The IRS Employee Plans Division (“EP”) has just announced a pilot program that will dramatically change the way that EP examinations are conducted.
This new pilot program was announced in the June 3rd Edition of the EP Newsletter and it takes effect this month. The program description is so clearly and concisely written that it seems barely necessary to summarize it in this blog post; I suggest you simply read it for yourself. So, rather than rehashing what the Newsletter says, the purpose of this blog post is to make a few pointed observations about the program it announces.
Before the IRS commences an examination of a plan sponsor’s plan, they have to notify the sponsor by letter. By sending this letter, EP has formally commenced an examination of the subject plan. That’s the rule under IRS current practice.
What’s “new and improved” about the new pilot program—for starters—is that the notification letter does not serve to commence an examination. EP would have to take some further action to formally initiate one, and that can’t happen for at least 90 days. The letter is merely a notice that the named plan has been selected for possible exam by EP. Now a clock starts ticking, and it’s very important that the sponsor take immediate action to put itself in the best position to achieve a favorable outcome.
The pre-examination letter gives the plan sponsor a 90-day “window” to make a self-audit—a review of its plan documents and plan operations—to determine whether there are violations needing correction. The sponsor must then respond to EP, by the end of the window, or face the certainty of a plan exam. In this way, the pilot program gives an enormous incentive for sponsors to immediately start working with their counsel and service providers to identify violations and determine the best way to correct them, so that they can present a cogent and persuasive response to EP.
Back to this notion that the pre-examination letter doesn’t actually commence an exam, whereas under ordinary practice the initial notice letter does.
When a plan is considered to be “under examination,” as defined in EPCRS (Rev. Proc. 2021-30), the sponsor is no longer eligible to use either self-correction (“SCP”) (other than for insignificant failures) or the voluntary correction program (“VCP”) to correct violations that might be found in the exam. Corrections can only be made under the closing agreement program, or “CAP.” This means that the two main workhorse correction programs—SCP and VCP—suddenly become off limits. The sponsor may have been pondering how to correct a particularly thorny violation that it has known about, and now it may be too late to correct it creatively. Under CAP, correction methods are much more circumscribed, and draconian penalties (“sanction amounts”) are routinely imposed.
Here is where a few more of the “new and improved” features of the pilot program take center stage. Goodie number one: Under the pilot program, any violation that is eligible for self-correction may be self-corrected. No penalty, only the cost of making the correction, for example, corrective contributions when deferrals have been improperly omitted (but that cost is a given in any type of correction scenario).
Goodie number two. For mistakes that aren’t eligible for self-correction, those must be resolved under CAP, but the sanction amounts associated with them will be determined using the more forgiving VCP fee structure.
Let’s say your pre-exam review discovers serious violations, or something for which the correction method might be potentially controversial. You will have identified these issues in advance and expended some time and brain power trying to determine how best to correct them. Hopefully you’ll know what you want to propose to the EP agent once the exam begins. And you’ve looked up the VCP penalty, so you’ll know exactly how much the sanction payment would be if EP agrees with your correction method.
You might ask, why is EP doing this? Have they gone soft, or just plain out of their minds? No, they’re relaxing the rules to encourage greater compliance with the tax code—to “reduce taxpayer burden” as they put it. And for themselves, they’ve done it to “reduce the amount of time spent on retirement plan examinations.” Although they haven’t said whose “time spent” would be reduced, it’s plain that they mean the time of their exam agents. In other words, they want to make better use of a valuable resource—the working hours of their exam agents.
What is so clever about the way they have done it is that the program shifts much more of the actual grunt work of plan exams onto sponsors. But sponsors ought to welcome this, in exchange for greatly reduced penalties under this program. An EP exam can be an enormously costly undertaking! Getting a 90-day head start can make a huge difference in the ultimate outcome, as sponsors may find more flexibility in the choice of correction methods—and of course there are those reduced penalty structures.
Quoting from the program description again: “The IRS will review your documentation and determine if we agree with your conclusions and that you appropriately self-corrected any mistakes. We’ll then issue a closing letter or conduct either a limited or full scope examination.”
If the sponsor discovers violations, it can correct them, or at least commence to correct them, while the window is still open. By the end of the 90-day window, the sponsor can report in writing to EP on the status of their plan’s compliance. The response should detail what you did to review plan operations, what you found and whether there were any violations in need of correction.
This might include a statement that the plan is in full compliance, assuming that’s a true statement, in which case a full-blown exam might actually be avoided. If your response is thorough and persuasive, EP might decide it’s in their best interest to skip the exam. Why conduct one when, from all appearances (per a well-written response), the plan sponsor would come out of the exam with flying colors?
All things considered, I don’t think it is an exaggeration to say that the new pilot program is nothing short of brilliant. Here’s hoping that it proves to be a success.