Publications

A commonly heard complaint about qualified retirement plans and §403(b) tax sheltered annuity programs is that when a plan administrative error is made, not only are there the costs of correcting the error (e.g., additional benefits for new participants), but there may also be retroactive income tax consequences, interest and penalties.

In recent years, the IRS instituted several programs to encourage plan sponsors to voluntarily take corrective action to remedy administrative errors. The first of these programs was the Administrative Policy Regarding Sanctions (“APRS”), issued in 1991. Under APRS, the IRS would not seek to disqualify a plan merely because of certain minor operational violations. While APRS offered significant relief to some plan sponsors, it was criticized as too narrowly drawn to address the most common problems, and it was not available for §403(b) programs.

Subsequent IRS compliance initiatives, such as the Walk-In Closing Agreement Program (“Walk-In CAP”), the Voluntary Correction Program (“VCR”) and the Tax Sheltered Annuity Voluntary Correction Program (“TVC”) permit plan sponsors with a broader range of opera- tional problems to voluntarily correct the problem and pay a negotiated sanction amount to the IRS. In return, the IRS will not take any additional action against the plan sponsor (such as plan disqualification).

In January of this year, the IRS issued its new Administrative Policy Regarding Self-Correction (“APRSC”), which replaces the APRS. Unlike Walk-In CAP, VCR and TVC, APRSC includes a self-correction mechanism which, if timely followed, enables the plan sponsor to totally avoid any monetary sanction from the IRS.

APRSC is available for qualified and tax sheltered annuity (403(b)) plans that meet the following eligibility requirements:

1. The defect is an operational defect arising solely from a violation of the plan’s terms. Examples of defects that are not operational defects and therefore do not qualify for APRSC include: (a) defects that can only be corrected through plan amendment; or (b) misuse or diversion of plan assets and other violations of the exclusive benefit rule.
2. The plan sponsor has established plan procedures reasonably designed to promote and facilitate overall compliance. The plan document is not sufficient to fulfill this requirement. A plan sponsor may fulfill this requirement through the use of an administrative checklist. In addition, the plan sponsor must show that the established procedures were routinely followed.
3. The defect occurred as a result of an oversight or mistake or inadequacy of procedures.
4. The plan sponsor makes retroactive correction of all relevant violations. The plan sponsor must correct all violations in all years. The correction should put both current and former participants in the same position they would have been had the defect not occurred.
5. The plan sponsor timely corrects the defect. Two timing rules are applied under APRSC. In general, the plan sponsor must correct the defect before the end of the plan year following the plan year in which the defect occurred, and the plan sponsor must correct the defect for all plan years in which the defect existed. An “insignificant” defect may be voluntarily corrected at any time without disqualifying the plan. Factors used by the IRS to determine whether a violation is insignificant include:
   • the number of violations in the period examined,
   • the percentage of plan assets and contributions involved in the violation;
   • the number of years the violation occurred;
   • the number of affected participants compared to the total number of participants;
   • the number of participants actually affected compared to the number that could be affected;
   • whether corrections were made prior to examination; and
   • the reason for the violations.

Although APRSC is welcome relief for all plan sponsors, it still pays to be vigilant about plan operational issues, Unless a defect is insignificant, APRSC may not be used after the plan sponsor receives notice of an audit of the plan for the year in which the defect occurred.