The IRS Has Announced a “90-Day Pre-examination Compliance Pilot” for Sponsors of 401(K), Pension, and Other Qualified Retirement Plans

In the June 3 issue of Employee Plans News, the Internal Revenue Service announced a pilot program to give employers whose qualified retirement plans have been selected for audit a 90-day window during which they are encouraged to review plan compliance (of their plan document and plan operations) to discover any qualification errors and then to correct those errors on their own, before the commencement of the audit. By discovering and correcting plan qualification errors before audit commencement, an employer may avoid the payment of significant tax penalties that might otherwise result from the scheduled audit.

By way of background, the IRS has for many years sponsored a robust program that an employer can utilize if it discovers that its qualified retirement plan has a defect that could potentially disqualify it from tax benefits. Plan disqualification could lead to substantial tax liabilities and penalties being imposed on a plan’s sponsoring employer, or even on the plan’s participating employees, although the IRS usually works with an employer to protect employees from financial harm. This program, which is called the “Employee Plans Compliance Resolution System,” or EPCRS, is currently embodied in Revenue Procedure 2021-30. EPCRS has constantly evolved, generally getting more complicated, but also getting more generous in terms of the ability of a plan sponsor to correct plan errors in the most practical manner possible. The principle behind EPCRS is that the IRS Employee Plans function has always viewed its mission not as raising revenue, but as ensuring that retirement plans deliver to employees the benefits they are supposed to under the law.

EPCRS generally consists of three components:

• The Self-Correction Program, or SCP
• The Voluntary Compliance Program, or VCP, and
• The Audit Closing Agreement Program, or Audit CAP

Under SCP, an employer may correct plan qualification errors on its own, without contacting the IRS, if those errors are either “insignificant” or are corrected by the end of the third plan year following the plan year containing the error.

Under VCP, employers may correct errors (other than egregious errors) that do not qualify for SCP by submitting descriptions of the errors and proposed corrections to the IRS for approval and paying a very small compliance fee. The compliance fee is currently $3,500 for plans with over $10 million in assets, $3,000 for plans with between $500,000 and $10 million in assets, and $1,500 for plans with $500,000 or less in assets. Note that while the fees charged by the IRS for SCP are nonexistent, and those for VCP are very small, correction may still require a substantial financial outlay by an employer, for example where the error resulted in significant missed plan contributions by employees.

Audit CAP is reserved for situations in which significant errors in a plan’s document or administration are discovered while the plan is under audit by the IRS. In Audit CAP, an employer can avoid disqualification of its plan only if it both corrects the plan’s errors, as in SCP or VCP, and pays the IRS a penalty. The amount of the penalty is the result of a negotiation between the IRS and the employer (or, more typically, the employer’s employee benefits counsel). The penalty can vary significantly from case to case based on the employer’s facts and circumstances but is typically substantial and far more than the $1,500 to $3,500 compliance fee under VCP.

Since its inception, a key feature of EPCRS has been that SCP and VCP (the components of VCP which, again, entail either no, or minimal, IRS monetary penalties) were not available to employers that had received from the IRS a notice of an employee plans audit. If the employer was under audit, correction of plan defects to avoid disqualification could only occur through Audit CAP, likely entailing, again, substantial monetary penalties. The IRS believed that putting SCP and VCP off-limits for employers whose plans came under audit provided an incentive to employers to proactively find and correct plan errors.

Now, however, the IRS will abandon that approach, at least for some plans, during a “trial period.” Under the “90-day Pre-Examination Compliance Pilot,” if a plan receives a notice of audit from the IRS, the employer will have a 90-day window during which it can self-correct any known or newly discovered plan errors. If the employer takes advantage of this 90-day window, the employer will either pay no penalties to the IRS at all, if the errors would otherwise (i.e., but for the notice of audit) qualify for SCP, or pay the minimal $1,500, $3,000, or $3,500 VCP fees described above if the errors do not qualify for SCP.

An employer that takes advantage of the 90-day window may even avoid the scheduled IRS audit altogether if the IRS is satisfied with the employer’s documentation of its corrections. However, the IRS may also still conduct the audit, although it may be more limited in scope than it would have been if the employer had not taken advantage of the 90-day correction window.

The IRS’s announcement of the “90-day Pre-Examination Compliance Pilot” is unusually brief given its potential ground-breaking significance for plan sponsors, and leaves some important questions unanswered, such as:

• How long will the program last?
• Will all notices of audit received by plan sponsors while the pilot program is in effect include the 90-day compliance window?
• Will the IRS, in reviewing employers’ corrections of plan defects during the 90-day window, be as flexible and practical as it sometimes is in VCP, given that the employer has taken the steps it has under direct threat of an audit?
• Does the IRS intend, either during the period of the pilot program, or after its conclusion and evaluation, if it is viewed as successful, to increase the number of audit notices that it sends to employers, seeing the new 90-day window as a way to leverage the effectiveness of its audit staff?

While we have no immediate answers to the above questions, what is clear is that an employer that receives a notice from the IRS of an Employee Plans audit should immediately contact its employee benefits counsel, or seek out employee benefits counsel, in order to take maximum advantage of the 90-day compliance window, if offered. There is no downside to doing so since the employer will already be under audit.

A copy of the June 3 IRS Employee Plans Newsletter announcing and explaining the new “90-day Pre-Examination Compliance Pilot” can be found here. You will need to click on the “+” under June 3, 2002, to read the newsletter.

The views and opinions expressed in the article represent the view of the authors and not necessarily the official view of Clark Hill PLC. Nothing in this article constitutes professional legal advice nor is intended to be a substitute for professional legal advice.