EPCRS Revised
Rev. 05/11/06, E-mail Alert 2006-9

Highlights of the EPCRS Changes
The Internal Revenue Service (IRS) has been working on updating the Employee Plans Compliance Resolution System (EPCRS), Rev. Proc. 2006-27. The update was released May 5, 2006. The program was last updated in June of 2003 (Rev. Proc 2003-44). The general effective date is September 1, 2006 although some provisions are effective May 30, 2006. Further, the IRS is permitting employers to apply the provisions at any time on or after May 30, 2006. The IRS has issued a number of releases about the new EPCRS and we present links to them at the bottom of this article. This article provides highlights of the changes between the old EPCRS (Rev. Proc. 2003-44) and the new improved version.

Participant Loan Corrections
The IRS has provided correction methods to prevent an improperly made participant loan from being deemed a defaulted loan. Here are some commonly occurring problems and corrections.

Exceeding the limit of half the vested account balance but not more than $50,000. If a loan exceeds the limit, the appropriate correction will be to allow the participant to repay the amount in excess of the limit to the plan at the time the error is discovered and to re-amortize the remaining loan balance. Re-amortization will permit the reduction of future payments by taking into consideration any overpayments made based on the excess loan balance.

For example, let’s say that a participant had a vested account balance of $60,000 and a nonconforming loan was issued for $10,000 too much i.e. $40,000. Repayments of principal and interest on this amount are higher than would be necessary to repay the maximum allowable loan in this example of $30,000. Under the new EPCRS, the extra amount already paid will be used to reduce the amount to be repaid after correction occurs and will be so reflected in the new amortization schedule.

Exceeding the five-year term. If a loan was initiated with a repayment period in excess of five years and the loan was not used to purchase a primary residence, the employer would be able to shorten the term of the nonconforming loan to five years by making a submission through the Voluntary Correction Program (VCP). The correction in this situation is to shorten the remaining term of the loan, based on the date of the discovery of the error, so the loan will mature within five years of its origination date. In addition, the loan repayment schedule must be re-amortized and the revised payments completed within five years from the loan origination date. If the discovery is beyond five years from the origination date, this correction procedure is unavailable.

Paying overdue amounts during the grace period. When a participant is behind in repayments and still in the grace period, he or she will now have a choice to either repay the overdue amount as a lump sum or to re-amortize the amounts over the remaining loan period.

Correction for the exclusion of an eligible employee from a 401(k) plan. The current correction method calls for qualified nonelective employer contributions (QNECs) equal to the average of the actual deferral percentage (ADP) for the nonhighly compensated employees (NHCEs) if the employee is an NHCE or of the Highly Compensated Employees (HCEs) if the employee is an HCE during the time the employee was incorrectly excluded from the plan. The new correction method requires a QNEC equal to only 50% of the applicable ADP during the exclusion period. While not actually discussed in the new Revenue Procedure, it appears that the plan will not have to be retested reflecting the new lower contribution amount.

If after-tax contributions could have been made, the QNEC would equal 40% of the amount that could have been contributed.

This QNEC amount represents what is called the “lost opportunity” cost to the improperly excluded employee. It is based on an IRS analysis showing that an employee who received cash instead of making deferrals would lose a tax-free buildup equivalent to 50% of the deferral. Note that if matching contributions are also lost, the full amount of the lost deferrals will be used to calculate the matching contribution for the improperly excluded employee. The matching contribution is also to be a qualified contribution and may be made as a QNEC, rather than a QMAC.

Safe harbor 401(k) plan eligible employee excluded. Safe harbor 401(k) plan has special rules for an eligible employee who was incorrectly excluded. If the safe harbor is a 3% NEC, the amount of the missed deferral is deemed to be 3%. The amount the employer must make-up is 50% of the 3% deferral and the 3% safe harbor contribution. If the safe harbor plan uses the matching formula, the correction is based on 50% of the estimate of the missed deferral. The missed deferral is the greater of 3% or the maximum deferral percentage for which the employer provides a matching contribution. In addition, the employer must provide the matching contribution that would have been made on the missed deferral. Of course, the amounts are to be adjusted for earnings.

Spousal consent missing additional correction methods. If spousal consent was not obtained, two new methods of correction have been added. The spouse may select which of the two he or she prefers. The first permits a lump sum equal to the actuarial present value of the survivor annuity, the second choice is a survivor annuity benefit.

Waiver of excise tax. In addition to the existing excise tax waiver for failure to make corrective distributions, the new EPCRS provides two additional waivers as follows:

Situation 1: If a plan sponsor makes an additional contribution as part of a correction for an operational failure under EPCRS; but the contribution is nondeductible because it exceeds the deductible limit for the year of correction; then the excise tax is waived.

Situation 2: A 401(k) plan fails the ADP and/or the ACP (actual contribution percentage) test due to incorrect data and there are additional excess contributions to be returned when the test(s) are rerun with the proper data, then the excise tax on the additional amounts returned is waived.

Determination letter for EPCRS corrections. An employer will not be required to seek a determination letter for an amendment under EPCRS if the amendment is minor and does not significantly affect the benefits provided by the plan.

Fee schedule for nonamenders. Frequently, an employer is unaware that an amendment is missing until its plan is submitted for a determination letter and the IRS discovers that an earlier amendment is missing. Under the updated EPCRS a new fee schedule will apply. The penalties are greater than those imposed by the Voluntary Compliance Program (VCP) submission schedule but less than those under the audit cap program. The penalty schedule is tiered according to number of participants and has a separate fee for each amendment that may be missing.

Fee schedule for RMD failures. A new fee schedule will apply to plan failures involving required minimum distribution (RMD) rules (IRC Section (401(a)(9)). If 50 or fewer participants are affected by the failure, the penalty will be $500, regardless of the actual number of plan participants. In addition to simplifying and encouraging the correction process, this enhancement sets a clear benchmark in an area of plan administration that is likely to occur at one time or another.

Sole Amendment Failure VCP Submission. There is a new reduced VCP fee ($375 per year) for plans that fail to timely adopt certain amendments such as the EGTRRA good faith amendment; 401(a)(9) RMD amendment; and interim amendments pursuant to Rev. Proc. 2005-66. The IRS has introduced a streamlined format for applying with a sample format for a VCP submission where the only issue is a nonamender failure and a sample form for use by interim nonamenders.

Abusive Tax Avoidance Transactions and EPCRS. The IRS has provided rules for the availability of EPCRS for plans or plan sponsors who are a party to an abusive tax avoidance transaction (ATAT). Specifically, SCP is unavailable. VCP submissions will await referral by IRS EP Tax Shelter Coordinator. Upon receiving the response, if an ATAT has occurred, the IRS will determine if VCP is available based on the plan or sponsor’s involvement. Similar treatment will be afforded for audit cap. The IRS may limit the availability of VCP or audit CAP based on the plan or sponsor’s involvement in the ATAT.

SEP and SIMPLE IRA VCP fees have been reduced to $250.

Bill Grossman, QPA