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Davis Brown Tax Law Blog

Tax Law Blog: New Procedures to Correct Retirement Plan Mistakes - July 7, 2015

The IRS has recently modified the Employee Plans Compliance Resolution System (EPCRS) to encourage employers to adopt automatic contribution features, and to detect and correct errors in retirement plans quickly.  Revenue Procedure 2013-12 sets forth three ways to correct errors in retirement plans: Self-Correction, Voluntary Correction, and Audit Closing Agreement Program. Revenue Procedure 2013-12 is not superseded, rather only specific provisions are modified by the new Revenue Procedures, 2015-27 and 2015-28.

Errors in retirement plan administration or in the underlying documents can cause the plan to lose is tax-exempt status. The EPCRS sets forth safe harbors on how to correct certain mistakes. The type of failure (operational, plan document, or qualification) will determine the available methods to fix the failure.

A common operational failure relates to elective deferrals, either improper exclusion of a certain employee from participation in the plan, or failure to correctly implement elective deferrals according to an employee’s election or the plan’s automatic contributions. In such a case, the employee received in their paycheck funds they intended to contribute to the retirement plan.  As a result, the funds were included in their income, but they lose the growth potential of those funds being in the retirement plan.

Under Revenue Procedure 2013-12, the common correction method for this type of operational failure is for the employer to contribute 50% of the missed deferral to the retirement account (adjusted for earnings that the funds would have earned had it been contributed at the proper time). The employer would additionally contribute any employer matching contributions that were missed, also adjusted for earnings. This creates somewhat of a windfall for the employee, in that the employee received the funds in income, and an additional 50% of the funds were placed into the employee’s respective retirement account.

Revenue Procedure 2015-28 adopts new safe harbor correction methods that are less punitive to the employer. Whether a particular safe harbor is available depends on if the plan has an automatic contribution feature, and how quickly the correction is made.

For plans with an automatic contribution feature, if the failure is corrected within 9 1/2 months after the year the failure occurred, the employer can provide notice to the employee of the failure, and can correct the failure by making only the missed matching contributions. In other words, the employer only contributes what it should have contributed from its own funds, and it is not required to contribute the additional 50% of the deferral amount on behalf of the employee. Remember, the employee received the funds intended to be contributed to the account as income, so he/she is not really losing out on the money.  

A similar new safe harbor applies if the failure is corrected within 3 months, regardless of whether there was an automatic contribution feature. If the failure is corrected within 3 months, proper notice is given to the employee, and the employer makes the corrective matching contributions, the employer is not required to contribute additional funds for the missed opportunity of the employee.

A third new safe harbor applies if the correction is made by the end of the second plan year following the year in which the failure occurred. If the timing requirements are met and proper notice is given to the employee, then the employer makes a corrective contribution equal to 25% of the missed deferral (adjusted for earnings) and also the missed matching contributions. This is more favorable than the otherwise required 50% corrective contribution.

Revenue Procedure 2015-28 contains more details on the new safe harbors, including the information to be provided to the employee in the notice. Additionally, Revenue Procedure 2015-27 was recently released and makes various changes and clarifications to EPCRS and Revenue Procedure 2013-12.