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Managing Liability For Plan QualificationBy Elliot D. Raff

I. IntroductionThe prospect of disqualification of a qualified retire-

ment plan, such as a profit sharing plan or 401(k) plan, haslong raised the specter of devastating tax consequences.Recognizing that no plan can operate in perfect complianceall the time, the Internal Revenue Service (IRS) hasdeveloped the Employee Plans Compliance ResolutionSystem (EPCRS), which allows sponsors of qualifiedretirement plans to correct almost any violation of the

qualified plan rules with certainty and fairness.

II. Disqualification: Whats the Big Deal?If a plan fails to comply with the Internal Revenue Codes requirements

for a qualified plan, the plan is technically disqualified. Disqualificationwipes out all of the tax benefits gained by having a qualified plan:

Deductions previously taken for contributions are disallowed.

Contributions are included in the gross income of highly compensatedemployees.

The trust holding the plan assets loses its tax exemption.

These consequences lead to additional taxes, penalties and interest beingowed. Further, disqualification can lead to personal liability for the lost benefitsunder ERISA.

Disqualification by the IRS has always been a drastic measure. However, inthe absence of lesser sanctions and formal correction programs, the threat ofdisqualification was always taken seriously, even with regard to accidental errors,and, except in rare cases, practitioners could not be certain that corrections

would be acceptable to the IRS.

III. Overview of EPCRSEPCRS, which has evolved over time, allows correction of the four broad

types of Qualification Failures, all of which technically disqualify a plan:

Operational Failure:A failure to operate a plan in accordance with itsterms and the Code. Examples include:

Failing to enroll eligible employees in a 401(k) plan.

Failing to pay required minimum distributions to certain older workers.

Improperly allocating forfeitures.

Document Failures: Plan documents fail to conform to legal requirements.For example, the failure to amend for legal changes.

Demographic Failure:A failure to satisfy non-discrimination and coveragerules other than an operational failure.

Employer Eligibility Failure: The employer adopts a plan it is not eligibleto adopt. For example, an employer that already sponsors a plan adopts aSIMPLE 401(k) plan.

Copyright 2003 Employee Benefits Report Flaster/Greenberg P.C

www.flastergreenberg.com Winter/Spring 2003

EMPLOYEEBENEFITSREPORTA Newsletter from the Employee Benefits Practice Group

EMPLOYEEBENEFITSREPORTA Newsletter from the Employee Benefits Practice Group

Elliot D. Raff

(continued on page 3)

Editors NoteThis issue of the Flaster/

Greenberg Employee BenefitsReportis devoted to solvingproblems. Specifically, wediscuss the programs that havebeen created by the Internal

Revenue Service and U.S.Department of Labor (DOL)to allow plan sponsors and

fiduciaries to voluntarily correct violations of thetax and labor laws governing the establishment,administration and operation of retirement plans.

These programs are designed to help a plansponsor or fiduciary minimize the adverse conse-quences of errors that can occur in the life of aqualified plan. The key feature of these programsis their voluntary nature. With limited exceptions,they are not available if the government firstdiscovers the problem or defect. Using proper

follow-through and guidance, these programsare useful to employers able to discover potentialproblems on their own. The best way to accom-plish this is to go through the process of aself-audit. This process examines the plansoperations, compliance with IRS and DOLreporting requirements and plan document com-pliance with changes in the law and regulations.In addition, even if no problems are found, theprocess itself helps fulfill the employers basiclegal duty to ensure that a plan is being properlyadministered in accordance with its terms andapplicable law, by examining the processes anddata behind the annual reports. Thus, a periodicself-audit is a practical way to make sure serviceproviders are properly performing their services,and to expose and fix problems that could leadto significant liabilities before they are discoveredunder less favorable circumstances.

Flaster/Greenberg has extensive experiencewith the self-correction programs, as well aswith carrying out self-audits for plan sponsors.Please feel free to contact us if you requireassistance in any of these areas.

Allen P. Fineberg


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Expanded Voluntary Fiduciary Compliance Program By Marc R. Garber

As any properly advised plan sponsor or fiduciary is well aware, there isa class of transactions, referred to as party-in-interest transactions,or prohibited transactions that is strictly prohibited by the

Employee Retirement Income Security Act of 1974 (ERISA). Generally,

a party-in-interest includes the plan sponsor, a trustee or other fiduciaryand certain parties related to them. Engaging in a party-in-interest transac-tion exposes the fiduciaries to personal liability for losses and civil penaltiesunder ERISA and further, exposes the party-in-interest to excise taxesunder the Internal Revenue Code. This is the case even if the transactionresults in a tremendous gain for the plan. Party-in-interest transactions areprohibited based solely on thepotential for abuse. Thus, even a transactionnegotiated at arms length and for fair market value will be prohibited if itis a party-in-interest transaction involving plan assets not covered by astatutory or class exemption. If a plan fiduciary is contemplating using planassets in a transaction with a party-in-interest for which no general exemp-tion exists, it could apply to the U.S. Department of Labor (DOL) for aprivate exemption, but obtaining an exemption is costly and takes time.

Until recently, upon learning that such a transaction was not allowed,sponsors and fiduciaries often had difficulty undoing these transactions reversing a party-in-interest transaction usually constitutes a new impropertransaction which also requires administrative relief from the DOL. Further,short of obtaining such an individual prohibited transaction exemptionregarding the fix (also costly and time-consuming process), there was no

way to be certain that the DOL would accept the correction and no way toobtain relief from the penalties and excise taxes.

A few years ago, the DOL launched its Voluntary Fiduciary ComplianceProgram (VFC Program). As originally designed, the VFC Programoffered no relief from IRS excise taxes orDOL civil penalties. Now, the DOL has

expanded the VFC Program to allow theuniform correction of a broader range ofviolations that may be fixed with DOLapproval. More recently, a jointDOL/IRS exemption formally grantedrelief from certain IRS excise taxes inconnection with a submission under the

VFC Program. Clearly, the DOL expectsthe VFC Program to encourage voluntarycorrection of the specified ERISA violations. As such, plan sponsors andfiduciaries are advised to review plan operations and correct such errors asmay be found, because this relief is not available if the plan is under audit.

The following violations can now be corrected under the VFC Program

and qualify for relief from both ERISA civil penalties and IRS excise taxes:Contribution Violations Failure of an employer to remit participant contributions to a retire-

ment plan trustee or custodian on a timely basis.

An employers failure to forward participant contributions to aninsured welfare plan or a funded welfare plan trust within the time lim-its of the Plan or, if shorter, under DOL rules.

Participant Loan Violations Non-exempt plan loan to a party-in-interest at fair market rates.

Non-exempt plan loan at below market rates to a party-in-interest.

Non-exempt plan loan to a non-party-in-interest at below-market rates.

Non-Exempt Purchase and Sales of Assets Purchase of an asset by a plan trustee from a

party-in-interest.

Sale of a plan asset by a trustee to a party-in-interest.

A plans purchase of an asset from a non-party-in-interest for more than fair market value.

A plans sale of an asset to a non-party-in-interest for less than fair market value.

Benefits Payment of benefits without properly valuing

the assets of the plan.

Plan Expenses Payment of duplicative, excessive or unneces

sary compensation by a plan.

Payment of dual compensation to a planfiduciary.

A successful submission under the VFCProgram will result in the DOL issuing a No

Action Letter, in effect, approving the correctionand agreeing not to take any enforcement action

with respect to the identified and correctedviolations. In order to participate in theVFC Program, a formal written submis-

sion explaining the violations, their causeand their correction is required. Further,the violations must be corrected at thetime of the submission and the correctionmust be in accordance with DOLguidelines, including the requirementsregarding the calculation of lost earningsor interest. Generally, however, thepermitted corrections are fairly simple,

for example, depositing withheld contributionsplus interest, or recalculating benefit paymentamounts after properly valuing plan assets.

If a sponsor or fiduciary is going to the

trouble of a VFC Program submission, it shouldtake advantage of the excise tax and civil penaltyrelief. To do so, the taxpayer must also provide

written notice of the VFC Program submissionto all plan participants, who have a right tosubmit written comments to the DOL.

Although this notice puts all participants onnotice of the prohibited transaction and increasesthe possibility of a private claim by participants,the risk of participant action is probably minimal(especially since the violations have already beencorrected), so the relief from the excise taxes and

2

Employee Benefits Report Flaster/Greenberg P.C.

(continued on page 3)

the DOL expects theVFC Program to encourage

voluntary correction of the

specified ERISA violations.


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Qualification Failures are corrected under the following programs:

Self-Correction Program (SCP): Allows correction without paying any fee orsanction.

Voluntary Correction Program (VCP): Allows correction any time before

audit with payment of a limited fee and formal IRS approval.Audit CAP: Permits corrections in the context of an audit with payment of asanction and IRS approval.

Several recent developments make VCP more user-friendly.

Fixed Sanction Ranges and Presumptive Sanction Amounts: Gives certain-ty as to cost.

John Doe VCP:Allows anonymous submissions.

VCO and VCS: Simplified procedures where only operational failures are pres-ent and corrected using standard correction methods.

Retroactive Plan Amendments: In some cases, errors may be corrected byconforming a plan document to operations, generally avoiding the cost of cor-

rection (although a sanction will still be owed). Excise Tax Relief: The IRS will also give relief from certain excise taxes, such

as the 50% excise tax for failing to give 70 1/2 distributions.

Standard Corrections and Calculation Methodologies: Now, standardcorrections will automatically be approved under VCP (previously, standard cor-rections existed only under the non-submission self-correction program). Further,EPCRS now provides detailed guidance on how a wide variety of calculations, forexample, of lost earnings, should be performed.

A few additional points are worth noting:

IRS approval only extends to the errorsdisclosed and corrected.

Errors must be corrected for all years in

which they occurred, including closed yearsthat could not be audited.

Earnings or interest must be restored.

EPCRS is not available to correct prohibited transactions.

IV. ExamplesThe following are based on actual client matters we have handled:

1. 401(k) plan accidentally failed to give enrollment forms to certainemployees. Corrected under SCP by making a contribution, with interest, onbehalf of the excluded employees.

2. Distributions made without spousal consent. Corrected by obtaining consentto the distributions.

3. Failure to make required 70 1/2 distributions. Corrected by paying themissed distributions. Relief from the excise tax (50% of the missed payment)charged to the employee obtained in VCP.

4. Combining programs under EPCRS. EPCRS also can be strategically used.A new actuarial firm discovered a variety of operational errors as well as thefailure to amend the plan to comply with the Tax Reform Act of 1986.Investigation showed some errors stretching back 10 years. Errors regardingallocations, forfeitures and the document failure were submitted under VCP.The plan sponsor was unwilling to pay for other corrections and wanted toobtain approval of retroactive plan amendments. We submitted these underJohn Doe VCP. On the strength of our submission, we obtained a positive

Managing Liability For Plan Qualification (continued from page 1)

civil penalties probably justifies the riskof notification. Of course, the employermay also need to address employee rela-tions issues arising from this disclosure.

Despite these concerns, the new VFCProgram offers an improved tool thatplan sponsors and fiduciaries can use tomanage their exposure to potentialERISA liability. Given the expansion ofthe scope of the violations covered bythe VFC Program and the ability toobtain relief from excise taxes and civil

penalties, sponsors and fiduciaries shouldactively consider a self-audit to determine

whether they are in compliance withthese ERISA provisions.

Expanded VFC Program(continued from page 2)

response to the John Doe VCP,disclosed the clients identity, andcombined the two applications forresolution.

V. ConclusionEPCRS can be an invaluable tool for

correcting problems that will almostinevitably occur, given the incrediblecomplexity of the plan qualificationrequirements. In order to maximize thepotential benefits of this program,employers would be well-advised toundertake a self-audit of their plans. Aself-audit, to varying degrees, attemptsto simulate an audit by the IRS to findout if there are any qualification prob-lems, although the scope and depth

may vary. Discovered problems can thenbe fixed under SCP or VCP, which willbe far less costly than correcting theproblem under Audit CAP. In additionto protecting the tax benefits of a quali-fied plan, this helps ensure proper planadministration and avoids potentialERISA liability as well.

This report is for general use and infor-mation, and the content should not beinterpreted as rendering legal advice onany matter. Specific situations may raiseadditional or different issues and suchinformation should be coordinated withprofessional legal advice.

IRS approval only

extends to the errors

disclosed and corrected.


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Return Service Requested

Employee Benefits Practice GroupJeffrey A. Cohen

(856) [email protected]

Allen P. Fineberg(856) 661-2264

[email protected]

Richard J. Flaster(856) 661-2260

[email protected] R. Garber (Of Counsel)


Stephen M. Greenberg(856) 661-2261

[email protected]

J. Philip Kirchner(856) 661-2268

[email protected]

Elliot D. Raff(856) 382-2241

[email protected] J. Russoniello


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istration of qualified retirement plan

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