By: Adrienne I. Moore, Esq.
Section 305 of the SECURE 2.0 Act was a welcome modification to 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. Section 305, however, left many questions open – particularly whether the positive changes from the law were effective immediately, or if they awaited updated guidance of the correction procedures, which the law requires the IRS to issue (and which cannot be expected anytime soon).
On May 25, 2023, the IRS issued Notice 2023-43 (the “Notice”), which provides interim guidance on interpretation and application of Section 305 while the updated EPCRS procedure is pending. And it contains good news.
The Good News
The Notice gave us two pieces of really great news. First, it authorizes the use of the Section 305 changes immediately. Therefore, we can now self-correct many more types of failures and the permissible correction period is longer than before.
Further, the Notice authorizes the more lenient correction process to be used for failures that occurred before SECURE 2.0 was enacted.
The Notice also provided additional guidance about permissible self-correction of failures, so that practitioners can now correct under SECURE 2.0 with confidence of what is and is not permitted. In particular, the Notice provides guidance on self-correcting loan failures that is more expansive than what was available under EPCRS, and authorizes self-correction of failures, such as coverage failures, that previously could not be self-corrected.
Now For the Details…
What SECURE 2.0 Section 305 Did
EPCRS, the current version of which is found in Revenue Procedure 2021-30, contains three distinct correction programs: the self-correction program (“SCP”), the Voluntary Correction Program (“VCP”), and the Audit Closing Agreement Program (“Audit CAP”). Audit CAP is the correction method for plans that have errors discovered during an IRS examination. 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. SCP is, as it sounds, a method for correcting plan failures without involving the IRS. If a plan can use SCP, it is usually less expensive than VCP. Historically, use of SCP was limited to certain types of failures and required correction of significant failures within three years of the year of occurrence.
Section 305 of the SECURE 2.0 Act permits plan sponsors to correct most eligible inadvertent failures (“EIF”) through SCP regardless of the type of failure or the time during which it occurred. Therefore, it makes SCP much more accessible, and reduces the cost of many corrections.
The Self-Correction Details of the Notice
When is the Notice Effective?
The Notice is effective as of the date it is issued, i.e., May 25, 2023, and may be relied upon until the new EPCRS procedure is issued. For plans currently under examination, the Notice can be used immediately to self-correct insignificant EIFs or to demonstrate that EIFs that were self-corrected earlier in reliance on SECURE 2.0 were handled appropriately.
Plan sponsors were permitted to apply a good faith, reasonable interpretation of Section 305 in completing the self-correction of failures prior to the Notice being issued. If those earlier corrections aligned with the Notice’s requirements, they are deemed to have been completed using a good faith, reasonable interpretation.
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. 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. This opens up a great many failures for self-correction than have not historically been permitted.
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 law. 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.
Revised Timing for Self-Correction
Unlike the prior EPCRS procedures, Section 305 provides that an EIF may be self-corrected at any time before it is identified by the IRS –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. However, the rules require that the correction be completed within a reasonable period after the EIF is identified.
When is an EIF deemed to be “identified by the Secretary”? What demonstrates a “specific commitment to implement a self-correction”? What is a reasonable period for completion? Notice 2023-43 provides several answers for plan sponsors and practitioners as we await a fully updated EPCRS.
When is a Failure “Identified” by the IRS?
The Notice tells us that 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. 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, compliance checks from the IRS also will not block a plan sponsor from SCP, nor will investigations of the plan by the Department of Labor (“DOL”).
This restriction on self-correction applies only to significant failures. If a failure is insignificant, self-correction is still permitted even if the plan is under examination. This is true under EPCRS, and the Notice explicitly provides that it continues to be true.
What is a “Specific Commitment to Implement” a Self-Correction?
Whether a plan sponsor has made a specific commitment is a facts and circumstances determination that the employer is “actively pursuing correction.” It appears from the Notice that a specific identification of a failure and action toward correcting that failure is needed. So, 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 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. On the other hand, we believe that it is likely that finding an error and retaining a professional to help correct the error does constitute a specific commitment to implement the correction.
Needless to say, there is a wide gap between not knowing that an error exists and hiring a professional to fix one you’ve identified. 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. The IRS has provided us with 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. 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).
Self-Correcting Loan Failures
The Notice clarifies that the remaining restrictions on self-correcting certain loan failures are eliminated (in particular, limitations on correcting loan defaults and on correcting loans that were defective from issuance).
Generally, the permissible correction method under EPCRS for a loan in default is to either make a lump sum payment of the amount in arrears or to reamortize the loan over the remaining portion of the 5-year period. If the 5-year period is expired, the failure can be corrected only by either declaring the remaining balance as income in the year of correction or repaying the total remaining balance as a lump sum.
While the Notice is an IRS release that does not affect rules enforced by the DOL, remember that SECURE 2.0 specifically overrides the DOL’s position that VCP 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.
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.
- 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. 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).
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. Additionally, nothing in the Notice prohibits a plan sponsor from filing a VCP for any EIF. 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. It is also mandatory to fully correction if the plan lacks the required practices or procedures.
What Still Cannot be Self-Corrected?
The Notice lists several failures that are not eligible for self-correction (i.e., VCP is needed to fully correct). These failures are:
- 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 Treas. Reg. 1.401(k)-1(a)(3)(iii)(A). The Notice leaves unanswered whether a failure by a related employer (i.e., a member of a controlled or affiliated service group under Code Section 414) to adopt a participating employer agreement for a plan that is sponsored by another related employer is a failure to adopt an initial written plan. However, we continue to believe that, since related employers are considered a single employer, the employer has adopted the plan. Therefore, 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.
- A failure that occurred in an orphan plan.
- A significant failure in a terminated plan. This implies that we can self-correct insignificant failures in a terminated plan (which EPCRS is somewhat ambiguous about now but does not explicitly prohibit). The Notice does not define a “terminated plan.” Reasonable definitions include (i) any plan for which legal action to terminate (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). We are hoping that the latter definition prevails.
- A failure involving excess contributions to a SEP or SIMPLE IRA that is corrected by permitting excess to remain in a participant’s IRA.
- 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“). Under EPCRS, demographic failures (i.e., failures of coverage, nondiscrimination, or participation (IRC 401(a)(26) in a defined benefit plan)) could not be self-corrected, so that the -11(g) Regulation was the only authorization for correcting those errors. But, if we were already authorized by the -11(g) Regulation to make this correction, how is this changed under the Notice? We believe that timing is the key. The 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 (i.e., October 15 for calendar year plans). Before SECURE 2.0 and the Notice, if the amendment was not adopted by that date, the only recourse was VCP. The inclusion of this rule in the Notice implies that the -11(g) Regulation correction can be made anytime within the normal self-correction period discussed above. Note, however, that the -11(g) Regulation does not require earnings to be contributed on the corrective deposits. EPCRS, on the other hand, does so require. Therefore, if a demographic EIF is being corrected more than 9½ months after the plan year end, any corrective contribution must be adjusted for earnings. The Notice does restrict use of certain testing strategies in a retroactive corrective amendment under SCP.
- 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. 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. Note that this is not tantamount to the approval of any retroactive amendment anytime. The amendment under EPCRS must be to conform the plan 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.
- 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).
What EPCRS Requirements and Restrictions No Longer Apply?
In addition to those discussed above, the Notice identifies the following specific restrictions found in the current EPCRS that are no longer applicable as of the passage of SECURE 2.0:
- 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). [EPCRS 5.01(4) and 5.02(5)]
- EPCRS previously permitted a plan sponsor to complete self-correction of a significant operational failure only if the self-correction was substantially completed before the earlier of (a) the end of the 3-year period after the year of the failure; or (b) when the plan or plan sponsor is under IRS examination. [EPCRS 4.02(2), EPCRS 9.02(3)] The 3-year restriction no longer applies, as the Notice is controlling until a new EPCRS is issued.
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.
The Notice has specific recordkeeping obligations. In particular, a plan sponsor must be able to provide an IRS auditor with the following 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.
- Identification and substantiation of the correction (including the date of correction).
- Changes to practices and procedures to avoid recurrence of the failure.
For example, suppose that a plan sponsor 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 to provide that another individual within the organization will receive communications from the recordkeeper upon any changes to deferral elections and is responsible for implementing those elections 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.
Additional FBLC Thoughts About the Notice
- We want to strongly emphasize the importance of documenting when a failure is identified. This means that 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.
- The need to help clients have practices and procedures is more acute than ever. We need to all help our 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. Failure to do so will result in an ineligibility for self-correction. Further, as part of the correction process, we should help our clients comply with the mandate that practices and procedures be improved to avoid recurrence of the EIF.
- Documenting self-correction is no longer just a wise choice – it’s a requirement. Be sure to help your clients maintain the good records that the Notice requires regarding finding and correcting the error and procedures.
- Remember that the Notice is effective only until the EPCRS procedure is updated. The IRS is asking for input on that updated procedure and the Notice. Consider either commenting directly or speaking with those who do about what you would like to see in the new procedure.
If you have any questions about or IRS Notice 2023-43 or self-correction, let us know. After all, we are your ERISA solution!
- Posted by Ferenczy Benefits Law Center
- On May 31, 2023