Since the dawn of employer-sponsored retirement plans, employers have made mistakes in their compliance with the law governing those plans. Those mistakes are usually inadvertent and have often taken the form of failures to comply with the letter of the law – either in operation, demographic coverage, and/or documentary hygiene.
The Internal Revenue Code (“Code”) itself is unforgiving; almost any failure to adhere to the technical and nuanced retirement plan rules set forth in the Code (no matter how insignificant) triggers a “disqualification” of the plan – causing a loss of the plan’s tax-exempt status. However, since the 1990s, the IRS has realized that the primary impact of plan disqualification is on the plan participants, few of whom are ever involved in plan administration and operation. Stated another way, the Code only allows for the significant tax advantages associated with qualified plans if the plan complies precisely with the letter of the law, but almost every plan experiences a foot fault now and again – and a policy that would regularly disqualify such plans would discourage employers from offering such plans and destroy the ability of many average Americans to save for retirement.
The IRS has instead, since 1998, issued a series of Revenue Procedures establishing the then-applicable “Employee Plans Compliance Resolution System” allowing correction of retirement plan failures through three programs: the Self Correction Program (“SCP”), the Voluntary Correction Program (“VCP”) and the Audit Closing Agreement Program (“Audit CAP”). As the name suggests, the SCP is the most favorable to employers, since no IRS involvement is required. The SCP allows correction in accordance with EPCRS guidance/principles without IRS approval, fees, or sanctions. Over time, the SCP has become more “employer friendly” allowing additional corrections over longer periods. The IRS is focused on incentivizing employers to take proactive steps to find their foot faults and address them.
In addition, so-called “full-scope” plan examinations are generally costly and inefficient for the IRS and the employer. Thus, the IRS is expanding its Pre-Examination Compliance Pilot Program (“Pilot Program”), whereby an employer may entirely avoid – or limit – the scope of an impending examination if they act promptly to correct existing errors under the SCP. Specifically, the IRS has rolled out the second phase of the Pilot Program. As a part of this Pilot Program, employers are notified by letter that their retirement plan was selected for an upcoming examination and that the employer has 90 days to review their plan’s document and operations to determine if they meet current Code requirements. Here’s what employers should know:
- Be on the lookout for any letter from the IRS Employer Plans divisions regarding a retirement plan audit
- Don’t delay – act swiftly to work with plan counsel and administrators to review your plan’s documents or operations (i.e., perform a mock internal audit) to identify any plan failures
- Correct those failures ASAP (ideally, within the 90-day window set forth in the letter)
- Respond and notify the IRS of any corrections made
A failure to respond within 90 days, will trigger scheduling of a regular “full-scope” examination.
Under the Pilot Program, failures identified during the pre-examination 90-day period may be corrected under either the SCP or a version of the VCP. Specifically, failures that aren’t eligible under the SCP can be corrected by requesting a closing agreement. In those cases, the IRS will apply the favorable VCP fee structure to determine the sanction amount payable.
The IRS will review documentation submitted in the pre-examination process and, if the IRS agrees with the conclusions/corrections, it may issue a closing letter to avoid the audit altogether. In some instances, a limited-scope examination will be conducted in lieu of a full-scope audit.
While this program remains in pilot form, it presents a great opportunity to avoid the disruption and cost associated with an IRS audit, and we hope that continued positive participation will cause the IRS to make this program permanent.