Amending an adoption agreement...retroactive?

[Lori Friedman]

Effective 01/01/04,an employer adopted a regional prototype PSP with a 401(k) provision.

Employer accidently checked a box to state that HCEs aren't eligible to participate. This is wrong wrong wrong and certainly wasn't the employer's intention. The HCEs enrolled in the plan last year and made elective deferrals contributions throughout 2004.

How can this problem be fixed? Can the employer make a retroactive change to the adoption agreement? Does the employer need to use a correction program and pay a user fee?

Thank you in advance. I slipped on some ice yesterday and broke my arm and wrist. Today, I'm trying to get some work done and am reaching out for whatever help I can find.

[Blinky the 3-eyed Fish]

Here is the official response:

The IRS has consistently said that there are no scrivener's errors. So now you are left with an operational failure. Rev. Proc. 2003-44 has the details, but my recollection is that an amendment is not an option here because it serves to only benefit HCE's. Thus I believe VCP is your only offical recourse of correction.

Now if you want to ignore that and prepare a replacement page, well then that's an option too. It's one that can get you in a lot of trouble, but nonetheless an option.

[mbozek]

I would just amend the adoption agreement as of 1/1/04 to conform to operation of the plan because the change does discriminate in favor of the HCE since the NHCEs are already covered. The timing of the amendment does not discriminate in favor of HCEs since the NHCEs are not excluded. Its no different than increasing a plan contribution after the end of the plan yr but before the date for filing the tax return. If you are risk adverse then apply for VCP

[Blinky the 3-eyed Fish]

I don't think there is any good answer here, but I would be concerned with an amendment because it creates a big red flag in case of audit. I certainly would explain the options and the potential ramifications of each to the client, have them decide and get something in writing to protect yourself if VCP is not chosen.

[mbozek]

I dont know what the are the ramifications in amending the plan that you are thinking of since there is no cutback of benefits or discriminatory effect.

[Blinky the 3-eyed Fish]

Then perhaps I can help. As I alluded to in my first post, Rev. Proc. 2003-44 prescribes the conditions for correction by amendment. Here are the applicable sections. I bolded the important parts. As you will see this situation does not meet the criterion and therefore cannot be corrected legitimately by an amendment. I think we can agree that an illegitimate correction invites ramifications.

Section 4.05(2)

(2) Certain correction by plan amendment permitted in SCP. A Plan Sponsor may use SCP for a Qualified Plan to correct an Operational Failure by a plan amendment to conform the terms of the plan to the plan's prior operations only to correct Operational Failures listed in section 2.07 of Appendix B. These failures must be corrected in accordance with the correction methods set forth in section 2.07 of Appendix B. The amendment must comply with the requirements of section 401(a), including the requirements of sections 401(a)(4), 410(b), and 411(d)(6). SCP is not otherwise available for a Plan Sponsor to correct an Operational Failure by a plan amendment. Thus, if loans were made to participants, but the plan document did not permit loans to be made to participants, the failure cannot be corrected under SCP by retroactively amending the plan to provide for the loans. However, if a Plan Sponsor corrects an Operational Failure in accordance with SCP, it may amend the plan to the extent necessary to reflect the corrective action. For example, if the plan failed to satisfy the average deferral percentage ("ADP") test required under section 401(k)(3) and the Plan Sponsor must make qualified nonelective contributions not already provided for under the plan, the plan may be amended to provide for qualified nonelective contributions. The issuance of a compliance statement does not constitute a determination as to the effect of any plan amendment on the qualification of the plan.

Appendix B Section 2.07(3)

3) Inclusion of Ineligible Employee Failure. (a) Plan Amendment Correction Method. The Operational Failure of including an ineligible employee in the plan who either (i) has not completed the plan's minimum age or service requirements, or (ii) has completed the plan's minimum age or service requirements but became a participant in the plan on a date earlier than the applicable plan entry date, may be corrected under VCP and SCP by using the plan amendment correction method set forth in this paragraph. The plan is amended retroactively to change the eligibility or entry date provisions to provide for the inclusion of the ineligible employee to reflect the plan's actual operations. The amendment may change the eligibility or entry date provisions with respect to only those ineligible employees that were wrongly included, and only to those ineligible employees, provided (i) the amendment satisfies section 401(a) at the time it is adopted, (ii) the amendment would have satisfied section 401(a) had the amendment been adopted at the earlier time when it is effective, and (iii) the employees affected by the amendment are predominantly nonhighly compensated employees.

[mbozek]

See RR 82-66 for retroactive correction after close of plan yr.

[Blinky the 3-eyed Fish]

"The purpose of this revenue Ruling is to provide additional guidelines for determining when a plan may make retroactive qualifying plan amendments after the expiration of the remedial amendment period provided in section 401(b) of the Internal Revenue Code and section 1.401(b)-1 of the Income Tax Regulations."

Excluding HCE's is not a disqualifying defect. That RR has no application to this situation.

[david rigby]

Locate Revenue Rulings here: http://www.taxlinks.com/rulings/findinglist/revrulmaster.htm

[mbozek]

The employer accepted deferrals from the HCEs in violation of plan terms (i.e.plan not administered accordance with its terms). Therefore correction after end of plan year is permitted to cure defect.

[Guest Pensions in Paradise]

mbozek - amending the plan retroactively to add the HCEs could be a cutback for the NHCEs. As currently drafted, the plan only covers NHCEs. So if the plan sponsor makes a profit sharing contribution for 2004, only the NHCEs would be eligible to receive the profit sharing contribution. If you amend the plan to add the HCEs for 2004, then the amount the NHCEs receive would be reduced since the HCEs would also share in the allocation.

[Blinky the 3-eyed Fish]

I don't pretend to have been around when that promulgation came out, nor have I read it before today. However, I am not sure how you can completely discount Rev. Proc. 2003-44 when it is right on point and is the existing guideline for correction measures today. Let me also copy the very first part of 82-66.

"Extension of remedial amendment period to qualify a plan. The Service will permit a retroactive amendment to qualify a plan after the remedial amendment period has expired, including any extensions thereof, if the following two conditions are met: (1) the plan is retroactively amended to comply with the qualification requirements as of the time the defect in the plan arose, and (2) employee benefit rights are retroactively restored to the levels they would have been had the plan been in compliance with the qualification requirements from the date the defect in the plan arose."

Is this not talking about plans that failed to amend within the remedial amendment period? How can you extend that to an operation failure when the remedial amendment period is soley due to legislative changes? Do you honestly think an IRS agent will buy this argument?

[david rigby]

The IRS has consistently said that there are no scrivener's errors.

I'm not so sure about the "no" part. True, the IRS does not like claims of scrivener's errors. Perhaps there is a high burden of proof, but that does not throw them out entirely. Or am I overlooking something else?

[Guest clyde14]

sorry to hear about your fall.

[Blinky the 3-eyed Fish]

The IRS has consistently said that there are no scrivener's errors.

I'm not so sure about the "no" part. True, the IRS does not like claims of scrivener's errors. Perhaps there is a high burden of proof, but that does not throw them out entirely. Or am I overlooking something else?

I have never heard a different message. In fact, last week a panel that contained Holland, Schultz, Pippens and others reiterated, "There are no scrivener's errors."

[mbozek]

I have used RR 82-66 to correct plan docs in cases that go beyond the facts of the ruling. Its a matter of how the solution to the issue is presented to the IRS. You dont have to elect my solution- You can tell the client to file for VCP and pay the fines.

[Blinky the 3-eyed Fish]

What was the circumstance(s) to present this to the IRS? Did you just submit the document via the regular determination process? Were they being audited? Was it a VCP submission (or a predecessor program)?