Employee Stock Ownership Plans (ESOPs) provide powerful tax advantages to companies that sponsor them, but to qualify for those benefits, an ESOP company needs to demonstrate and document that the plan is properly organized and implemented.
The absolute last thing any ESOP sponsor wants for their business is for the plan to face the potentially ruinous consequences of being disqualified by the Internal Revenue Service (IRS). And yet, mistakes can happen.
Ramifications of plan disqualification can include significant taxes imposed on plan participants for vested contributions made by the employer during the period when the ESOP trust is determined to have been improperly organized and run.
The good news is that the Internal Revenue Service’s (IRS) Employee Plans Compliance Resolution System (EPCRS) provides plan sponsors the opportunity to “make voluntary and timely corrections” of certain operational failures and document failures, such as overpayments to plan participants. Responsive action on the part of a plan sponsor using EPCRS can enable the company to preserve the ESOP’s tax advantages if a plan error or failure occurs.
The most recent update to EPCRS was published in Revenue Procedure 2021-30, and became effective January 2022.
How to Correct Plan Errors Using EPCRS
Any size organization that sponsors a retirement plan can use EPCRS to identify and correct plan failures. The system includes three different correction programs:
- Self-Correction Program (SCP): Allows plan sponsors that have established compliance practices and procedures to correct plan failures, including operational failures and plan document failures, without having to contact the IRS to apply or report the errors, and without having to pay a user fee or sanction
- Voluntary Correction Program (VCP): Allows sponsors to pay a limited fee and correct failures that aren’t eligible for the self-correction program, or to get a written statement from the IRS specifying that failures were corrected
- Audit Closing Agreement Program (CAP): Used for resolution of failures not already corrected via SCP or VCP that were discovered during an IRS audit; the plan sponsor can correct the failure and pay a sanction bearing “a reasonable relationship to the nature, extent, and severity of the failure, taking into account the extent to which correction occurred before audit”
Recent Updates to EPCRS
Revenue Procedure 2021-30 made some major changes and revisions to the correction programs, which the IRS outlines in detail. Among the updates are the following major changes:
- Expanded options for self-correction include a correction period of three years for significant operational failures
- It’s easier to use retroactive plan amendments for correcting operational failures
- Overpayment correction principles have been expanded and reduce the need to seek repayment from overpaid participants or beneficiaries
- Anonymous VCP submissions are no longer accepted, but the IRS now permits sponsors or their representatives to anonymously request a pre-submission conference to discuss possible VCP submissions
General Underlying Principles of EPCRS
The IRS and Department of Labor promote the use of EPCRS to encourage sponsors and administrators to act voluntarily to ensure that plans are run properly, in compliance with the Internal Revenue Code and with individual plans’ designs. Timely correction of any plan failures helps ensure participating employees will receive their expected retirement benefits. Limited, graduated fees for voluntary corrections create an incentive to correct failures as soon as they are detected.
On the flip side, sanctions for plan failures identified on audit are not as limited. Rather, EPCRS principles state these sanctions “should be reasonable in light of the nature, extent, and severity of the violation.” Even so, it’s crucial to understand what’s at stake: a qualified retirement plan needs to remain qualified in order to maintain tax-favored status.
Administrative and recordkeeping responsibilities are essential to maintaining a properly run, compliant ESOP that delivers tax advantages to your business and a meaningful retirement benefit to employees. We’ve created a month-by-month planning tool to help ensure you don’t miss key dates, filing requirements, and more. Get yours today—just click the link below to download your personal copy.