Post on 29-Jul-2020
Employee Plans Compliance Resolution System (EPCRS):Case Studies From the Darkside!
Alison J. Cohen, Esq., CPCPartner
Ferenczy Benefits Law Center LLPacohen@ferenczylaw.com
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Agenda
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• Review of EPCRS Basics and Principles
• Understanding the Self-Correction Program (SCP)
• Knowing When to Properly Use SCP
• Review of VCP, Audit CAP, and VCAP
• VCP General Requirements and Considerations
• Newest Nightmares
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“Oh yes, there will be blood.”
-Jigsaw
EPCRS: The Framework
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• Employee Plans Compliance Resolution System
– Rev. Proc. 2016-51 released September 29, 2016
– Comprehensive system for resolving plan errors
Four Types of Qualification Failures
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• Plan-document failures
– Terms of plan not qualified
– Failure to timely adopt interim amendment/restatement
• Demographic failures
– Failure to satisfy §410(b) or §401(a)(26)
• Employer-eligibility failures
– Not eligible to establish type of plan (e.g., government 401(k) or ineligible for 403(b))
• Operational failures
– Not following the terms of the plan (i.e., usually everything else you encounter)
• Other than prohibited transactions: exclusive benefit violations
Consequences of Disqualification
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• Taxation (IRS refers to this in EPCRS as maximum payment amount)
– Employer deductions lost if no inclusion in employee income
– Trust is taxable (earnings may be taxable)
– Employees taxed on contributions during disqualified years once vested
• Exception: if sole failure is §410(b) coverage or §401(a)(26) participation failure, then only HCEs taxable - on entireaccounts
How Do You Correct?
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• EPCRS (Rev. Proc. 2016-51) contains pre-approved correction methods
– Following these methods is safe
• Otherwise, find reasonable, appropriate method
– Use code, regulations, and EPCRS as guide
– Correct discrimination failures by giving $ to NHCEs
• Note: the farther you get frompre-approved methods, the morebeneficial it is to ask for IRS approval
Correction Principles
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• Must correct all taxable years (even if closed)
• Restore plan and participants to position they would have been in had the failure not occurred
• Should be reasonable and appropriate
– Appendix A and B solutions deemed reasonable
• Consistent with code (don’t create another violation)
• Provide benefits to NHCEs
• Keep assets in the plan
• Consideration of other agencies (e.g., DOL on abandoned plans)
Exceptions to Full Correction
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• Unreasonable or not feasible (tough one to apply)
• Reasonable estimates are necessary (e.g., earnings)
• Distribution of small amounts ($75 or less)
• Recovery of small overpayments ($100 or less)
• Lost participants
• Small excess allocations ($100 or less)
EPCRS Structure
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• Three correction procedures:
– Self-Correction Program (SCP)
• Operational errors ONLY
• Insignificant errors: anytime
• Significant errors: time limited
– Voluntary Correction Program (VCP)
• Forms 8950, 8951, 14568, etc.
• Cannot be “under examination”
– Audit Closing Agreement Program (CAP)
Self-Correction Program
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• Insignificant failures
– CORRECTION MAY BE MADE AT ANY TIME
• Even if the plan is under audit by the IRS
Self-Correction Program
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• What is “insignificant?” Balancing of factors:
– Have other failures occurred?
– Percentage of plan assets and contributions involved
– Number of years involved
– Number of participants affected (as percentage of total in plan and as percentage of those who could have been affected)
– Was correction made within a reasonable time after discovery?
– Why did the failure happen?
Self-Correction Program
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• Significant error:
– Defined: anything that is not insignificant
• Rule: must be “substantially” corrected during the “correction period”
– Correction period:
• General rule: last day of the second plan year following year of occurrence
• ADP/ACP: last day of third plan year following year for which testing is failed
Voluntary Correction Program
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• Plan sponsor submits a plan to the IRS for coordinated correction process
– Fee payable
– Plan must be eligible for the program
– No correction applies until after approval granted under VCP (correction letter)
VCP General Steps
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• General procedure
– File with the IRS
– Pay user fee – based on assets on most recent Form 5500 (See. Rev. Proc. 2018-4 for most recent fee schedule)
– Negotiate with IRS on correction method
– Sign compliance statement with agreed-upon correction
– Complete correction within 150 days after final letter
Audit Closing Agreement Program (CAP)
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• IRS discovers problem during audit
• IRS and plan sponsor enter into a contract called a “Closing Agreement” to correct the problem
• Sponsor pays a sanction to the IRS
Audit CAP Sanction
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• Starting place for negotiations:
taxes that would be due if the
plan were disqualified
(“Maximum Payment Amount”)
• Procedure requires that the sanction:
– Not be excessive
– Bear reasonable relationship to the nature, extent, severity of
the failure
• Problem: “excessive” and “reasonable” are in the eye of the
beholder
• Rev. Proc. 2016-51 expanded criteria for consideration (facts and
circumstances also count)
Voluntary Closing Agreement Program (VCAP)
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• Like a super-secret program
– Used for tax-related plan matters
– Issue can’t be resolved through VCP
– Can’t be under examination or investigation
– Can’t be used for abusive or willful tax avoidance transactions
– User fee - TBD
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“You know that part in scary movies when somebody does something really stupid and everyone hates
them for it? This is it.”
- Jeepers Creepers
VCP Filing Decisions and Procedures
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Decision #1: Should We Submit at All?
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• Can we self-correct and, if so, any reason to submit?
• Cost-benefit analysis for client
– Differences between submittedcorrection and unsubmittedcorrection
– Cost of filing, including:
• IRS-user fees
• Service-provider fees
• Internal client costs to gather information, etc.
– Considering discoverability and Circular 230 requirements
Decision #2: Disclosed or No-Name?
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• Advantage to “no-name”
– If you don’t like IRS’s correction requirements, you can walk away…but you lose your user fee!!!
• Disadvantage to “no-name”
– If the plan is audited while VCP is pending, you go straight to audit CAP
– If the name is disclosed, audit process is suspended until VCP is complete
Timing of Submission
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• Hurry! You don’t want to get audited while things are pending!
• But, want a complete, well-thought-out submission
Case Studies for Your Consideration
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“We don’t need a stretcher in there. We need a mop!”
- Nightmare on Elm Street
It
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It
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• In 1997, a doctor closed his private practice and started working for a hospital
• Starting in 1998, the hospital took over the solo practice records, including the plan
• Sometime in the 2000s, everyone lost track of the plan
• In 2014, when the doctor hired a new CPA, the issue of the plan was raised and a new TPA was engaged
It
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• New TPA starts trying to collect information from the doctor
• After two years, doctor and TPA are resolved to the facts that:
– The only documentation they can find are the last determination
letter from 1987 and the corresponding plan document
– No participant-accounting has been done since 1997
• Doctor reports that several years ago, he was threatened by a
participant’s son and paid him $5,000 out of pocket
It
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• In collecting financial data, it is discovered that $250,000 in a
bank account was “accidentally” escheated to the state several
years ago after no activity
• State of Euphoria sent the good doctor a letter in 2009 telling
him they considered his practice closed
– So, is the plan actually sponsored?
• After reconstructing the participant accounts, the doctor and
his accountant realize that two of the three other participants
are over age 70½
– And one of those two is dead
It: The Exciting Conclusion
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• Clearly, this will have to be fixed through VCP
• Document issue – simple non-amender
• Dissolution of employer in 2009 – ask for forgiveness and promise to terminate ASAP
• Late RMD – request forgiveness of excise taxes
• Escheated funds – not the IRS’s concern (attributed to doctor)
• Locating missing participants….or their snotty, greedy children
Friday the 13th: No Adult Supervision
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Friday the 13th: No Adult Supervision
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• Plan originally permitted individual
insurance contracts to be taken
out by participants for a number
of years
• Initially, the insurance premiums were paid out of plan assets
• A few years in, the plan merged into a multiple-employer plan (MEP),
and the employer assumed that the MEP sponsor was taking control
– Somehow, the employer began paying the insurance premiums
(but, no one can actually remember how or why)
– Eventually, the employer spun-out the plan from the MEP and
started its own plan again
Friday the 13th: No Adult Supervision
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• In reviewing the plan documents received (finally), a few other
failures were found:
– Plan number in the single plan that spun-out was
incorrectly listed as #001
– Plan sponsor NAME was incorrect
– Plan document didn’t permit insurance contracts as plan
assets
• Client can’t find any sort of breakdown of insurance premium
payments
• Client can’t even find records
of profit-sharing allocations
Friday the 13th: No Adult Supervision
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• One concern that was raised was whether the insurance benefit was incidental– Data was incomplete, so it was impossible
to determine with certainty– Based on limited data, had to demonstrate basic “trend” using the
spotty data that was received– Of course, one of the three affected participants was an owner
• Additional calculations were required – Because the premiums were not paid from plan assets, and the policies
were held within the plan, the premiums had to be considered an additional contribution
– Now, we had an operational failure – failure to follow the terms of the plan for the profit-sharing allocation
Friday the 13th: No Adult Supervision
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• Solution: needed to be filed through VCP
– Submission covered:
• Document drafting errors, including failure to provide for grandfathered insurance
• Removal of excess allocations
• IRS very receptive to proposed solutions
• Be careful about scope-creep
– Your original quote may notend up with what you get
– And then you end up eating the excess
The Sixth Sense:I See Dead People
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The Sixth Sense: “I See Dead People”
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• TPA established DB Plan in 2013 for a law firm
• In 2014, the partner/husband is diagnosed with lung cancer and has to have a lung removed
• In 2015, the partner/wife has a massive stroke ending up mostly disabled and requires round-the-clock care
• Firm is floundering, losing over $1 million per year
• Partner/husband dies in mid-2016
• Nothing has been funded to the DB plan since the original contribution
The Sixth Sense: “I See Dead People”
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• TPA suggests that they hire FBLC to “retroactively” terminate the DB plan
• Can you retroactively do that?
– Plan documents are up to date
• Majority of the assets belong to the partners
• AFTAP for valuation date 12/31/14 drops to 48 percent
• 2014 Form 5500 filed with funding shortfall
• 2015 Form 5500 filed with funding shortfall
• IRS initiates a compliance check – no Form 5330 filed
The Sixth Sense: “I See Dead People”
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• Race to VCP submission before compliance check comes due
• Narrative to IRS requesting mercy and retroactive termination based on AFTAP plan freeze
• IRS originally rejected VCP, but was compelled by the client’s story and agreed to look for another solution
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Split
Split
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• Plan covers all of the
“subsidiaries” of a national
company starting in 2005
• Moves to a big-box vendor in 2009
• In 2015, new client-relationship manager assigned to client
starts asking about organization
• Turns out that “subsidiaries” may also be owned by outside,
unrelated individuals in part
• CRM recommends that client get a controlled-group analysis
Split
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• After performing analysis, only 14 of the entities are actually controlled – other eight are not related
• Also discovered that no document update has been done since original plan
• So, how was big-box vendor administering the plan?
• Testing was always done as a single-employer plan
Split
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• Testing had to be re-done applying the new non-controlled entity
• Re-test of 2014 showed mixed results – some entities passed and some failed compared to prior results
• Had to retest 2012 and 2013 to show a trend in testing
• Resulting testing failures triggered one-to-one QNECs
• Document also revealed that 2005 was drafted with six months of service, but plan had been operating with one year of service since 2009 changeover
Split
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• VCP submission filed with IRS in January 2017
– Still pending
– Requested IRS to accept sampling of three years and not make client correct prior years – claim of de minimis compared to cost of repair
– Prior vendor held accountable for failure
Split
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• Since the filing…..– Client has been operating as a
multiple-employer plan– Client has been asked quarterly to
identify any new entities and ownership changes– Added five new entities in the past two years
• 2017 testing then shows up….– TPA forwards copy of test for one entity failing miserably that
includes ownership information on 3/11/18– Ownership information doesn’t match firm records– When contacting client, she says “oops”– Revised analysis of ownership changes over 2016-2017 results in
re-alignment of nearly half of the entities– All 2017 testing has to be redone (and 2016!!)
Get Out
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Get Out
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• Seasonal tour company starts a plan in 2008
• TPA retires and in 2017 plan moves to a new TPA
• New TPA discovers a few things:
– Plan was never restated for EGTRRA
– Original document was written using elapsed time
– All seasonal employees were excluded in operation – the original TPA said that they didn’t have to be included
– Form 5500 was prepared counting only the 40 year-round employees and excluding the other 220+ seasonal employees
Get Out
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• New TPA performs 2016 testingand prepares the Form 5500 showing the eligible employees as 260+
• Now, plan is required to be audited – and has been required to be audited for years
• Plan has also been a safe-harbor matching contribution formula
– Notice was never given to seasonal employees
• In calculating the potential corrective QNEC and matching contribution, plus earnings, the annual estimate is $150,000 to correct
Get Out
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• In discussing the options, it is also discovered that the client also excluded overtime from the definition of compensation although not in the document
– Not only do we have a failure to follow the terms of the plan, but the definition of compensation is discriminatory
– And for bonus points – what happens to a safe-harbor plan when the definition of compensation is discriminatory?
Get Out
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• So, what do you do when the cost of correction is over
$1 million (at least) and will bankrupt your client?
• How do you get around the audit requirement for 2017?
– Rules for Form 5500 – active employee count wouldn’t include
seasonal employees if they are terminated at the end of each
season with no guarantee of any re-employment they don’t count
for December 31
• Since they are also not employed as of January 1, they don’t
count there either
• Your client has to make the call and fully understand the risks
Gone Girl
Gone Girl
• Husband and wife only have a defined-benefit plan
• In 2015, wife finds out husband has had multiple affairs and kicks husband out
• Husband wants to buy new love nest next in posh area of town
• Because husband and wife are still married, bank requires wife’s approval for mortgage
• Wife tells husband to pound sand
• So, husband withdraws $440,000 from the DB plan (has $1m in his accrued benefit)
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Gone Girl
• Oops – husband doesn’t have any taxes withheld from the $440k distribution
• In 2017, plan gets selected for IRS audit• Husband comes to wife and asks her to backdate a withdrawal
form– Will this even help?
• Wife tells husband to pound sand again• Husband is now 71 and plan doesn’t provide for in-service
distributions• IRS auditor also discovers 2015 tax extension was never filed
– But, 2015 contribution made in August 2016
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Gone Girl
• So, now we have an impermissible withdrawal and a tax violation
• Plus, we also have a non-deductible contribution
• (Side note – and we have a raging divorce action still going on)
• Propose to IRS to allow 2015 contribution to become a 2016 contribution– Requires 2015 corporate taxes to be amended, resulting in $135k in owed
federal taxes
– 2016 taxes are still being prepared, but 2016 contribution was made in August 2017
– So, 2016 contribution ends up becoming a 2017 contribution instead (and they all rolled over and one fell out….)
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Gone Girl
• IRS permits $440k withdrawal to be corrected by a retroactive amendment to permit in-service withdrawals at age 62
• BUT – IRS also insists that transaction is a prohibited transaction– Requires $64k to be repaid to the plan as interest– Also triggers $26k in excise taxes
• AND – there is the $140k in taxes, $10k in interest, $17k in penalties
• Cherry on top – a $20,000 sanction• Moral of the story – it’s always cheaper to keep her
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“One thing about living in Santa Clara I never could stomach, all the damn
vampires.”- The Lost Boys
This House Is Clean
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The Happy Ending We All Want
Things to Remember …
• Credibility is important
– Get a reputation with thelocal IRS and DOL offices for being honest
• That does not mean that you should necessarily offer all information, regardless of what is asked (although there may be times when getting in front of something has value)
• It does mean that you are never caught in a lie or a material misstatement
Things to Remember……
• Don’t make yourself part of the horror story
– Do not do anything that would:
• Violate your ethical requirements, both business and personal;
• Violate the law; or
• Put you into the story as a bad actor
QUESTIONS
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Contact Information
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Alison J. CohenFerenczy Benefits Law Center
2200 Century Parkway
Suite 560
Atlanta, Georgia 30345
(678) 399-6604 (V)
(866) 515-5140 (toll free)
(404) 320-1105 (F)acohen@ferenczylaw.com
Follow us on Twitter! @ferenczylaw