IRS Pilots Pre-Examination Retirement Plan Compliance Program

The IRS pilot program allows a plan sponsor to conduct a self-examination before a full or limited retirement plan audit would be initiated.

In its June 3, 2022, Employee Plans Newsletter, IRS Employee Plans announced a “pre-examination retirement plan compliance program” (Pre-Examination Program) pilot beginning in June 2022.

Under the program, rather than immediately initiating a retirement plan audit, the Pre-Examination Program notification letter provides the plan sponsor with a 90-day window to conduct a self-examination of one or more targeted aspects of the plan’s documentation and administration in order to identify and correct any failures and report the results of the self-examination to the IRS.

Depending on its evaluation of the plan sponsor’s report, the IRS may take one of three actions:

• Determine that no further action is necessary and issue an audit closing letter with no further contact.
• Enter into a closing agreement that addresses any errors identified in the self-examination that are not eligible for self-correction.
• If the IRS determines that a closer review of the retirement plan is necessary, open a limited or full-scope audit.

If the plan sponsor fails to respond to the Pre-Examination Program notification within the 90-day window, the IRS will schedule the plan for an examination.

Observation: While the announcement of the pilot Pre-Examination Program provides limited details, it is clear that the program will provide plan sponsors with a valuable opportunity to potentially avoid the time-consuming—and typically expensive—process of a full-scope retirement plan audit. Upon receiving a Pre-Examination Program letter from the IRS, a plan sponsor should immediately contact experienced legal counsel and begin work on the self-examination. A plan sponsor’s failure to respond to a Pre-Examination Program letter within the 90-day period will void any opportunity to potentially close the audit on expedited terms.

Current Procedure

In the normal course, once the IRS selects a retirement plan for examination, the IRS immediately initiates the audit (typically with a lengthy document production request) and there is no opportunity for the plan sponsor to avoid or limit the scope of the audit.

Further, once a plan sponsor receives the audit notice from the IRS, the plan sponsor’s ability to identify and voluntarily correct errors on favorable terms is significantly limited. That is, the IRS’s correction program for tax-qualified retirement plans, the Employee Plans Compliance Resolution System (EPCRS), provides that once a plan sponsor receives notice of a plan audit from the IRS, the plan sponsor may only use the Self Correction Program (SCP) component of EPCRS to self-correct insignificant operational failures or significant operational failures that are “substantially completed.” In addition, plans sponsors are barred from using the Voluntary Correction Program (VCP) component of EPCRS to voluntarily correct failures that are not otherwise eligible for SCP.

As a result, operational and plan document failures that are either identified but not yet corrected under EPCRS, or that are identified through the audit, often may only be corrected under the Audit Closing Agreement Program (Audit CAP) component of EPCRS. And corrections under Audit CAP can be significantly more costly because of the additional sanctions that the IRS may impose (over and above the cost of effecting any correction).

Pilot Program Procedure

In contrast, under its pilot Pre-Examination Program, the IRS is providing plan sponsors with an opportunity to self-identify and correct failures on more favorable terms:

• Full Use of SCP to Correct Eligible Errors. The Pre-Examination Program appears to provide plan sponsors with the full use of SCP to self-correct eligible failures identified during the 90-day self-examination window (including any significant failures that occurred within the SCP correction time period, even if correction is not “substantially completed”). The plan sponsor must provide documentation to the IRS describing the failures identified in the self-examination and the steps taken by the plan sponsor to self-correct those failures.
  
  Observation: The IRS newsletter and the first Pre-Examination Program letters that we have seen suggest that the IRS expects full correction of any identified failures to be completed within the 90-day window. Moreover, the Pre-Examination Program letters indicate that any self-correction must follow “the correction principles outlined in [EPCRS].” However, full correction of operational failures may be difficult or impossible depending on the extent or nature of any failures discovered (for example, corrections that require locating former participants, participant elections, etc.). It is not yet clear whether the IRS would accept disclosure of the failures and the plan sponsor’s intended correction approach in these instances without requiring completion of the full correction during the 90-day window. It is possible that an inability to complete a self-correction during the 90-day window might result in the failure becoming ineligible for SCP and, instead, the failure would be resolved through a closing agreement under the Pre-Examination Program (as discussed below with respect to failures that cannot be corrected through SCP).

• More Favorable Correction Terms Outside of SCP. For any operational or plan document failures identified during the 90-day self-examination window that are not eligible for SCP, the Pre-Examination Program provides that plan sponsors can request a closing agreement from the IRS, and further provides that the sanctions under the closing agreement will be based on the user fees applicable under VCP. Under VCP, plan sponsors may submit an application to the IRS requesting review and approval of the steps taken to address operational failures, and the applicable user fees are scaled based on the asset size of the affected plan, with the highest user fee currently set at $3,500 for a plan with over $10 million in assets (see EPCRS user fee schedule). These modest and capped user fees generally are significantly less than the sanctions the IRS may otherwise impose to correct failures under Audit CAP. As with the SCP corrections described above, the plan sponsor must provide documentation to the IRS describing the nature of the failures and the proposed correction.
  
  Observation: For this reason, the Pre-Examination Program is particularly helpful for a plan sponsor that is in the process of correcting operational errors or preparing a VCP at the time the plan sponsor is notified of the examination (as the plan sponsor otherwise would then be unable to file the VCP submission). Under the Pre-Examination Program, the plan sponsor would have the opportunity to request a closing agreement related to the in-process VCP submission.

Areas of Uncertainty

One area of uncertainty regarding the Pre-Examination Program is the scope of the IRS’s review of plan operations and the nature and extent of the self-examination that the IRS may expect a plan sponsor to conduct during the self-examination period. Practically speaking, it would be extremely difficult or impossible for a plan sponsor to conduct a thorough full-scope audit and examine every aspect of a plan’s administration within the 90-day self-examination period.

Observation: The announcement of the Pre-Examination Program coincided with the mailing of notification letters to plans selected as part of the launch. In one of these letters, the IRS identified a specific tax qualification issue for review (compliance with the Internal Revenue Code Section 415 annual additions limit for a defined contribution plan), but also invited the plan sponsor to provide information about “any other issues that exist.” This suggests that the IRS may be targeting compliance with specific issues in the Pre-Examination Program, but also providing plan sponsors with an opportunity to provide information about other compliance issues of which plan sponsors may be aware or may identify during the self-examination period.

Another area of uncertainty is the nature and extent of the information that the IRS may expect a plan sponsor to provide to demonstrate compliance with a particular tax-qualification requirement.

Observation: The Pre-Examination Program does not mandate specific information that must be provided to demonstrate compliance with particular tax-qualification requirements. By way of example, the issued Pre-Examination Program letter targeting Code Section 415 compliance directs the plan sponsor to “[s]end us the steps you took and documentation that demonstrates how you determined your compliance (or noncompliance),” and suggests information and documentation that the plan sponsor “may also want to provide” to substantiate compliance (such as the plan document, participant allocation schedules, employee census reports, account statements, and W-2s). In addition, the letter included instructions to the plan sponsor on how to conduct its self-examination of the plan’s Code Section 415 compliance.

IRS Determinations

Once a plan sponsor provides documentation of its failures and corrections to the IRS for review, the IRS will determine whether it agrees or disagrees with the plan sponsor’s conclusions and any corrective actions.

By way of example, in the Pre-Examination Program letter focusing on Code Section 415 compliance, the IRS states that “a closing letter with no further contact” will be issued if the IRS agrees with the conclusions and any methods used to self-correct mistakes. If the IRS disagrees with any self-correction actions, or if the plan sponsor requests a closing agreement or has other issues, the IRS will “conduct either a limited or full scope exam.” An examination will also follow if the plan sponsor does not respond to the Pre-Examination Program notification within the 90-day window.

The IRS did not indicate how long the Pre-Examination Program will last, but at the end of the pilot, the IRS will review how effectively the program functioned and determine whether it will continue.

Next Steps

The pilot Pre-Examination Program offers plan sponsors a potentially valuable opportunity to disclose known failures and resulting corrections, and the possibility of significantly reduced sanctions compared with amounts that otherwise might be assessed where failures are disclosed or identified during a compliance audit.

Observation: As noted above, upon receipt of a Pre-Examination Program notice letter, a plan sponsor should immediately contact experienced legal counsel and start work to evaluate the specific issues addressed in the letter. Even in advance of receiving a Pre-Examination Program notice letter, proactive plan sponsors may want to consider conducting an operational audit of certain “hot list” issues that are likely to be targeted for the Pre-Examination Program (e.g., plan documents, adherence to Code Section 415 contribution limits, correct application of deferral and match, processing of hardship withdrawals and loans). By doing so, plan sponsors should be well positioned for a quick and relatively low-cost resolution of any compliance issues.

Contacts

If you have any questions or would like more information on the issues discussed in this LawFlash, please contact any of the following:

Pittsburgh
Claire E. Bouffard
Matthew H. Hawes
R. Randall Tracht

Seattle
Claire P. Rowland