Employee Plans Compliance Resolution System (EPCRS):Case Studies From the Darkside!

Alison J. Cohen, Esq., CPCPartner

Ferenczy Benefits Law Center LLPacohen@ferenczylaw.com

1

Agenda

2

• 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

3

“Oh yes, there will be blood.”

-Jigsaw

EPCRS: The Framework

4

• Employee Plans Compliance Resolution System

– Rev. Proc. 2016-51 released September 29, 2016

– Comprehensive system for resolving plan errors

Four Types of Qualification Failures

5

• 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

6

• 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?

7

• 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

8

• 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

9

• 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

10

• 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

11

• Insignificant failures

– CORRECTION MAY BE MADE AT ANY TIME

• Even if the plan is under audit by the IRS

Self-Correction Program

12

• 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

13

• 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

14

• 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

15

• 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)

16

• 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

17

• 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)

18

• 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

19

“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

20

Decision #1: Should We Submit at All?

21

• 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?

22

• 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

23

• 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

24

25

“We don’t need a stretcher in there. We need a mop!”

- Nightmare on Elm Street

It

26

It

27

• 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

28

• 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

29

• 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

30

• 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

31

Friday the 13th: No Adult Supervision

32

• 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

33

• 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

34

• 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

35

• 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

36

The Sixth Sense: “I See Dead People”

37

• 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”

38

• 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”

39

• 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

40

Split

Split

41

• 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

42

• 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

43

• 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

44

• 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

45

• 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

46

Get Out

47

• 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

48

• 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

49

• 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

50

• 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)

52

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

53

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….)

54

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

55

56

“One thing about living in Santa Clara I never could stomach, all the damn

vampires.”- The Lost Boys

This House Is Clean

57

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

60

Contact Information

61

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