IRS Expands Self-Correction Program

On April 19, 2019, the IRS issued Rev. Proc. 2019-19, updating its Employee Plans Compliance Resolution System (“EPCRS”) which permits retirement plan sponsors and administrators to correct compliance failures that may adversely affect the tax-qualified status of their plans. The new guidance expands the IRS’ Self Correction Program (“SCP”) under EPCRS to specifically cover the correction of certain failures, many of which historically could only be corrected by submitting a Voluntary Correction Program (“VCP”) application with the IRS and paying a fee, as described in more detail below.

Plan Loan Failures

The new guidance expands SCP to cover the self-correction of certain failures involving plan loans made to participants, making it much easier to correct these types of failures:

Defaulted Loans. In prior iterations of EPCRS, self-correction for many loan failures (either by collecting the missed payments plus interest from the participant or reamortizing the outstanding balance of the loan plus interest) was generally not available. A VCP application had to be filed with the IRS in order to obtain relief from defaulting the loan and reporting it as a deemed (taxable) distribution on Form 1099-R, and the plan sponsor was required to pay a penalty.

Under the new guidance, however, if the maximum permissible period for repayment under the Internal Revenue Code (“Code”) has not yet expired, an outstanding loan may be self-corrected by (1) collecting a single lump sum payment from the participant that includes all missed loan payments, including interest on the missed payments, or (2) reamortizing the outstanding balance of the loan, including all accrued interest, over the remaining period of the loan so that the loan is repaid by the end of its original term or by the end of the maximum period permitted under the Code (e.g., 5-years for a general purpose loan). A combination of (1) and (2) may also be used to correct. If the loan is corrected in this manner, a deemed distribution is avoided and there is no need to issue a Form 1099-R.

If an outstanding loan is not corrected using the methods described above (to the extent applicable), then the loan must be reported as a deemed (taxable) distribution. Historically, a plan sponsor could request that the loan be treated as a deemed (taxable) distribution in the year of correction, instead of in the year of the failure under normal rules, by submitting a VCP application to the IRS specifically requesting this relief. Under the new guidance, the plan sponsor may report the loan as a deemed (taxable) distribution in the year of correction, instead of in the year of the failure, without the necessary of filing a VCP application specifically requesting such relief.

Note, certain types of loan failures (e.g., where the terms of the loan do not comply with the Code’s limit on participant loan amounts) may only be corrected under VCP or if the plan is under audit by the IRS (“Audit Cap”).

It is also important to point out that if an outstanding loan is self-corrected under the new guidance, the Department of Labor does not view the loan as having been fully corrected for ERISA purposes. Therefore, depending on the magnitude of the error, a separate filing under the DOL’s Voluntary Fiduciary Correction program may be appropriate to correct the ERISA fiduciary issues (i.e., to ensure that the loan does not represent a prohibited transaction and that excise taxes are not accruing).

Failure to Obtain Spousal Consent. If a loan was issued to a married participant and the required spousal consent to the loan was not obtained, the new guidance provides that the plan sponsor notify the participant and the spouse of the spousal consent requirement so that the spouse can retroactively provide his or her consent to the loan. If, spousal consent is not obtained, the failure to obtain spousal consent must be corrected under either VCP or Audit Cap.
Number of Loans Issued Exceeds Number Allowed Under Plan. If the number of loans issued to a participant exceeds the number of loans permitted under the terms of the plan, the new guidance provides that the plan may be retroactively amended to conform plan terms with operation. Self-correction is available to correct this type of error as long as the plan, as amended, satisfies the requirements applicable to plan loans under Code Section 72(p), the amendment complies with the requirements of Code Section 401(a), and plan loans in excess of the number permitted under the terms of the plan were available to all participants or solely to one or more non-highly compensated employees.

Plan Document Failures

The new guidance also expands the SCP for plan document failures (i.e., failures involving a plan provision, or the absence of a plan provision, that, on its face, violates the requirements of the Code). This type of failure typically arises when a plan sponsor does not timely adopt an amendment following a change in the law. To rely on this guidance, the plan must otherwise qualify for self-correction, including the requirement to have a favorable determination letter. Because plan document failures are always considered significant, the failure must be corrected no later than the close of the second plan year following the plan year in which the amendment should have been adopted. (Note that this expanded guidance does not include correction of an initial failure to timely adopt a qualified plan or a written 403(b) plan document.)

Operational Failures

SCP is also now available to correct certain operational failures by a retroactive plan amendment, which conforms the plan document to the plan’s prior operation. In general, SCP is available in this instance if the corrective amendment is provided to all eligible employees and results in an increase in participants’ benefits, rights or features. Note, a retroactive plan amendment to conform the plan document to operation must still be corrected under VCP if the operational failure does not provide a uniform increase in benefits, rights or features for all eligible employees.

The changes described above, which became immediately effective on April 19, 2019, are welcomed guidance from the IRS to allow plans to more efficiently address compliance issues.