Will self-correction almost entirely replace the IRS’s Voluntary Correction Program?

[Peter Gulia]

Section 305 of the SECURE 2.0 Act of 2022 division of the Consolidated Appropriations Act, 2023 undoes some limits on the Internal Revenue Service’s Self-Correction Program.

In a BenefitsLink discussion, Luke Bailey invites considering “whether VCP [the Internal Revenue Service’s Voluntary Correction Program] will be the rare exception going forward, replaced almost entirely by SCP, in light of SECURE 2.0 Sec. 305[.]” https://benefitslink.com/boards/index.php?/topic/70104-brain-cramp-employer-has-two-401k-plans/#comment-327871.

To open a discussion:

Who decides that the plan’s administrator had “established practices and procedures” that allow one to use self-correction?

Who decides that a failure is inadvertent?

Who decides that a failure meets the further conditions for an “eligible inadvertent failure”?

Who decides that a correction fits within what a Revenue Procedure allows?

How does a plan’s sponsor or administrator get comfort that a failure was eligible for self-correction and is sufficiently corrected?

If a client wants a comfort letter, may a practitioner who is neither an attorney-at-law nor a certified public accountant render the letter?

If a third person (for example, an acquirer of shares of, or business assets from, the plan’s sponsor or a participating employer) wants a comfort letter, may a practitioner who is neither an attorney-at-law nor a certified public accountant render the letter?

[AKowalski]

Are you asking who makes the final decision, or who decides for the company whether to treat an error as properly corrected? The second question is a practical matter that every company will have to resolve for itself. With respect to the first question, the IRS would generally be the final arbiter of whether self-correction was properly completed if/when they happen to notice the issues on audit.

In theory, there could be a fiduciary or ERISA breach underlying just about any operational or documentary failure, which would need to be separately corrected to the extent possible under DOL procedures (which are rather lacking in this regard). The DOL could determine that a self-correction was insufficient under IRS procedures and therefore give it no credit with respect to the underlying ERISA/fiduciary breaches (to the extent that it would receive credit in the first place), and thus impose further penalties. There could also be a participant lawsuit, but that would generally be grounded on Title 29 ERISA violations, not on breaches of the tax code, and in any event, EPCRS corrections technically offer no protection against participant lawsuits (except, perhaps, to the extent that the participant has been substantively made whole as part of the correction) regardless of whether the correction complied with EPCRS. 

[Peter Gulia]

AKowalski, thank you for your many helpful observations.

What I hear from friends in employee-benefits and retirement-services practices is that, while the employer/administrator is responsible, self-correction puts some subtle and not-so-subtle pressures on a professional to find (1) that the employer had procedures (when it really didn’t), (2) that the defect is proper for self-correction (when that finding too is shaky), and (3) that the correction fits the Revenue Procedure (even if one strongly suspects or almost knows the employer isn’t spending the money and effort needed for sufficient correction).

And, while the employer is responsible, a client wants comfort, if not the professional’s express written assurance at least the implied assurance that results from allowing the self-correction to proceed with the professional omitting to raise that it doesn’t work.

With VCP a practitioner is professionally responsible for a truthful presentation of relevant facts, but can lay off interpretations and findings to the IRS. And the procedure ends with a paper with the IRS’s name at the head.

Some practitioners like self-correction because it puts a professional in charge.

Others dislike self-correction because it puts responsibility on the professional.

If I did corrections work, I’d be inclined toward self-correction. But I can see why some prefer to ask (and sometimes be compelled to ask) for a government agency’s approval.

[Belgarath]

One of the chinks in the armor of SCP is that employers are supposed to document how they will prevent this error from happening again. We, of course, explain this to them, but I don't believe they all do it. Or, if they do, they then don't follow the procedure...

[Christine Roberts]

I wonder if employers who have a liquidity event on their horizon and the prospect of ERISA due diligence may have concerns about SCP versus VCP due to the lack of IRS imprimatur.  (I wonder the same thing about the proposed self-correction under VFCP.) 

Also there is the issue of eligibility for SCP based on the established practices and procedures requirement.  Imagine a newly adopted 401(k) plan that mis-applies the plan definition of compensation from day one.  Does it have established practices and procedures?  If so what are they and how are they described/evidenced for purposes of SCP eligibility.  

[Peter Gulia]

Many of my current and former students do deal work—some from a firm’s M&A practice, and more from a firm’s employee-benefits practice (with deal flow still the biggest driver of billable hours in many eb practices). They might like things that result in an agency’s no-action or closing letter. Among other reasons, that’s easy to furnish in a due-diligence stage. Absent a government agency’s letter, someone acting for the buyer, a buy-side investment banker, or a lender will push the seller to deliver its law firm’s opinion letter that all defects were and are sufficiently corrected. Lawyers hate that because it exposes the firm’s capital-interest partners to personal liability (worse, with exposures to persons that might have little or no relationship with the firm). A firm with clients over time anticipates the later requests that will come when a business is sold, reorganized, or refinanced.

Appetites and tastes vary when the client is unlikely to become a subject of deal work.

[Luke Bailey]

Peter, there are definitely a lot of open questions. Section 305 does seem crystal clear on removing the three-year limit for significant errors. I.e., if a plan administrator discovered a significant error going back 10 years for which the correction is clear under the IRS's current guidance, then the employer can self-correct now.

I think Congress also tells the IRS in Section 305 (although this is not as clear) that it wants IRS to publish principles-based correction guidance, perhaps so that if an error is not precisely included in any of the prefabricated corrections, an employer could proceed anyway with SCP by applying the newly articulatyed general principles. Whether the IRS will give this part of Section 305 an expansive interpretation, e.g. providing general guidance regarding what to do about missing data or documents, for example, is uncertain.

Regarding the requirement of having established procedures, as well as the issue of whether having a VCP compliance letter is important for deal work, I think this may make attorney involvement in correction even more attractive than it has been in the past. An attorney can advise, or even give an opinion, in some cases, that self-correction "should" be available, and that a particular correction "should" fix the error. And that advice will be protected by attorney-client privilege. And unless in such a case the accountants (in the case of a large plan) can require the plan administrator to inform them of counsel's opinion (and I don't think they can) and the fact that they applied SCP, the advice and correction could remain secret. Moreover, unless the acquirer in a deal specifically asks whether the plan has used SCP in, say, the preceding 5 years (as opposed to what I typically see, which is just that the plan sponsor has no reason to think that the plan has failed a document or operational qualification requirement), maybe the employer is good to go. I'm not saying this is the most conservative course or that it is what all, or even most, employers will want to do, but it does seem to me to be a possible course of action under Section 305. But to go down this route the employer would definitely need a lawyer to be in charge and have all the experts working for the lawyer, as often do now anyway.

Finally, regarding your point, AKowalski, I totally agree that a broad interpretation of Section 305 really puts the ball over in the DOL's court, if they devote the resources to dealing with it. I have always thought that EPCRS should work the way Section 305 now seems to require, for two reasons. First, the penalty of disqualification is inappropriate in many ways (that I will not go into here) for the types of errors that can be corrected under SCP as broadened by Section 305, even if one gives Section 305 its broadest possible effect. Second, in difficult cases, VCP's can involve a lot of practical compromise between the plan sponsor and the IRS, and because the VCP compliance agreement is confidential, neither the DOL nor the participants are informed of what the compromises were. And the IRS works solely from correspondence, and may not have seen all of the employer's cards, even though the employer may have been able to provide the penalties of perjury representation without risk.