IRS Correction Program - Qualified Retirement Plans
John Doe Program:
For a wide range of common compliance problems, self-correction makes sense, as do the standard corrections that the IRS publicizes in its EPCRS revenue procedure (the latest version, as this writing, being noted above). As a practical matter, plan sponsors face three main choices for how to proceed when they discover compliance problems with respect to their tax-qualified retirement plans:
1. Self-correct on a Going Forward Basis. This approach involves adopting a simple plan amendment, and accepting the risk that an IRS audit could result in significant penalties. Plan disqualification is theoretically possible but highly unlikely. Nevertheless, the IRS has singled out, for audit purposes, the detection of mistakes involving what compensation to take into account for plan purposes (see item 3 of this IRS “Fix-it” Guide). As a result, if an IRS audit were to find this mistake, the IRS could condition the plan’s continued qualification on full correction and penalties for as far back as 2008 (or earlier of the mistake affected prior years). When the IRS finds the mistake, the correction costs could be double, triple, or even worse than those that apply if the employer initiates corrective action. Further, ERISA fiduciary duty rules need consideration because doing nothing could itself implicate a breach of those duties.
2. File a Standard Corrective Application. This type of filing begins with full disclosure of the employer’s name, which provides the IRS with leverage to require a “standard” correction for the plan's failure. For instance, where insufficient deferrals and matching contributions occurred, the standard correction involves going back to all tainted years, and identifying how the mistake affected each participant, and making a contribution to each affected participant’s account. The amount of that contribution generally equals the 401(k) deferral that would have occurred and 50% of the associated matching contribution it would have triggered. Where a past failure such as this involves many plan years, the cost of correction for all years can involve hundreds of thousands of dollars. Under a standard filing, it is very difficult to get the IRS to approve a limited correction (such as one for only a particular look-back period), or some form of retroactive amendment that mitigates the cost of correction.
3. File an Anonymous Corrective Application. This filing – under the “John Doe” alternative -- involves identification of the employer-applicant only after the IRS has accepted the proposed correction. The anonymity enables an employer to propose, and to negotiate for, non-standard corrections such as a retroactive amendment that conforms the plan terms to its operation. The IRS generally dislikes that solution, which means the employer needs to be able to show a solid history of employer communications that unambiguously support the way in which the plan operated. Note that even if an employer's facts are not convincing, the proposal for a low-cost correction -- sometimes through a retroactive amendment -- can make sense because an anonymous application opens the door for a negotiated solution. That being noted, a non-standard solution is likely to work only if the application presents compelling facts, and presents them in a manner indicating that plan participants are being treated fairly and appropriately.
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