SECTION 6. CORRECTION

PRINCIPLES AND RULES OF GENERAL APPLICABILITY

.01 Correction principles; rules of gen- eral applicability . The general correction principles in section 6.02 and rules of general applicability in sections 6.03 through 6.10 apply for purposes of this revenue procedure.

.02 Correction principles . Generally, a failure is not corrected unless full correction is made with respect to all participants and beneficiaries, and for all taxable

2001–7 I.R.B. 597 February 12, 2001

years (whether or not the taxable year is closed). Even if correction is made for a closed taxable year, the tax liability associated with that year will not be redetermined because of the correction. In the case of a Qualified Plan with an Operational Failure, correction is determined taking into account the terms of the plan at the time of the failure. Correction should be accomplished taking into account the following principles:

(1) Restoration of benefits . The correction method should restore the plan to the position it would have been in had the failure not occurred, including restoration of current and former participants and beneficiaries to the benefits and rights they would have had if the failure had not occurred.

(2) Reasonable and appropriate cor- rection . The correction should be reasonable and appropriate for the failure. Depending on the nature of the failure, there may be more than one reasonable and appropriate correction for the failure. For Qualified Plans, any correction method permitted under Appendix A or Appendix B is deemed to be a reasonable and appropriate method of correcting the related Qualification Failure. Any correction method permitted under Appendix A applicable to a 403(b) Plan is deemed to be a reasonable and appropriate method of correcting the related 403(b) Failure. Whether any other particular correction method is reasonable and appropriate is determined taking into account the applicable facts and circumstances and the following principles:

(a) The correction method should, to the extent possible, resemble one already provided for in the Code, regulations thereunder, or other guidance of general applicability. For example, for Qualified Plans, the defined contribution plan correction methods set forth in § 1.415–6(b)(6) would be the typical means of correcting a failure under § 415. Likewise, the correction method set forth in § 1.402(g)–1(e)(2) would be the typical means of correcting a failure under § 402(g).

(b) The correction method for failures relating to nondiscrimination should provide benefits for nonhighly compensated employees. For example, for Qualified Plans, the correction method set forth in § 1.401(a)(4)–11(g) (rather than

methods making use of the special testing provisions set forth in § 1.401(a)(4)–8 or § 1.401(a)(4)–9) would be the typical means of correcting a failure to satisfy nondiscrimination requirements. Similarly, the correction of a failure to satisfy the requirements of § 401(k)(3), § 401(m)(2), or § 401(m)(9) (relating to nondiscrimination), solely by distributing excess amounts to highly compensated employees would not be the typical means of correcting such a failure.

(c) The correction method should keep plan assets in the plan, except to the extent the Code, regulations, or other guidance of general applicability provide for correction by distribution to participants or beneficiaries or return of assets to the employer or Plan Sponsor. For example, if an excess allocation (not in excess of the § 415 limits) made under a Qualified Plan was made for a participant under a plan (other than a cash or deferred arrangement), the excess should be reallocated to other participants or, depending on the facts and circumstances, used to reduce future employer contributions.

(d) The correction method should not violate another applicable specific requirement of § 401(a) or § 403(b) (for example, § 401(a)(4), § 411(d)(6), or § 403(b)(12), as applicable), or § 408(k) for SEPs. If an additional failure is created as a result of the use of a correction method in this revenue procedure, then that failure also must be corrected in conjunction with the use of that correction method and in accordance with the requirements of this revenue procedure.

(3) Consistency Requirement . Generally, where more than one correction method is available to correct a type of Operational Failure for a plan year (or where there are alternative ways to apply a correction method), the correction method (or one of the alternative ways to apply the correction method) should be applied consistently in correcting all Operational Failures of that type for that plan year. Similarly, earnings adjustment methods generally should be applied consistently with respect to corrective contributions or allocations for a particular type of Operational Failure for a plan year.

(4) Principles regarding corrective allocations and corrective distributions . The following principles apply where an appropriate correction method includes

the use of corrective allocations or corrective distributions:

(a) Corrective allocations under a defined contribution plan should be based upon the terms of the plan and other applicable information at the time of the failure (including the compensation that would have been used under the plan for the period with respect to which a corrective allocation is being made) and should be adjusted for earnings (including losses) and forfeitures that would have been allocated to the participant’s account if the failure had not occurred. The corrective allocation need not be adjusted for losses. See section 3 of Appendix B for additional information on calculation of earnings for corrective allocations.

(b) A corrective allocation to a participant’s account because of a failure to make a required allocation in a prior limitation year will not be considered an annual addition with respect to the participant for the limitation year in which the correction is made, but will be considered an annual addition for the limitation year to which the corrective allocation relates. However, the normal rules of § 404, regarding deductions, apply.

(c) Corrective allocations should come only from employer contributions (including forfeitures if the plan permits their use to reduce employer contributions).

(d) In the case of a defined benefit plan, a corrective distribution for an individual should be increased to take into account the delayed payment, consistent with the plan’s actuarial adjustments.

(5) Special exceptions to full correc- tion . In general, a failure must be fully corrected. Although the mere fact that correction is inconvenient or burdensome is not enough to relieve a Plan Sponsor of the need to make full correction, full correction may not be required in certain situations because it is unreasonable or not feasible. Even in these situations, the correction method adopted must be one that does not have significant adverse effects on participants and beneficiaries or the plan, and that does not discriminate significantly in favor of highly compensated employees. The exceptions described below specify those situations in which full correction is not required.

(a) Reasonable estimates . If it is not possible to make a precise calculation,

February 12, 2001 598 2001–7 I.R.B.

or the probable difference between the approximate and the precise restoration of a participant’s benefits is insignificant and the administrative cost of determining precise restoration would significantly exceed the probable difference, reasonable estimates may be used in calculating appropriate correction.

(b) Delivery of very small benefits . If the total corrective distribution due a participant or beneficiary is $20 or less, the Plan Sponsor is not required to make the corrective distribution if the reasonable direct costs of processing and delivering the distribution to the participant or beneficiary would exceed the amount of the distribution.

(c) Locating lost participants . Reasonable actions must be taken to find all current and former participants and beneficiaries to whom additional benefits are due, but who have not been located after a mailing to the last known address. In general, such actions include use of the Internal Revenue Service Letter Forwarding Program (see Rev. Proc. 94–22, 1994–1 C.B. 608) or the Social Security Administration Reporting Service. A plan will not be considered to have failed to correct a failure due to the inability to locate an individual if either of these programs is used; provided that, if the individual is later located, the additional benefits must be provided to the individual at that time.

(6) Reporting . Any distributions from the plan should be properly reported.

.03 Correction of an Employer Eligibility Failure (only available under VCP general procedures, VCT, and VCSEP) . (1) The permitted correction of an Employer Eligibility Failure is the cessation of all contributions (including salary reduction and after-tax contributions) beginning no later than the date the application under VCP is filed. Pursuant to VCP correction, the assets in such a plan are to remain in the trust, annuity contract, or custodial account and are to be distributed no earlier than the occurrence of one of the applicable distribution events, e.g., for 403(b) Plans, the events described in § 403(b)(7) (to the extent the assets are held in custodial accounts) or § 403(b)(11) (for those assets invested in annuity contracts that would be subject to § 403(b)(11) restrictions if the employer

were eligible). A Plan that is corrected through VCP will be treated as subject to all of the requirements and provisions of § 401(a) for a Qualified Plan, § 403(b) for a 403(b) Plan, and § 408(k) for a SEP (including Code provisions relating to rollovers).

(2) Cessation of contributions is not required if continuation of contributions would not be an Employer Eligibility Failure (for example, a tax-exempt employer may maintain a § 401(k) plan after 1996).

(3) Because a plan with an Employer Eligibility Failure will be treated as subject to all of the applicable Code qualification requirements, the Plan Sponsor must also correct all other failures in accordance with this revenue procedure.

.04 Correction by plan amendment . In any case in which correction of a Qualified Plan failure includes correction of a Plan Document Failure or correction of an Operational Failure by plan amendment as permitted under section 4.06, other than adoption of a model amendment or a standardized or prototype plan, the amendment must be submitted to the Service for approval under the appropriate application form (i.e., Form 5300 series or Form 6406) to ensure that the amendment satisfies applicable qualification requirements.

.05 Special rules relating to Excess Amounts . (1) Treatment of Excess Amounts under Qualified Plans . A distribution of an Excess Amount is not eligible for the favorable tax treatment accorded to distributions from Qualified Plans (such as eligibility for rollover under § 402(c)). To the extent that a current or prior distribution was a distribution of an Excess Amount, distribution of that Excess Amount is not an eligible rollover distribution. Thus, for example, if such a distribution was contributed to an individual retirement arrangement (“IRA”), the contribution is not a valid rollover contribution for purposes of determining the amount of excess contributions (within the meaning of § 4973) to the individual’s IRA. A distribution of an Excess Amount is generally treated in the manner described in section 3 of Rev. Proc. 92–93, 1992–2 C.B. 505, relating to the corrective disbursement of elective deferrals. The distribution must be reported on

Forms 1099–R for the year of distribution with respect to each participant or beneficiary receiving such a distribution. Where an Excess Amount has been distributed the Plan Sponsor must notify the recipient that (a) the Excess Amount was distributed and (b) the Excess Amount was not eligible for favorable tax treatment accorded to distributions from Qualified Plans (and, specifically, was not eligible for tax-free rollover).

(2) Treatment of Excess Amounts under 403(b) Plans . (a) Distribution of Excess Amounts . Excess Amounts for a year, adjusted for earnings through the date of distribution, must be distributed to affected participants and beneficiaries and are includible in their gross income in the year of distribution. The distribution of Excess Amounts is not an eligible rollover distribution within the meaning of § 403(b)(8). A distribution of Excess Amounts is generally treated in the manner described in section 3 of Rev. Proc. 92–93, 1992–2 C.B. 505, relating to the corrective disbursement of elective deferrals. The distribution must be reported on Forms 1099–R for the year of distribution with respect to each participant or beneficiary receiving such a distribution. In addition, the Plan Sponsor must inform affected participants and beneficiaries that the distribution of Excess Amounts is not eligible for rollover. Excess Amounts distributed pursuant to this subparagraph (2)(a) are not treated as amounts previously excludable under § 403(b)(2)(A)(ii) for purposes of calculating the maximum exclusion allowance for the taxable year of the distribution and for subsequent taxable years.

(b) Retention of Excess Amounts . Under VCT and Audit CAP, Excess Amounts will be treated as corrected (even though the Excess Amounts are retained in the 403(b) Plan) if the following requirements are satisfied. Excess Amounts arising from a § 415 failure, adjusted for earnings through the date of correction, must reduce affected participants’ applicable § 415 limit for the year following the year of correction (or for the year of correction if the Plan Sponsor so chooses), and subsequent years, until the excess is eliminated. Excess Amounts (whether arising from a § 415 failure or a § 403(b)(2) failure), adjusted for earnings

2001–7 I.R.B. 599 February 12, 2001

through the date of correction, must also reduce participants’ exclusion allowances by being treated as amounts previously excludable under § 403(b)(2)(A)(ii) beginning with the year following the year of correction (or the year of correction if the Plan Sponsor so chooses). If this correction method is used, it must generally be used for all participants who have Excess Amounts.

.06 Correction under statute or regula- tions . Generally, none of the correction programs are available to correct failures that can be corrected under the Code and related regulations. For example, as a general rule, a Plan Document Failure that is a disqualifying provision for which the remedial amendment period under § 401(b) has not expired can be corrected by operation of the Code through retroactive remedial amendment.

.07 Matters subject to excise taxes . (1) Except as provided in paragraph (3) of this subsection, excise taxes and additional taxes, to the extent applicable, are not waived merely because the underlying failure has been corrected or because the taxes result from the correction. Thus, for example, the excise tax on certain excess contributions under § 4979 is not waived under these correction programs.

(2) Except as provided in paragraph (3) of this section, the correction programs are not available for events for which the Code provides tax consequences other than plan disqualification (such as the imposition of an excise tax or additional income tax). For example, funding deficiencies (failures to make the required contributions to a plan subject to § 412), prohibited transactions, and failures to file the Form 5500 cannot be corrected under the correction programs. However, if the event is also an Operational Failure (for example, if the terms of the plan document relating to plan loans to participants were not followed and loans made under the plan did not satisfy § 72(p)(2)), the correction programs will be available to correct the Operational Failure, even though the excise or income taxes generally still will apply.

(3) As part of VCP, if the failure involves the failure to satisfy the minimum required distribution requirements of § 401(a)(9), in appropriate cases, the

Service will waive the excise tax under § 4974 applicable to plan participants. The waiver will be included in the compliance statement. The Plan Sponsor, as part of the submission, must request the waiver and in cases where the participant subject to the excise tax is an owneremployee, as defined in § 401(c)(3), or a 10 percent owner of a corporation, the Plan Sponsor must also provide an explanation supporting the request.

.08 Correction for SEPs . (1) Correction for SEPs generally . Generally, the correction for a SEP is expected to be similar to the correction required for a Qualified Plan with a similar Qualification Failure.

(2) Special correction for SEPs . Under VCSEP, in any case in which correction under section 6.08(1) is not feasible for a SEP or in any other case determined by the Service in its discretion (including failures relating to §§ 402(g), 415, and 401(a)(17), failures relating to deferral percentages, discontinuance of contributions to a SARSEP, and retention of overcontributions for cases in which there has been no violation of a statutory limitation), the Service may provide for a different correction. See section 12.07 for a special fee that may apply in such a case.

(3) Correction of failure to satisfy deferral percentage test . If the failure involves a violation of the deferral percentage test under § 408(k)(6)(A)(iii) applicable to a SARSEP, there are several methods to correct the failure, similar to the methods used in VCS and VCO. This failure may be corrected in one of the following ways:

(a) The Plan Sponsor may make contributions that are 100% vested to all eligible nonhighly compensated employees (to the extent permitted by § 415) necessary to raise the deferral percentage needed to pass the test. This amount may be calculated as either the same percentage of compensation or the same flat dollar amount (regardless of the terms of the SEP).

(b) The Plan Sponsor may effect distribution of excess contributions, adjusted for earnings through the date of correction, to highly compensated employees to correct the failure. The Plan Sponsor must also contribute to the SEP an amount equal to the total amount dis

tributed. This amount must be allocated to (i) current employees who were nonhighly compensated employees in the year of the failure, (ii) current nonhighly compensated employees who were nonhighly compensated employees in the year of the failure, or (iii) employees (both current and former) who were nonhighly compensated employees in the year of the failure.

(4) Treatment of undercontributions to a SEP . (a) Make-up contributions; earnings . The Plan Sponsor should correct undercontributions to a SEP by contributing make-up amounts that are fully vested, adjusted for earnings credited from the date of the failure to the date of correction.

(b) Earnings adjustment methods . (i) The earnings rate generally is based on the investment results that would have applied to the corrective contribution if the failure had not occurred.

(ii) Insofar as SEP assets are held in IRAs, there is no earnings rate under the SEP as a whole. If the Plan Sponsor is unable to determine what the actual investment results would have been, a reasonable interest rate may be used.

.09 Confidentiality and disclosure . Because each correction program relates directly to the enforcement of the Code qualification requirements, the information received or generated by the Service under the program is subject to the confidentiality requirements of § 6103 and is not a written determination within the meaning of § 6110.

.10 No effect on other law . Correction under these programs has no effect on the rights of any party under any other law, including Title I of the Employee Retirement Income Security Act of 1974 (“ERISA”).