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pam@bbm

Is this a document or operational failure?

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Our client has a 401k plan.  We (the TPA) just discovered an error in the way the client has been calculating deferrals.  Prior to the EGTRRA restatement, bonuses were excluded for deferral purposes.   When restating for EGTRRA, we (the TPA) did not code the adoption agreement correctly to exclude the bonus.  So both the EGTRRA and PPA restatements were written to have deferrals deducted from bonus.  The client has never deducted deferrals from bonus, and that has been their intent for over 15 years.  Do we have an operational failure or a document failure?  Or is this a scrivener's error?  What is the best way to correct?  Do we have to go to VCP?

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Does the plan also have safe harbor? Match or nonelective? Discretionary match? Additional profit sharing? Does the bonus amount get included/excluded for different purposes? In other words, is this strictly a deferral problem, or are there also missed employer contributions for 15 years? The problem could get larger than it seems at first glance.

You might consider seeking ERISA counsel on this - it is possible, depending on the amount of money involved, the recommendation might be to ignore the issue and just correct moving forward. I'm making no recommendation, just tossing that out there for consideration.

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You want to talk to an ERISA attorney that knows the VCP process well. 

I have seen a number of times where if you can show the intent was all along to exclude bonuses and show that was how it was communicated to the employees all the time the IRS will allow a retroactive amendment.   i am not saying it is 100% and VCP filings aren't cheap so you need to look at the choices but I have seen the IRS sign off on it. 

I would see if you know an attorney that has gotten this done to review the facts.  

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I can corroborate ESOP Guy's tale - I too had a VCP submission approved for a retroactive amendment - they never meant to include bonuses, told the employees as much, but their bundled prototype didn't have the box checked properly for PPA after always having it correct when a TPA had done their prior versions.

 

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Will third ESOP Guy and Bri. Had exactly this case few years ago. Involved several million dollars. IRS ruled favorably on VCP except for a couple of years at the beginning of the period where our backup on what was communicated to employees was not good. It is an operational failure, but may be correctable by plan amendment. You really have to read between the lines of Rev. Proc. 2019-19 and prior EPCRS Rev. Procs. to understand this is possible. Of course, makes you good only for IRS. In theory, DOL or employees could sue you under ERISA, but I have not seen that. Also, see 7th Cir. Verizon case for argument that you can retroactively rform plan document under ERISA, although there is also a 4th Circuit case contra.

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Luke Bailey,  I'm in the process of reading Rev. Proc. 2019-19.    You are correct that you really have to read between the lines with this correction stuff.

Thank you for the comments.

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How did they communicate the no-bonus policy to the employees?

I would think the the plan was restated incorrectly, then the SPD was also drafted incorrectly, and the participants would have that info in the official plan documentation.

Were they told of the limitation in another way?  I'm sure there have been new employees since the EGTRRA restatement, so it's not they they come from a position of "that's the way it was in our previous plan document."

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Ditto on the operational error under VCP.   the key to getting a compliance letter (I have received a number of these) is finding written communication to the employees, no matter how informal, to support the operational procedures used.  The IRS reviewers often use the words "employee expectations" in this context. 

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Query: Pam@bbm.  Are you, the TPA, covering all client costs of your error?  In any case, I think you have a conflict with the client at this point and I would recommend that that VCP work or whatever be handled from hereon by the client's ERISA attorney with you footing his or her bill and all other costs your client incurs.

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Luke Bailey: I don't think the failure can be corrected by SCP retroactive amendment under Rev Proc 2019-19. Were you implying that you think it can? I'm thinking it can't because the plan amendment -- presumably to retroactively exclude bonuses -- would not result in an increase of a BRF, but would rather result in a decrease.  Thoughts?

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4 hours ago, JRN said:

Luke Bailey: I don't think the failure can be corrected by SCP retroactive amendment under Rev Proc 2019-19. Were you implying that you think it can? I'm thinking it can't because the plan amendment -- presumably to retroactively exclude bonuses -- would not result in an increase of a BRF, but would rather result in a decrease.  Thoughts?

JRN, no, of course. Thanks for the clarification. This would not qualify for SCP. Would need to be a VCP submission, and depending on facts and possibly other factors, IRS might or might not grant the correction requested. Might be a good candidate for anonymous submission, although a careful consideration of the pros and cons must always be done in deciding whether a submission should be anonymous or disclosed.

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I have a similar situation and am fairly convinced that IRS would not bless a retro amendment.  In my case, sponsor didn't match on catchup contributions, and hasn't since the plan added catchups in 2002.  Document, SPD and the enrollment materials all clearly say catchup contributions are matched. 

This sponsor is very unusual in that they have always used a catchup election form, which participants sign indicating how much they want to contribute as catchup.  No need to comment on the appropriateness of the form.  We know catchups are "created" by exceeding a limit, they are not typically designated by a participant.

In any case, the catchup election form has a clear statement that catchup contributions will not be matched.  The sponsor apparently has such a form for every catchup eligible participant.

My thinking was that it is unlikely the IRS would allow this sponsor to eliminated a vested accrued benefit given the conflicting messages to participants, but given the comments above, I'm thinking it may be worth trying anonymous VCP? 

Additional question: Since this is a VCP anyway (significant failure and goes back more than two years) can an anonymous VCP requesting retro amendment be turned into a regular VCP where the sponsor contributes the match (with interest) if the IRS won't bless the retro amendment?  In other words, can you start with an anonymous VCP requesting permission to retroactively amend, and then if you don't get the result you want, change gears with the same VCP and request a compliance statement blessing a missed match contribution with interest?

Maybe this would be just as much work as just starting over with a regular VCP, but at least you'd avoid a second $3500 filing fee (this is a large plan).

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LANDO, the criteria IRS seems to use are (a) what did the sponsor intend, and (b) what did it consistently communicate to participants. There may be other factors as well. I am only inferring this from prior cases, both mine and ones other practitioners have discussed, since the standards are not published or articulated by IRS.

In the case you described, it seems the communications with participants may have been mixed. A careful review of all the documents and other facts would be required to determine the merits.

You can convert an anonymous to a regular VCP. Note that if the employer is committed to making the required contributions if it comes to that, then there may or may not be a tactical advantage to going in anonymously first. In any event, a careful calculation of the sponsor's exposure worst case should be done.

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