2 multiple operational failure questions

[card]

(1) How do you define an Operational Failure? For example, assume you do an audit of plan loans and discover that a number of them are defective for reasons A, B, and C. Is this one Operational Failure or 3?

(2) Assume you have a single Operational Failure in 1997 that is obviously no longer within the 2 year significant failure correction period. By itself you have determined that this failure is insignificant. But assume you also have similar failures that occurred in 1999 and 2000, and that in the aggregate you have determined that all the failures are significant.

Can you treat the 1999 and 2000 failures separately from the 1997 failure? Ie, correct the 1999 and 2000 failures under SCP, leaving only the 1997 failure, which can now be corrected under APRSC as insignificant? Does this work or have you failed to fully correct since this is all one Operational Failure and you can't correct 1997 under SCP?

2000-17 says that in when determining whether failures are in the aggregate insignificant you ignore failures corrected under SCP.

Thanks for any thoughts.

card

[Guest Benefits Lady]

I would probably not worry so much about the semantics. I would fix the issues and then if questioned upon IRS audit, argue the equities and that you corrected issues for all open years and that such errors were insignificant.

[Guest CMC]

For what it's worth, Q 2:54 of Reish & Ashton's Plan Correction Book reads as follows:

"A 2:54: If a significant defect is partially but not fully corrected, can the qualification failure then be treated as insignifcant?

No (a technically correct answer). Although there is no formal guidance on this point, IRS officials have stated informally that the significance of the qualification failure or failures will be analyzed by the revenue agent as of the time the qualificaiton fialure or failures occurred. Even if, after an attempted but incomplete correction, the remaining qualification failure would be considered insignificant, the test is whether the qualification failures, in the aggregate, were significant at the time they occurred. Obviously, this means that full and proper correction is critical to the use of APRSC.

Practitioner Tip: In this situation, the revenue agent should take into account a partial but incomplete correction as a favorable equity for a lower sanction under Audit CAP (see chapter 7). Further, as a practical matter, some revenue agents will take the position that the attempted correction is a factor to be taken into account in determining whether a qualification failure is insignificant. Thus, revenue agents may be inclined to find that qualification failures corrected in good faith, but incorrectly, are insignificant. In those cases, even though the plan is being examined, the proper correction of the qualification failures can be completed under APRSC, since, in the revenue agent's estimation, the qualification failures are significant."

I'm not sure how to reconcile this with Section 8.03 of Rev. Proc. 2001-17, which says that "Operational Failures that have been corrected under SCP in section 9 and VCP in sections 10 and 11 are not taken into account for purposes of determining if Operational Failures are insignificant in the aggregate." (Essentially the same language (but for the names of the programs) appeared in 2000-16, so its not a matter of this being a new development that post-dates Reish & Ashton's Q&A. (I've got the 2001 edition of their book which reflects 2000-16).

I take the Q&A to say that you cannot (as you suggest in (2) above) self-correct failures in the last two years and then determine the significance of the remaining failures without reference to those you have self-corrected. But the language of the Rev. Proc. suggests that you don't have to continue to factor in problems that have been corrected. Perhaps the thing to take away is that you ought not game the system by using SCP to render otherwise significant problems insignificant, but that you also not need factor back in problems that have been self-corrected in good faith.

I hope this is helpful. I'd be interested to know what others think about this. I thought your question was a good one.

[david rigby]

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