Retirement Plans FAQs regarding the Self-Correction Program (SCP)

These frequently asked questions and answers provide general information and should not be cited as any type of legal authority. They provide the user with information responsive to general inquiries. Because these answers do not apply to every situation, yours may require additional research.

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1. Is there a way to attain IRS approval prior to audit regarding the appropriate way to correct a failure under the SCP?
2. What practices and procedures are required to be in place in order for a plan to be eligible for relief under the SCP?
3. If a Plan Sponsor discovers a failure of the Actual Deferral Percentage (ADP), Actual Contribution Percentage (ACP), or Multiple Use tests in the Plan Sponsor's profit-sharing plan, may the failures be corrected under the SCP?
4. What are Insignificant Operational Failures under the SCP?
5. When correcting Significant Operational Failures, what actions must be taken by a Plan Sponsor by the end of the two-year correction period in order to be entitled to relief under the SCP?
6. Assume a Plan Sponsor discovers a vesting problem in which the plan terms were not followed, should the Plan Sponsor use SCP or the Voluntary Correction Program to correct the problem?
   

Is there a way to attain IRS approval prior to audit regarding the appropriate way to correct a failure under the SCP?

The SCP is a voluntary employer-initiated program that does not involve IRS approval; therefore, the IRS will not approve a Plan Sponsor's method of correction prior to audit. However, Revenue Procedure 2008-50 sets forth General Correction Principles designed to assist a Plan Sponsor in determining the appropriate method of correction for a failure. In addition, Appendix A and Appendix B of Rev. Proc. 2008-50 provide Plan Sponsors with sample correction methods for certain failures. To the extent the Plan Sponsor applies the applicable correction method set forth in either of these appendices, the correction is deemed to be reasonable and appropriate correction for the failure. Upon examination, the IRS has the right to review whether the taxpayer made the correct determination that such failure(s) were eligible under the SCP as well as whether the correction method is acceptable.

What practices and procedures are required to be in place in order for a plan to be eligible for relief under the SCP?

The IRS is concerned that the practices and procedures of a plan foster compliance with the requirements of the Code.

• Practices and procedures may be formal or informal.
• Practices and procedures must be routinely followed.
• Practices and procedures need not be in place for a specific failure (as long as practices and procedures exist that evidence an overall effort on the part of the Plan Sponsor to maintain the plan in compliance with the Code requirements).
• A plan document alone is not sufficient to establish evidence of good practices and procedures.
• An example of an acceptable practice or procedure outside of the plan document is a checksheet routinely followed for determining whether an employee is a key employee for purposes of meeting the top-heavy requirements.

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If a Plan Sponsor discovers a failure of the Actual Deferral Percentage (ADP), Actual Contribution Percentage (ACP), or Multiple Use tests in the Plan Sponsor's profit-sharing plan, may the failures be corrected under the SCP?

Yes. A failure of the ADP, ACP or Multiple Use Tests is treated as an Operational Failure for purposes of EPCRS. Under Code section 401(k) and (m), a Plan Sponsor has until the end of the plan year following the plan year in which an excess contribution or excess aggregate contribution was made to correct the failure; under the SCP, the two-year correction period applicable to Significant Operational Failures does not begin under the expiration of the statutory correction period. (Note that the Multiple Use Test has been repealed for plan years beginning after 12/31/01.)

Example – In 2006, a Plan Sponsor discovers that in 2005, when testing the contributions made in its section 401(k) plan during 2005 for the ADP test, mistakes were made in determining the correct amount of compensation that should have been taken into account under the test. When the ADP test was rerun with the correct data, the Plan Sponsor discovers that the ADP test was failed. Assuming the other eligibility requirements of the Self-Correction Program are satisfied, if the ADP failure is a Significant Operational Failure, the Plan Sponsor may correct the failure to satisfy the ADP test by the end of the 2008 plan year. If the ADP failure is an Insignificant Operational Failure, the Plan Sponsor has even longer to correct the failure, and may correct even upon audit of the plan.

What are Insignificant Operational Failures under the SCP?

The SCP permits Plan Sponsors to correct Significant Operational Failures within two years of the year in which the failure occurred, provided the other requirements of the SCP are satisfied. A number of factors are considered in determining whether Operational Failures are insignificant. These include, but are not limited to:

• whether other failures occurred during the period being examined (for this purpose, a failure is not considered to have occurred more than once merely because more than one participant is affected by the failure);
• the percentage of plan assets and contributions involved in the failure;
• the number of years the failure occurred;
• the number of participants affected relative to the total number of participants in the plan;
• the number of participants affected as a result of the failure relative to the number of participants who could have been affected by the failure;
• whether correction was made within a reasonable time after discovery of the failure; and
• the reason for the failure (for example, data errors such as errors in the transcription of data, the transposition of numbers, or minor arithmetic errors).

This is not an exclusive list and no single factor is determinative. Failures will not be considered significant merely because they occur in more than one year. In addition, the IRS will apply these factors in a way so as to not preclude small businesses from being eligible for the SCP merely because of their size.

The following examples illustrate the application of insignificant failures.  It is assumed, in each example, that the eligibility requirements relating to SCP have been satisfied and that no Operational Failures occurred other than the Operational Failures identified below.

Example 1:  In 1991, Employer X established Plan A, a profit-sharing plan that satisfies the requirements of § 401(a) in form. In 2004, the benefits of 50 of the 250 participants in Plan A were limited by § 415(c). However, when the Service examined Plan A in 2006, it discovered that, during the 2004 limitation year, the annual additions allocated to the accounts of 3 of these employees exceeded the maximum limitations under § 415(c). Employer X contributed $3,500,000 to the plan for the plan year.  The amount of the excesses totaled $4,550. Under these facts, because the number of participants affected by the failure relative to the total number of participants who could have been affected by the failure, and the monetary amount of the failure relative to the total employer contribution to the plan for the 2004 plan year, are insignificant, the § 415(c) failure in Plan A that occurred in 2004 would be eligible for self-correction.

Example 2: The facts are the same as in Example 1, except that the failure to satisfy § 415 occurred during each of the 2003, 2004, and 2005 limitation years. In addition, the three participants affected by the § 415 failure were not identical each year. The fact that the § 415 failures occurred during more than one limitation year did not cause the failures to be significant; accordingly, the failures are still eligible for self-correction.

When correcting Significant Operational Failures, what actions must be taken by a Plan Sponsor by the end of the two-year correction period in order to be entitled to relief under the SCP?

In general, correction must be completed by the end of the two-year correction period in order for a plan to be entitled to relief under the SCP. However, where a Plan Sponsor substantially completes correction within the correction period, the Plan Sponsor will not lose the relief provided under the SCP merely because correction wasn’t completed during the correction period. There are two circumstances under which correction is considered to have been substantially completed:

First, where,

• during the correction period, the Plan Sponsor is reasonably prompt in identifying the  Operational Failure, formulating a correction method, and initiating correction in a manner that demonstrates a commitment to completing correction of the Operational Failure as expeditiously as practicable; and
• within 90 days after the last day of the correction period, the Plan Sponsor completes correction of the Operational Failure; and

Second, where,

• during the correction period, correction is completed with respect to 85% of all participants affected by the Operational Failure; and
• thereafter, the Plan Sponsor completes correction of the Operational Failure with respect to the remaining affected participants in a diligent manner.

In addition, a Plan Sponsor will not be considered to have failed to fully correct within the correction period where a Plan Sponsor takes reasonable action to find but has not located all current and former participants and beneficiaries to whom additional benefits are due. Reasonable action includes the use of the Internal Revenue Service Letter-Forwarding Program or the Social Security Administration Reporting Service. If an individual is later located, the additional benefits must be provided to the individual at that time.

If correction of an Operational Failure is being implemented through adoption of a plan amendment, the required application for a determination letter must be submitted by the end of the employer's applicable amendment period pursuant to Rev. Proc. 2005-66 in order for correction to be considered to have been timely implemented. The amendment related to self-correction must be clearly identified in the determination letter application.

Assume a Plan Sponsor discovers a vesting problem in which the plan terms were not followed, should the Plan Sponsor use SCP or the Voluntary Correction Program to correct the problem?

The decision of whether to use the SCP or Voluntary Correction Program to correct an Operational Failure depends on a number of factors, including: (1) the type of failure involved, (2) the practices and procedures under the plan, (3) whether, if the failure is an Operational Failure, it would be considered to be a Significant Operational Failure,, (4) whether a Favorable Letter has been issued with respect to the plan, (5) whether the failure is an Egregious Failure, (6) when the failure is discovered, and (7) the amount of comfort the Plan Sponsor has with respect to the method used to correct the failure.

Although the SCP does not require the payment of a fee or notification to the IRS, it is limited to correcting Operational Failures that are not egregious. In addition, if the failure is a Significant Operational Failure, the Plan Sponsor must complete correction of the failure within two years of the year in which the failure occurred. Although a Plan Sponsor does not necessarily get assurance that the correction method employed under the SCP is acceptable to the IRS, the IRS has provided several examples of failures and acceptable correction methods under Appendix A and Appendix B in Revenue Procedure 2008-50. If a Plan Sponsor corrects a failure listed in Appendix A or Appendix B in accordance with the correction method set forth in the appendix, the Plan Sponsor may be assured that the IRS will find that correction method to be acceptable.

In this example, an Operational Failure, a vesting failure, has occurred. Appendix B, section 2.03 provides examples of acceptable correction methods for a vesting failure. Therefore, if there are acceptable practices and procedures under the plan (see Q&A 2 above), and the failure is an Insignificant Operational Failure, the Plan Sponsor may use the SCP to correct the failure at any time, even if the plan is Under Examination. Further, if the Plan Sponsor uses one of the correction methods under Appendix B of the revenue procedure, it will have assurance that the plan would be entitled to relief under the SCP with respect to its correction method. If, however, the failure is a Significant Operational Failure, the plan would be entitled to relief under the SCP only if the failure is identified and corrected within the two-year correction period under the SCP. Also, if the failure is a Significant Operational Failure, the plan would be eligible for relief under the SCP only if a Favorable Letter has been issued with respect to the plan. If the failure would be considered an Egregious Failure, it would be eligible for correction under the Voluntary Correction Program, but not under the SCP.