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How to Correct Retirement Plan Mistakes to Avoid Disqualification

June 23, 2014

Be sure to maintain your tax benefits by complying with Plan rules.

Qualified retirement plans, such as 401(k)s, provide valuable tax benefits to both the employer (the plan sponsor) and the employees (the plan participants). To maintain these tax benefits, the plan must comply with a wide variety of rules. Plan mistakes can lead to disqualification — and the loss of the tax benefits.

Fortunately, under the IRS’s Employee Plans Compliance Resolution System (EPCRS), plan sponsors can correct plan errors and avoid disqualification using one of three programs:

  1. Self-correction program (SCP). This program allows plan sponsors to correct mistakes without contacting the IRS or paying a fee. SCP is available for “insignificant” operational errors. Factors that could affect whether an error is insignificant include the number of years and the percentage of plan assets involved. Some types of plans may even use the SCP to correct a “significant” operational error if it is within two years of the end of the plan year in which the error occurred.
  2. Voluntary correction program (VCP). Plan sponsors can use the VCP to voluntarily correct errors that are ineligible for the SCP. Under the VCP, the plan sponsor must identify the mistake, propose the correction and changes to its procedures that will ensure that the error does not occur, and pay a fee. The IRS will approve the correction, and the plan then has 150 days to implement it. Given the written IRS approval, some sponsors prefer the VCP even for errors eligible for the SCP.
  3. Audit closing agreement program (Audit CAP). If a significant mistake is uncovered during an IRS audit of the plan, the plan sponsor can preserve the plan’s qualified status by using the Audit CAP. Under this program, the plan sponsor corrects the plan error, enters a “closing” agreement with the IRS and pays a sanction — which may be substantially more than what it would have paid under the VCP.

Since the tax consequences of plan disqualification are severe, it’s critical to correct mistakes before a plan can be disqualified. To learn more about any of the EPCRS programs, please contact us.

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