Most Expanded Self-Corrections Available Immediately for Workplace Retirement Plans, but Not for IRA
The IRS has green-lighted immediate use of most – but not all – expanded self-corrections for compliance failures involving tax-qualified retirement plans set out in Section 305 of the SECURE 2.0 Act of 2022 prior to any official updates to the IRS’s Employee Plans Compliance Resolutions System (EPCRS) self-correction program, as set out in Rev. Proc. 2021-30.
Although SECURE 2.0 expanded EPCRS to include individual retirement accounts (IRAs) not linked to an employer-sponsored retirement plan, those accounts must wait for further IRS guidance before they can use the new SECURE 2.0 relief.
IRA custodians and owners may be disappointed at having to wait for further IRS guidance to use the SECURE 2.0 relief, but expanding EPCRS to include IRAs is very good news. Previously, the only relief for inadvertent failures in an IRA was to enter into a voluntary closing agreement with the IRS or seek a private letter ruling.
IRS Notice 2023-43 sets out a dozen questions and answers explaining what taxpayers can and cannot do until the IRS formally updates EPCRS. The notice provides taxpayers certainty and generally makes self-correction easier and less expensive.
Although the 10-page notice is welcome guidance, it did not address recovering plan overpayments or correcting automatic contribution errors, which were both included in the new SECURE 2.0 relief.
Which errors can be corrected and when?
SECURE 2.0 gives plans and IRAs an indefinite period to correct all “eligible inadvertent failures.” Previously, significant qualification failures had to be corrected within three years after the failure occurred, although insignificant errors generally could be corrected at any time.
The notice sets out a new rule for plans or plan sponsors that are under IRS examination. In that situation, self-correction is not available after the IRS notifies the plan or plan sponsor of an examination, unless the plan or plan sponsor can demonstrate a specific commitment to self-correction. This is a different standard than that provided in Rev. Proc. 2021-30, which is intended to eliminate arguments over who found the error first.
The notice requires self-correction to be completed “within a reasonable period of time after the failure was identified.” Correcting failures within 18 months after discovery is deemed to be reasonable, except for employer eligibility failures. Those failures must be corrected no later than six months after the failure was discovered, but only if the employer stops all contributions to the plan as soon as practicable after discovering the failure.
Importantly, the notice confirms that qualification failures that happened before SECURE 2.0 was enacted on December 29, 2022, can be self-corrected under the expanded SECURE 2.0 relief. For corrections that were already made based on the expanded SECURE 2.0 relief from December 29, 2022 (the date SECURE 2.0 was enacted) through May 25, 2023 (the date the notice was released), the IRS will allow taxpayers to use a good faith, reasonable interpretation of the new SECURE 2.0 relief. Compliance with the notice is deemed to be reasonable, good faith compliance.
What is an eligible inadvertent failure?
An eligible inadvertent failure is a plan operational, document or demographic failure that violates the IRC qualification requirements. The failure occurred despite the plan having regular practices and procedures for plan oversight and administration that satisfy existing EPCRS standards. It does not include any failure that is egregious, diverts or misuses plan assets or directly or indirectly relates to an abusive tax avoidance transaction. It also does not include any failure identified by the IRS before “any actions demonstrating a specific commitment to implement self-correction with respect to the failure.” Whether such actions have been taken depends on facts and circumstances, but generally include proof that the plan is actively pursuing correction of the failure. The notice states that the mere completion of an annual compliance audit or a general statement of intent to correct failures is not sufficient.
Despite the breadth of EPCRS, it is not available to correct all plan errors. Rather, EPCRS is available only to correct plan qualification failures. Administering retirement plans is complex, and sometimes non-qualification errors occur. For example:
A recordkeeper may change the wrong fee to plan participants’ accounts. While that is clearly an error that should be fixed, it is not a plan qualification failure, so EPCRS is not available for that correction.
Late deposits of employee salary deferrals are also not plan qualification failures (even though they are prohibited transactions), so EPCRS cannot be used to fix late deposits. However, they may be self-corrected under the Department of Labor’s (DOL’s) Voluntary Fiduciary Correction Program (VFCP). The DOL is currently updating and expanding VFCP.
Late filing of a Form 5500 or top-hat notice is also not eligible for correction under EPCRS. Late filings can be corrected under the DOL’s Delinquent Filer Voluntary Compliance Program (DFVCP) unless the DOL has notified the plan in writing of the late filing. Generally, the IRS will not impose late filing penalties if a plan uses DFVCP. Interestingly, if the IRS notifies the plan of a late filing penalty, but the DOL has not notified the plan of a late filing, the plan can still use DFVCP to reduce or eliminate late filing penalties.
Are there any eligible inadvertent failures that cannot be corrected now?
The notice lists failures that cannot be self-corrected until the IRS updates EPCRS, including:
Failure to initially adopt a written plan
Correcting an operational failure by plan amendment that conforms the plan document to the plan’s prior operations in a manner that is less favorable for a participant or beneficiary than the original plan terms
Significant failures in a terminated plan
Certain demographic failures
Failures in orphan (abandoned) plans
Employee stock ownership plan (ESOP) failures involving IRC Section 409
Excess contributions to a SEP or SIMPLE IRA that allows the excess to remain in the plan
Failures in SEPs or SIMPLE IRAs that do not use the IRS model plan documents and even for model plans when excess contributions remain in the IRA account
Mergers and acquisitions due diligence teams should pay particular attention to these ineligible failures that cannot be self-corrected. Items are often discovered in the pre- or post-closing document reviews and without self-correction could be an additional cost of the deal.
Are any existing EPCRS rules no longer applicable?
The notice immediately eliminated certain long-standing EPCRS requirements for self-correcting eligible inadvertent failures:
A favorable IRS approval letter is no longer needed to use EPCRS.
Plan loan failures can now be self-corrected without an IRS filing.
Significant failures, if they were inadvertent, can be self-corrected at any time (instead of only within three years after the plan year in which the error occurred).
Are excise tax waivers now automatic for self-corrected items?
No. However, plans and plan sponsors can still submit a Voluntary Compliance Program (VCP) application through EPCRS requesting a waiver of otherwise applicable excise taxes. For example, if the plan files a VCP application, the IRS can waive the 50% excise tax that participants and beneficiaries (not the plan) would otherwise owe for missed required minimum distributions (RMDs). The IRS can also waive the 10% early withdrawal penalty if the plan files a VCP application. A plan may also submit a VCP application requesting the IRS to waive excise taxes due to excess contributions, under IRC Sections 4972, 4973 and 4979.
A plan sponsor is not required to self-correct and may continue to submit VCP applications to the IRS even for failures that are eligible for self-correction.
Are there any new recordkeeping requirements to use expanded self-correction before the IRS issues updated EPCRS guidance?
No, but plan administrators should keep in mind that the existing EPCRS documentation rules still apply. If requested upon examination, plans should be prepared to substantiate the self-correction:
Identifies the failure, including years of occurrence, the number of employees affected and the date the failure was identified
Explains how the failure occurred and demonstrates that there were established practices and procedures (formal or informal) in place at the time of the failure that were reasonably designed to promote overall compliance
Identifies and substantiates the correction method and the date the correction was completed
Identifies any changes made to the established practices and procedures to endure that the same failure will not recur
A contemporaneous internal file memo is recommended to provide the IRS with a narrative that tells your story about what, when and how the failure happened, but you must also have substantiation (proving that your story is true). Many taxpayers erroneously believe that narration only is sufficient for EPCRS.
The notice requests comments on other methods the IRS should consider as self-correction of eligible inadvertent failures in employer-sponsored plans. The IRS also asked for help in identifying common IRA failures and what self- correction methods should be considered for each, as well as comments on the possibility of expanding EPCRS to both IRA custodians and IRA owners. Comments are due by August 23, 2023.
In the meantime, bipartisan Congressional leaders informed the IRS that Congress intends to correct at least four technical errors in SECURE 2.0 regarding the start-up tax credit (Section 102), RMD beginning age (Section 107), SIMPLE IRA and SEPs (Section 601) and catch-up contributions (Section 603).
If you have questions, contact HFM today. Our professionals are well versed on the latest issues to provide our clients with professional, personalized services.