Check out this article published in the September issue of Maricopa Lawyer.
Through qualified retirement plans, employers can set money aside in a plan for employees’ retirement, receive a current tax deduction for the contribution, and employees can defer tax on retirement savings until they are withdrawn from the plan. Mistakes in drafting or operation of the plan can cause a loss of these benefits. This article summarizes the basic rules and options available to correct legal and operational failures in plan documentation and administration.
Since 1913, the Internal Revenue Code (“Code”) has required taxpayers to include in their taxable income any accession to wealth. Money transferred to or for the benefit of an employee generally meant immediate taxation for the employee. The Employee Retirement Income Security Act of 1974 (“ERISA”), which supplemented both the Code and labor and employment statutes, introduced provisions that deferred employee income while giving employers deductions for contributions made to retirement plans. ERISA conditions these tax benefits on plans complying with section 401 et seq. of the Code. ERISA also imposed fiduciary duties on employer/plan sponsors to make prudent decisions with respect to money set aside for employees and to properly manage and account for the money held by plans for the benefit of employees.
Early on, most qualified retirement plans were custom-drafted to satisfy the Code and fiduciary requirements described above. Employers and their counsel submitted each plan to the Internal Revenue Service (“Service”) for review and approval, and each plan received an individual letter confirming its qualified status. Every change in the qualification requirements necessitated plan amendments and sometimes updated qualification letter requests. Because of the widespread adoption of qualified retirement plans, over time the Service adopted policies to make plan compliance and administration simpler.
Some of most important efficiency tools developed by the Service and the U.S. Department of Labor (“DOL”) were the Service’s Voluntary Correction Program (“VCP”) and DOL’s Voluntary Fiduciary Correction Program (“VFCP”). These programs replace formal negotiations, closing agreements, and expensive fines or loss of qualified status with several levels of self-effectuating correction, depending on the problem, and with payments to the plan that hold plans and plan participants harmless from the financial impact of the errors. The programs also allow employers to avoid expensive litigation with government agencies over qualification problems and fiduciary violations.
The Service’s VCP program has three levels of correction. The simplest is self-correction, which an employer may use to correct problems that are isolated in occurrence and limited in their impact both as to the amount involved and of the participants affected. More difficult or long-lasting problems may require employers to file a formal VCP submission that is reviewed by and subject to comment by the Service. Issues addressed in these ways may include failing to timely update plan documents or inadvertently excluding participants from plan benefits like an employer match. More egregious or repeated failures may still require a formal closing agreement with the Service, but such solutions are rarer than in past years.
The DOL enforces fiduciary compliance. Fiduciary breaches can result in legal claims by plan participants, the DOL, or both. The DOL developed the VFCP to minimize litigation over inadvertent fiduciary failures. Under VFCP, self-correction, which was first allowed in 2025, is available on a limited basis for late deposit of employee contributions that are corrected within 180 days and that involve no more than $1,000 in lost earnings, or certain inadvertent operational failures related to plan loans. Other violations can be addressed only through formal submissions. An example of a problem eligible for correction under VFCP include an employer’s untimely (more than a day or two after payroll payments) deposit of 401(k) deferral contributions.
With a correction under either program, an employer should (i) carefully identify and report all plan compliance failures to prevent an agency from raising them on audit, and (ii) determine whether a compliance failure resulted in a “prohibited transaction”. Employers and others that engage in prohibited transactions can have fiduciary liability and be subject to an excise tax (15% of the amount involved if corrected before an audit, or of 100% if the Service audits the transaction). The Service and the DOL coordinate their efforts in examining and accepting corrections, so a comprehensive review of plan operations and documents is appropriate.
Qualified retirement plans are a critical and popular component of Americans’ savings programs. The government properly expects employers to safeguard plans and their assets. Correction programs are a critical tool that the government offers employers to avoid expensive liability and penalties and to protect the retirement savings of their employees.
Click here to read Otto's article published in the September issue of Maricopa Lawyer.
About the Author
Otto Shill helps individuals, business owners, and employers comply with and plan for laws and regulations related to federal and state taxation, employee benefits, and executive compensation. Recognized as a Certified Tax Specialist by the State Bar of Arizona's Board of Legal Specialization, Otto assists clients with audits, investigations, and regulatory disputes related to these areas and advises business owners on various transactions and long-term succession and estate planning.