 |
 |
 |
||||||||
 |
 |
 |
 |
 |
 |
 |
 |
 |
|
|
|
|||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
 |
Comments by: C. Frederick Reish, Esq., Bruce L. Ashton, Esq., and Nicholas J. White, Esq.
ERISA Attorneys with the Firm
Service Providers Continue to Actively Use APRSC
Service providers to qualified retirement plans continue to actively use the IRS' Administrative
Policy Regarding Self-Correction (APRSC) to correct qualification failures, 1999 survey data shows.
In this, our second APRSC survey, responses from over 100 service providers, mostly third party
administrators, detail the correction of "operational" qualification failures in over 700 plans during
1999. (The IRS defines "operational failures" as those qualification failures that arise solely from
a failure to follow the plan's terms.) The survey results indicate that the APRSC program is having
a positive effect on compliance by encouraging the discovery and resolution of these types of
retirement plan problems.
History of APRSC
EPCRS consists of five programs:
1. the Audit Closing Agreement Program (CAP), under which plan document failures (that is,
the failure of the plan document to meet the current Code requirements as to form) and
operational failures discovered by the IRS on audit can be corrected;
2. Walk-in CAP, which permits plan sponsors to voluntarily correct plan document failures
with IRS supervision;
3. the Voluntary Compliance Resolution (VCR) program, under which plan sponsors may
voluntarily correct operational failures with IRS supervision;
4. the Standardized VCR Procedure (SVP), which is a simplified program within VCR for
voluntary correction of specified operational defects using specified corrections; and
5. APRSC, which permits plan sponsors to voluntarily self-correct any operational failure
without IRS supervision by the last day of the second plan year following the plan year in
which the failure occurred, and to correct "insignificant" defects at any time, even if the plan
is under an IRS audit.
On August 5, 1999, the IRS issued Rev. Proc. 99-31, which contains guidance and examples upon
which plan sponsors can rely in correcting operational failures in their qualified plans. Previously,
this guidance consisted of only the SVP-mandated forms of correction set forth in Appendix A of
Rev. Proc. 98-22. On January 22, 2000, the IRS issued Rev. Proc. 2000-16, which expands SVP to
include the operational failures and correction guidance contained in Rev. Proc. 99-31. Rev. Proc.
2000-16 also updated and consolidated the balance of the guidance for EPCRS. The original SVP-
mandated forms of correction and the guidance previously contained in Rev. Proc. 99-31 now appear
as Appendix A and Appendix B of Rev. Proc. 2000-16, respectively; together, they create "safe-
harbor" correction methods that can be used and relied on by plan sponsors and their advisors in
resolving qualification defects under APRSC. [NOTE: On January 19, 2001, the IRS released Rev.
Proc. 2001-17, which updates the guidance on EPCRS and makes a number of substantive and
procedural changes to the remedial programs. Among other things, the new guidance renames
APRSC the "Self-Correction Program" or "SCP."]
Instituted in early 1997, APRSC permits self-correction of qualification failures without IRS
supervision. Because of this, evidence of how well or poorly the program works was, prior to our
surveys, purely anecdotal. We have conducted these surveys in order to develop statistical data on
the effectiveness of the program. We believe these statistics can assist plan sponsors and their service
providers in making corrections in the future. We also believe the data will continue to assist the IRS
in developing its remedial programs, especially in areas where there is a high degree of non-
compliance.
Survey Overview
Since the survey information does not include the number of plans represented by each service
provider, we were unable to develop statistics on what proportion of each service provider's clients
had a qualification problem. However, we did secure data indicating that over 56% of the responding
providers represent between 100 and 599 plans, and nearly 10% represent more than 1,000 plans.
This data, combined with the statistic that over 75% of the respondents used APRSC to correct 6 or
fewer plans, gives a strong indication that operational non-compliance occurs in a small percentage
of plans. This gives some degree of confirmation to what we surmised in our 1998 report.
In nearly 76% of the cases, the service providers reported that the defects were insignificant. Just
over 24% were reported as significant defects which were corrected within two plan years after
discovery of the defect. These statistics remain virtually unchanged from those developed from our
1998 survey.
The 1999 data, however, indicates that just over 2% of the insignificant defects (13 cases, or a little
over 1.5% of all defects) were discovered by the IRS on audit and corrected under APRSC. In
comparison to the 1998 data, in which 11% of the insignificant defects (8.5% of all defects) were
discovered and corrected during an IRS audit, the decrease in the number of uncorrected operational
defects discovered by the IRS suggests that service providers are taking greater advantage of APRSC
to correct defects soon after they occur although it may also reflect the low IRS audit level in 1999.
As always, the accuracy of APRSC data is difficult to judge due to the absence of a clear definition
of "insignificant;" however, the statistics do show that a substantial majority of APRSC cases
involve minor operational problems which are self-discovered and self-corrected. In general, this
suggests a very high level of voluntary compliance in resolving operational failures.
The types of operational failures were quite broad, but there are statistically meaningful categories.
The largest percentage of defects occurred due to a failure to follow the plan's written terms. This
occurred in 24.7% of the plans, an increase of over 8% from last year's survey, in which this was the
second most common defect (after incorrect allocations). In our 1999 survey, incorrect allocations
was the second most common defect (15.5%), followed by failure to admit eligible employees
(12.7%), admission of ineligible employees (10.6%) and ADP/ACP test failures (10%). Other
statistically significant groups of defects were top-heavy violations (9.2%) and incorrect distributions
(6%). Note that the IRS has addressed all of these defects, except for the admission of an ineligible
employee, in its "safe-harbor" correction examples under Rev. Proc. 2000-16. We have previously
urged the IRS, based on anecdotal evidence, that the admission of an ineligible employee is a
significant problem. This statistical validation should encourage the IRS to issue correction guidance
on that defect. [In fact, with the recent issuance of Rev. Proc. 2001-17, EPCRS now provides a safe
harbor correction for this defect.]
By a large margin, corrections were based on readministering the plan according to its terms (almost
40% of the cases). [NOTE: In both our 1998 and 1999 surveys, Question No. 8 ("How Defect Was
Corrected") shows a lower percentage of defects being corrected by readministering the plan than
Question No. 5 (which inquired as to the basis of the "Correction Method"). This discrepancy is
most likely due to respondents breaking down the general category of "readministering the plan" in
Question No. 8 into sub-categories, such as putting money into a suspense account or reallocating
money from the accounts of HCEs to the accounts of NHCEs.] Presumably, this is based on the
overriding correction principle in EPCRS that operational violations should be resolved by putting
participants in the position they would have been in absent the defect. In nearly 25% of the cases,
correction involved putting more money into the plan, or otherwise increasing benefits, for rank-and-
file employees.
Finally, the percentage of plans in which the correction is documented remained very high from our
1998 survey (about 95% for both years). Based on our experience, documentation of the defect and
the manner of correction is very helpful if the plan is subsequently audited by the IRS.
Survey Results in Detail
1. Indicate the number of cases in which you have corrected or advised on the correction
of plan qualification failures:
Since the survey information does not include the number of plans represented by each service
provider, we cannot develop statistics on what proportion of each service provider's clients had a
qualification problem. However, it is significant that approximately 90% of the respondents
identified and corrected at least one defect during the year. This indicates a high level of awareness
of the IRS programs and suggests qualified plans are receiving advice to correct defects when
discovered. Also, see our comment under the following survey question.
2. If you are an advisor to plans, indicate the appropriate number of qualified plans your
firm administered or advised in 1999:
Table 2: Number of Qualified Plans Administered
Although we do not have the data necessary to prepare statistics on what proportion of each service
provider's clients had qualification defects, we do know from the data in survey question No. 2 that
over 56% of the providers indicated that they represent between 100 and 599 plans, and nearly 10%
indicated that they represent more than 1,000 plans. This information, combined with the data from
survey question No. 1 indicating that over 75% of the respondents reported corrections in 6 or fewer
plans, suggests that operational non-compliance is discovered (and perhaps only occurs) in a
relatively small percentage of plans. This gives some degree of confirmation to what we surmised
in our 1998 report.
3. Was the defect:
Table 3: Significant vs. Insignificant Defects
As was the case with our 1998 survey results, in over 75% of the corrections the defect was
described by the service provider as "insignificant." The difficulty in relying on this data is that the
term "insignificant" has not been defined by the IRS. Therefore, whether a qualification failure is
insignificant is initially left to the determination of the plan sponsor and/or its advisors, subject to
review by the IRS if the plan is audited. The problem for the plan sponsor in this regard is that there
is always the risk that an IRS Revenue Agent might, on audit, disagree with the plan sponsor's or
advisor's determination that a defect is insignificant. This could result in plan disqualification;
however, it is more likely to be resolved on the basis of an Audit CAP. To help avoid this serious
problem, we continue to urge the IRS to provide further guidance to clarify the distinction between
significant and insignificant defects.
In our 1998 survey, almost 20% of the defects were corrected more than two years after they
occurred. In this survey, that percentage has not decreased significantly. This is somewhat surprising
in view of the amount of press given to APRSC in 1999. At the same time, this may simply reflect
the fact that the IRS did not issue formal correction guidance relative to APRSC until August 5,
1999, when it released Rev. Proc. 99-31.
4. For an insignificant defect, was the defect:
Table 4: Voluntary Correction vs. Correction on Audit
With over 97% of the insignificant defects being self-discovered and corrected, this indicates a very
high level of voluntary compliance. This statistic is up nearly 9 percentage points from our 1998
survey. This suggests that as plan sponsors and service providers become more familiar with APRSC
and the IRS' safe-harbor correction methods, they are more likely to engage in self-auditing and self-
correction.
In last year's survey, the percentage of APRSC corrections made under IRS supervision on audit was
approximately 11%. In view of the increase in self-discovery and self-correction, it is not surprising
that in 1999 this percentage dropped to just over 2%.
5. Correction
Table 5: Correction Method
In our 1998 survey, nearly one-half of the defects were corrected by readministering the plan in
accordance with its terms. We commented that this was not surprising, since the primary correction
principle listed in Rev. Proc. 98-22 is to put the participants in the position they would have been
in had the qualification failure not occurred. In the 1999 survey, the use of this correction method
is down 8.5%. At the same time, the percentage of defects corrected in accordance with IRS
examples is up nearly 14 percentage points. This suggests that the issuance of the correction
examples in Rev. Proc. 99-31 has had a dramatic impact on correction methodology.
Not surprisingly, the survey also suggests that the IRS correction examples have reduced the number
of instances in which correction was made based on the plan sponsor's or advisor's judgment of an
equitable correction. The percentage of such cases has gone down nearly 5.5% from our 1998 survey.
6. If the failure was corrected without IRS supervision, how was the self-correction
documented?
Table 6: Documenting Self-Correction
The percentage of plans in which the correction is documented remains very high from our 1998
survey (both surveys indicate nearly a 95% documentation rate). Based on our experience,
documenting the failure and its correction is very helpful if the plan is subsequently audited. This
is consistent with what IRS officials have indicated in both informal statements and speeches around
the country.
7. Type of defect:
Table 7: Type of Defect
1
1
1
1
2
2
1
1
Statistically, the most common type of defect was the failure to follow the plan's written terms. This
occurred in 24.7% of the plans, an increase of over 8% from last year's survey in which this was the
second most common category of defect (after incorrect allocations). Failure to follow the plan's
terms is a catchall which includes a number of other possible types of failure. It is a common defect
and it highlights the importance of coordinating the administration of the plan with the
documentation. In our experience, examples of common problems of this type are: participant loans
where the plan documents do not permit participant loans; more outstanding loans to a participant
than the plan document permits (e.g., the plan document only permits one outstanding loan to a
participant at a time); hardship withdrawals where the plan document does not have a provision
permitting such withdrawals or where the hardship withdrawal is not administered in accordance
with the plan provision; distributions in forms or at times not permitted by the plan document;
admission of employees to participation prior to completing the eligibility requirements in the plan;
use of compensation data different from the definition in the plan document; deferrals in excess of
the Code section 402(g) or plan document limits; failures to comply with the minimum required
distribution rules; and failures to comply with the plan's requirements regarding matching
contributions.
The second largest group of defects was incorrect allocations at 15.5%; the third was failing to timely
admit eligible employees with 12.7%. Other statistically large groups of defects were ADP/ACP test
failures (10%), top-heavy violations (9.2%) and incorrect distributions (6%). The IRS has addressed
all of these defects in its safe-harbor correction examples in appendices A and B of Rev. Proc. 2000-
16.
In this year's survey, early admission of ineligible employees remains the fourth largest identified
group of defects, down less than 0.5% from last year's survey. Unfortunately, the IRS has not yet
provided published guidance on correction for this type of qualification failure. We continue to urge
the IRS to issue correction guidance on this significant problem. (NOTE: As indicated in the history
of APRSC section on page 1, the recently released Rev. Proc. 2001-17 provides a safe harbor
correction for this defect.)
8. Was the defect corrected by:
Table 8: How Defect Was Corrected
1
1
1
1
1
1
1
1
1
1
1
1
1
2
1
1
5
1
1
1
1
1
3
1
1 1
As was the case with the 1998 survey, the largest category of corrections fell under the broad heading
of readministering the plan according to its terms (over 30%). As indicated above, resolving
operational defects in this manner is consistent with the IRS correction principle under EPCRS that
participants should be put in the position they would have been in absent the defect. It is also
consistent with certain of the IRS's correction examples, which formally approve readministration
of the plan (referred to in the correction examples as the "reallocation correction method") as a safe-
harbor correction method. (NOTE: Survey Question No. 5 indicates that 39% of the defects were
corrected by readministering the plan. In this Question No. 8, the percentage of defects corrected
in this manner is 30.5%. The difference is primarily attributable to the fact that in Question No. 5
we were asking about the basis for the correction methodology, and in Question No.8 we were
asking for the specific method of correction. Thus, in Question No. 8, it is logical to assume that
some of the corrections which fall under the general category of "readministering the plan" were
broken down by the respondents into other categories, such as (1) putting money in a suspense
account or (2) reallocating money from the accounts of HCEs to the accounts of NHCEs.)
Nearly 25% of the corrections involved putting more money into the plan for, or otherwise increasing
the benefits of, rank-and-file employees. This is similar to what the 1998 data showed. The fact that
a significant number of defects are being corrected in this manner may be due, in part, to plan
sponsor concerns about the ill will that might be created if certain plan participants are asked to
return a portion of their benefits in order to support correction for other participants through
readministration of the plan.
9. When you worked on correcting the defect(s) under APRSC, was that in your capacity
as:
Table 9: Capacity of Person Correcting
This information is not surprising and it is not significantly different from what the 1998 data
showed. Clearly, the first person who is likely to discover an error is the third-party administrator
who is in the business of reviewing the plan administration data. Also, given the fact that APRSC
has simplified the correction process, especially when coupled with the new IRS correction
examples, it makes sense that the TPA is the party who most typically assists the plan and plan
sponsor in making correction.
About the Authors
Fred Reish, managing partner of the ERISA practice at the law firm of Reish Luftman Reicher & Cohen, was
recently inducted as a Charter Fellow of the American College of Employee Benefits. He serves as
Co-Chair of the Los Angeles Benefits Conference as well as on numerous other professional
organizations. Fred is a member of the Editorial Board of the Journal of Pension Benefits, writes a
quarterly column for the 401(k) Advisor, and is co-author of the Plan Correction Answer Book and
the Handbook for Retirement Plan Trustees.
Bruce Ashton, an ERISA partner at Reish Luftman Reicher & Cohen, represents plans and their sponsors in
controversies before the IRS and the PWBA. Bruce is co-author of the Plan Correction Answer Book
and Actuarial Audits: A Legal and Tactical Analysis. He is a member of the Editorial Board and
frequent contributor to Panel Publisher's 401(k) Advisor and the Journal of Pension Benefits as well
as other tax and pension publications.
Nick White, an ERISA partner at Reish Luftman Reicher & Cohen, specializes in all aspects of employee benefits
law. Before joining the firm, he served as a Tax Law Specialist for the Western Key District Office
of the Employee Plans and Exempt Organizations Division of the Internal Revenue Service. Nick
has written articles for various tax and pension publications, including the Journal of Taxation and
the Journal of Pension Benefits.
Reish Luftman Reicher & Cohen
|
||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
|
|
11755 Wilshire Blvd., 10th Floor, Los Angeles, CA 90025-1539 Phone: (310) 478-5656 Fax: (310) 478-5831 About Us | Practice Areas | Attorneys | Publications | Events | Recruiting | Contact Us | Site Map | Home © 2000 - , Reish & Reicher, A Professional Corporation. All Rights Reserved. |