Greenberg Traurig Alert
Avoidance of IRS Employee Plans Monetary Sanctions
By Jeffrey D. Mamorsky, Greenberg Traurig,
New York Office
Under the IRS Closing Agreement Program ("CAP"), if an IRS auditor identifies
any failures in the plans operational compliance with the qualification requirements
of the Internal Revenue Code ("Code"), the auditor will require retroactive
correction of the failures and ask the plan sponsor (i.e., the employer or the trustees in
the case of a multi-employer plan) as "responsible fiduciaries" to make a
non-deductible payment to the IRS (the "CAP monetary sanction"), the amount of
which is generally based on the total amount of tax that would be imposed on the
contributing employers, trust and participants if the plan were disqualified. In many
instances this will be a substantial amount (possibly millions of dollars).
Sanctions can be imposed by the IRS even if the failures are unintentional
administrative errors that result in no harm to plan participants. Also, the IRS has
emphasized that sanctions will be imposed for failure to follow the terms of the plan
document even if the plan operation otherwise complies with the Codes qualification
requirements. The IRS has already concluded over 5,000 CAP Audits and has imposed monetary
sanctions of at least $26 million on just one employer ($10 million in the case of a large
multiemployer plan) for failure to comply operationally with the Codes qualification
requirements. Hundreds of additional cases are currently being negotiated with IRS under
the CAP Program.
The issues identified by the IRS on audit rarely constitute intentional or blatant
violations of the Codes qualification requirements. The majority of the problems
appear to involve failures which often occur in the administration of qualified plans and
are of the type which can easily be discovered on an audit by IRS.
Although IRS relief from CAP monetary sanctions is available through various remedial
programs (discussed below), the way to comply with such programs is by identifying and
correcting operational and document failures through a self-audit process prior to an
audit by IRS. The Fiduciary Audit® Operational Review, which is exclusively available
through Greenberg Traurig, enables employers and trustees in the case of multiemployer
plans, to establish self-audit internal control procedures that are designed to assure
operational compliance on a cost effective basis. This will help to avoid litigation and
the imposition of draconian monetary sanctions under the IRS CAP Program. The
Fiduciary Audit® Operational Review, which is the basis for indemnification against IRS
liability (eg, CAP monetary sanctions) under the Qualified Plan Insurance Program offered
by Lloyds of London and other major insurers, is also invaluable in structuring solutions
that facilitate mergers and acquisitions and enhance their value by identifying and
eliminating qualified plan liability from the balance sheet and providing protections on
the representations and warranties and opinions necessary with respect to the operation of
qualified plans in accordance with plan documents and the requirements of ERISA and the
CAP Monetary Sanctions
Although much of the information regarding IRS audits of qualified plans under CAP is
protected from public disclosure and therefore cannot be revealed by the IRS, we have been
able to obtain some general information from various IRS personnel and other sources. For
example, we are aware of one instance where the trustees of a large collectively bargained
defined benefit plan paid in excess of $5 million dollars in CAP monetary sanctions plus
the cost of correction of various service crediting failures which resulted in vesting and
benefit accrual violations. The service crediting problem resulted from the failure of the
employers and plan administrator to maintain a system to track "covered
employment" (i.e., employment covered under the terms of the collectively bargained
agreement). The case involved an industry in which union shops went in and out of business
frequently and there was no system in place to keep track of union members as they moved
from one shop to another or from employment status to unemployment status and vice versa.
Another case involved a large collectively bargained defined benefit plan that did not
track service properly and as a result a large number of employees did not receive service
credit under the plan. Moreover, as a result of a failure to adjust employer contribution
rates the plan became vastly overfunded. This resulted in the assessment and collection of
a multi-million dollar CAP monetary sanction upon audit by the IRS.
You may already be aware of a case in which a corporate employer paid between $20
million to $35 million in CAP monetary sanctions. An IRS audit of a large 401(k) plan
identified operational failures that included a failure to (i) timely enroll employees in
the plan, (ii) obtain spousal consent witnessed by either a plan representative or notary
public, (iii) satisfy the participant consent requirement for lump sum distributions in
excess of $3,500 by not complying with certain IRS disclosure requirements to insure
"informed" consent (e.g., joint and survivor and tax explanations, etc.) and
(iv) keep track of the current mailing address of terminated vested participants who were
owed benefits from the plan. The IRS assessed CAP monetary sanctions on the plan sponsor
employer as if the plan were disqualified. In addition to the CAP monetary sanction, it is
our understanding that the IRS also required the employer to retain an independent auditor
at a cost of approximately $3 million to report operational compliance to the IRS for a
two year period and to retroactively correct all operational defects. Correction of
operational defects included the mailing of letters to approximately 55,000 former
participants "inviting" them to recontribute their lump sum distributions to the
We are also aware of an IRS audit of a large 401(k) plan in which the IRS identified an
inadvertent delayed enrollment of rehired employees whose prior period of employment was
not properly taken into account when determining eligibility for participation in the plan
upon rehire. IRS imposed a $7.5 million CAP monetary sanction on the employer plan
sponsor. The penalty was assessed even though the failure was inadvertent and affected
less than 1% of plan participants.
In another case involving a companys qualified plan, the IRS imposed CAP monetary
sanctions in the amount of $9 million. The CAP sanction was imposed even though the
principal issue raised by IRS was the companys failure to obtain spousal consent
from only 1% to 2% of plan participants.
In another case, a 401(k) plan failed to pass the ADP nondiscrimination test for two
consecutive years. In order to avoid this problem in the future, the plan was amended to
eliminate coverage of highly compensated employees ("HCEs"). In spite of the
plan amendment making HCEs ineligible, HCEs were allowed to make salary deferrals.
Subsequent to an IRS audit identifying this operational failure, the employer plan sponsor
"agreed" to correct the operational defect by making an additional contribution
of over $400,000 to the plan on behalf of non-highly compensated employees plus payment to
the IRS of a substantial amount of CAP monetary sanctions.
IRS Relief From CAP Monetary Sanctions
Fortunately, the IRS has provided relief from these draconian monetary sanctions. On
January 24, 2000, the IRS released Revenue Procedure 2000-16 which updates and
consolidates the comprehensive system of correction programs for sponsors of retirement
plans (i.e., employers or trustees in the case of multiemployer plans) that are intended
to satisfy the requirements of Sections 401(a), 403(a) or 403(b) of the Internal Revenue
Code ("Code"), but that have not met those requirements for a period of time.
This system, the Employee Plans Compliance Resolutions System ("EPCRS"), permits
plan sponsors to correct failures under Code §§401(a), 403(a) or 403(b) and thereby
continue to provide their employees with retirement benefits on a tax-favored basis.
The components of EPCRS are the Administrative Policy Regarding Self-Correction
(APRSC"), the Voluntary Compliance Resolution ("VCR") program, the Walk-in
Closing Agreement Program ("Walk-in Cap"), the Audit Closing Agreement Program
("Audit CAP") and the Tax Sheltered Annuity Voluntary Correction
Revenue Procedure 2000-16 contains a self correction program, APRSC, which allows plan
sponsors to identify violations in plan operation and correct the failures without any
involvement of the IRS and without the payment of any CAP monetary sanctions provided that
corrections are made prior to an IRS audit and within two years following the year in
which the failure occurred.
APRSC is only available to correct operational failures and not plan document errors.
In this regard, it is important to note that the IRS emphasizes that failure to follow the
terms of the plan is an operational violation even if the operation of the plan would
otherwise satisfy the Codes requirements. APRSC is not available to correct
violations that can be corrected only by plan amendment (e.g., failure to timely amend the
plan), exclusive benefit failures relating to the misuse or diversion of plan assets,
failures relating to plans which do not have a current IRS determination letter, and
violations relating to any plan under IRS examination or plans which have been notified of
an IRS examination.
If APRSC is not available (e.g., the plan document needs to be amended to conform with
operation or the plan does not have a current determination letter), all is not lost.
Revenue Procedure 2000-16 also includes a "Walk-in CAP" program in which plan
sponsors voluntarily submit failures and corrections to the IRS for approval. The Walk-in
CAP program permits correction of a plan document or operational failure that does not
comply with APRSC if the plan sponsor agrees to pay a compliance correction fee and to
correct the failures identified in accordance with a closing agreement with IRS. The
Walk-in CAP Compliance Correction Fees for plans with assets of less than $500,000 are
$500 to $4,000 with a presumptive fee amount of $2,000 for plans with 10 or fewer
participants; $500 to $8,000 with a presumptive fee amount of $4,000 for plans with 11 to
50 participants; $500 to $12,000 with a presumptive fee amount of $6,000 for 51 to 100
participants; $500 to $16,000 with a presumptive fee amount of $8,000 for 101 to 300
participants; $500 to $30,000 with a presumptive fee amount of $15,000 for 301 to 1,000
participants. The minimum fee of $500 is replaced by a fee of $1,250 for plans with assets
of at least $500,000 and no more than 1,000 participants, $5,000 for plans with 1,001 to
10,000 participants, or $10,000 in the case of plans with 10,000 or more participants. For
plans with more than 1000 participants, the maximum fee is $70,000 with a presumptive fee
amount of $35,000.
As you can see, Revenue Procedure 2000-16 is truly welcome news. Prior to the release
of this Revenue Procedure, plan sponsors that conducted an audit of their plan, corrected
administrative failures and/or plan document errors, and approached the IRS for amnesty
could still face millions of dollars in IRS penalties. Now the maximum penalty plan
sponsors face is $70,000 provided that they conduct an operational audit of their plan and
correct administrative or plan document failures prior to an audit by IRS.
Additional Relief with the Fiduciary Audit® Operational Review
Circumstances often arise where plan sponsors are unable to make corrections and submit
them to the IRS for approval under the "Walk-in CAP" program. This would be the
case, for example, in the case of a term or provision in the plan document that is
inconsistent with plan operation as the result of a "scriveners error"
which is ineligible for retroactive amendment under the "Walk-in CAP" program.
Also, this could occur in a merger/acquisition transaction where there is not enough time
to correct document and operational failures and submit corrections to the IRS for
approval under "Walk-in CAP." In either case, the Fiduciary Audit® Operational
Review enables plan sponsors to qualify for indemnification against IRS liability (CAP
monetary sanctions) under the Qualified Plan Insurance Program offered by Lloyds of London
and other major insurers.
In sum, we believe that the Fiduciary Audit® Operational Review provides a
cost-effective means of sanction avoidance, balance sheet enhancement and transactional
IRS Audits in 2000 Will Target 403(b) Tax-Sheltered Annuity Plans
The IRS recently announced that 403(b) tax-sheltered annuity plans will be the target
of enhanced enforcement in 2000 through a significant increase in its examination
activities relating to 403(b) school arrangements, public colleges, hospitals and health
In light of this new emphasis on 403(b) plan audits, IRS Revenue Procedure 2000-16 is
more important then ever. Rev. Proc. 2000-16 extends to 403(b) tax-sheltered annuity plans
all of the correction programs covered under the IRS Employee Plans Compliance
Resolution System ("EPCRS").
EPCRS permits employers to (1) voluntarily correct failures that occur when a
tax-sheltered annuity plan fails to met the requirements of Section 403(b) of the Internal
Revenue Code and thereby continue to provide employees with retirement benefits on a
tax-favored basis and most importantly, (2) avoid the imposition of IRS monetary
Voluntary correction is permissible only with respect to 403(b) plans that have not
already been selected for an IRS examination. If you are interested in learning more about
how to identify and correct 403(b) plan failures under EPCRS, please contact us for more
Also it is important to note that the the Fiduciary Audit® Operational Review and
Qualified Plan Insurance Program discussed in the previous article apply to 403(b) plans.
Supreme Court Cites Employee Benefits Law Treatise
Citing Jeffrey D. Mamorsky's two volume treatise, Employee Benefits Law, as authority,
the U.S. Supreme Court has ruled that ERISA allows an employer to amend a retirement plan
to create a new plan structure within an existing plan structure without creating a de
facto second plan where the same source of assets is used to pay the obligations of both
plan structures [Hughes Aircraft Company et al. v. Jacobson 525 U.S. 432, 119 S. Ct. 755,
22 EBC 2296].
In a decision written by Justice Clarence Thomas, the Supreme Court reversed a ruling
of the Ninth Circuit Court of Appeals that had permitted a class of participants in a
contributory defined benefit retirement plan to sue Hughes Aircraft Company under ERISA
after it had created a noncontributory benefit structure, and had transferred the
overfunded plan's surplus, which amounted to almost $1 billion, to this new
noncontributory plan structure that included many new employees who had not contributed to
the original plan.
In rejecting the class' claim that the plan amendments created a separate
noncontributory plan that could not be legally funded with surplus assets which were
comprised in part of the investment growth of employee contributions, the Supreme Court
emphasized that: "The act of amending a preexisting plan cannot as a matter of law
create two de facto plans if the obligations (both preamendment and postamendment)
continue to draw from the same single, unsegregated pool or fund of assets."
© 2000 Greenberg Traurig
This GT ALERT is issued for informational purposes only and is not intended
to be construed or used as general legal advice. Greenberg Traurig attorneys provide
practical, result-oriented strategies and solutions tailored to meet our clients’
individual legal needs.