Despite the best intentions of the various players in the qualified pension plan drama, including Plan Sponsors, Plan Administrators, and Trustees, it is inevitable that an employer or plan will discover at some point that it is out of compliance. This will occur in several ways. First, the parties charged with running a Plan will discover there is a problem. Often this occurs when there’s a transaction on the horizon, such as the sale of an employer. Sometimes, it will occur when a Plan participant complains. Second, it may occur when a Plan is the subject of an IRS audit. How real is the possibility of an IRS audit? It’s real. In the late 1980s, the IRS stepped up its audits of Plans to determine operational compliance. In 1987, the IRS performed about 5,000 examinations. But by 1989, that number had grown to 32,000 examinations annually. The IRS faces personnel challenges but even today the potential for an IRS audit can’t be ruled out. This is particularly the case if a disgruntled Plan participant alerts the IRS.
About 20 years ago, the IRS organized its plans to correct compliance problems under the Employee Plans Compliance Resolution System or EPCRS. There are three paths under EPCRS depending on when a compliance problem is discovered. Under certain circumstances, a plan can “self-correct” without paying any fee or sanction, known as SCP. Next, a Plan may make a “voluntary correction” before an IRS audit with a limited fee, known as VCP. Finally, a Plan can correct upon discovery of a problem in an audit, paying a sanction that bears “a reasonable relationship to the nature, extent, and severity of the failure, taking into account the extent of the correction made before audit,” known as Audit CAP.
Like ice cream, plan defects come in multiple flavors. An operational defect is the failure of a retirement plan to operate the plan correctly in accordance with its plan documents. Sometimes a plan fails to say the right thing at the right time, known as a form defect. Or, a defect in the plan’s operation may arise from a change in employer demographics, known as a demographic defect. An example of a demographic defect is the failure to satisfy a nondiscrimination requirement in operation because of a shift in the demographics of an employer’s workforce.
Confronting and correcting a defect is important because under the applicable law there is zero tolerance for plan defects. Any defect no matter how minor can be the basis for disqualifying a retirement plan. If a plan is disqualified, the ability of participants to use favorable tax treatment to plan for their retirements ceases. Any funds placed in retirement plans while they are not qualified become immediately taxable to the participants.
A plan defect is easier and cheaper to fix the sooner it is identified. If you suspect your plan has a defect and is out of compliance under ERISA, don’t wait. Call an ERISA attorney to find out promptly what you’re up against.
If you have any questions about this, please contact us.
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