Employee Benefit Plan Mistakes Can, and Do, Happen. How You Fix Them Matters!

With the ever-increasing rules and regulations placed on employee benefit plan, staying in compliance is not an easy task.  Mistakes can happen, even in the most effectively run plans and it is important to understand the available remedies and correction programs to avoid severe monetary penalties, legal ramifications, or potentially even disqualification of a plan’s tax-exempt status, leading to taxation of participant’s accounts, trust income and loss of tax deductibility of employer contributions.

While there are many parties involved when it comes to employee benefit plan oversight, the two key players are the Internal Revenue Service (IRS) and the Department of Labor (DOL).  The IRS is responsible for establishing and monitoring the tax-exempt status of a plan by ensuring that the plan is operating in accordance with appropriate internal revenue code.  The DOL has established the Employee Benefit Security Administration (EBSA) to monitor plans for adherence to the Employee Retirement Income Security Act of 1974 (ERISA), a federal law that sets minimum standards for most voluntarily established retirement and health plans in private industry to provide protection for plan participants.   Both the IRS and the DOL have separate correction programs available to help plan sponsors correct plan defects and protect plan participants by maintaining the tax benefits for the plan and participants. The programs are structured to encourage plan sponsors to voluntarily keep their plans in compliance.

There are four general categories of plan failures:

  • Operational failure – Failure to follow the terms of the plan (the most common failure);
  • Plan document failure – Failure of the plan document to reflect mandatory legal language;
  • Employer eligibility failure – An organization sponsors a plan it is not permitted to have; and
  • Demographic failure – Failure to satisfy certain nondiscrimination tests.

The nature of the correction for a failure will often depend on the type of plan failure that took place and the significance of the failure. The following facts and circumstances should be considered when determining significance of a plan error:

  • Other failures in the same period (not how many people are affected)
  • Percentage of affected plan assets and contributions
  • Number of years it occurred
  • Participants affected relative to the total number in the plan
  • Participants affected relative to how many could have been affected
  • Whether correction was made soon after discovery
  • Reason for the failure

The correction program available through the IRS is called the Employee Plans Compliance Resolution System (EPCRS) and has three available correction methods.  Under each of these methods, the plan sponsor agrees to make the correction of the error and the IRS agrees not to disqualify the plan because of the error. Correction methods under EPCRS are as follows:

  1. Self-Correction Program (SCP) – Allows for corrections of mistakes to be made without contacting the IRS and without payment of a fee. SCP is available for the following errors:
    • Insignificant operational failures – Can be corrected for any plan at any time.
    • Significant operational failures – Must be substantially corrected before the end of the second plan year after the failure occurred. SIMPLE IRA and SEP plans with significant failures are not eligible for SCP.
  2. Voluntary Correction Program (VCP) – When errors cannot be corrected through SCP, VCP can be used to correct all types of failures at any time, with the exception of errors identified under IRS audit. VCP requires the following process:
    • File informational Form 8950 with the IRS identifying the mistake and proposing corrections and changes to current administrative procedures to prevent further mistakes from occurring.
    • File Form 8951 with the IRS to calculate the necessary compliance fee up to $3,500.
    • The IRS will issue a Compliance Statement detailing the mistake and providing for the correction method.
    • The Plan Sponsor has 150 days from issuance of the IRS Compliance Statement to correct the error.
  3. Audit Closing Agreement Program (Audit CAP) – When errors are identified through the audit of a plan by the IRS, Audit CAP is the only available correction method. Under Audit CAP, the plan sponsor agrees to the following:
    • Enter into a Closing Agreement with the IRS.
    • Correction is made prior to entering into the Closing Agreement.
    • Sanction is negotiated with the IRS and paid.
      • Sanctions will generally be larger in dollar amount than the Compliance Fee under VCP, but less than tax, interest and penalties due if the plan loses tax-exempt status.
      • Sanctions cannot be excessive and must bear reasonable relationship to the nature, extent and severity of the failure.

The DOL, through EBSA, protects the assets of employee benefit plans (both retirement and health) under Title I of the ERISA.  EBSA has two available voluntary self-correction programs for plan administrators who need help in meeting ERISA requirements.

  1. Delinquent Filer Voluntary Compliance Program (DFVCP) – Assists late or missed Form 5500 filers in coming up to date with corrected filings. DFVCP is NOT available if the DOL has already notified the plan of the failure. Typically, there are higher civil penalties if DOL has notified the plan of the failure. DFVCP filing is a two-part process as follows:
    • File Form 5500 and applicable schedules with the DOL ensuring that you check the box on line D of Part I for “DFVC.”
    • Submit a second copy of the Form 5500 to the DFVCP with the applicable monetary penalty, up to $4,000 per plan depending on number of participants.
  1. Voluntary Fiduciary Correction Program (VFCP) – Allows plan fiduciaries to correct certain violations such as prohibited purchases, sales and exchanges, improper loans, delinquent participant contributions and improper plan expenses before the DOL investigates. VFCP will provide for specific correction methods including how to calculate missed earnings and losses. Plan sponsors must file with the DOL through EBSA.  Filing under VFCP includes the following:
    • Detailed narrative of the error and proposed correction.
    • Providing necessary supporting documentation.
    • Signing of a Penalty of Perjury statement.
    • Completion and signing of VFCP checklist.

The following table outlines some common plan errors and which correction programs would apply:

In conclusion, employee benefit plan mistakes will happen.  It is important for plan sponsors to act swiftly when errors are discovered to avoid costly penalties or the loss of qualified tax status.  Dannible & McKee, LLP has qualified professionals available to assist with employee benefit plan failures. Contact Benjamin Sumner, CPA, with any questions.