IRS Aligns Determination Letter Program and Employee Plans Compliance Resolution System for ESOPs
March 31, 2017
By Peter J. Shuler and Mark D. Swanson, J.D.
Changes to the IRS determination letter program and Employee Plans Compliance Resolution System (EPCRS) finally are here. The changes are positive and refresh previously published guidance by consolidating the changes to both into one revenue procedure and removing references to programs that have been eliminated.
Determination Letter Program
The basic principle underlying all qualified retirement plans, including employee stock ownership plans (ESOPs), is that they must be operated according to the terms of a written plan document, which will contain certain discretionary provisions and must contain all provisions required by applicable laws and regulations. Traditionally, if the plan sponsor desired the IRS’ blessing that the terms of the plan document complied with applicable requirements, the sponsor could apply to the IRS for a determination letter. While obtaining a letter was not required, it certainly provided some comfort in the event the IRS later questioned a provision.
In the past, when there were changes in the law that required a change to a plan document, the plan would enter a remedial amendment period. During this period, the plan still needed to operate in compliance with all applicable laws and regulations, but the plan document did not need to be amended to reflect the changes in the law. Plan sponsors would update their plans (a process called “restating”) and, before the end of the remedial amendment period, request a determination letter from the IRS. This process resulted in mass submissions of documents as the end of the remedial amendment period approached. To help even out the application process, the IRS established a five-year cycle during which sponsors would submit plans for a determination letter every five years. Plans were assigned to one of five cycles based on the last digit of the employer identification number so that approximately one-fifth of plan documents were restated and reviewed for a determination letter each year.
In 2015, the IRS announced that effective Jan.1, 2017, the five-year remedial amendment cycle was being eliminated so that the IRS could more efficiently direct its limited resources to other projects and programs. The IRS later clarified that determination letters still would be issued for new plans, terminating plans, and in other limited cases as determined by the IRS. Those limited circumstances have not been defined, but the IRS has indicated it would consider factors such as significant law changes, new approaches to plan design, and the inability of certain types of plans to use preapproved documents. Plan sponsors can continue to rely on current favorable determination letters, as long as their plan documents are not amended or affected by a law change.
While the determination letter program for ongoing plans has gone away, it does not mean that plan documents do not need to be updated for both discretionary amendments and required amendments that reflect changes in laws and regulations. To assist plan sponsors, the IRS will publish two lists on an annual basis: a required amendments list and an operational compliance list. Generally, plans will need to adopt required amendments by the end of the second calendar year following the year the list is published. For example, plan amendments for items on the 2016 list generally must be adopted by Dec. 31, 2018. Discretionary amendments still will follow the rules that apply for adoption of such amendments. Such amendments usually need to be adopted by the end of the year in which the provision is put into operation or, in some cases, before the provision is effective.
The former determination letter program provided some comfort because, as long as a plan’s determination letter was current, the terms of the document received some form of IRS approval. That comfort likely was the result of plan sponsors working closely with legal counsel and other professionals to keep things on track. Transition to the new system will bring questions, so coordinating with legal counsel and other professionals will be even more important to help keep everything up to date and operating correctly.
Errors can occur, even when plan sponsors operate their plans with the intention of complying fully with the terms of the plan document and applicable laws and regulations. One of the principles underlying EPCRS is to provide sponsors with the ability to take corrective action to maintain a plan’s qualified status.
EPCRS categorizes operational failures eligible for correction under the self-correction program (SCP), voluntary correction program (VCP), or the audit closing agreement program (audit CAP). If the operational failure meets the criteria to be corrected using the SCP, a plan sponsor with established compliance practices and procedures may correct operational failures without paying a fee or sanction. Operational failures under the VCP may be corrected at any time before IRS audit by paying a fee and receiving IRS approval for the correction. There are special procedures under VCP for anonymous submissions and group submissions. If the failure is discovered during an IRS audit, the sponsor may correct the failure and pay a sanction under the audit CAP.
The IRS updated its guidance about EPCRS in Revenue Procedure 2016-51, and the changes were effective Jan. 1, 2017. Under the previous EPCRS programs, a plan had to have a favorable determination letter. Some corrections also required that a plan or amendment be submitted for a determination letter as part of the correction. Because the IRS now is issuing determination letters only in certain circumstances, many plans will not have a determination letter. As a result, a determination letter no longer is required in order to correct failures under EPCRS. Similarly, no determination letter application is required to be filed as part of the correction. The current guidance also removes references to the IRS and Social Security Administration letter-forwarding programs as options to help locate lost participants because these programs have been eliminated.
In the past, if a plan corrected an error using the VCP, the fee to be paid was found in the revenue procedure containing EPCRS guidance and based on the number of plan participants. The fee would remain the same until it was superseded by a new fee in another revenue procedure. Going forward, the IRS will publish a fee schedule for VCP corrections annually (see Revenue Procedure 2017-4 for current fees). Under prior guidance, a fee also was submitted with an anonymous request to the IRS, which would approve the proposed correction without knowing the name of the plan or plan sponsor. If the IRS did not approve the proposed correction, it would refund 50 percent of the fee. The new guidance eliminates the 50 percent refund.
Under audit CAP, the sanction previously was determined as a negotiated percentage of the maximum payment amount. Under the new guidance, the sanction will be determined using a facts and circumstances approach based on a number of factors, such as the steps taken to ensure the plan had no failures, the steps taken to identify failures that occurred, the extent to which corrections began after being discovered, and the number of nonhighly compensated participants who would be adversely affected if the plan were disqualified.
The IRS also clarified that certain correction methods will qualify as safe harbor methods but that plans can use other methods, as long as the methods used are reasonable and satisfy EPCRS correction principles. Finally, the definition of plan document failures is expanded to include definitions of good faith amendment, interim amendment, and nonamender failures.
Overall, the outlook as a result of these changes seems positive. Many plans have used EPCRS to correct qualifying errors, and the updated guidance further demonstrates the IRS’s desire to promote voluntary compliance and a more reasonable approach when failures are discovered during an audit. The impact of the elimination of the determination letter program on ongoing plans has yet to fully unfold, as there still is some reliance on existing letters. Keep in mind, though, that the elimination of this program does not mean plan documents no longer need to be updated. In fact, it is even more important to coordinate with your legal counsel and third-party service providers to ensure compliance.