled or affiliated service group under Code Section 414) that has not signed a participating employer agreement for a plan that is sponsored by another related employer? Is that a failure to adopt an initial written plan? It is reasonable to intuit that, since related employers are considered a single employer, the “employer” adopted the plan when the main plan sponsor started it. The fact that employees of a related employer were allowed to participate, where the document excluded them, is an operational failure that can be corrected by a plan amendment, such as signing a retroactive participation agreement. However, the IRS may not interpret its own rules this way, so caution is encouraged.
- A failure that occurred in an orphan plan. Orphan plans usually are the result of a plan sponsor disappearing suddenly, often because the business has closed or filed for bankruptcy. In such cases, the IRS still wants to be involved in any correction process. Because orphan plans are often simultaneously abandoned plans (as determined in accordance with Labor Regulation Section 2578.1), and may be lacking in plan fiduciaries, regulators may be concerned that it would be difficult to obtain records in the future if a later examination were to occur. Requiring orphan plans to correct failures through VCP provides some assurance to both the IRS and the participants that things are being done correctly before the plan closes up shop for good. (Note that, as we go to press, the DOL is considering widening its procedures for orphan or abandoned plans. We will see how this affects plans with IRS failures, if at all.)
- A significant failure in a terminated plan. It stands to reason that, if the IRS has clarified that significant failures cannot be self-corrected, plan sponsors must be able to self-correct insignificant failures in a terminated plan (which EPCRS is somewhat ambiguous about now but does not explicitly prohibit).
What is a “terminated plan”? Reasonable definitions include: (i) any plan for which legal action to terminate has been taken (such as the adoption of a termination resolution or amendment); or (ii) any plan that has been fully paid out (which is consistent with IRS Revenue Ruling 89-87, which provides that a plan that does not distribute assets within a reasonable time is frozen, and not terminated). Similarly, even if legal action has been taken to terminate a plan, the DOL does not consider a plan to have been terminated until assets have been distributed (as evidenced by the requirement to continue filing a Form 5500 until no assets remain). Until the IRS provides guidance to the contrary, it is reasonable to interpret the Notice to mean that a terminated plan is one whose assets have been fully paid out, and adopting a termination amendment or resolution alone does not mean the plan is terminated.
- A failure involving excess contributions to a SEP or SIMPLE IRA that is corrected by permitting excess to remain in a participant’s IRA. Any such excess contributions must be distributed if self-correction is being used. [EPCRS § 6.11(5)]
- A demographic failure that is being corrected in any manner other than using the retroactive corrective amendment rules found in Treas. Reg. Section 1.401(a)(4)-11(g) (the-11(g) Regulation). Treasury regulations permit the self-correction of demographic failures (that is, failures of coverage, nondiscrimination, or participation (that is, the application of Code Section 401(a)(26) in a defined benefit plan)) within a certain period. In particular, the -11(g) Regulation provides a plan sponsor with the ability to correct a demographic failure by adopting an amendment with retroactive effect only so long as it is adopted by the 15th day of the 10th month after the plan year end (that is, October 15 for calendar year plans). EPCRS, on the other hand, does not permit self-correction in addition to the -11(g) alternative. [EPCRS § 4.06] Therefore, before SECURE 2.0 and the Notice, if the demographic failure was not corrected within the available 9½-month period under the -11(g) Regulation, the only recourse was VCP.
Because the Notice specifies that the -11(g) correction is permitted (and specifically notes that the preclusion of self-correction of demographic failures is obsolete), it appears that the -11(g) Regulation correction can be made anytime within the normal self-correction period discussed above. Note, however, that, while the -11(g) Regulation does not require earnings to be contributed on the corrective deposits, EPCRS does so require. Therefore, if a demographic EIF is being corrected after the deadline provided in the -11(g) Regulation, any corrective contribution must be adjusted for earnings.
This limitation also appears to mean that demographic failures that cannot be corrected by an -11(g) amendment cannot be self-corrected. These errors would potentially include actual deferral percentage (ADP) and actual contribution percentage (ACP) testing failures. A significant disappointment for many.
Finally, the Notice also contains one more provision of note: it restricts the use of certain testing strategies in determining the proper correction of a demographic failure under SCP. These strategies normally result in a less expensive required correction. Further, they may have been used routinely in years past (and in the original calculation for the current year). Therefore, the failure to correct within the initial 9½ months also causes modified testing and a different correction amount is likely.
- An operational failure that is being corrected by a plan amendment if the benefit to any participant is less favorable than original provision. This is a change from the current EPCRS, under which such retroactive amendments to correct operational failures are permitted only in limited situations, such as if they increase a benefit, right, or feature. [EPCRS § 4.05] Here, self-correction by amendment to conform to operations is permissible so long as it does not result in something less favorable for a participant, but need not necessarily result in an increase. This may take care of many so-called scrivener’s errors, where the intended provision is different from what was actually reflected in the plan’s language. Having said that, however, it is important to note that this provision is not tantamount to the approval of any retroactive amendment anytime. Besides not cutting back on what the participant is entitled to receive under the original plan terms, the corrective amendment must conform the plan document to actual plan operations that occurred.
- A failure in a SIMPLE IRA or SEP that does not use a model or prototype plan document. We can now self-correct failures for a SIMPLE IRA or SEP that uses the model forms or a prototype plan document, whether the failure is significant or insignificant. That is a change from the existing EPCRS, which only permitted self-correction for insignificant failures. [EPCRS § 4.03(2)]
- A failure in an Employee Stock Ownership Plan relating to Code Section 409 that involves tax consequences other than disqualification (specifically noting Code Section 409(p), which addresses prohibited allocations of securities in an S corporation).
Additionally, nothing in the Notice prohibits a plan sponsor from using VCP to correct an EIF that is eligible for self-correction. If a plan sponsor wants to be assured of IRS approval of a correction or is at all concerned that the correction lies on the margins of permissibility, VCP is still a valuable tool. VCP is still mandatory for full correction if the plan lacks the required practices or procedures.
What EPCRS Requirements and Restrictions No Longer Apply?
The Notice specifically identifies sections in the current EPCRS procedure that are no longer applicable as of the passage of SECURE 2.0. [Notice Q&A-3] These include:
- A plan is no longer required to be subject to a favorable letter (as that term is defined in EPCRS, which includes both a favorable determination letter and an IRS Opinion Letter issued to a preapproved document sponsor) to be eligible for self-correction. [EPCRS §§ 5.01(4), 5.02(5)]
- As noted earlier, EPCRS historically has limited self-correction of significant operational failures to those that could be identified and substantially corrected before the earlier of (a) the end of the three-year period after the year of the failure; or (b) when the plan or plan sponsor is under IRS examination. [EPCRS §§ 4.02(2), 9.02(3)] The three year restriction is overridden by the SECURE 2.0 rules, and the guidance in the Notice is controlling until a new EPCRS procedure is issued. This does not necessarily provide a longer time for self-correction. As the period of correction is presumed to be reasonable under the Notice only if it is completed within 18 months of when the error is identified, the self-correction period may be shorter than three years for a quickly discovered failure.
EPCRS did not include any specific recordkeeping requirements related to self-correction, although a prudent practitioner or plan sponsor would retain detailed information about the failure and its correction to show the IRS in the event of an examination. (In absence of such proof, how could the practitioner demonstrate compliance with EPCRS?) Apparently, the IRS believes that those presumed records were de rigueur, because the Notice claims that no new recordkeeping obligations are being imposed … then proceeds to specify recordkeeping obligations not previously shown in EPCRS.
In particular, a plan sponsor must be able to provide an IRS auditor with the following correction documentation:
- Identification of the failure, including the year(s) in which the failure occurred and the number of employees affected.
- The date the failure was identified.
- An explanation of how the failure occurred and a demonstration of the existence at the time of practices and procedures reasonably designed to promote and facilitate overall compliance. Practices and procedures may be both formal and informal. Having a formal written procedure, however, will make demonstrating to the IRS the existence of practices and procedures much easier.
- Identification and substantiation of the correction (including the date of correction). Such substantiation would include proof of funding of any corrective contribution or signed and dated copies of corrective amendments. It bears repeating that any corrective amendments with retroactive effect must be dated contemporaneously and not backdated.
- Changes to practices and procedures to avoid recurrence of the failure. Presumably, if a mistake occurred, the prior practices and procedures were insufficient. The IRS wants to see what the plan sponsor is doing to close that loophole to avoid future errors.
For example, suppose that a company failed to implement an employee’s deferral election because the person in charge of payroll was on vacation. The plan sponsor might update its payroll policies by designating someone else at the company as the permanent back-up to the payroll person, and ensure that the backup will also receive communications from the recordkeeper about deferral changes. The procedure might further outline a training obligation so that the backup person understands how to implement participant changes if the payroll person is out of the office. Even such simple changes, where practical and targeted, can help ensure failures do not happen again.
Practitioners Should Take a Proactive Stance on Getting Their Clients to Take Compliance Seriously
The importance of documenting when a failure is identified, when correction begins, and how it is carried out cannot be overstated. Action taken to correct the EIF may represent the steps needed to prove that the correction process predated an IRS examination. It also allows the plan sponsor or practitioner to know the outside boundary of a timely correction under the IRS’s 18-month safe harbor.
Clients need help in establishing practices and procedures, and that need is more acute than ever. You should consider what you can do to help your clients set up processes in their offices so that they can both help keep their plan in compliance with the law and demonstrate that these processes exist, should self-correction ever become necessary. This may be particularly critical for a company that has customarily sustained compliance problems on a common basis. It would be awful to have the failure discovered and corrected, only to have the IRS impose a sanction for the failure on audit because a lack of procedures made the plan ineligible for self-correction.
Further, practitioners should position themselves to assist in the correction process (or to help the client find professional assistance in making corrections), so that the need for practices and procedures can be diagnosed and addressed.
Documenting self-correction is no longer just a wise choice—it’s a requirement. The Notice reflects that the IRS understands Congress’s determination that compliance corrections must be more easily implemented, and that self-correction is the way forward.
Although this Notice is effective only until a new EPCRS is issued, it seems likely that the IRS will continue to expand self-correction options and procedures, and will provide us with specific approved methods for corrections. Proper documentation and procedures will keep the ever-expanding self-correction options available to you and your clients.
Copyright © 2023 CCH Incorporated. All Rights Reserved.
Reprinted from Journal of Pension Benefits, Autumn 2023, Volume 31, Number 1,
pages 36–42, with permission from Wolters Kluwer, New York, NY,
- Posted by Ferenczy Benefits Law Center
- On January 19, 2024