Understanding Employee Plans ComplianceResolution System (EPCRS):

The Basics

Alison J. Cohen, Esq., CPCPartner

Ferenczy Benefits Law Center LLPacohen@ferenczylaw.com

1

What You Can Expect

• A review of EPCRS principles and terms

• Understanding the Self-Correction Program (SCP)

• Decision making on how/when to use the Voluntary Correction Program (VCP)

• Case studies for your consideration

– Shock, dismay, and possibly some nausea

2

EPCRS: The Framework

• Employee Plans Compliance Resolution System

– Rev. Proc. 2016-51 released September 29, 2016

• Effective January 1, 2017

– Modified and superseded Rev. Proc. 2013-12

– Incorporates Rev. Procs. 2015-27 & 2015-28

3

Four Types of Qualification Failures

• Plan document failures

• Terms of plan not qualified

• Failure to timely adopt interim amendment/restatement

• Demographic failures

• Failure to satisfy §410(b) or §401(a)(26)

• Employer eligibility failures

• Not eligible to establish type of plan (e.g., government 401(k) or ineligible for 403(b))

• Operational failures

• Not following the terms of the plan (i.e., usually everything else you encounter)

• Other than prohibited transactions: exclusive benefit violations

4

Consequences of Disqualification

• Taxation (IRS refers to this in EPCRS as maximum payment amount)

• Employer deductions lost if no inclusion in employee income

• Trust is taxable (earnings may be taxable)

• Employees taxed on amounts not subject to risk of forfeiture

• Exception: If sole failure is §410(b) coverage or §401(a)(26) participation failure, then only HCEs taxable

5

How Do You Correct?

• EPCRS (Rev. Proc. 2016-51) contains pre-approved correction methods

• Following these methods is safe

• Otherwise, find reasonable, appropriate method

• Use code, regulations, and EPCRS as guide

• Correct discrimination failures by giving $ to NHCEs

• Note: the farther you get from pre-approved methods, the more beneficial it is to ask for IRS approval

6

Correction Principles

• Must correct all taxable years (even if closed)

• Restore plan and participants to position in which they would have been had the failure not occurred

• Should be reasonable and appropriate

• Appendix A & B solutions deemed reasonable

• Consistent with code (don’t create another violation)

• Provide benefits to NHCEs

• Keep assets in the plan

• Consideration of other agencies (e.g., DOL on abandoned plans)

7

Exceptions to Full Correction

• Unreasonable or not feasible (tough one to apply)

• Reasonable estimates are necessary (e.g., earnings)

• Distribution of small amounts ($75 or less)

• Recovery of small overpayments ($100 or less)

• Lost participants

• Small excess allocations ($100 or less)

8

Lost Earnings

• Corrective contributions, allocations, or distributions must be adjusted for earnings

– Don’t have to adjust for losses, but can

– Assume that the date on which the earnings begin

• Date on which contributions/forfeiture would have been allocated to the participant’s amount

• For salary deferrals and after-tax contributions, assume mid-point of plan year (or period of exclusion)

9

Lost Earnings

• Methods for determining earnings:

• Generally, use actual earnings based on EEs investment choices

• Reasonable estimates of investment returns

• Multiple investment options – option with highest rate of return (if most affected EEs are NHCEs)

• If EE has no investment selections – weighted average

• Can the DOL’s online calculator be used?

10

EPCRS Structure

• Three correction procedures:

• Self Correction Program (SCP)

• Insignificant errors: anytime

• Significant errors: time-limited

• Voluntary Correction Program (VCP)

• Forms 8950, 8951, 14568, etc.

• Cannot be “under examination”

• Audit Closing Agreement Program (CAP)

11

Self-Correction Program

• Insignificant Failures

• CORRECTION MAY BE MADE AT ANY TIME

• Even if the plan is under audit by the IRS

12

Self-Correction Program

• What is “insignificant?” Balancing of factors:

• Have other failures occurred?

• Percentage of plan assets and contributions involved

• Number of years involved

• Number of participants affected (as percentage of total in plan and as percentage of those who could have been affected)

• Was correction made within a reasonable time after discovery?

• Why did the failure happen?

13

Self-Correction Program

• Defined: anything that is not significant

• Rule: must be “substantially” corrected during the “correction period”

– Correction period:

• General Rule: last day of the second plan year following year of occurrence

• ADP/ACP: last day of third plan year following year for which testing is failed

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Can Self-Correction Work?

• Remember timing rule:

• If insignificant failure, can correct any time

• If significant failure, have until last day of the second year following the year of failure (and ADP/ACP testing failure is deemed to happen at end of testing year)

• Can we be sure a failure is “insignificant?”

• Rule of thumb: get things corrected within two-year correction period or at least consider VCP’ing the rest unless they are obviously insignificant

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Self-Correctable Failures

• Do we have any (let’s identify them)?

• Do we have the requisite requirements?

• FDL or equivalent?

• Policies and procedures?

• No exam by IRS noticed

• Options under self-correction

• Correct

• IRS approved correction?

• Unapproved correction?

• Don’t correct

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What if Errors Are Not Self-Correctable Under EPCRS?

• Option 1: VCP

• Option 2: Correct with no filing

• Option 3: Don’t correct

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General Guide for EPCRS Correction

• If there is an IRS-approved correction available, that is where to start

• Rev. Proc. 2016-51, Section 6, Appendices A & B

• Use that, unless there is a reason not to do so

• Too impractical

• Too expensive

• Very unpopular to rank-and-file

• Check out informal IRS guidance that is available

• IRS answers to Q&As

• What other practitioners have experienced

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General Guide for EPCRS Correction

• If you have to formulate your own correction, remember the correction principles discussed on slides 8 – 9

• So, for each failures discovered, what are the:

• IRS pre-approved corrections

• Probably IRS preferred corrections

• What we would like to do if permitted

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Voluntary Correction Program

• Plan sponsor submits a plan to the IRS for coordinated correction process

– Fee payable

– Plan must be eligible for the program

– No correction applies until after approval granted under VCP (correction letter)

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VCP General Steps

• General procedure

– File with the IRS

– Pay user fee – based on type of failure and number of participants on most recent Form 5500 (See. Rev. Proc. 2016-8 for most fees)

– Negotiate with IRS on correction method

– Sign compliance statement with agreed-upon correction

– Complete correction within 150 days after final letter

21

VCP Fees – the Battle Continues

• Revenue Procedure 2018-4 released 1/2/18

– Changed VCP user fees from participant-based to asset-based fees

– Removed all special fees for loans and RMDs

– Rep. Neal (Ways & Means) filed letter to IRS Commissioner requesting reconsideration

22

Audit Closing Agreement Program

• IRS discovers problem during audit

• IRS and plan sponsor enters into a contract called a “Closing Agreement” to correct the problem

• Sponsor pays a sanction to the IRS

23

Audit CAP Sanction

• Starting place for negotiations: taxes that would be due if the plan were disqualified (“Maximum Payment Amount”)

• Procedure requires that the sanction:

– Not be excessive

– Bear reasonable relationship to the nature, extent, severity of the failure

• Problem: “excessive” and “reasonable” are in the eye of the beholder

• Criteria under Rev. Proc. 2016-51 have opened up criteria for consideration (facts and circumstances also count)

24

Voluntary Closing Agreement Program (VCAP)

• Like a super-secret program

– Used for tax-related plan matters

– Issue can’t be resolved through VCP

– Can’t be under examination or investigation

– Can’t be used for abusive or willful tax avoidance transactions

– User fee - TBD

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VCP Filing Decisions and Procedures

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Should We Submit At All?

• Can we self-correct and, if so, any reason to submit?

• Cost-benefit analysis for client

• Differences between submitted correction and un-submitted correction

• Cost of filing, including:

• IRS user fees

• Service provider fees

• Internal client costs to gather information, etc.

• Considering discoverability and Circular 230 requirements

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Disclosed or No-Name?

• Advantage to “no-name”

• If you don’t like IRS’s correction requirements, you can walk away…but you lose your user fee!!!

• Disadvantage to “no-name”

• If the plan is audited while VCP is pending, you go straight to audit CAP

• If the name is disclosed, audit process is suspended until VCP is complete

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Timing of Submission

• Hurry! As you don’t want to get audited while things are pending!

• But, want a complete, well thought-out submission

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Let the Case Studies Begin!

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Isn’t a Date a Piece of Fruit?

• Client is moving from bundled to TPA solution

• TPA receives PPA documents from bundled vendor

• PPA restatement effective January 1, 2015

• PPA restatement is signed, but no dates

• Is the PPA restatement acceptable?

• If not, can we self-correct?

31

Missed it by Thaaat Much

• Client changes payroll vendors as of January 1, 2017

• During the transition, new payroll vendor misses the set-up of the loan repayments

• Missed repayments caught in July 2017 during the 2016 audit for the Form 5500

• Can the employer go back and make up the missed repayments?

32

Surely, You Must Be Kidding..• Medical practice with three plans:

• First, PS only from solo practitioner before practice was formed (PS#1)

• Second, PS only sponsored by practice (PS#2)

• Third, DB sponsored by practice (DB)

• Medical practice is merging with larger medical group

• Unable to locate or obtain plan documents from “Accountant/Adviser” (A/A) or broker

• No TPA works on any plan

• All valuation work done by A/A and broker

• Form 5500s appear to all have been filed

33

No, I’m Not Kidding…

• PS#1 is invested nearly 90 percent in a limited partnership run by the A/A

– A/A has neither accounting nor financial adviser licenses

– A/A is also the treasurer/officer of the medical practice

– A/A has acted as the plan administrator (3(16)) in operation

• PS#2 is invested in two mutual funds – one is money market

– No testing has ever been formally done on the plan

– Broker has been creating valuations on balance-forward basis (incorrectly!!)

– Plan covers one HCE and all but three NHCEs (approx. 12-30)

• DB is a 412(e) that appears not to be properly funded

– Plan covers remaining two HCEs and only three NHCEs– No testing has ever been formally done on the plan

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And Don’t Call Me Shirley• Owner/doctor signed all documents, but “never read anything”

• Relied on A/A and former office manager (now fired) for everything

• Assets underlying limited partnership appear to all be dummy corporations set up by the A/A

• Plan was originally properly invested, but between 2008 – 2010 90 percent of assets transferred out to limited partnership

• Financial reports indicate that $1.7m is likely gone

• Form 5500 is now due for 2014 – how do you complete it?

• Plan documents from 2011 now surface – A/A is immediately removed as named trustee from all plans

• No other documents found – clearly failure involved on all 3 plans

• TPA/actuary engaged to rebuild practice plans from inception (2006)

• Since no “real” information on PS#1 assets, can’t produce valuation35

Can It Possibly Get Worse?

• After re-creating census data for 2006 – 2014, it is discovered that some employees were put into the wrong plan

• No Forms 1099R were ever prepared for distributions

• The DB Plan Form 5500 indicates that the plan year is off-calendar, but PS#2 is a calendar-year plan

– There are coverage testing problems with the DB Plan

– Inconsistency in DB documents shows possible intent to use calendar year

• Participants, including the former office manager, are asking about the status of the plans (and distributions)

• Owner/doctor hired a litigation attorney to pursue legal action against A/A and broker

36

And Now for the Big Reveal…..

• Civil suit still pending against two bad guys• DOL has investigation going and they are pursuing criminal action

against at least one bad guy• Client is cooperating and agreed to fix plans

• VCP proved to be the best option:• Plan #1 – value based on last known good investments, and bring

balances forward using reasonable earnings• Client will have to fund amounts for all non-key employees to

the tune of approximately $400k• Fix document and operational failures through VCP• Requested retroactive effective date to January 1, 2006 to be

in sync with DB plan

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And Now For the Big Reveal (Continued)

• Plan #2

• IRS unofficially agreed that we have to retroactively treat it as having the same plan year as the PS plan

• Lost §412(e) status and surrendered all policies

• Actuary hired to rebuild plan since inception and perform proper testing

• Included proper eligible employees

• Threw in failure to file 1099Rs for good measure

• Plan #3

• Recreated participant accounts since inception due to past improper calculation of eligibility

• Using reasonable blended rate of return for earnings

• VCP for document issue approved in two months38

Questions?

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Alison J. CohenFerenczy Benefits Law Center

2200 Century Parkway, Suite 560Atlanta, Georgia 30345

(678) 399-6604 (V)(866) 515-5140 (toll free)

(404) 320-1105 (F)acohen@ferenczylaw.com

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