IRS Announces Limited Expansion of its Determination Letter Program for Individually Designed Retirement Plans – But Questions Remain
On May 1, 2019, the IRS released Revenue Procedure 2019-20 which provides for a limited-scope expansion of its determination letter program for individually designed plans. Beginning on September 1, 2019, the IRS will accept determination letter applications submitted for the following types of plans:
Statutory hybrid plans (e.g., cash balance or pension equity plans). Applications will need to be filed during the 12-month period beginning on September 1, 2019 and ending on August 31, 2020.
“Merged Plans” (i.e., plans that have had other plans merged into them in connection with business transactions). Applications for merged plans will be accepted on an ongoing basis provided that (i) the plan merger was completed by the end of the first full plan year following the business transaction, and (2) the application is submitted by the end of the first full plan year following the plan merger.
By way of background, prior to 2017, individually designed retirement plans were generally required to renew IRS determinations of qualified status every five years (called the “remedial amendment cycle program”). The IRS announced in Revenue Procedure 2016-37 that it was ending the remedial amendment cycle program effective January 31, 2017, and that it would review only new or terminating individually designed plans going forward. The IRS reserved the right to open limited review periods at its discretion to ensure that plans are properly amended for law changes during the applicable remedial amendment period, which for required amendments, generally runs from the date the IRS issues the applicable “Required Amendment List” to the end of the second full plan year following that date. Similar to the old “Cumulative Lists,” the Required Amendment List is an annual list of required plan amendments issued by the IRS.
In 2018, the IRS sought comments on whether and to what extent the determination letter program should be expanded. In response to those comments, the IRS has now expanded the program to cover two areas ripe for IRS review – hybrid plans and merged plans. Key aspects of the new revenue procedure, including the deadlines and eligibility rules, are summarized below.
Individually Designed Statutory Hybrid Plans – Special One-Year Period for Review
As explained above, the IRS reserves the right to open limited review periods to ensure required amendments are timely adopted. Overall, there have been relatively few statutory and regulatory changes requiring amendments after the remedial amendment cycle program for individually designed retirement plans ended.
There have been, however, required amendments for statutory hybrid benefits plans that were not covered by prior IRS determinations. The IRS is opening a limited review period to pick up these changes. In brief, statutory hybrid plans are generally defined benefit plans that use either: (i) a cash balance formula (the balance of a hypothetical account maintained for the participant); or (ii) a pension equity formula (an accumulation percentage of the participant’s final average compensation).
Although it is not entirely clear, it would appear that the one-year review period would be open to any defined benefit plan that has a hybrid benefit formula, even if the plan’s hybrid formula applies only to a subset of the plan’s participants. In that case, the IRS would still review the entire plan for compliance with the 2017 Required Amendments List and all Required Amendments Lists and Cumulative Lists issued prior to 2016. As explained below, the IRS will assess penalties if it finds a plan document failure that is not related to the hybrid plan regulations.
Employers and other organizations sponsoring hybrid defined benefit plans should consider submitting their plans to the IRS in the upcoming review period. The guidance includes a favorable penalty structure in the event the IRS finds a plan document failure (whether or not related to the hybrid plan regulations). Even if a plan sponsor is confident that its plan has no document failures, obtaining a new determination letter provides important protection if the IRS audits a plan (and would mitigate some of the complications described in our May 3, 2017 blog entry describing life without a determination letter program). Further, although expiration dates on determination letters are no longer applicable (as set forth in Rev. Proc. 2016-37), plan sponsors cannot rely on a determination letter with respect to provisions that have been affected by a change in law.
Merged Plans – Ongoing Determination Letter Program
Beginning on September 1, 2019, the IRS will accept determination letter applications for individually designed “merged plans,” which are defined to include a single individually designed plan that results from the consolidation of two or more plans maintained by unrelated entities in connection with a corporate merger, acquisition, or other similar transaction between unrelated entities.
At first glance, the merged plan review procedure appears relatively straight-forward. However, the guidance gives rise to a number of important issues:
Are Sponsors Required to Submit Merged Plans for Review? Although IRS determinations are technically optional, the old remedial amendment cycle program imposed a significant cost for not participating – prior determinations would expire. After the old determination letter program was terminated, the IRS issued guidance stating that expiration dates in determination letters were no longer operative. Nevertheless, that guidance stated that a plan sponsor could rely on a determination letter only with respect to plan provisions that were not amended or affected by a change in law. Plan mergers require amendments related to, among other things, eligibility, vesting, transfer of assets, and maintenance of protected benefits. By not submitting a merged plan for review under the expanded review program, a sponsor would not be able to rely on a prior determination letter for provisions added to effectuate a plan merger occurring after the prior determination letter program was issued.
Merging Pre-Approved Plans into Individually Designed Plans. It is clear that in order to be eligible for the new merged plan review program, the end-product (i.e., the merged plan) must be individually designed. It is not clear, however, whether each merging plans needs to be individually designed. For example, many large companies routinely acquire small companies with pre-approved plans and then merge those pre-approved plans into the company’s individually designed plan. Although a pre-approved plan should be covered by an IRS opinion letter, it would make sense for the individually designed merged plan to be eligible for review.
Plan Document Failures from Acquired Plans. Even pre-approved plans can cause a plan document failure if the sponsor is unable to produced signed documents and amendments in connection with a determination letter review. Although the IRS’s expanded determination letter program has a favorable penalty structure when compared to the old remedial amendment cycle program, the program’s penalties for document failures in acquired plans are still higher than under the IRS’s Voluntary Correction Program. Therefore, the IRS has maintained an incentive to use the Voluntary Correction Program for document failures unrelated to provisions necessary to effectuate a plan merger.
Pre-2017 Transactions. Under the timing requirements set forth above, a number of plan mergers that occurred after the old remedial amendment cycle program ended would not be eligible for review.
Multiple Plan Mergers. Many companies make acquisitions every year. For these companies, complying with the expanded determination program could be burdensome. To get IRS review of each plan merger (and, thus, take advantage of the favorable penalty structure), these companies would have to submit their merged plans for review every year.
Special Sanction/Penalty Structure
The IRS also outlined a special sanction structure for plan document failures identified during the expanded determination letter review program. The IRS will not impose sanctions for any document failure (i) related to a plan provision required to meet the statutory hybrid plan regulations, or (ii) related to a plan provision intended to effectuate a plan merger (provided application timing requirements are met). For plan document failures unrelated to plan provisions implementing the statutory hybrid plan regulations or to the plan provision effectuating a plan merger, the IRS will impose a reduced sanction as if the plan sponsor self-identified the error through the IRS’s Voluntary Correction Program (provided that the error was made in good faith).
For all other plan document failures identified during the determination letter review process, the IRS will impose a sanction equal to 150% or 250% (depending on duration of failure) of the IRS user fee that would have applied had the error been self-identified under the Voluntary Correction Program. Under this special sanction structure, penalties (if any) for document failures are generally less severe than they would have been had they been discovered by IRS review under the old remedial amendment cycle program. The IRS maintained the incentive to correct under the Voluntary Correction Program, which is generally a cheaper option when correcting document failures.
The IRS is accepting comments on the expanded determination letter program. A plan sponsor considering whether to submit a plan for review under the expanded program should consult with counsel to ensure that the plan is eligible for the program and that all potential qualification issues are considered prior to submission.