Self-Correction of Plan Failures Made Easier — At Least For Now

ADRINE A. CARGILL and JOELLE TAVAN, December 19 2023

Since 1990, the Internal Revenue Service (IRS) has provided plan sponsors with programs and related mechanisms to correct plan qualification failures (or “defects”) and avoid significant penalties for their failures to comply with certain of the tax-qualification requirements under section 401(a) of the Internal Revenue Code (“Code”). In response to requests by practitioners, in 1998, the IRS modified and consolidated its remedial guidance for qualified plans under the Employee Plans Compliance Resolution System (EPCRS). The IRS has since periodically updated and modified EPCRS and its component correction programs. EPCRS was most recently revised and restated in Revenue Procedure 2021-30 (Rev. Proc. 2021-30). 

In its current form, EPCRS continues to offer the following three programs for plan sponsors to use in correcting plan failures, thereby avoiding the consequences of plan disqualification (i.e., the immediate and retroactive loss of all favorable tax treatment extended to tax-qualified plans under the Code¹):

Self-Correction Program (SCP), which permits plan sponsors to correct certain plan failures without seeking IRS approval or paying a fee;

Voluntary Correction Program (VCP), which permits plan sponsors to disclose to the IRS plan defects and proposed methods of correction through the filing of a written application and payment of a relatively modest application fee (the application must be filed before the plan is under examination), and obtain IRS written approval of agreed-upon corrective actions;

Audit Closing Agreement Program (Audit CAP), which permits plan sponsors to pay a negotiated monetary sanction. 

In this article, we focus on the expansion of the SCP rules under the SECURE 2.0 Act of 2022 (“SECURE 2.0”), and IRS Notice 2023-43 (“Notice”).

I. SCP Under the Current Version of EPCRS (Rev. Proc. 2021-30)

Rev. Proc. 2021-30 sets forth EPCRS for sponsors of qualified plans, 403(b) plans, SEPs, and SIMPLE IRA plans that have failed to satisfy the requirements of Code sections 401(a), 403(a), 403(b), 408(k), or 408(p) of the Code. In addition to setting forth the requirements of SCP, VCP and Audit CAP, EPCRS provides correction principles, rules of general applicability, and certain IRS-approved correction methods.

EPCRS provides that, under SCP, a plan sponsor of a qualified plan or a 403(b) plan generally may self-correct insignificant operational failures at any time (even if they are discovered on examination) — and may self-correct certain significant operational failures and plan document failures by the last day of the third plan year following the plan year in which the failure occurred. 

To be eligible for SCP, EPCRS requires that a plan sponsor have established practices and procedures designed to promote and facilitate overall compliance with applicable Code requirements. In addition, to be eligible for correction of significant plan failures under SCP, a qualified plan or a 403(b) plan must, as of the date of correction, be the subject of a favorable letter.²

Importantly, under SCP, a plan sponsor must self-correct a failure in accordance with the principles and rules of general applicability described in EPCRS. Certain failures (i.e., certain plan document and participant loan failures, and employer eligibility and demographic failures) are not eligible for correction under SCP and, therefore, can be corrected in accordance with EPCRS only through the filing of an application under VCP. EPCRS sets forth permitted correction methods for loan failures and identifies the loan failures that may not be corrected under SCP. 

II.  Expansion of SCP Under SECURE 2

SECURE 2.0 provides that, except as otherwise provided in the Code, regulations, or other IRS guidance of general applicability, any “eligible inadvertent failure” to comply with applicable Code requirements is eligible for self-correction under EPCRS,³ as long as 1) the failure is not first identified by the IRS prior to any actions that demonstrate a “specific commitment” to correcting such failure, and 2) the self-correction is completed within a reasonable period after the failure is identified. 

A.  Eligible Inadvertent Failure Defined 

SECURE 2.0 broadly defines an eligible inadvertent failure as a failure that occurs notwithstanding the plan sponsor’s practices and procedures. An eligible inadvertent failure does not include any failure that is egregious, relates to the diversion or misuse of plan assets, or is directly or indirectly related to an abusive tax avoidance transaction. 

B.  Period to Correct Eligible Inadvertent Failures 

SECURE 2.0 sets no deadline for self-correcting an eligible inadvertent failure (provided the failure is corrected before it is identified by the IRS and within a reasonable period after it is identified by the plan sponsor), and specifically provides that the correction period “is indefinite and has no last day” except as otherwise provided in the Code, regulations, or other IRS guidance of general applicability. Thus, eligibility for self-correction is driven by when an error is discovered, rather than when it occurred.

C.  Upcoming Revisions to Rev. Proc. 2021-30

In SECURE 2.0, Congress instructs the IRS to revise Rev. Proc. 2021-30, or any successor guidance, to include these new provisions regarding the self-correction within 2 years after the date SECURE 2.0 was enacted (i.e., by December 29, 2024). Congress also instructs the IRS to issue specific guidance on the correction methods for eligible inadvertent failures, including general principles of correction if a specific correction method is not specified by the IRS.

III.  IRS Notice 2023-43 – Interim Guidance 

On May 25, 2023, the IRS issued Notice 2023-43, which provides interim guidance on the expansion of self-correction under SECURE 2.0, pending SECURE 2.0 and other updates to EPCRS. The Notice provides that if certain conditions are satisfied, a plan sponsor may self-correct an eligible inadvertent failure before the IRS updates Rev. Proc. 2021-30.

The Notice does not address the other sections of SECURE 2.0 that relate to plan corrections, including the recovery of plan overpayments and correction of automatic contribution errors. Further, the Notice does not address any elements over which the Department of Labor has authority. Plan sponsors may rely on the Notice until the next version of EPCRS is published, and may apply a good faith, reasonable interpretation of the SECURE 2.0 Act changes for any self-correction completed on or after December 29, 2022, and before the issuance of the Notice.

Trucker Huss Comment: Plan sponsors need not worry about unwinding any self-corrections completed after SECURE 2.0 was enacted, but before the Notice was issued, if such corrections were based on a good faith, reasonable interpretation of SECURE 2.0.

A.  Failures That May Be Self-Corrected 

A plan sponsor may self-correct eligible inadvertent failures before the IRS updates EPCRS, if the following conditions are satisfied:

1. The IRS does not identify the failure prior to any actions demonstrating a specific commitment to implement a self-correction of that failure;
2. The plan sponsor completes the self-correction within a reasonable period after the failure was identified;
3. The failure is not egregious, does not directly or indirectly relate to an abusive tax avoidance transaction, and does not relate to the diversion or misuse of plan assets; and
4. The self-correction satisfies all of the provisions applicable to self-correction set forth in Rev. Proc. 2021-30, including that:

• • The plan sponsor must have established practices and procedures reasonably designed to promote and facilitate overall compliance with applicable Code requirements;
  • The plan sponsor must apply the correction principles and rules of general applicability set forth in Rev. Proc. 2021-30;
  • The plan sponsor may, but is not required to, self-correct using a safe harbor correction method set forth in Rev. Proc. 2021-30; and
  • The plan sponsor may not use a correction method that is prohibited under Revenue Procedure 2021-30.

B.  Failures That May Not Be Self-Corrected 

Plan sponsors may not self-correct the following eligible inadvertent failures before the IRS updates Rev. Proc. 2021-30:

1. A failure to initially adopt a written plan for a Code Section 401(a) qualified plan, 403(a) qualified annuity plan, 403(b) plan, 408(k) SEP or 408(p) SIMPLE IRA plan, including the failure to timely adopt a written 403(b) plan document to meet the requirements of the 2007 IRS final regulations under Section 403(b);
2. A failure in an orphan plan;
3. A significant failure in a terminated plan;
4. A failure that involves excess contributions to a SEP or SIMPLE IRA plan and that is corrected by permitting the excess contributions to remain in an affected participant’s IRA;
5. A demographic failure that is corrected using a method other than a method set forth in Treasury Regulations Section 1.401(a)(4)-11(g);
6. An operational failure that is corrected by a plan amendment that conforms the terms of the plan to the plan’s prior operations in a manner that is less favorable for a participant or beneficiary than the original terms of the plan;
7. A failure occurring in a SEP with a plan document that does not consist of either a valid Model Form 5305-SEP or 5305A-SEP or a prototype SEP;
8. A failure occurring in a SIMPLE IRA plan with a plan document that does not consist of either a Model Form 5305-SIMPLE or 5304-SIMPLE or a prototype SIMPLE IRA plan; and
9. A failure in an ESOP that involves Code Section 409 (qualification requirements for tax credit ESOPs) in which tax consequences other than plan disqualification are associated with the failure.

C.  Certain Provisions of Rev. Proc. 2021-30 Do Not Apply 

Pending IRS updates to EPCRS, the following provisions of Rev. Proc. 2021-30 do not apply to the self-correction of an eligible inadvertent failure:

1. The requirement that a qualified plan or a Code Section 403(b) plan be the subject of a favorable letter from the IRS;
2. The prohibition of self-correction of demographic failures and employer eligibility failures;
3. The prohibition of self-correction of significant failures under SEPs and SIMPLE IRA plans;
4. The prohibition of self-correction of self-correction of certain loan failures;
5. The provisions relating to self-correction of significant failures that have been substantially completed before the plan or plan sponsor is under examination by the IRS; and
6. The requirement that the correction of a significant failure must be completed or substantially completed by the end of a specified correction period (generally, the last day of the third plan year following the plan year in which the failure occurred).

D.  Demonstration of Commitment to Implement SCP and Completion of Correction Within a Reasonable Period: A Facts and Circumstances Test

Until the IRS updates EPCRS, once the plan or plan sponsor comes under examination, the eligible inadvertent failure is no longer eligible for self-correction unless the plan sponsor has, before the plan or plan sponsor comes under examination, demonstrated a specific commitment to implement a self-correction of the eligible inadvertent failure. A determination as to whether actions taken by a plan sponsor demonstrate a specific commitment to implement the self-correction of an identified eligible inadvertent failure will be made based on all the facts and circumstances. The plan sponsor’s actions must generally demonstrate that the plan sponsor is actively pursuing correction of the specific identified failure. Note that the mere completion of an annual compliance audit or adoption of a general statement of intent to correct failures when they are discovered are not actions demonstrating a specific commitment to implement the self-correction of an identified failure.

Similarly, pending updates to EPCRS, for purposes of ascertaining whether the self-correction of an eligible inadvertent failure has been completed within a reasonable period after it has been identified by the plan sponsor, a “reasonable period” will be determined by considering all relevant facts and circumstances. 

Except with respect to an employer eligibility failure, a failure that has been corrected by the last day of the 18th month following the date the plan sponsor identifies the failure will be treated as having been completed within a reasonable period after it has been identified. A self-correction of an eligible inadvertent failure that is an employer eligibility failure will be treated as having been corrected within a reasonable period after it has been identified by the plan sponsor only if the plan sponsor ceases all contributions to the plan as soon as reasonably practicable after the failure is identified and no later than the last day of the 6th month following the date the failure is identified.

E.  No Additional Recordkeeping Requirements

Section 305 of SECURE 2.0 does not provide any new IRS recordkeeping requirements with respect to the self-correction of an eligible inadvertent failure. However, current IRS recordkeeping requirements continue to apply. Accordingly, if the IRS so requests upon an examination of the plan, a plan sponsor must be able to provide documentation that:

1. Identifies the failure, including the years of occurrence;
2. Explains how the failure occurred and demonstrates that there were established practices and procedures (formal or informal) reasonably designed to promote and facilitate overall compliance which were in effect when the failure occurred;
3. Identifies and substantiates the correction method and the date of the completion of the correction; and
4. Identifies any changes made to those established practices and procedures to ensure that the same failure will not recur.

Trucker Huss Comment: Plan sponsors must ensure they have practices and procedures in place reasonably designed to facilitate compliance with the qualified plan rules. Failure to do so will prevent the plan from being eligible for SCP. Additionally, plan sponsors who take advantage of the expansion of self-correction should be careful to properly document the dates when defects were discovered, all corrective actions taken, and when they occurred. 

Conclusion

The expansion of the self-correction rules of plan failures under SECURE 2.0 is a welcome relief to plan sponsors. Additionally, the Notice provides much-needed guidance on which plan sponsors can rely until EPCRS is updated. Plan sponsors should take this opportunity to address and correct any outstanding failures as soon as possible. Because of the limited, non-comprehensive nature of the guidance, however, plan sponsors should continue to work closely with their advisors before relying on the new guidance for any self-correction method that is not currently permitted by EPCRS and specifically addressed in the Notice.

Lastly, we note that the expansion of self-correction under EPCRS follows a proposal by the Department of Labor to expand corrections under its Voluntary Fiduciary Correction Program. In November 2022, the Department of Labor proposed a rule that would permit fiduciaries to self-correct errors related to the repayment of loans and delayed investment of employee contributions. Our Newsletter Article on the Department of Labor’s proposed rule can be found here.

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¹  Favorable tax treatment includes the current deductibility of contributions to the retirement plan by the employer, the deferral of income tax on the earnings on plan assets, and no current taxation to the employees based on the contributions made on their behalf, as well as the ability to further defer taxation by rolling over the benefits to another qualified plan or an IRA.

²  A favorable determination letter is issued by the IRS in response to a request by a plan sponsor as to the qualified status of its retirement plan; it expresses the IRS’s opinion regarding the form of the plan (based on applicable IRS-issued Cumulative and Required Amendments Lists); and it applies only to the employer and the plan participants on whose behalf the determination letter was issued.

³  This also includes eligible inadvertent failures relating to a loan from a plan to a participant, which may be self-corrected according to the rules of Rev. Proc. 2021-30, including the provisions related to whether a deemed distribution must be reported on Form 1099-R.