Internal Revenue Bulletin: 2016-42

October 17, 2016


Highlights of This Issue

These synopses are intended only as aids to the reader in identifying the subject matter covered. They may not be relied upon as authoritative interpretations.

INCOME TAX

Notice 2016–60 Notice 2016–60

This notice explains the circumstances under which the 4-year replacement period under section 1033(e)(2) is extended for livestock sold on a count of drought. The Appendix to this notice contains a list of counties that experienced exception, extreme, or severe drought conditions during the 12-month period ending August 31, 2016. Taxpayers may use this list to determine if any extension is available.

T.D. 9786 T.D. 9786

This document contains final regulations concerning the application of the credit for increasing research activities and provide guidance on software that is developed by (or for the benefit of) the taxpayer primarily for internal use by the taxpayer (internal use software). These final regulations also include examples to illustrate the application of the process of experimentation requirement to software.

EMPLOYEE PLANS

Rev. Proc. 2016–51 Rev. Proc. 2016–51

This revenue procedure updates the comprehensive system of correction programs for sponsors of retirement plans that are intended to satisfy the requirements of § 401(a), 403(a), 403(b), 408(k), or 408(p) of the Internal Revenue Code (the "Code"), but that have not met these requirements for a period of time. This system, the Employee Plans Compliance Resolution System ("EPCRS"), permits Plan Sponsors to correct these failures and thereby continue to provide their employees with retirement benefits on a tax-favored basis. EPCRS is being modified to take into account the changes in the determination letter application program, as described in Rev. Proc. 2016–37. In addition, this revenue procedure incorporates certain modifications set forth in Rev. Proc. 2015–27 and Rev. Proc. 2015–28, two prior revenue procedures which modified Rev. Proc. 2013–12. The revenue procedure also includes modifications to Rev. Proc. 2013–12 from Rev. Proc. 2016–8. Rev. Proc. 2013–12, Rev. Proc. 2015–27 and Rev. Proc. 2015–28 modified and superseded by this revenue procedure.

ESTATE TAX

Rev. Proc. 2016–49 Rev. Proc. 2016–49

This guidance provides procedures to disregard and treat as null and void for transfer tax purposes a qualified terminable interest property (QTIP) election in situations where the QTIP election was not necessary to reduce the estate tax liability to zero. This guidance provides that such procedures are unavailable where QTIP elections are made in estates in which the executor elected portability of the deceased spousal unused exclusion (DSUE) amount under § 2010(c)(5)(A). This guidance modifies and supersedes Rev. Proc. 2001–38, 2001–1 C.B. 1335.

GIFT TAX

Rev. Proc. 2016–49 Rev. Proc. 2016–49

This guidance provides procedures to disregard and treat as null and void for transfer tax purposes a qualified terminable interest property (QTIP) election in situations where the QTIP election was not necessary to reduce the estate tax liability to zero. This guidance provides that such procedures are unavailable where QTIP elections are made in estates in which the executor elected portability of the deceased spousal unused exclusion (DSUE) amount under § 2010(c)(5)(A). This guidance modifies and supersedes Rev. Proc. 2001–38, 2001–1 C.B. 1335.

ADMINISTRATIVE

Rev. Proc. 2016–52 Rev. Proc. 2016–52

This procedure publishes the amounts of unused housing credit carryovers allocated to qualified states under section 42(h)(3)(D) of the Code for calendar year 2016.

Notice 2016–59 Notice 2016–59

This notice advises of revisions to the requirements for the reduced user fee for substantially identical letter rulings set forth in section 15.07(2) of Rev. Proc. 2016–1, 2016–1 I.R.B. 1, and further described in paragraph (A)(5)(a) of Appendix A of Rev. Proc. 2016–1. This notice also corrects the amount of the user fee for Foreign Insurance Excise Tax Waiver Agreements stated in paragraph (A)(3)(e) of Appendix A of Rev. Proc. 2016–1.

Preface

The IRS Mission

Provide America’s taxpayers top-quality service by helping them understand and meet their tax responsibilities and enforce the law with integrity and fairness to all.

Introduction

The Internal Revenue Bulletin is the authoritative instrument of the Commissioner of Internal Revenue for announcing official rulings and procedures of the Internal Revenue Service and for publishing Treasury Decisions, Executive Orders, Tax Conventions, legislation, court decisions, and other items of general interest. It is published weekly.

It is the policy of the Service to publish in the Bulletin all substantive rulings necessary to promote a uniform application of the tax laws, including all rulings that supersede, revoke, modify, or amend any of those previously published in the Bulletin. All published rulings apply retroactively unless otherwise indicated. Procedures relating solely to matters of internal management are not published; however, statements of internal practices and procedures that affect the rights and duties of taxpayers are published.

Revenue rulings represent the conclusions of the Service on the application of the law to the pivotal facts stated in the revenue ruling. In those based on positions taken in rulings to taxpayers or technical advice to Service field offices, identifying details and information of a confidential nature are deleted to prevent unwarranted invasions of privacy and to comply with statutory requirements.

Rulings and procedures reported in the Bulletin do not have the force and effect of Treasury Department Regulations, but they may be used as precedents. Unpublished rulings will not be relied on, used, or cited as precedents by Service personnel in the disposition of other cases. In applying published rulings and procedures, the effect of subsequent legislation, regulations, court decisions, rulings, and procedures must be considered, and Service personnel and others concerned are cautioned against reaching the same conclusions in other cases unless the facts and circumstances are substantially the same.

The Bulletin is divided into four parts as follows:

Part I.—1986 Code. This part includes rulings and decisions based on provisions of the Internal Revenue Code of 1986.

Part II.—Treaties and Tax Legislation. This part is divided into two subparts as follows: Subpart A, Tax Conventions and Other Related Items, and Subpart B, Legislation and Related Committee Reports.

Part III.—Administrative, Procedural, and Miscellaneous. To the extent practicable, pertinent cross references to these subjects are contained in the other Parts and Subparts. Also included in this part are Bank Secrecy Act Administrative Rulings. Bank Secrecy Act Administrative Rulings are issued by the Department of the Treasury’s Office of the Assistant Secretary (Enforcement).

Part IV.—Items of General Interest. This part includes notices of proposed rulemakings, disbarment and suspension lists, and announcements.

The last Bulletin for each month includes a cumulative index for the matters published during the preceding months. These monthly indexes are cumulated on a semiannual basis, and are published in the last Bulletin of each semiannual period.

Part I. Rulings and Decisions Under the Internal Revenue Code of 1986

T.D. 9786

Credit for Increasing Research Activities

DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1

AGENCY:

Internal Revenue Service (IRS), Treasury.

ACTION:

Final regulations.

SUMMARY:

This document contains final regulations concerning the application of the credit for increasing research activities. These final regulations provide guidance on software that is developed by (or for the benefit of) the taxpayer primarily for internal use by the taxpayer (internal use software). These final regulations also include examples to illustrate the application of the process of experimentation requirement to software. These final regulations will affect taxpayers engaged in research activities involving software.

DATES:

Effective date: These regulations are effective on October 4, 2016.

Applicability date: For date of applicability see § 1.41–4(e).

FOR FURTHER INFORMATION CONTACT:

Martha Garcia or Jennifer Records of the IRS Office of the Associate Chief Counsel (Passthroughs and Special Industries) at (202) 317-6853 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

This document contains final regulations that amend the Income Tax Regulations (26 CFR part 1) relating to the credit for increasing research activities (research credit) under section 41 of the Internal Revenue Code (Code). Section 41(d)(4)(E) provides that, except to the extent provided by regulations, research with respect to software that is developed by (or for the benefit of) the taxpayer primarily for internal use by the taxpayer is excluded from the definition of qualified research under section 41(d). Software that is developed for use in an activity that constitutes qualified research for purposes of section 41(d) and software that is developed for use in a production process with respect to which the general credit eligibility requirements under section 41 are satisfied are internal use software, but are not excluded under section 41(d)(4)(E) from the definition of qualified research and are not subject to these regulations.

On January 20, 2015, the Treasury Department and the IRS published in the Federal Register (80 FR 2624, January 20, 2015) a notice of proposed rulemaking (REG–153656–03, 2015–5 IRB 566) under section 41 (the proposed regulations) relating to the research credit. Comments responding to the proposed regulations were received and a public hearing was held on April 17, 2015. After consideration of all of the comments received, these final regulations adopt the proposed regulations as revised by this Treasury decision.

Summary of Comments and Explanation of Provisions

I. Definition of Internal Use Software

The proposed regulations provided that software is developed by (or for the benefit of) the taxpayer primarily for internal use if the software is developed by the taxpayer for use in general and administrative functions that facilitate or support the conduct of the taxpayer’s trade or business. General and administrative functions, as defined in the proposed regulations, are limited to (1) financial management functions, (2) human resource management functions, and (3) support services functions. Financial management functions are functions that involve the financial management of the taxpayer and the supporting recordkeeping. Human resource management functions are functions that manage the taxpayer’s workforce. Support services functions are functions that support the day-to-day operations of the taxpayer, such as data processing or facilities services.

Commenters expressed concern that the list of general and administrative functions in the proposed regulations was overly broad and included functions that do not represent “back-office” functions. In particular, the commenters noted that inventory management, marketing, legal services, and government compliance services can provide significant benefits to third parties and may be developed to enable a taxpayer to interact with third parties or to allow third parties to initiate functions or review data on the taxpayer’s system. Specifically, one commenter noted that many inventory management software applications are an integral part of a taxpayer’s supply chain management system and can be readily seen as part of the modern “front office.” This commenter noted that modern inventory management software usually requires interaction with a number of third party vendors to ensure the correct flow of raw materials and a corresponding flow of finished goods. Additionally, the commenter added that inventory management is inherently customer facing because it provides the proper amount of inventory to customers at the point of sale at the right time. Another commenter added that marketing is an external-facing function by nature, and software that supports marketing is necessarily intended to interact with third parties.

The Treasury Department and the IRS understand that many modern software systems perform more than back-office functions. These software systems commonly provide benefits to vendors and include functions that are customer facing. Additionally, software with functions such as marketing or inventory management may not provide solely back-office functions, but may also contain functions that enable a taxpayer to interact with third parties or to allow third parties to initiate functions or review data on the taxpayer’s system. Recognizing such situations, the proposed regulations provided rules under § 1.41–4(c)(6)(iv)(C) (dual function rules) to evaluate whether software that has both back-office and front-office functions is developed primarily for internal use. The Treasury Department and the IRS continue to believe that functions such as inventory management, marketing, legal services, and government compliance services provide support to day-to-day operations of a taxpayer in carrying on business regardless of the taxpayer’s industry and that the benefits that such functions may provide to third parties are collateral and secondary. In addition, the Treasury Department and the IRS believe the dual function rules in these final regulations sufficiently address these comments by allowing taxpayers to identify subsets of elements of dual function software that only enable a taxpayer to interact with third parties or allow third parties to initiate functions or review data. Accordingly, the list of general and administrative functions provided in the proposed regulations remains unchanged in the final regulations.

Another commenter referred to the tax software example in the preamble to the proposed regulations which notes that tax software developed by a company engaged in providing tax services to its customers is not used by the taxpayer in general and administrative functions even though tax is listed under § 1.41–4(c)(6)(iii)(B)(1) of the proposed regulations, as a general and administrative function. The commenter requested that we make this concept more explicit by revising § 1.41–4(c)(6)(iii)(A) of the proposed regulations and providing additional examples. As discussed in the preamble to the proposed regulations, the list of general and administrative functions is intended to target the back-office functions that most taxpayers would have regardless of the taxpayer’s industry, although the characterization of a function as back office will vary depending on the facts and circumstances of the taxpayer. Because § 1.41–4(c)(6)(v) of these final regulations makes clear that the determination of whether software is developed primarily for internal use depends on the intent of the taxpayer and the facts and circumstances at the beginning of software development, the Treasury Department and the IRS believe that additional clarifying language and examples are unnecessary.

II. Definition of software not developed primarily for internal use

The proposed regulations provided that software is not developed primarily for internal use only if it is developed to be commercially sold, leased, licensed, or otherwise marketed to third parties, or if it is developed to enable a taxpayer to interact with third parties or to allow third parties to initiate functions or review data on the taxpayer’s system. After consideration of the comments described herein, these final regulations clarify that (1) software is not developed primarily for the taxpayer’s internal use if it is not developed for use in general and administrative functions that facilitate or support the conduct of the taxpayer’s trade or business; and (2) software that is developed to be commercially sold, leased, licensed, or otherwise marketed to third parties and software that is developed to enable a taxpayer to interact with third parties or to allow third parties to initiate functions or review data on the taxpayer’s system are examples of software that is not developed primarily for the taxpayer’s internal use.

A. Software developed to be commercially sold, leased, licensed or otherwise marketed to third parties

A commenter requested that § 1.41–4(c)(6)(iv)(A)(1) of the proposed regulations be revised to state that software is not developed primarily for the taxpayer’s internal use if the software is developed to be commercially sold, leased, licensed, hosted, or otherwise marketed to third parties. (Emphasis added.) The commenter also recommended additional language to further define “otherwise marketed” to include transactions where the taxpayer effectively provides the functionality of the software to a third party even if there is no transfer of a copy of the software itself to such third party. The Treasury Department and the IRS understand that a taxpayer may develop software where the full functionality of that software is provided to a third party even though there is no transfer of a copy of the software. The Treasury Department and the IRS believe the phrase “software that is developed to be commercially sold, leased, licensed or otherwise marketed to third parties” is sufficiently broad to encompass hosted software and other software where there is no transfer of a copy of the software. An example has been added to further illustrate this point (Example 9 of these final regulations).

B. Software developed to enable a taxpayer to interact with third parties or allow third parties to initiate functions or review data on the taxpayer’s system

Several commenters requested clarification on the terms “interact,” “initiate,” or “review,” and recommended additional examples illustrating the terms. One commenter noted that a common example that should be clarified is whether a third party reviewing a website constitutes “interaction,” “initiate functions,” or “review data.” In response to these comments, the final regulations clarify that software that is developed to enable a taxpayer to interact with third parties or to allow third parties to initiate functions or review data on the taxpayer’s system are examples of software that is not developed primarily for the taxpayer’s internal use. In addition, these final regulations provide that the determination of whether software is internal use or developed to enable a taxpayer to interact with third parties or to allow third parties to initiate functions or review data on the taxpayer’s system depends on the intent of the taxpayer and the facts and circumstances at the beginning of the software development. Accordingly, Example 3 of the proposed regulations, now designated as Example 4 in these final regulations, is revised to show that software developed with the intent of marketing via a website and not to allow third parties to review data on the taxpayer’s system is developed for internal use because it was developed for use in a general and administrative function.

III. Connectivity software

In the proposed regulations, the Treasury Department and the IRS requested comments on the appropriate definition and treatment of connectivity software that allows multiple processes running on one or more machines to interact across a network, sometimes referred to as bridging software, integration software, or middleware. The Treasury Department and the IRS received very few responses to this request for comments. One of the commenters noted that the treatment of such software is challenging because of its multi-faceted purposes; it could fall within a category in which it is not sold, does not interact with a third party, and does not perform a general and administrative function. The other commenter recommended that the regulations provide a general rule for connectivity software that is tied to the intent of the taxpayer and the facts and circumstances at the beginning of the software development and that the regulations provide examples demonstrating the rule. In addition, with respect to this category of software, the Treasury Department and the IRS understand that with wide use and availability of enterprise resource planning (ERP) software, few companies actually engage in developing connectivity software. Connectivity software is often purchased or the need for it has diminished due to the use of ERP software.

After further consideration of business practices and the limited comments received, the Treasury Department and the IRS believe that a special rule for connectivity software is not needed. The final regulations clarify that software is not developed by (or for the benefit of) the taxpayer primarily for the taxpayer’s internal use if the software is not developed for use in general and administrative functions. Accordingly, any software that is not developed to be used in a general and administrative function will not be considered to be developed for internal use. This is the case even if the software is not developed to be commercially sold, leased, licensed, or otherwise marketed to third parties, or is not developed to enable a taxpayer to interact with third parties or to allow third parties to initiate functions or review data on the taxpayer’s system.

Furthermore, connectivity software should not be specifically identified or categorized differently from other types of software. Whether certain software is developed to be used primarily for internal use should be based on the function the software provides, rather than the type of software. For example, connectivity software that is developed to connect a taxpayer’s existing payroll software with financial budgeting software to allow an exchange of data between the two software modules would be considered to be developed for the taxpayer’s internal use because the connectivity software’s function is to be used in human resources and financial management functions. Accordingly, the Treasury Department and the IRS believe that the general rule in the final regulations to determine whether or not software is developed primarily for internal use already provides sufficient guidance for connectivity software. Whether software, including connectivity software, is developed for use in general and administrative functions depends upon the intent of the taxpayer and the facts and circumstances at the beginning of the software development.

IV. Intent of the taxpayer and the facts and circumstances at the beginning of the software development

The proposed regulations provided that whether software is or is not developed primarily for internal use depends upon the intent of the taxpayer and the facts and circumstances at the beginning of the software development. If a taxpayer originally develops software primarily for internal use but later makes improvements to the software with the intent to hold the improved software for commercial sale, lease, or license or to allow third parties to initiate functions or review data on the taxpayer’s system, the improvements will be considered separate from the existing software and will not be considered developed primarily for internal use. Likewise, if a taxpayer originally develops software for commercial sale, lease, or license or to interact with third parties or to allow third parties to initiate functions or review data on the taxpayer’s system, but later makes improvements to the software with the intent to use the software in general and administrative functions, the improvements will be considered separate from the existing software and will be considered developed primarily for internal use. After consideration of the comments described below, these final regulations retain these rules without modification.

A commenter explained that it is common for a taxpayer to initiate a software development project with one purpose in mind and to later discover that other purposes should be considered and pursued. Commenters also explained that it is common for a taxpayer to abandon its original intentions of how the software might be used. Commenters made several different recommendations, among them that the final regulations adopt a standard that allows facts at any point during the software development to be considered. Another suggested looking to the intended use of the software, and not just the improvements, as of the tax return filing date for the taxable year or the beginning of the taxable year in which the software development expenditures were incurred. One commenter further suggested that if the regulations require a determination at the beginning of the software development, the regulations should allow that determination to be rebutted with evidence about how the software is actually used when it is placed in service. Commenters also noted that taxpayers will likely have difficulty substantiating their intended use of the software at the beginning of the development process.

The Treasury Department and the IRS conclude that only a rule that generally requires that a determination be made at the beginning of software development is consistent with the intent and the purpose of section 41. Congress intended that the credit for increasing research activities would provide an incentive for greater private activity in research. That incentive nature of section 41 is promoted by taking into account a taxpayer’s intent at the beginning of the software development; allowing any change in a taxpayer’s intent throughout the development to support treatment as qualifying research of expenses incurred prior to that change would frustrate the purpose of the credit. Furthermore, allowing a taxpayer to redetermine the overall project’s credit eligibility throughout the development which could span multiple years would provide uncertain and inconsistent treatment and impose an undue burden on both taxpayers and the IRS. Finally, the final regulations continue to provide a special rule for improvements to software that can be separately identified. This special rule would apply, for example, when a taxpayer completes a software development and then decides to improve that software by undertaking further development to the same software.

V. Dual Function Software and Safe Harbor

A. Presumption and third party subset

The proposed regulations provided that software developed by (or for the benefit of) the taxpayer both for use in general and administrative functions that facilitate or support the conduct of the taxpayer’s trade or business and to enable a taxpayer to interact with third parties or to allow third parties to initiate functions or review data (dual function software) is presumed to be developed primarily for a taxpayer’s internal use. However, this presumption is inapplicable to the extent that a taxpayer can identify a subset of elements of dual function software that only enables a taxpayer to interact with third parties or allows third parties to initiate functions or review data on the taxpayer’s system (third party subset). The proposed regulations provided that if the taxpayer can identify a third party subset, the portion of qualified research expenditures allocable to such third party subset of the dual function software may be eligible for the research credit, provided all the other applicable requirements are met.

The Treasury Department and the IRS received several comments on dual function software rules. One commenter recommended changes to clarify that the dual function software rules do not apply to software developed to be commercially sold, leased, licensed, or otherwise marketed to third parties, even if such software was also developed to enable a taxpayer to interact with third parties or to allow third parties to initiate functions or review data on the taxpayer’s system.

The Treasury Department and the IRS believe such clarification is unnecessary as § 1.41–4(c)(6)(iv)(C)(1) of the proposed regulations clearly defines dual function software as software that is developed by the taxpayer both for use in general and administrative functions and to enable a taxpayer to interact with third parties or to allow third parties to initiate functions or review data. Software that is developed to be commercially sold, leased, licensed, or otherwise marketed to third parties is not dual function software, even if such software was also developed to enable a taxpayer to interact with third parties or to allow third parties to initiate functions or review data on the taxpayer’s system.

One commenter suggested that the “substantially all” and “shrink back” rules found in § 1.41–4(b)(2) can be easily applied to evaluate dual function software. If substantially all of the software is non-internal use, then all of the software should be considered non-internal use under the substantially all rule. Similarly, if substantially all of the software is internal use, then the software should be considered internal use. In the case where the software as a whole does not meet the substantially all rule, then the taxpayer would apply the shrink back rule and the software would be divided into subcomponents based on functionality until the non-internal use portion and the internal use portion were appropriately separated. That commenter noted that these two rules have worked for many years with little difficulty in other areas of the research credit rules and could be used equally well to address the issue of dual function software. Another commenter encouraged the addition of a rule to cover cases in which a taxpayer’s dual function subset’s third party use or interaction exceeds 80 percent. The commenter stated that in this circumstance, the remaining internal use is de minimis and should be disregarded and the entire development should be treated as not developed for internal use.

The shrink back rule provides that the requirements of section 41(d) and § 1.41–4(a) are to be applied first at the level of the discrete business component, that is, the product, process, computer software, technique, formula, or invention to be held for sale, lease, or license, or used by the taxpayer in a trade or business of the taxpayer. If these requirements are not met at that level, then they apply at the most significant subset of elements of the product, process, computer software, technique, formula, or invention to be held for sale, lease, or license. This shrinking back of the product is to continue until either a subset of elements of the product that satisfies the requirements is reached, or the most basic element of the product is reached and such element fails to satisfy the test.

The Treasury Department and the IRS believe that the proposed rules already apply principles similar to the shrink back rule to allow taxpayers to identify a subset of elements of dual function software that only enables a taxpayer to interact with third parties or allows third parties to initiate functions or review data on the taxpayer’s system. The substantially all test referenced by the commenter is similar to the general credit eligibility requirement in section 41(d)(1)(C), which provides that in order for activities to constitute qualified research, substantially all of the activities must constitute elements of a process of experimentation that relates to a qualified purpose. Under § 1.41–4(a)(6), this substantially all requirement is satisfied only if 80 percent or more of a taxpayer’s research activities, for the development or improvement of a business component, measured on a cost or other consistently applied reasonable basis, constitute elements of a process of experimentation. In contrast to the general requirement of section 41(d)(1) pertaining to qualifying research, section 41(d)(4)(E) does not apply the substantially all test when it excludes activities related to internal use software from qualifying research. Accordingly, the Treasury Department and the IRS believe the use of the substantially all test in these regulations is inappropriate, and the final regulations do not adopt the commenter’s suggested approach.

Another commenter requested that the dual function rules be eliminated because the provisions are confusing and unnecessary and that trying to delineate elements of dual function software raises significant administrative issues. Similarly, another commenter noted that the concepts in the dual function rules can be confusing to taxpayers and will require additional recordkeeping by taxpayers. According to this commenter, most taxpayers do not differentiate their software applications by “third party interactions” or generally track such interactions. One commenter similarly stated that § 1.41–4(c)(6)(iv)(C) of the proposed regulations fails to take into account that software systems cannot always be broken into mutually exclusive subsets enabling only internal use or third party functionality.

Regarding the presumption that dual function software is developed for internal use, a commenter stated that such presumption is contrary to the intent of the statute. One commenter recommended that the presumption should be replaced with a primary purpose test, consistent with the statutory language that looks to whether software is developed “primarily” for internal use.

The Treasury Department and the IRS believe it is necessary to implement rules for dual function software as this type of software development is increasingly common in business practice. Rather than simply reiterating the “primarily” language in the statute, these regulations specifically identify the types of software functions that are considered to be primarily for internal use. A definition that specifically identifies the types of software functions that are considered to be primarily for internal use provides a clearer objective test that will provide consistency in application. The nature of software and its development has rapidly evolved over time, and the statute did not expressly address the treatment of dual function software. In conjunction with crafting a narrow definition of internal use, the Treasury Department and the IRS believe that the dual function software rules in the proposed regulations strike an appropriate balance between the administrative burdens and compliance concerns relating to claiming the research credit for activities relating to software. Thus, these final regulations retain the dual function rules. These final regulations are applicable to taxable years beginning on or after the date of their publication in the Federal Register. Taxpayers have been aware of the proposed rules and have had the opportunity to begin maintaining the necessary documentation to establish their entitlement to research credits under these rules.

B. Safe Harbor

The proposed regulations provided taxpayers with a safe harbor to apply to dual function software if there remains a subset of elements of dual function software (dual function subset) after the third party subset has been identified. The safe harbor allows a taxpayer to include 25 percent of the qualified research expenditures of the dual function subset in computing the amount of the taxpayer’s credit, provided that the taxpayer’s research activities related to the dual function subset constitute qualified research and the use of the dual function subset by third parties or by the taxpayer to interact with third parties is reasonably anticipated to constitute at least 10 percent of the dual function subset’s use.

Some commenters requested that the safe harbor be removed from the regulations. Specifically, one commenter stated that the burdens associated with the safe harbor may be greater than its benefits and noted the multiple steps that a taxpayer must take to determine if it meets the safe harbor. Another commenter noted that the safe harbor complicates the administration of the credit for both taxpayers and the IRS.

Another commenter noted that the safe harbor potentially penalizes the taxpayer with the inequitable result of allowing only 25 percent of the qualified research expenditures. According to the commenter, given that a taxpayer must document anticipated use, it should then follow that the portion of software treated as third party facing should mirror this analysis. In other words, the proportion anticipated to be third party facing should be the proportion of software that is not developed primarily for internal use.

After careful consideration, the final regulations do not adopt these comments. However, the safe harbor has been modified to clarify that the safe harbor can be applied to the dual function software or the dual function subset after the application of § 1.41–4(c)(6)(vi)(B) of the final regulations. The safe harbor is not a requirement but an option available for taxpayers who cannot identify a third party subset, or after identification of a third party subset, still have a dual function subset. Without the safe harbor, dual function software or a dual function subset would be presumed to be internal use and the taxpayer would have to demonstrate that the research with respect to the dual function software or dual function subset meets the high threshold of innovation test in addition to the general eligibility requirements under section 41(d)(1). The safe harbor provides a benefit, not a detriment, to taxpayers, provided the dual function software or dual function subset’s use by third parties is anticipated to be at least 10 percent of the total use. Taxpayers who consider it too burdensome to comply with the requirements of the safe harbor can choose not to rely upon it.

C. Time of determination

Several commenters noted concerns with the time of determination for the application of the safe harbor. A commenter noted that determining the percentage of third party use based upon an estimate made at the beginning of software development imposes an undue administrative burden and may not be an accurate reflection of the actual use once the software is released. This commenter requested that the rule be eliminated or amended to provide that a taxpayer must estimate third party use once the software is deployed. Similarly, another commenter noted that it has not been their experience that taxpayers plot out the future expected use of their software at the time the development begins with such specificity, especially given that software development is an iterative development process where functionality and expected uses rapidly evolve. Lastly, another commenter requested that, similar to the provisions for improvements to existing software, there should be a mechanism to recharacterize software over time.

While the Treasury Department and the IRS understand commenters’ concerns, the final regulations do not change the requirement that the time of determination occur at the beginning of the software development. As discussed herein, the Treasury Department and the IRS continue to believe that the rule requiring that a determination be made at the beginning of the software development is most accurate and appropriate given Congress’ intent that the research credit serve as an incentive to conduct qualifying research rather than an unanticipated reward for doing so.

D. Objective reasonable method

In the proposed regulations, the Treasury Department and the IRS invited comments on the administrability of measuring the reasonably anticipated use of software by taxpayers to interact with third parties and by third parties to initiate functions or review data based on reasonable methods (such as processing time, amount of data transfer, number of software user interface screens, number of third party initiated functions, and other objective, reasonable methods) and whether the regulations should include specific reasonable methods and examples.

A commenter recommended that due to the wide range of taxpayers that will be subject to these regulations, the final regulations should not provide overly detailed examples of “reasonable methods.” This commenter noted that it should be clear that any examples of reasonable methods are for illustrative purposes only and any reasonable method may be acceptable. Another commenter recommended the adoption of the phrase “within each industry” to ensure that the application of the objective, reasonable method takes into account unique aspects of all taxpayers within given industries.

The Treasury Department and the IRS agree that it is unrealistic to impose one specific method that will be used to measure reasonably anticipated use due to the variety of industries that are subject to the final regulations. Therefore, the final regulations provide that any objective, reasonable method within the taxpayer’s industry may be used for purposes of the safe harbor.

VI. Third party definition

The proposed regulations provided that the term “third party” means any corporation, trade or business, or other person that is not treated as a single taxpayer with the taxpayer pursuant to section 41(f). A commenter raised concerns and requested that the Treasury Department and the IRS reconsider whether it is appropriate to apply the controlled group standard under section 41(f). The commenter contended that this third party definition would potentially deny a research credit to some software for artificial reasons. The commenter further noted that if the regulations do not modify the third party definition, taxpayers should at least have an opportunity to demonstrate that software provided to a member of the controlled group is not internal use software based on the facts and circumstances.

The Treasury Department and the IRS continue to believe that the use of the controlled group standard under section 41(f) is appropriate. A well established, objective standard is essential and using the standard in section 41(f) is consistent with the reference to section 41(f) in section 41(b)(2) relating to in-house research expenditures and in § 1.41–6(a)(3)(ii) relating to the definition of controlled group for purposes of aggregating expenditures.

The proposed regulations also provided that third parties do not include any persons that use the software to support the taxpayer’s general and administrative functions that facilitate or support the conduct of the taxpayer’s trade or business, e.g., the taxpayer’s own vendors. A commenter contended that excluding any person that uses a taxpayer’s software to support a general and administrative function from the definition of third party creates confusion and blurs a well-conceived, objective measurement. This commenter believes the term third party suggests a person who is external to the organization or a person who is not an employee. The Treasury Department and the IRS note that the statute provides a higher standard for internal use software, in part, because the benefits of such software are intended primarily for the taxpayer developing it. Where a taxpayer develops software for internal use, any benefit to others, such as vendors or those who provide support services to the taxpayer, is collateral and secondary. Accordingly, the final regulations do not adopt these comments requesting a change to the definition of third party.

VII. High Threshold of Innovation - Significant Economic Risk

The proposed regulations provided that certain internal use software is eligible for the research credit if the software satisfies the high threshold of innovation test, the three parts of which are (1) software is innovative in that the software would result in a reduction in cost or improvement in speed or other measurable improvement, that is substantial and economically significant, if the development is or would have been successful; (2) software development involves significant economic risk in that the taxpayer commits substantial resources to the development and there is a substantial uncertainty, because of technical risk, that such resources would be recovered within a reasonable period; and (3) software is not commercially available for use by the taxpayer in that the software cannot be purchased, leased, or licensed and used for the intended purpose without modifications that would satisfy the innovation and significant economic risk requirements. The proposed regulations further provided that substantial uncertainty exists if, at the beginning of the taxpayer’s activities, the information available to the taxpayer does not establish the capability or method for developing or improving the software.

A. Design Uncertainty

Several commenters requested that the final regulations include design uncertainty in the definition of technical risk for purposes of meeting the significant economic risk test. Commenters noted that both sections 174 and 41 have long included the concept of design uncertainty. Commenters also raised concerns that the statute and regulations do not define the concepts of capability, methodology, and design uncertainty. Commenters further explained that these three types of uncertainties are inherently related to each other, and it is often difficult for taxpayers to clearly state or describe which type of uncertainty they face.

The use of the word “substantial” before “uncertainty” in the significant economic risk test for internal use software indicates a higher threshold of uncertainty than that required for business components that are not internal use software. While there may be design uncertainty in the development of internal use software, substantial uncertainty generally exists only when there is also uncertainty in regard to the capability or method of achieving the intended result. However, the Treasury Department and the IRS understand that it is difficult to delineate the types of technical uncertainties and attempting to do so may lead to unnecessary burdens on both taxpayers and the IRS. Furthermore, the appropriate design uncertainty of internal use software may be inextricably linked to substantial uncertainty regarding capability or method. The focus of the significant economic risk test should be on the level of uncertainty that exists and not the types of uncertainty. For these reasons, the final regulations remove the reference to capability and method uncertainty. However, the Treasury Department and the IRS believe that internal use software research activities that involve only uncertainty related to appropriate design, and not capability or methodology, would rarely qualify as having substantial uncertainty for purposes of the high threshold of innovation test.

B. Substantial Resources/Reasonable Time Period

A commenter requested that the final regulations provide further explanation or examples on what constitutes “substantial resources” or a “reasonable time period” for purposes of meeting the significant economic risk test. The Treasury Department and the IRS believe that whether the amount of resources committed is substantial or whether substantial resources would be recovered within a reasonable time period are factual determinations to be resolved based on the taxpayer’s facts and circumstances and, therefore, further explanation or examples would be too specific and not helpful. Accordingly, the final regulations do not adopt these comments.

C. Application of High Threshold of Innovation Test

Another commenter requested deletion of the statement, “[i]t is not always necessary to have a revolutionary discovery or creation of new technologies such as a new programming language, operating system, architecture, or algorithm to satisfy the high threshold of innovation test.” The commenter is concerned that the sentence can be read to imply that in some situations it will be necessary to have a revolutionary discovery to qualify internal use software for the research credit. The Treasury Department and the IRS did not intend the inclusion of this statement to have the interpretation suggested or taken by the commenter. Accordingly, the Treasury Department and the IRS agree that this statement should be removed from the final regulations because a revolutionary discovery is not required to meet the high threshold of innovation test.

Furthermore, the Treasury Department and the IRS are revising §§ 1.41–4(c)(6)(i) and (ii) of the proposed regulations to clarify that the internal use software rules under § 1.41–4(c)(6) do not apply to (1) software developed for use in an activity that constitutes qualified research, (2) software developed for use in a production process to which the requirements of section 41(d)(1) are met, and (3) a new or improved package of software and hardware developed together by the taxpayer as a single product. Accordingly, under the final regulations, the high threshold of innovation test applies only to the software developed for use in general and administrative functions that facilitate or support the conduct of the taxpayer’s trade or business and to dual function software.

VIII. Examples

A. Process of Experimentation

Section 1.41–4(a)(8) of the proposed regulations provided six new examples illustrating the application of the process of experimentation requirement to software under section 41(d)(1)(C).

One commenter noted that the examples appear to suggest a presumption that activities related to developing web design or ERP software do not meet the process of experimentation requirement. This commenter requested that the final regulations clearly state the reasons for such presumption. The proposed regulations and these final regulations do not establish a presumption against a particular type of software; rather these examples focus on the facts and circumstances surrounding activities to determine whether they involve a process of experimentation.

Another commenter requested that the final regulations include additional examples demonstrating fact patterns that do not initially qualify as a process of experimentation but where a change in facts introduces technical uncertainty that requires a process of experimentation. The final regulations could provide examples describing a particular change in facts that would introduce technical uncertainty and require a process of experimentation; however, because the examples are very factual and would differ based on a taxpayer’s business, we do not think more examples would provide the clarification that the commenter is seeking. Accordingly, the final regulations do not include additional examples to address this comment.

i. Example 6

Section 1.41–4(a)(8), Example 6, of the proposed regulations analyzed whether activities related to selecting a commercial software vendor with object-oriented functions and selecting and incorporating the specific functions into new software developed by X involved conducting a process of experimentation.

One commenter noted that the use of certain terms in Example 6, such as “develop,” “evaluate,” and “determine” suggest that the process of experimentation criteria may be met and recommended changes to clearly show that a purchase, installation, and selection from pre-determined categories do not meet a process of experimentation. We disagree with the commenter because the use or nonuse of certain terms is not an implication that the process of experimentation criteria has or has not been met. This example is intended to show that the process of experimentation requirement is not met regardless of the terms used. Accordingly, the final regulations do not adopt this comment.

ii. Example 7

Section 1.41–4(a)(8), Example 7, of the proposed regulations analyzed whether when developing software, activities relating to X’s decision to use a separate server to distribute the workload across each of the web servers and X’s decision that a round robin workload distribution algorithm is appropriate for its needs involved conducting a process of experimentation.

Two commenters recommended removing Example 7. One commenter believed that the example did not provide any clarification. The other commenter stated that the example shows a failure to meet the technical uncertainty requirement under section 174, rather than a process of experimentation. While the Treasury Department and the IRS agree with the commenter that activities under section 174 must be for the purpose of discovering information that would eliminate uncertainties, Example 7 is intended to demonstrate the process of experimentation requirement under section 41(d). The example shows a taxpayer’s failure to meet the process of experimentation requirement under section 41(d)(1) because the use of a technique or design, such as a round robin workload distribution algorithm, does not qualify where the taxpayer did not conduct a process of evaluating alternatives intended to eliminate uncertainty regarding the development of software. Accordingly, the final regulations do not adopt these comments.

iii. Example 8

Section 1.41–4(a)(8), Example 8, of the proposed regulations analyzed whether X’s activities relating to design and systematic testing and evaluation of several different algorithms in the development of load balancing software involved conducting a process of experimentation.

One commenter recommended that all references to the terms “dynamic” and “highly volatile” be removed because the commenter believes the terms provide no additional value and that they suggest that the nature of X’s business environment has some bearing on the performance of qualified research. The Treasury Department and the IRS disagree and the final regulations do not adopt the commenter’s recommendation because we believe the nature of a taxpayer’s business environment can be a valuable indicator of circumstances that may result in the necessary uncertainty required for a process of experimentation.

Another commenter requested that for both Example 8 and Example 10, the Treasury Department and the IRS provide clarification by applying the high threshold of innovation test once the software is determined to be internal use software. Additionally, this commenter requested that the final regulations provide an additional example addressing this process. The Treasury Department and the IRS note that the examples are added to illustrate only the application of a process of experimentation to software research. They are not meant to address the high threshold of innovation test; those examples were provided under § 1.41–4(c)(6)(vi) of the proposed regulations. Furthermore, a comprehensive example that applies the rules contained in § 1.41–4(c)(6) would require more developed facts and layers of analysis and would be better suited for a different type of published guidance than these final regulations. Accordingly, the final regulations do not adopt these comments.

iv. Example 9

Section 1.41–4(a)(8), Example 9, of the proposed regulations analyzed whether X’s activities relating to the installation of an ERP system involved a process of experimentation.

Two commenters requested deletion of the phrase “routine programming” in Example 9 because the term is subjective, immeasurable, and inconsistent with Suder v. Commissioner, T.C. Memo 2014–201. One commenter also stated that taxpayers may confront uncertainty about the appropriate design of the configuration of an ERP system, and the example does not address this technical uncertainty. The Treasury Department and the IRS did not intend to illustrate in this example the types of uncertainty that must be eliminated to satisfy the process of experimentation requirement under section 41(d)(1). Rather, this example demonstrates a taxpayer’s failure to meet the process of experimentation requirement under section 41(d)(1) because X did not conduct a process of evaluating alternatives in order to eliminate uncertainty regarding the development of the ERP software. Accordingly, the Treasury Department and the IRS believe further clarification of these examples is unnecessary. Furthermore, the Tax Court’s decision in Suder is not inconsistent with Example 9 because in Suder the court did not address whether “routine programming” could meet the process of experimentation requirement.

B. Internal Use Software

The proposed regulations provided examples illustrating the provisions contained in § 1.41–4(c)(6) of the proposed regulations.

i. Example 3

Section 1.41–4(c)(6)(vi), Example 3, of the proposed regulations analyzed whether software that is developed for a website that provides general information about the taxpayer’s business, and which does not enable a taxpayer to interact with third parties or allow third parties to initiate functions or review data, is internal use software.

One commenter disagreed with the characterization of the facts in Example 3 which illustrates a support services function. The commenter believes that the software is dual function software that is developed to allow a third party to review data and to be used in marketing. The Treasury Department and the IRS disagree with the commenter’s characterization of Example 3. The example demonstrates that the software is intended to serve marketing purposes and thus is developed to be used in general and administrative functions. Changes were made to clarify this example which is designated as Example 4 of the final regulations.

ii. Example 6

Section 1.41–4(c)(6)(vi), Example 6, of the proposed regulations analyzed the definition of third parties, specifically whether software that is developed to allow its users to upload and modify photographs at no charge allows third parties to initiate functions on the taxpayer’s system.

A commenter believed the example is an important example that comes to the correct conclusion, but the commenter believed it is not a particularly good fact pattern to illustrate the third party interaction exclusion. Specifically, the commenter requested changes to the conclusion of the example to show that the advertising software is developed for use in a marketing function to an unrelated third party.

The purpose of the example is to illustrate the third party definition and to demonstrate whether the software is developed to allow third parties to initiate functions or review data. The example is not meant to address which, if any, general and administrative function applies to the software. Accordingly, the final regulations do not adopt this comment. However, other changes were made to clarify Example 6 of the proposed regulations, which is designated as Example 8 of the final regulations.

IX. Effective/Applicability Date

Some commenters requested that the final regulations apply retroactively back to 1986, while one commenter requested that the final regulations apply retroactively back to 2004 to give software development equal treatment with all other types of qualified research as defined under TD 9104 (69 FR 22). After further consideration, the effective date in the proposed regulations is generally retained with slight modifications. These final regulations are prospective and apply to taxable years beginning on or after the date of publication of this Treasury decision in the

Federal Register.

Retroactive application of these final regulations may provide an unfair advantage to taxpayers whose prior taxable years are not closed by the statute of limitations. Furthermore, retroactively determining whether taxpayers engaged in research activities does not further the purpose of section 41 which is to encourage taxpayers to engage in qualifying research activities within the United States and would impose a significant administrative burden on the IRS.

Section 41(d)(4)(E) provides that, except to the extent provided by regulations, research with respect to computer software that is developed by (or for the benefit of) the taxpayer primarily for internal use by the taxpayer is excluded from the definition of qualified research under section 41(d). The nature of software and its development has rapidly evolved over time. Recognizing the evolving nature of software technology and its role in business practices, these final regulations more narrowly define internal use software than the rules that apply for prior periods. These final regulations are not, and should not be viewed as, an interpretation of prior regulatory guidance. Software not developed for internal use under these final regulations, such as software developed to enable a taxpayer to interact with third parties, may or may not have been internal use software under prior law.

The proposed regulations provided that the 2004 ANPRM (published in the Federal Register (69 FR 43)) is withdrawn effective for taxable years beginning on or after January 20, 2015, the date the proposed regulations were published in the Federal Register (80 FR 2624). For taxable years ending before January 20, 2015, taxpayers may choose to follow either all of the internal use software provisions of § 1.41–4(c)(6) in the final regulations published on January 3, 2001 in the Federal Register (TD 8930; 66 FR 280) or all of the internal use software provisions of § 1.41–4(c)(6) contained in the proposed regulations (REG–112991–01) published on December 26, 2001 in the Federal Register (66 FR 66362). In addition, the IRS will not challenge return positions consistent with all of paragraph (c)(6) of these final regulations or all of paragraph (c)(6) of the proposed regulations for any taxable year that both ends on or after January 20, 2015, the date the proposed regulations were published in the Federal Register (80 FR 2624), and begins before October 4, 2016.

X. Duty of Consistency

Some commenters noted the administrative difficulties of applying the duty of consistency rule under section 41(c)(6)(A) and requested guidance on how to comply with the consistency rule.

The duty of consistency is a statutory requirement and existing regulations under §§ 1.41–3(d) and 1.41–9(c) provide sufficient guidance for taxpayers to follow. In computing the research credit, qualified research expenses and gross receipts must be determined on a basis consistent with the definition of qualified research expenses and gross receipts for the credit year. These final regulations do not modify this existing law. Section 1.41–3(d) provides that in computing the credit for increasing research activities, qualified research expenses and gross receipts taken into account in computing a taxpayer’s fixed-base percentage and a taxpayer’s base amount must be determined on a basis consistent with the definition of qualified research expenses and gross receipts for the credit year, without regard to the law in effect for the taxable years taken into account in computing the fixed-base percentage or the base amount. Section 1.41–3(d) also provides examples illustrating the requirement. Current section 1.41–9(c) contains similar rules. Accordingly, the final regulations do not adopt the commenters’ suggestions concerning the duty of consistency.

Special Analyses

Certain IRS regulations, including this one, are exempt from the requirements of Executive Order 12866, as supplemented and reaffirmed by Executive Order 13563. Therefore, a regulatory impact assessment is not required. It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations, and because the regulations do not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of the Code, the notice of proposed rulemaking was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business, and no comments were received.

Drafting Information

The principal author of these regulations is Martha M. Garcia, Office of the Associate Chief Counsel (Passthroughs and Special Industries), IRS. However, other personnel from the Treasury Department and the IRS participated in their development.

* * * * *

Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 1 is amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by adding an entry in numerical order to read in part as follows:

Authority: 26 U.S.C. 7805 * * *

*****

Section 1.41–4 also issued under 26 U.S.C. 41(d)(4)(E).

*****

Par. 2. Section 1.41–0 is amended by:

1. Revising the entry in the table of contents for § 1.41–4(c)(6).

2. Adding entries in the table of contents for § 1.41–4(c)(6)(i) through (viii).

The revision and additions read as follows:

§ 1.41–0. Table of contents.

* * * * *

§ 1.41–4. Qualified research for expenditures paid or incurred in taxable years ending on or after December 31, 2003.

* * * * *

(c) * * *

(6) Internal use software.

(i) General rule.

(ii) Inapplicability of the high threshold of innovation test.

(iii) Software developed primarily for internal use.

(iv) Software not developed primarily for internal use.

(v) Time and manner of determination.

(vi) Software developed for both internal use and to enable interaction with third parties (dual function software).

(vii) High threshold of innovation test.

(viii) Illustrations.

* * * * *

Par. 3. Section 1.41–4 is amended by:

1. Adding Example 5 through Example 10 at the end of paragraph (a)(8).

2. Revising paragraphs (c)(6) and (e).

The additions and revisions read as follows:

§ 1.41–4 Qualified research for expenditures paid or incurred in taxable years ending on or after December 31, 2003.

(a) * * *

(8) * * *

Example 5. (i) Facts. X, a retail and distribution company, wants to upgrade its warehouse management software. X evaluates several of the alternative warehouse management software products available from vendors in the marketplace to determine which product will best serve X’s technical requirements. X selects vendor V’s software.

(ii) Conclusion. X’s activities to select the software are not qualified research under section 41(d)(1) and paragraph (a)(5) of this section. X did not conduct a process of evaluating alternatives in order to eliminate uncertainty regarding the development of a business component. X’s evaluation of products available from vendors is not a process of experimentation.

Example 6. (i) Facts. X wants to develop a new web application to allow customers to purchase its products online. X, after reviewing commercial software offered by various vendors, purchases a commercial software package of object-oriented functions from vendor Z that X can use in its web application (for example, a shopping cart). X evaluates the various object-oriented functions included in vendor Z’s software package to determine which functions it can use. X then incorporates the selected software functions in its new web application software.

(ii) Conclusion. X’s activities related to selecting the commercial software vendor with the object-oriented functions it wanted, and then selecting which functions to use, are not qualified research under section 41(d)(1) and paragraph (a)(5) of this section. In addition, incorporating the selected object-oriented functions into the new web application software being developed by X did not involve conducting a process of evaluating alternatives in order to eliminate uncertainty regarding the development of software. X’s evaluation of products available from vendors and selection of software functions are not a process of experimentation.

Example 7. (i) Facts. In order to be more responsive to user online requests, X wants to develop software to balance the incoming processing requests across multiple web servers that run the same set of software applications. Without evaluating or testing any alternatives, X decides that a separate server will be used to distribute the workload across each of the web servers and that a round robin workload distribution algorithm is appropriate for its needs.

(ii) Conclusion. X’s activities to develop the software are activities relating to the development of a separate business component under section 41(d)(2)(A). X’s activities to develop the load distribution function are not qualified research under section 41(d)(1) and paragraph (a)(5) of this section. X did not conduct a process of evaluating different load distribution alternatives in order to eliminate uncertainty regarding the development of software. X’s selection of a separate server and a round robin distribution algorithm is not a process of experimentation.

Example 8. (i) Facts. X must develop load balancing software across a server cluster supporting multiple web applications. X’s web applications have high concurrency demands because of a dynamic, highly volatile environment. X is uncertain of the appropriate design of the load balancing algorithm, given that the existing evolutionary algorithms did not meet the demands of their highly volatile web environment. Therefore, X designs and systematically tests and evaluates several different algorithms that perform the load distribution functions.

(ii) Conclusion. X’s activities to develop software are activities to develop a separate business component under section 41(d)(2)(A). X’s activities involving the design, evaluation, and systematic testing of several new load balancing algorithms meet the requirements as set forth in paragraph (a)(5) of this section. X’s activities constitute elements of a process of experimentation because X identified uncertainties related to the development of a business component, identified alternatives intended to eliminate those uncertainties, and evaluated one or more alternatives to achieve a result where the appropriate design was uncertain at the beginning of X’s research activities.

Example 9. (i) Facts. X, a multinational manufacturer, wants to install an enterprise resource planning (ERP) system that runs off a single database so that X can track orders more easily, and coordinate manufacturing, inventory, and shipping among many different locations at the same time. In order to successfully install and implement ERP software, X evaluates its business needs and the technical requirements of the software, such as processing power, memory, storage, and network resources. X devotes the majority of its resources in implementing the ERP system to evaluating the available templates, reports, and other standard programs and choosing among these alternatives in configuring the system to match its business process and reengineering its business process to match the available alternatives in the ERP system. X also performs some data transfer from its old system, involving routine programming and one-to-one mapping of data to be exchanged between each system.

(ii) Conclusion. X’s activities related to the ERP software including the data transfer are not qualified research under section 41(d)(1) and paragraph (a)(5) of this section. X did not conduct a process of evaluating alternatives in order to eliminate uncertainty regarding the development of software. X’s activities in choosing between available templates, reports, and other standard programs and conducting data transfer are not elements of a process of experimentation.

Example 10. (i) Facts. Same facts as Example 9 except that X determines that it must interface part of its legacy software with the new ERP software because the ERP software does not provide a particular function that X requires for its business. As a result, X must develop an interface between its legacy software and the ERP software, and X evaluates several data exchange software applications and chooses one of the available alternatives. X is uncertain as to how to keep the data synchronized between the legacy and ERP systems. Thus, X engages in systematic trial and error testing of several newly designed data caching algorithms to eliminate synchronization problems.

(ii) Conclusion. Substantially all of X’s activities with respect to this ERP project do not satisfy the requirements for a process of experimentation. However, when the shrinking-back rule is applied, a subset of X’s activities do satisfy the requirements for a process of experimentation. X’s activities to develop the data caching software and keeping the data on the legacy and ERP systems synchronized meet the requirements of qualified research as set forth in paragraph (a)(2) of this section. Substantially all of X’s activities to develop the specialized data caching and synchronization software constitute elements of a process of experimentation because X identified uncertainties related to the development of a business component, identified alternatives intended to eliminate those uncertainties, and evaluated alternatives to achieve a result where the appropriate design of that result was uncertain as of the beginning of the taxpayer’s research activities.

* * * * *

(c) * * *

(6) Internal use software—(i) General rule. Research with respect to software that is developed by (or for the benefit of) the taxpayer primarily for the taxpayer’s internal use is eligible for the research credit only if—

(A) The research with respect to the software satisfies the requirements of section 41(d)(1);

(B) The research with respect to the software is not otherwise excluded under section 41(d)(4) (other than section 41(d)(4)(E)); and

(C) The software satisfies the high threshold of innovation test of paragraph (c)(6)(vii) of this section.

(ii) Inapplicability of the high threshold of innovation test. This paragraph (c)(6) does not apply to the following:

(A) Software developed by (or for the benefit of) the taxpayer primarily for internal use by the taxpayer for use in an activity that constitutes qualified research (other than the development of the internal use software itself);

(B) Software developed by (or for the benefit of) the taxpayer primarily for internal use by the taxpayer for use in a production process to which the requirements of section 41(d)(1) are met; and

(C) A new or improved package of software and hardware developed together by the taxpayer as a single product (or to the costs to modify an acquired software and hardware package), of which the software is an integral part, that is used directly by the taxpayer in providing services in its trade or business. In these cases, eligibility for the research credit is to be determined by examining the combined hardware-software product as a single product.

(iii) Software developed primarily for internal use—(A) In general. Except as otherwise provided in paragraph (c)(6)(vi) of this section, software is developed by (or for the benefit of) the taxpayer primarily for the taxpayer’s internal use if the software is developed for use in general and administrative functions that facilitate or support the conduct of the taxpayer’s trade or business. Software that the taxpayer develops primarily for a related party’s internal use will be considered internal use software. A related party is any corporation, trade or business, or other person that is treated as a single taxpayer with the taxpayer pursuant to section 41(f).

(B) General and administrative functions. General and administrative functions are:

(1) Financial management. Financial management functions are functions that involve the financial management of the taxpayer and the supporting recordkeeping. Financial management functions include, but are not limited to, functions such as accounts payable, accounts receivable, inventory management, budgeting, cash management, cost accounting, disbursements, economic analysis and forecasting, financial reporting, finance, fixed asset accounting, general ledger bookkeeping, internal audit, management accounting, risk management, strategic business planning, and tax.

(2) Human resources management. Human resources management functions are functions that manage the taxpayer’s workforce. Human resources management functions include, but are not limited to, functions such as recruiting, hiring, training, assigning personnel, and maintaining personnel records, payroll, and benefits.

(3) Support services. Support services are other functions that support the day- to-day operations of the taxpayer. Support services include, but are not limited to, functions such as data processing, facility services (for example, grounds keeping, housekeeping, janitorial, and logistics), graphic services, marketing, legal services, government compliance services, printing and publication services, and security services (for example, video surveillance and physical asset protection from fire and theft).

(iv) Software not developed primarily for internal use. Software is not developed primarily for the taxpayer’s internal use if it is not developed for use in general and administrative functions that facilitate or support the conduct of the taxpayer’s trade or business, such as —

(A) Software developed to be commercially sold, leased, licensed, or otherwise marketed to third parties; or

(B) Software developed to enable a taxpayer to interact with third parties or to allow third parties to initiate functions or review data on the taxpayer’s system.

(v) Time and manner of determination. For purposes of paragraphs (c)(6)(iii) and (iv) of this section, whether software is developed primarily for internal use or not developed primarily for internal use depends on the intent of the taxpayer and the facts and circumstances at the beginning of the software development. For example, software will not be considered internal use software solely because it is used internally for purposes of testing prior to commercial sale, lease, or license. If a taxpayer originally develops software primarily for internal use, but later makes improvements to the software with the intent to hold the improved software to be sold, leased, licensed, or otherwise marketed to third parties, or to interact with third parties or to allow third parties to initiate functions or review data on the taxpayer’s system using the improved software, the improvements will be considered separate from the existing software and will not be considered developed primarily for internal use. Alternatively, if a taxpayer originally develops software to be sold, leased, licensed, or otherwise marketed to third parties, or to interact with third parties or to allow third parties to initiate functions or review data on the taxpayer’s system, but later makes improvements to the software with the intent to use the software in general and administrative functions, the improvements will be considered separate from the existing software and will be considered developed primarily for internal use.

(vi) Software developed for both internal use and to enable interaction with third parties (dual function software)—(A) Presumption of development primarily for internal use. Unless paragraph (c)(6)(vi)(B) or (C) of this section applies, software developed by (or for the benefit of) the taxpayer both for use in general and administrative functions that facilitate or support the conduct of the taxpayer’s trade or business and to enable a taxpayer to interact with third parties or to allow third parties to initiate functions or review data on the taxpayer’s system (dual function software) is presumed to be developed primarily for a taxpayer’s internal use.

(B) Identification of a subset of elements of software that only enables interaction with third parties. To the extent that a taxpayer can identify a subset of elements of dual function software that only enables a taxpayer to interact with third parties or allows third parties to initiate functions or review data (third party subset), the presumption under paragraph (c)(6)(vi)(A) of this section does not apply to such third party subset, and such third party subset is not developed primarily for internal use as described under paragraph (c)(6)(iv)(B) of this section.

(C) Safe harbor for expenditures related to software developed for both internal use and to enable interaction with third parties. If, after the application of paragraph (c)(6)(vi)(B) of this section, there remains dual function software or a subset of elements of dual function software (dual function subset), a taxpayer may include 25 percent of the qualified research expenditures of such dual function software or dual function subset in computing the amount of the taxpayer’s credit. This paragraph (c)(6)(vi)(C) applies only if the taxpayer’s research activities related to the development or improvement of the dual function software or dual function subset constitute qualified research under section 41(d), without regard to section 41(d)(4)(E), and the dual function software or dual function subset’s use by third parties or by the taxpayer to interact with third parties is reasonably anticipated to constitute at least 10 percent of the dual function software or the dual function subset’s use. An objective, reasonable method within the taxpayer’s industry must be used to estimate the dual function software or dual function subset’s use by third parties or by the taxpayer to interact with third parties. An objective, reasonable method may include, but is not limited to, processing time, amount of data transfer, and number of software user interface screens.

(D) Time and manner of determination. A taxpayer must apply this paragraph (c)(6)(vi) based on the intent of the taxpayer and the facts and circumstances at the beginning of the software development.

(E) Third party. For purposes of paragraphs (c)(6)(iv), (v), and (vi) of this section, the term third party means any corporation, trade or business, or other person that is not treated as a single taxpayer with the taxpayer pursuant to section 41(f). Additionally, for purposes of paragraph (c)(6)(iv)(B) of this section, third parties do not include any persons that use the software to support the general and administrative functions of the taxpayer.

(vii) High threshold of innovation test—(A) In general. Software satisfies this paragraph (c)(6)(vii) only if the taxpayer can establish that—

(1) The software is innovative;

(2) The software development involves significant economic risk; and

(3) The software is not commercially available for use by the taxpayer in that the software cannot be purchased, leased, or licensed and used for the intended purpose without modifications that would satisfy the requirements of paragraphs (c)(6)(vii)(A)(1) and (2) of this section.

(B) Innovative. Software is innovative if the software would result in a reduction in cost or improvement in speed or other measurable improvement, that is substantial and economically significant, if the development is or would have been successful. This is a measurable objective standard, not a determination of the unique or novel nature of the software or the software development process.

(C) Significant economic risk. The software development involves significant economic risk if the taxpayer commits substantial resources to the development and if there is substantial uncertainty, because of technical risk, that such resources would be recovered within a reasonable period. The term “substantial uncertainty” requires a higher level of uncertainty and technical risk than that required for business components that are not internal use software. This standard does not require technical uncertainty regarding whether the final result can ever be achieved, but rather whether the final result can be achieved within a timeframe that will allow the substantial resources committed to the development to be recovered within a reasonable period. Technical risk arises from uncertainty that is technological in nature, as defined in paragraph (a)(4) of this section, and substantial uncertainty must exist at the beginning of the taxpayer’s activities.

(D) Application of high threshold of innovation test. The high threshold of innovation test of paragraph (c)(6)(vii) of this section takes into account only the results anticipated to be attributable to the development of new or improved software at the beginning of the software development independent of the effect of any modifications to related hardware or other software. The implementation of existing technology by itself is not evidence of innovation, but the use of existing technology in new ways could be evidence of a high threshold of innovation if it resolves substantial uncertainty as defined in paragraph (c)(6)(vii)(C) of this section.

(viii) Illustrations. The following examples illustrate provisions contained in this paragraph (c)(6). No inference should be drawn from these examples concerning the application of section 41(d)(1) and paragraph (a) of this section to these facts.

Example 1. Computer hardware and software developed as a single product—(i) Facts. X is a telecommunications company that developed high technology telephone switching hardware. In addition, X developed software that interfaces directly with the hardware to initiate and terminate a call, along with other functions. X designed and developed the hardware and software together.

(ii) Conclusion. The telecommunications software that interfaces directly with the hardware is part of a package of software and hardware developed together by the taxpayer that is used by the taxpayer in providing services in its trade or business. Accordingly, this paragraph (c)(6) does not apply to the software that interfaces directly with the hardware as described in paragraph (c)(6)(ii)(C) of this section, and eligibility for the research credit is determined by examining the combined software-hardware product as a single product.

Example 2. Internal use software; financial management—(i) Facts. X, a manufacturer, self-insures its liabilities for employee health benefits. X develops its own software to administer its self-insurance reserves related to employee health benefits. At the beginning of the development, X does not intend to develop the software for commercial sale, lease, license, or to be otherwise marketed to third parties or to enable X to interact with third parties or to allow third parties to initiate functions or review data on X’s system.

(ii) Conclusion. The software is developed for use in a general and administrative function because reserve valuation is a financial management function under paragraph (c)(6)(iii)(B)(1) of this section. Accordingly, the software is internal use software because it is developed for use in a general and administrative function.

Example 3. Internal use software; human resources management—(i) Facts. X, a manufacturer, develops a software module that interacts with X’s existing payroll software to allow X’s employees to print pay stubs and make certain changes related to payroll deductions over the internet. At the beginning of the development, X does not intend to develop the software module for commercial sale, lease, license, or to be otherwise marketed to third parties or to enable X to interact with third parties or to allow third parties to initiate functions or review data on X’s system.

(ii) Conclusion. The employee access software module is developed for use in a general and administrative function because employee access software is a human resources management function under paragraph (c)(6)(iii)(B)(2) of this section. Accordingly, the software module is internal use software because it is developed for use in a general and administrative function.

Example 4. Internal use software; support services—(i) Facts. X, a restaurant, develops software for a website that provides information, such as items served, price, location, phone number, and hours of operation for purposes of advertising. At the beginning of the development, X does not intend to develop the website software for commercial sale, lease, license, or to be otherwise marketed to third parties or to enable X to interact with third parties or to allow third parties to initiate functions or review data on X’s system. X intends to use the software for marketing by allowing third parties to review general information on X’s website.

(ii) Conclusion. The software is developed for use in a general and administrative function because the software was developed to be used by X for marketing which is a support services function under paragraph (c)(6)(iii)(B)(3) of this section. Accordingly, the software is internal use software because it is developed for use in a general and administrative function.

Example 5. Internal use software—(i) Facts. X, a multinational manufacturer with different business and financial systems in each of its divisions, undertakes a software development project aimed at integrating the majority of the functional areas of its major software systems (Existing Software) into a single enterprise resource management system supporting centralized financial systems, human resources, inventory, and sales. X purchases software (New Software) upon which to base its enterprise-wide system. X has to develop software (Developed Software) that transfers data from X’s legacy financial, human resources, inventory, and sales systems to the New Software. At the beginning of the development, X does not intend to develop the software for commercial sale, lease, license, or to be otherwise marketed to third parties or to enable X to interact with third parties or to allow third parties to initiate functions or review data on X’s system.

(ii) Conclusion. The financial systems, human resource systems, inventory and sales systems are general and administrative functions under paragraph (c)(6)(iii)(B) of this section. Accordingly, the Developed Software is internal use software because it is developed for use in general and administrative functions.

Example 6. Internal use software; definition of third party—(i) Facts. X develops software to interact electronically with its vendors to improve X’s inventory management. X develops the software to enable X to interact with vendors and to allow vendors to initiate functions or review data on the taxpayer’s system. X defines the electronic messages that will be exchanged between X and the vendors. X’s software allows a vendor to request X’s current inventory of the vendor’s product, and allows a vendor to send a message to X which informs X that the vendor has just made a new shipment of the vendor’s product to replenish X’s inventory. At the beginning of development, X does not intend to develop the software for commercial sale, lease, license, or to be otherwise marketed to third parties.

(ii) Conclusion. Under paragraph (c)(6)(vi)(E) of this section, X’s vendors are not third parties for purposes of paragraph (c)(6)(iv) of this section. While X’s software was developed to allow vendors to initiate functions or review data on the taxpayer’s system, the software is not excluded from internal use software as set forth in paragraph (c)(6)(iv)(B) of this section because the software was developed to allow vendors to use the software to support X’s inventory management, which is a general and administrative function of X.

Example 7. Not internal use software; third party interaction—(i) Facts. X, a manufacturer of various products, develops software for a website with the intent to allow third parties to access data on X’s database, to order X’s products and track the status of their orders online. At the beginning of the development, X does not intend to develop the website software for commercial sale, lease, license, or to be otherwise marketed to third parties.

(ii) Conclusion. The software is not developed primarily for internal use because it is not developed for use in a general and administrative function. X developed the software to allow third parties to initiate functions or review data on the taxpayer’s system as provided under paragraph (c)(6)(iv)(B) of this section.

Example 8. Not internal use software; third party interaction—(i) Facts. X developed software that allows its users to upload and modify photographs at no charge. X earns revenue by selling advertisements that are displayed while users enjoy the software that X offers for free. X also developed software that has interfaces through which advertisers can bid for the best position in placing their ads, set prices for the ads, or develop advertisement campaign budgets. At the beginning of the development, X intended to develop the software to enable X to interact with third parties or to allow third parties to initiate functions on X’s system.

(ii) Conclusion. The software for uploading and modifying photographs is not developed primarily for internal use because it is not developed for use in X’s general and administrative functions under paragraph (c)(6)(iii)(A) of this section. The users and the advertisers are third parties for purposes of paragraph (c)(6)(iv) of this section. Furthermore, both the software for uploading and modifying photographs and the advertising software are not internal use software under paragraph (c)(6)(iv)(B) of this section because at the beginning of the development X developed the software with the intention of enabling X to interact with third parties or to allow third parties to initiate functions on X’s system.

Example 9. Not internal use software; commercially sold, leased, licensed, or otherwise marketed—(i) Facts. X is a provider of cloud-based software. X develops enterprise application software (including customer relationship management, sales automation, and accounting software) to be accessed online and used by X’s customers. At the beginning of development, X intended to develop the software for commercial sale, lease, license, or to be otherwise marketed to third parties.

(ii) Conclusion. The software is not developed primarily for internal use because it is not developed for use in a general and administrative function. X developed the software to be commercially sold, leased, licensed, or otherwise marketed to third parties under paragraph (c)(6)(iv)(A) of this section.

Example 10. Improvements to existing internal use software—(i) Facts. X has branches throughout the country and develops its own facilities services software to coordinate moves and to track maintenance requests for all locations. At the beginning of the development, X does not intend to develop the software for commercial sale, lease, license, or to be otherwise marketed to third parties or to enable X to interact with third parties or to allow third parties to initiate functions or review data on X’s system. Several years after completing the development and using the software, X consults its business development department, which assesses the market for the software. X determines that the software could be sold at a profit if certain technical and functional enhancements are made. X develops the improvements to the software, and sells the improved software to third parties.

(ii) Conclusion. Support services, which include facility services, are general and administrative functions under paragraph (c)(6)(iii)(B) of this section. Accordingly, the original software is developed for use in general and administrative functions and is, therefore, developed primarily for internal use. However, the improvements to the software are not developed primarily for internal use because the improved software was not developed for use in a general and administrative function. X developed the improved software to be commercially sold, leased, licensed, or otherwise marketed to third parties under paragraphs (c)(6)(iv)(A) and (c)(6)(v) of this section.

Example 11. Dual function software; identification of a third party subset—(i) Facts. X develops software for use in general and administrative functions that facilitate or support the conduct of X’s trade or business and to allow third parties to initiate functions. X is able to identify a third party subset. X incurs $50,000 of research expenditures for the software, 50% of which is allocable to the third party subset.

(ii) Conclusion. The software developed by X is dual function software. Because X is able to identify a third party subset, the third party subset is not presumed to be internal use software under paragraph (c)(6)(vi)(A) of this section. If X’s research activities related to the third party subset constitute qualified research under section 41(d), and the allocable expenditures are qualified research expenditures under section 41(b), $25,000 of the software research expenditures allocable to the third party subset may be included in computing the amount of X’s credit, pursuant to paragraph (c)(6)(vi)(B) of this section. If, after the application of paragraph (c)(6)(vi)(B) of this section, there remains a dual function subset, X may determine whether paragraph (c)(6)(vi)(C) of this section applies.

Example 12. Dual function software; application of the safe harbor—(i) Facts. The facts are the same as in Example 11, except that X is unable to identify a third party subset. X uses an objective, reasonable method at the beginning of the software development to determine that the dual function software’s use by third parties to initiate functions is reasonably anticipated to constitute 15% of the dual function software’s use.

(ii) Conclusion. The software developed by X is dual function software. The software is presumed to be developed primarily for internal use under paragraph (c)(6)(vi)(A) of this section. Although X is unable to identify a third party subset, X reasonably anticipates that the dual function software’s use by third parties will be at least 10% of the dual function software’s use. If X’s research activities related to the development or improvement of the dual function software constitute qualified research under section 41(d), without regard to section 41(d)(4)(E), and the allocable expenditures are qualified research expenditures under section 41(b), X may include $12,500 (25% of $50,000) of the software research expenditures of the dual function software in computing the amount of X’s credit pursuant to paragraph (c)(6)(vi)(C) of this section.

Example 13. Dual function software; safe harbor inapplicable—(i) Facts. The facts are the same as in Example 11, except X is unable to identify a third party subset. X uses an objective, reasonable method at the beginning of the software development to determine that the dual function software’s use by third parties to initiate functions is reasonably anticipated to constitute 5% of the dual function software’s use.

(ii) Conclusion. The software developed by X is dual function software. The software is presumed to be developed primarily for X’s internal use under paragraph (c)(6)(vi)(A) of this section. X is unable to identify a third party subset, and X reasonably anticipates that the dual function software’s use by third parties will be less than 10% of the dual function software’s use. X may only include the software research expenditures of the dual function software in computing the amount of X’s credit if the software satisfies the high threshold of innovation test of paragraph (c)(6)(vii) of this section and X’s research activities related to the development or improvement of the dual function software constitute qualified research under section 41(d), without regard to section 41(d)(4)(E), and the allocable expenditures are qualified research expenditures under section 41(b).

Example 14. Dual function software; identification of a third party subset and the safe harbor—(i) Facts. X develops software for use in general and administrative functions that facilitate or support the conduct of X’s trade or business and to allow third parties to initiate functions and review data. X is able to identify a third party subset (Subset A). The remaining dual function subset of the software (Subset B) allows third parties to review data and provides X with data used in its general and administrative functions. X is unable to identify a third party subset of Subset B. X incurs $50,000 of research expenditures for the software, 50% of which is allocable to Subset A and 50% of which is allocable to Subset B. X determines, at the beginning of the software development, that the processing time of the third party use of Subset B is reasonably anticipated to account for 15% of the total processing time of Subset B.

(ii) Conclusion. The software developed by X is dual function software. Because X is able to identify a third party subset, such third party subset (Subset A) is not presumed to be internal use software under paragraph (c)(6)(vi)(A) of this section. If X’s research activities related to the development or improvement of Subset A constitute qualified research under section 41(d), and the allocable expenditures are qualified research expenditures under section 41(b), the $25,000 of the software research expenditures allocable to Subset A may be included in computing the amount of X’s credit pursuant to paragraph (c)(6)(vi)(B) of this section. Although X is unable to identify a third party subset of Subset B, 15% of Subset B’s use is reasonably anticipated to be attributable to the use of Subset B by third parties. If X’s research activities related to the development or improvement of Subset B constitute qualified research under section 41(d), without regard to section 41(d)(4)(E), and the allocable expenditures are qualified research expenditures under 41(b), X may include $6,250 (25% × $25,000) of the software research expenditures of Subset B in computing the amount of X’s credit, pursuant to paragraph (c)(6)(vi)(C) of this section.

Example 15. Internal use software; application of the high threshold of innovation test—(i) Facts. X maintained separate software applications for tracking a variety of human resource (HR) functions, including employee reviews, salary information, location within the hierarchy and physical location of employees, 401(k) plans, and insurance coverage information. X determined that improved HR efficiency could be achieved by redesigning its disparate software applications into one employee-centric system, and worked to develop that system. X also determined that commercially available database management systems did not meet all of the requirements of the proposed system. Rather than waiting several years for vendor offerings to mature and become viable for its purpose, X embarked upon the project utilizing older technology that was severely challenged with respect to data modeling capabilities. The improvements, if successful, would provide a reduction in cost and improvement in speed that is substantial and economically significant. For example, having one employee-centric system would remove the duplicative time and cost of manually entering basic employee information separately in each application because the information would only have to be entered once to be available across all applications. The limitations of the technology X was attempting to utilize required that X attempt to develop a new database architecture. X committed substantial resources to the project, but could not predict, because of technical risk, whether it could develop the database software in the timeframe necessary so that X could recover its resources in a reasonable period. Specifically, X was uncertain regarding the capability of developing, within a reasonable period, a new database architecture using the old technology that would resolve its technological issues regarding the data modeling capabilities and the integration of the disparate systems into one system. At the beginning of the development, X did not intend to develop the software for commercial sale, lease, license, or to be otherwise marketed to third parties or to enable X to interact with third parties or to allow third parties to initiate functions or review data on X’s system.

(ii) Conclusion. The software is internal use software because it is developed for use in a general and administrative function. However, the software satisfies the high threshold of innovation test set forth in paragraph (c)(6)(vii) of this section. The software was intended to be innovative in that it would provide a reduction in cost or improvement in speed that is substantial and economically significant. In addition, X’s development activities involved significant economic risk in that X committed substantial resources to the development and there was substantial uncertainty, because of technical risk, that the resources would be recovered within a reasonable period. Finally, at the time X undertook the development of the system, software meeting X’s requirements was not commercially available for use by X.

Example 16. Internal use software; application of the high threshold of innovation test—(i) Facts. X undertook a software project to rewrite a legacy mainframe application using an object-oriented programming language, and to move the new application off the mainframe to a client/server environment. Both the object-oriented language and client/server technologies were new to X. This project was undertaken to develop a more maintainable application, which X expected would significantly reduce the cost of maintenance, and implement new features more quickly, which X expected would provide both significant improvements in speed and reduction in cost. Thus, the improvements, if successful, would provide a reduction in cost and improvement in speed that is substantial and economically significant. X also determined that commercially available systems did not meet the requirements of the proposed system. X was certain that it would be able to overcome any technological uncertainties and implement the improvements within a reasonable period. However, X was unsure of the appropriate methodology to achieve the improvements. At the beginning of the development, X does not intend to develop the software for commercial sale, lease, license, or to be otherwise marketed to third parties or to enable X to interact with third parties or to allow third parties to initiate functions or review data on X’s system.

(ii) Conclusion. The software is internal use software because it is developed for use in a general and administrative function. X’s activities do not satisfy the high threshold of innovation test of paragraph (c)(6)(vii) of this section. Although the software meets the requirements of paragraphs (c)(6)(vii)(A)(1) and (3) of this section, X’s development activities did not involve significant economic risk under paragraph (c)(6)(vii)(A)(2) of this section. X did not have substantial uncertainty, because of technical risk, that the resources committed to the project would be recovered within a reasonable period.

Example 17. Internal use software; application of the high threshold of innovation test—(i) Facts. X wants to expand its internal computing power, and is aware that its PCs and workstations are idle at night, on the weekends, and for a significant part of any business day. Because the general and administrative computations that X needs to make could be done on workstations as well as PCs, X develops a screen-saver-like application that runs on employee computers. When employees’ computers have been idle for an amount of time set by each employee, X’s application goes back to a central server to get a new job to execute. This job will execute on the idle employee’s computer until it has either finished, or the employee resumes working on his computer. The ability to use the idle employee’s computers would save X significant costs because X would not have to buy new hardware to expand the computing power. The improvements, if successful, would provide a reduction in cost that is substantial and economically significant. At the time X undertook the software development project, there was no commercial application available with such a capability. In addition, at the time X undertook the software development project, X was uncertain regarding the capability of developing a server application that could schedule and distribute the jobs across thousands of PCs and workstations, as well as handle all the error conditions that occur on a user’s machine. X commits substantial resources to the project. X undertakes a process of experimentation to attempt to eliminate its uncertainty. At the beginning of the development, X does not intend to develop the software for commercial sale, lease, license, or to be otherwise marketed to third parties or to enable X to interact with third parties or to allow third parties to initiate functions or review data on X’s system.

(ii) Conclusion. The software is internal use software because it is developed for use in a general and administrative function. However, the software satisfies the high threshold of innovation test as set forth in paragraph (c)(6)(vii) of this section. The software was intended to be innovative because it would provide a reduction in cost or improvement in speed that is substantial and economically significant. In addition, X’s development activities involved significant economic risk in that X committed substantial resources to the development and there was substantial uncertainty that because of technical risk, such resources would be recovered within a reasonable period. Finally, at the time X undertook the development of the system, software meeting X’s requirements was not commercially available for use by X.

Example 18. Internal use software; application of the high threshold of innovation test—(i) Facts. X, a multinational manufacturer, wants to install an enterprise resource planning (ERP) system that runs off a single database. However, to implement the ERP system, X determines that it must integrate part of its old system with the new because the ERP system does not have a particular function that X requires for its business. The two systems are general and administrative software systems. The systems have mutual incompatibilities. The integration, if successful, would provide a reduction in cost and improvement in speed that is substantial and economically significant. At the time X undertook this project, there was no commercial application available with such a capability. X is uncertain regarding the appropriate design of the interface software. However, X knows that given a reasonable period of time to experiment with various designs, X would be able to determine the appropriate design necessary to meet X’s technical requirements and would recover the substantial resources that X commits to the development of the system within a reasonable period. At the beginning of the development, X does not intend to develop the software for commercial sale, lease, license, or to be otherwise marketed to third parties or to enable X to interact with third parties or to allow third parties to initiate functions or review data on X’s system.

(ii) Conclusion. The software is internal use software because it is developed for use in a general and administrative function. X’s activities do not satisfy the high threshold of innovation test of paragraph (c)(6)(vii) of this section. Although the software meets the requirements of paragraphs (c)(6)(vii)(A)(1) and (3) of this section, X’s development activities did not involve significant economic risk under paragraph (c)(6)(vii)(A)(2) of this section. X did not have substantial uncertainty, because of technical risk, that the resources committed to the project would be recovered within a reasonable period.

* * * * *

(e) Effective/applicability dates. Other than paragraph (c)(6) of this section, this section is applicable for taxable years ending on or after December 31, 2003. Paragraph (c)(6) of this section is applicable for taxable years beginning on or after October 4, 2016. For any taxable year that both ends on or after January 20, 2015 and begins before October 4, 2016, the IRS will not challenge return positions consistent with all of paragraph (c)(6) of this section or all of paragraph (c)(6) of this section as contained in the Internal Revenue Bulletin (IRB) 2015–5 (see www.irs.gov/pub/irs-irbs/irb15-05.pdf). For taxable years ending before January 20, 2015, taxpayers may choose to follow either all of § 1.41–4(c)(6) as contained in 26 CFR part 1 (revised as of April 1, 2003) and IRB 2001–5 (see www.irs.gov/pub/irs-irbs/irb01-05.pdf) or all of § 1.41–4(c)(6) as contained in IRB 2002–4 (see www.irs.gov/pub/irs-irbs/irb02-04.pdf).

John Dalrymple, Deputy Commissioner for Services and Enforcement.

Approved: August 22, 2016.

Mark J. Mazur Assistant Secretary of the Treasury (Tax Policy).

Note

(Filed by the Office of the Federal Register on October 3, 2016, 8:45 a.m., and published in the issue of the Federal Register for October 4, 2016, 81 F.R. 68299)

Part III. Administrative, Procedural, and Miscellaneous

Notice 2016–59

Reduced User Fee for Substantially Identical Letter Rulings and User Fee for Foreign Insurance Excise Tax Waiver Agreements

SECTION 1: PURPOSE

This notice advises of revisions to the requirements for the reduced user fee for substantially identical letter rulings set forth in section 15.07(2) of Rev. Proc. 2016–1, 2016–1 I.R.B. 1, and further described in paragraph (A)(5)(a) of Appendix A of Rev. Proc. 2016–1. This notice also corrects the amount of the user fee for Foreign Insurance Excise Tax Waiver Agreements stated in paragraph (A)(3)(e) of Appendix A of Rev. Proc. 2016–1.

SECTION 2: BACKGROUND

Section 7528 was added to the Internal Revenue Code by section 202 of the Extension of the Temporary Assistance for Needy Families Block Grant Program, Pub. L. No. 108–89, amended by section 891(a) of the American Jobs Creation Act of 2004, Pub. L. No. 108–357, and was made permanent by section 8244 of the U.S. Troop Readiness, Veterans’ Care, Katrina Recovery, and Iraq Accountability Appropriations Act, 2007, Pub. L. No. 110–28.

Section 7528 provides that the Secretary of the Treasury or delegate (the “Secretary”) shall establish a program requiring the payment of user fees for requests to the Internal Revenue Service (the “Service”) for letter rulings, opinion letters, determination letters, and other similar requests. The fees charged under the program are to: (1) vary according to categories or subcategories established by the Secretary; (2) be determined after taking into account the average time for, and difficulty of, complying with requests in each category and subcategory; and (3) be payable in advance. The Secretary is to provide for exemptions and reduced fees under the program as the Secretary determines to be appropriate, but the average fee applicable to each category or subcategory must not be less than the amount specified in section 7528(b)(3).

Rev. Proc. 2016–1 contains the current schedule of user fees and provides guidance for administering the user fee requirements for requests for letter rulings under the jurisdiction of the Associate Chief Counsel (Corporate), the Associate Chief Counsel (Financial Institutions and Products), the Associate Chief Counsel (Income Tax and Accounting), the Associate Chief Counsel (International), the Associate Chief Counsel (Passthroughs and Special Industries), the Associate Chief Counsel (Procedure and Administration), and the Associate Chief Counsel (Tax Exempt and Government Entities).

Section 15.07(2) of Rev. Proc. 2016–1 sets forth the requirements for a reduced user fee for certain substantially identical letter rulings requested for multiple entities with a common member or sponsor, or multiple members of a common entity. If the requirements of section 15.07(2) of Rev. Proc. 2016–1 are satisfied, paragraph (A)(5)(a) of Appendix A of Rev. Proc. 2016–1 provides that the user fee for each additional substantially identical letter ruling, after the $28,300 fee or reduced fee, as applicable, has been paid for the first letter ruling request, is $2,700 for requests received after February 1, 2015. The Service has recently determined that the requirements for this reduced user fee should be revised to include substantially identical letter rulings requested by taxpayers who are parties engaged together in the same transaction affecting all requesting taxpayers. The Service will include this additional basis for qualifying for a reduced user fee in Rev. Proc. 2017–1 that is published in January 2017. In addition, the Service has determined that this change is effective immediately to reflect more properly the Service’s actual costs in preparing letter rulings. Accordingly, pending publication of Rev. Proc. 2017–1, taxpayers may rely on this notice for purposes of requesting a reduced user fee. Section 3 of this notice sets forth the revised requirements for this reduced user fee.

Paragraph (A)(3)(e) of Appendix A of Rev. Proc. 2016–1 provides that the user fee for a request for a Foreign Insurance Excise Tax Waiver Agreement received on or after February 2, 2015 is $8,000. Effective for requests received on or after February 4, 2016, this user fee was decreased to $7,200; however, this decrease was inadvertently omitted from Rev. Proc. 2016–1. Section 4 of this notice corrects this discrepancy.

SECTION 3: REDUCED USER FEE FOR SUBSTANTIALLY IDENTICAL LETTER RULINGS

.01 Section 15.07(2) of Rev. Proc. 2016–1 is modified to read as follows:

(2) Substantially identical letter rulings. The user fee provided in paragraph (A)(5)(a) of Appendix A of this revenue procedure applies to a taxpayer or taxpayers requesting substantially identical letter rulings (including accounting period, method of accounting, and earnings and profits requests other than those submitted on Form 1128, Application to Adopt, Change, or Retain a Tax Year, Form 2553, Election by a Small Business Corporation, Form 3115, Application for Change in Accounting Method, and Form 5452, Corporate Report of Nondividend Distributions) in the following situations:

  • (a) The taxpayers to whom the letter rulings will be issued are multiple entities with a common member or sponsor, or multiple members of a common entity; or

  • (b) The taxpayers to whom the letter rulings will be issued are parties engaged together in the same transaction affecting all requesting taxpayers.

To qualify for this reduced user fee, all information and underlying documents must be substantially identical and all letter ruling requests must be submitted at the same time in a single submission. In addition, the taxpayer(s) must state that the letter ruling requests and all information and underlying documents are substantially identical, and must specifically identify the extent to which the letter ruling requests, information, and underlying documents are not identical.

If a taxpayer or taxpayers requesting reduced user fees pursuant to this section 15.07(2) also request a pre-submission conference pursuant to section 10.07, the taxpayer(s) should notify the Associate office at or before the pre-submission conference that the taxpayer(s) intend to request reduced user fees pursuant to this paragraph. At the pre-submission conference, the taxpayer(s) should discuss with the Associate office how the letter ruling requests will satisfy the requirements of this paragraph.

The reduced fee for substantially identical letter rulings is applicable to taxpayers requesting closing agreements as described in section 2.02 of this revenue procedure, assuming they meet the requirements described above for letter rulings.

.02 The text in the “CATEGORY” column of paragraph (A)(5)(a) of Appendix A of Rev. Proc. 2016–1 is modified to read as follows:

(5) User fee for substantially identical letter ruling requests, identical changes in method of accounting, or plans from issuing authorities under § 25(c)(2)(B). If the requirements of section 15.07 of Rev. Proc. 2016–1, 2016–1 I.R.B. 1, as modified by Notice 2016–59, are satisfied, the user fee for the following situations is as follows:

  • (a) Substantially identical letter rulings requested (other than changes in methods of accounting requested on Form 3115)

  • Requests for substantially identical letter rulings for multiple entities with a common member or sponsor, or for multiple members of a common entity, or for parties engaged together in the same transaction affecting all requesting taxpayers, for each additional letter ruling request after the $28,300 fee or reduced fee, as applicable, has been paid for the first letter ruling request. These requests may include, but are not limited to, requests for substantially identical letter rulings for two or more identical trusts, multiple beneficiaries of a trust, a trust divided into identical subtrusts, spouses making split gifts, or series funds within a single trust or series organization.

NOTE: Each entity or member that is entitled to the user fee under paragraph (A)(5)(a) of this appendix, that receives relief under § 301.9100–3 (for example, an extension of time to file an election) will be charged a separate user fee for the letter ruling request on the underlying issue.

NOTE: The fee charged for the first letter ruling is the highest fee applicable to any of the entities.

NOTE: Where the requests for the letter rulings are submitted by a private foundation described in § 509 and one or more disqualified persons described in § 4946, the fee charged for the first letter ruling to a disqualified person is the highest fee applicable to any of the taxpayers.

SECTION 4: USER FEE FOR FOREIGN INSURANCE EXCISE TAX WAIVER AGREEMENTS

The user fee for a request for a Foreign Insurance Excise Tax Waiver Agreement received on or after February 4, 2016 is $7,200. Paragraph (A)(3)(e) of Appendix A of Rev. Proc. 2016–1 is modified to reflect this correction.

SECTION 5: EFFECT ON OTHER DOCUMENTS

Section 15.07(2) of Rev. Proc. 2016–1 and paragraph (A)(5)(a) of Appendix A of Rev. Proc. 2016–1 are modified to reflect the revisions to the requirements for the reduced user fee for substantially identical letter rulings set forth in section 3 of this notice. Paragraph (A)(3)(e) of Appendix A of Rev. Proc. 2016–1 is modified to reflect the correct user fee for a request for a Foreign Insurance Excise Tax Waiver Agreement provided in section 4 of this notice.

SECTION 6: EFFECTIVE DATE

The guidance provided in section 3 of this notice is effective for letter ruling requests under the jurisdiction of the Associate Chief Counsel (Corporate), the Associate Chief Counsel (Financial Institutions and Products), the Associate Chief Counsel (Income Tax and Accounting), the Associate Chief Counsel (International), the Associate Chief Counsel (Passthroughs and Special Industries), the Associate Chief Counsel (Procedure and Administration), or the Associate Chief Counsel (Tax Exempt and Government Entites) received on or after September 27, 2016, and requests pending with the Service as of September 27, 2016.

The guidance provided in section 4 of this notice is effective for requests for Foreign Insurance Excise Tax Waiver Agreements received on or after February 4, 2016.

DRAFTING INFORMATION

The principal author of this notice is Laura Leigh Bates of the Office of the Associate Chief Counsel (Procedure and Administration). For further information regarding this notice, please contact Laura Leigh Bates at (202) 317–3400 (not a toll-free call).

Notice 2016–60

Extension of Replacement Period for Livestock Sold on Account of Drought

SECTION 1. PURPOSE

This notice provides guidance regarding an extension of the replacement period under § 1033(e) of the Internal Revenue Code for livestock sold on account of drought in specified counties.

SECTION 2. BACKGROUND

.01 Nonrecognition of Gain on Involuntary Conversion of Livestock. Section 1033(a) generally provides for nonrecognition of gain when property is involuntarily converted and replaced with property that is similar or related in service or use. Section 1033(e)(1) provides that a sale or exchange of livestock (other than poultry) held by a taxpayer for draft, breeding, or dairy purposes in excess of the number that would be sold following the taxpayer’s usual business practices is treated as an involuntary conversion if the livestock is sold or exchanged solely on account of drought, flood, or other weather-related conditions.

.02 Replacement Period. Section 1033(a)(2)(A) generally provides that gain from an involuntary conversion is recognized only to the extent the amount realized on the conversion exceeds the cost of replacement property purchased during the replacement period. If a sale or exchange of livestock is treated as an involuntary conversion under § 1033(e)(1) and is solely on account of drought, flood, or other weather-related conditions that result in the area being designated as eligible for assistance by the federal government, § 1033(e)(2)(A) provides that the replacement period ends four years after the close of the first taxable year in which any part of the gain from the conversion is realized. Section 1033(e)(2)(B) provides that the Secretary may extend this replacement period on a regional basis for such additional time as the Secretary determines appropriate if the weather-related conditions that resulted in the area being designated as eligible for assistance by the federal government continue for more than three years. Section 1033(e)(2) is effective for any taxable year with respect to which the due date (without regard to extensions) for a taxpayer’s return is after December 31, 2002.

SECTION 3. EXTENSION OF REPLACEMENT PERIOD UNDER § 1033(e)(2)(B)

Notice 2006–82, 2006–2 C.B. 529, provides for extensions of the replacement period under § 1033(e)(2)(B). If a sale or exchange of livestock is treated as an involuntary conversion on account of drought and the taxpayer’s replacement period is determined under § 1033(e)(2)(A), the replacement period will be extended under § 1033(e)(2)(B) and Notice 2006–82 until the end of the taxpayer’s first taxable year ending after the first drought-free year for the applicable region. For this purpose, the first drought-free year for the applicable region is the first 12-month period that (1) ends August 31; (2) ends in or after the last year of the taxpayer’s 4-year replacement period determined under § 1033(e)(2)(A); and (3) does not include any weekly period for which exceptional, extreme, or severe drought is reported for any location in the applicable region. The applicable region is the county that experienced the drought conditions on account of which the livestock was sold or exchanged and all counties that are contiguous to that county.

A taxpayer may determine whether exceptional, extreme, or severe drought is reported for any location in the applicable region by reference to U.S. Drought Monitor maps that are produced on a weekly basis by the National Drought Mitigation Center. U.S. Drought Monitor maps are archived at http://droughtmonitor.unl.edu/MapsAndData/MapArchive.aspx.

In addition, Notice 2006–82 provides that the Internal Revenue Service will publish in September of each year a list of counties, districts, cities, parishes, or municipalities (hereinafter “counties”) for which exceptional, extreme, or severe drought was reported during the preceding 12 months. Taxpayers may use this list instead of U.S. Drought Monitor maps to determine whether exceptional, extreme, or severe drought has been reported for any location in the applicable region.

The Appendix to this notice contains the list of counties for which exceptional, extreme, or severe drought was reported during the 12-month period ending August 31, 2016. Under Notice 2006–82, the 12-month period ending on August 31, 2016, is not a drought-free year for an applicable region that includes any county on this list. Accordingly, for a taxpayer who qualified for a four-year replacement period for livestock sold or exchanged on account of drought and whose replacement period is scheduled to expire at the end of 2016 (or, in the case of a fiscal year taxpayer, at the end of the taxable year that includes August 31, 2016), the replacement period will be extended under § 1033(e)(2) and Notice 2006–82 if the applicable region includes any county on this list. This extension will continue until the end of the taxpayer’s first taxable year ending after a drought-free year for the applicable region.

SECTION 4. DRAFTING INFORMATION

The principal author of this notice is Renay France of the Office of Associate Chief Counsel (Income Tax & Accounting). For further information regarding this notice, please contact Ms. France at (202) 317-4893 (not a toll-free number).

APPENDIX

Alabama

Counties of Baldwin, Bibb, Blount, Calhoun, Chambers, Cherokee, Clay, Cleburne, Colbert, Coosa, Cullman, DeKalb, Elmore, Etowah, Fayette, Franklin, Jackson, Jefferson, Lamar, Lauderdale, Lawrence, Lee, Limestone, Macon, Madison, Marion, Marshall, Morgan, Pickens, Randolph, Russell, Saint Clair, Shelby, Talladega, Tallapoosa, Tuscaloosa, and Walker.

Arizona

Counties of Apache, Cochise, Gila, Graham, Greenlee, La Paz, Maricopa, Navajo, Pima, Pinal, Santa Cruz, and Yuma.

Arkansas

Counties of Arkansas, Ashley, Bradley, Calhoun, Chicot, Clark, Cleveland, Columbia, Dallas, Desha, Drew, Faulkner, Garland, Grant, Hempstead, Hot Spring, Howard, Jefferson, Lafayette, Lee, Lincoln, Little River, Lonoke, Miller, Monroe, Montgomery, Nevada, Ouachita, Perry, Phillips, Pike, Polk, Prairie, Pulaski,

Saline, Scott, Sevier, Union, and Yell.

California

Counties of Alameda, Alpine, Amador, Butte, Calaveras, Colusa, Contra Costa, Del Norte, El Dorado, Fresno, Glenn, Humboldt, Imperial, Inyo, Kern, Kings, Lake, Lassen, Los Angeles, Madera, Marin, Mariposa, Mendocino, Merced, Modoc, Mono, Monterey, Napa, Nevada, Orange, Placer, Plumas, Riverside, Sacramento, San Benito, San Bernardino, San Diego, San Francisco, San Joaquin, San Luis Obispo, San Mateo, Santa Barbara, Santa Clara, Santa Cruz, Shasta, Sierra, Siskiyou, Solano, Sonoma, Stanislaus, Sutter, Tehama, Trinity, Tulare, Tuolumne, Ventura, Yolo, and Yuba.

Colorado

County of Baca.

Connecticut

Counties of Hartford, Litchfield, Tolland, and Windham.

Florida

Counties of Broward, Collier, Escambia, Miami-Dade, Monroe, and Palm Beach.

Georgia

Counties of Baldwin, Banks, Barrow, Bartow, Bibb, Bleckley, Bulloch, Burke, Butts, Candler, Carroll, Catoosa, Chattooga, Cherokee, Clarke, Clayton, Cobb, Coweta, Crawford, Dade, Dawson, DeKalb, Douglas, Effingham, Elbert, Emanuel, Fannin, Fayette, Floyd, Forsyth, Franklin, Fulton, Gilmer, Gordon, Greene, Gwinnett, Habersham, Hall, Haralson, Harris, Hart, Heard, Henry, Houston, Jackson, Jasper, Jenkins, Lamar, Laurens, Lincoln, Lumpkin, Madison, Meriwether, Monroe, Morgan, Murray, Muscogee, Newton, Oconee, Oglethorpe, Paulding, Peach, Pickens, Pike, Polk, Pulaski, Putnam, Rabun, Rockdale, Screven, Spalding, Stephens, Talbot, Taliaferro, Towns, Troup, Twiggs, Union, Upson, Walker, Walton, Washington, White, Whitfield, Wilkes, and Wilkinson.

Hawaii

Counties of Hawaii, Kauai, and Maui.

Idaho

Counties of Adams, Benewah, Blaine, Boise, Bonner, Boundary, Butte, Camas, Canyon, Clark, Clearwater, Custer, Elmore, Fremont, Gem, Gooding, Idaho, Jefferson, Jerome, Kootenai, Latah, Lemhi, Lewis, Lincoln, Minidoka, Nez Perce, Owyhee, Payette, Shoshone, Twin Falls, Valley, and Washington.

Kansas

Counties of Barber, Comanche, and Morton.

Louisiana

Parishes of Acadia, Allen, Ascension, Assumption, Avoyelles, Beauregard, Bienville, Bossier, Caddo, Calcasieu, Caldwell, Catahoula, Claiborne, Concordia, De Soto, East Baton Rouge, East Carroll, East Feliciana, Evangeline, Franklin, Grant, Iberia, Iberville, Jackson, Jefferson Davis, Jefferson, La Salle, Lafayette, Lincoln, Livingston, Madison, Morehouse, Natchitoches, Ouachita, Pointe Coupee, Rapides, Red River, Richland, Sabine, Saint Charles, Saint Helena, Saint James, Saint John the Baptist, Saint Landry, Saint Martin, Saint Tammany, Tangipahoa, Tensas, Union, Vermilion, Vernon, Washington, Webster, West Baton Rouge, West Carroll, West Feliciana, and Winn.

Maine

Counties of Androscoggin, Cumberland, Kennebec, Knox, Lincoln, Sagadahoc, and York.

Massachusetts

Counties of Barnstable, Bristol, Essex, Franklin, Hampden, Hampshire, Middlesex, Norfolk, Plymouth, Suffolk, and Worcester.

Michigan

Counties of Genesee, Shiawassee, and Wayne.

Minnesota

Counties of Big Stone, Douglas, Grant, Otter Tail, Traverse, and Wilkin.

Mississippi

Counties of Adams, Amite, Attala, Bolivar, Calhoun, Carroll, Chickasaw, Choctaw, Claiborne, Clay, Coahoma, Copiah, Covington, Forrest, Franklin, Grenada, Hinds, Holmes, Humphreys, Issaquena, Itawamba, Jasper, Jefferson, Jefferson Davis, Jones, Kemper, Lafayette, Lamar, Lauderdale, Lawrence, Leake, Lee, Leflore, Lincoln, Lowndes, Madison, Marion, Monroe, Montgomery, Neshoba, Newton, Noxubee, Oktibbeha, Panola, Pearl River, Pike, Pontotoc, Prentiss, Quitman, Rankin, Scott, Sharkey, Simpson, Smith, Stone, Sunflower, Tallahatchie, Tishomingo, Tunica, Union, Walthall, Warren, Washington, Webster, Wilkinson, Winston, Yalobusha, and Yazoo.

Montana

Counties of Beaverhead, Big Horn, Broadwater, Carbon, Carter, Cascade, Deer Lodge, Fallon, Flathead, Gallatin, Glacier, Granite, Jefferson, Lake, Lewis and Clark, Lincoln, Madison, Mineral, Missoula, Park, Pondera, Powder River, Powell, Ravalli, Sanders, Silver Bow, Stillwater, Sweet Grass, Teton, Toole, and Yellowstone.

Nebraska

Counties of Adams, Clay, Franklin, Kearney, and Webster.

Nevada

Counties of Carson City, Churchill, Clark, Douglas, Elko, Esmeralda, Eureka, Humboldt, Lander, Lincoln, Lyon, Mineral, Nye, Pershing, Storey, Washoe, and White Pine.

New Hampshire

Counties of Belknap, Cheshire, Hillsborough, Merrimack, Rockingham, and Strafford.

New Mexico

Counties of Lea, Roosevelt, and Union.

New York

Counties of Allegany, Broome, Cattaraugus, Cayuga, Chautauqua, Chemung, Cortland, Erie, Genesee, Jefferson, Lewis, Livingston, Monroe, Niagara, Onondaga, Ontario, Orleans Oswego, Schuyler, Seneca, Steuben, Suffolk, Tioga, Tompkins, Wayne, Wyoming, and Yates.

North Carolina

Counties of Alexander, Buncombe, Burke, Caldwell, Catawba, Cherokee, Clay, Cleveland, Gaston, Graham, Haywood, Henderson, Iredell, Jackson, Lincoln, Macon, Madison, McDowell, Mecklenburg, Polk, Rutherford, Swain, Transylvania, Union, and Yancey.

North Dakota

Counties of Bowman, Richland, and Slope.

Ohio

Counties of Allen, Ashland, Auglaize, Champaign, Clark, Crawford, Cuyahoga, Erie, Geauga, Hancock, Hardin, Holmes, Huron, Lake, Logan, Lorain, Madison, Marion, Mercer, Miami, Morrow, Richland, Seneca, Shelby, Union, Van Wert, Wayne, Wood, and Wyandot.

Oklahoma

Counties of Atoka, Beckham, Bryan, Carter, Cherokee, Choctaw, Cimarron, Comanche, Cotton, Ellis, Garvin, Greer, Harmon, Harper, Jackson, Jefferson, Johnston, Kiowa, Le Flore, Love, Marshall, McCurtain, Murray, Muskogee, Pontotoc, Pushmataha, Roger Mills, Stephens, Texas, Tillman, Wagoner, Woods, and Woodward.

Oregon

Counties of Baker, Benton, Clackamas, Clatsop, Columbia, Coos, Crook, Curry, Deschutes, Douglas, Gilliam, Grant, Harney, Hood River, Jackson, Jefferson, Josephine, Klamath, Lake, Lane, Lincoln, Linn, Malheur, Marion, Morrow, Multnomah, Polk, Sherman, Tillamook, Umatilla, Union, Wallowa, Wasco, Washington, Wheeler, and Yamhill.

Pennsylvania

Counties of Bradford, Cameron, Centre, Clearfield, Clinton, Elk, Erie, Lycoming, McKean, Potter, Susquehanna, and Tioga.

Puerto Rico

Municipios (municipalities) of Aguas Buenas, Aibonito, Arroyo, Barranquitas, Bayamon, Caguas, Canovanas, Carolina, Catano, Cayey, Ceiba, Cidra, Coamo, Comerio, Corozal, Culebra, Dorado, Fajardo, Guayama, Guaynabo, Gurabo, Humacao, Juncos, Las Piedras, Loiza, Luquillo, Manati, Maunabo, Morovis, Naguabo, Naranjito, Orocovis, Patillas, Rio Grande, Salinas, San Juan, San Lorenzo, Santa Isabel, Toa Alta, Toa Baja, Trujillo Alto, Vega Alta, Vega Baja, Vieques, and Yabucoa.

Rhode Island

County of Providence.

South Carolina

Counties of Abbeville, Allendale, Anderson, Bamberg, Barnwell, Berkeley, Calhoun, Cherokee, Chester, Chesterfield, Clarendon, Colleton, Darlington, Dorchester, Edgefield, Fairfield, Florence, Greenville, Greenwood, Hampton, Jasper, Kershaw, Lancaster, Lee, Lexington, McCormick, Oconee, Orangeburg, Pickens, Richland, Saluda, Spartanburg, Sumter, Union, Williamsburg, and York.

South Dakota

Counties of Butte, Custer, Fall River, Harding, Lawrence, Meade, Pennington, Perkins, and Roberts.

Tennessee

Counties of Bedford, Bledsoe, Blount, Bradley, Coffee, Cumberland, Franklin, Giles, Grundy, Hamilton, Hardin, Lawrence, Lincoln, Loudon, Marion, Marshall, Maury, McMinn, Meigs, Monroe, Moore, Polk, Rhea, Roane, Sequatchie, Van Buren, and Warren.

Texas

Counties of Anderson, Angelina, Archer, Atascosa, Bandera, Bastrop, Baylor, Bell, Bexar, Blanco, Bosque, Bowie, Brazos, Brown, Burleson, Burnet, Caldwell, Callahan, Camp, Cass, Castro, Cherokee, Childress, Clay, Cochran, Coke, Coleman, Collin, Comal, Comanche, Concho, Cooke, Coryell, Cottle, Crosby, Dallas, Deaf Smith, Delta, Denton, DeWitt, Dickens, Dimmit, Eastland, Ellis, Erath, Falls, Fannin, Fayette, Fisher, Floyd, Foard, Franklin, Freestone, Frio, Garza, Gillespie, Gonzales, Grayson, Gregg, Grimes, Guadalupe, Hale, Hamilton, Hardeman, Harrison, Haskell, Hays, Hemphill, Henderson, Hill, Hockley, Hood, Hopkins, Houston, Hunt, Jack, Jasper, Johnson, Jones, Karnes, Kaufman, Kendall, Kent, Kerr, Kimble, King, Kinney, Kleberg, Knox, La Salle, Lamar, Lampasas, Lavaca, Lee, Leon, Limestone, Lipscomb, Live Oak, Llano, Lubbock, Madison, Marion, Mason, Maverick, McCulloch, McLennan, McMullen, Medina, Menard, Milam, Mills, Mitchell, Montague, Montgomery, Morris, Motley, Nacogdoches, Navarro, Newton, Nolan, Nueces, Palo Pinto, Panola, Parker, Polk, Rains, Red River, Robertson, Rockwall, Runnels, Rusk, Sabine, San Augustine, San Jacinto, San Patricio, San Saba, Schleicher, Scurry, Shackelford, Shelby, Smith, Somervell, Stephens, Sterling, Stonewall, Sutton, Tarrant, Taylor, Terrell, Terry, Throckmorton, Titus, Tom Green, Travis, Trinity, Tyler, Upshur, Uvalde, Val Verde, Van Zandt, Walker, Washington, Webb, Wheeler, Wichita, Wilbarger, Williamson, Wilson, Wise, Wood, Yoakum, Young, and Zavala.

Utah

Counties of Beaver, Box Elder, Carbon, Davis, Duchesne, Juab, Millard, Piute, Salt Lake, Sanpete, Sevier, Summit, Tooele, Utah, Wasatch, and Weber.

Washington

Counties of Adams, Asotin, Benton, Chelan, Clallam, Clark, Columbia, Cowlitz, Douglas, Ferry, Franklin, Garfield, Grant, Grays Harbor, Island, Jefferson, King, Kitsap, Kittitas, Klickitat, Lewis, Lincoln, Mason, Okanogan, Pacific, Pend Oreille, Pierce, San Juan, Skagit, Skamania, Snohomish, Spokane, Stevens, Thurston, Wahkiakum, Walla Walla, Whatcom, Whitman, and Yakima.

Wyoming

Counties of Big Horn, Campbell, Converse, Crook, Johnson, Natrona, Niobrara, Park, Sheridan, Teton, Washakie, and Weston.

Rev. Proc. 2016–49

SECTION 1. PURPOSE

The 2010 amendment of § 2010(c) of the Internal Revenue Code (Code) allowing an executor of an estate to make an election under § 2010(c)(5)(A) (a portability election) may influence the decision of whether to make a qualified terminable interest property (QTIP) election under § 2056(b)(7) (a QTIP election). A QTIP election would reduce the decedent’s taxable estate and thereby maximize the amount of unused exclusion available to be used by the decedent’s surviving spouse. Thus, the executor of an estate electing portability of the decedent’s unused applicable exclusion amount (deceased spousal unused exclusion amount, or DSUE amount) may wish to make a QTIP election without regard to whether the QTIP election is necessary to reduce the estate tax liability to zero.

Rev. Proc. 2001–38, 2001–24 C.B. 1335, provides a procedure by which the IRS will disregard and treat as a nullity for federal estate, gift, and generation-skipping transfer tax purposes a QTIP election made in cases where the election was not necessary to reduce the estate tax liability to zero. Rev. Proc. 2001–38, when issued, provided relief to the surviving spouse of a decedent whose estate received no benefit from the unnecessary QTIP election. With the availability of portability elections, however, the procedure to void and nullify QTIP elections in Rev. Proc. 2001–38 may bring into question the ability of a decedent’s estate to make an otherwise unnecessary QTIP election to maximize the available unused exclusion amount.

This revenue procedure modifies and supersedes Rev. Proc. 2001–38. Although this revenue procedure confirms the procedures by which the IRS will disregard a QTIP election, it excludes from its scope those estates in which the executor made the portability election in accordance with the regulations under § 2010(c)(5)(A).

SECTION 2. BACKGROUND

.01 QTIP Rules and Rev. Proc. 2001–38.

(1) Section 2056(a) provides that, except as limited by § 2056(b), the value of a taxable estate is determined by deducting from the value of the gross estate an amount equal to the value of any interest in property which passes or has passed from the decedent to the surviving spouse. Section 2056(b)(1) denies a marital deduction for an interest passing to the surviving spouse that is a “terminable interest.” An interest is a terminable interest if the interest passing to the surviving spouse will terminate or fail on the lapse of time or on the occurrence of an event or contingency or on the failure of an event or contingency to occur, and on termination, an interest in the property passes to someone other than the surviving spouse.

(2) Section 2056(b)(7)(A) provides an exception to this terminable interest rule in the case of QTIP. For purposes of § 2056(a), QTIP is treated as passing to the surviving spouse, and no part of the property is treated as passing to any person other than the surviving spouse. Under § 2056(b)(7)(B)(i), QTIP is property that passes from the decedent, in which the surviving spouse has a qualifying income interest for life, and to which an election under § 2056(b)(7)(B)(v) applies.

(3) Section 2056(b)(7)(B)(v) provides that the QTIP election is made by the executor on the return of tax imposed by § 2001. This election, once made, is irrevocable.

(4) Section 20.2056(b)–7(b)(4)(i) of the Estate Tax Regulations provides that the QTIP election is made on the return of tax imposed by § 2001 (or § 2101). The term “return of tax imposed by § 2001” means the last estate tax return (Form 706–United States Estate (and Generation-Skipping Transfer) Tax Return) filed by the executor on or before the due date of the return, including extensions, or, if a timely return is not filed, the first estate tax return filed after the due date. Section 20.2056(b)–7(b)(4)(ii) confirms that the election, once made, is irrevocable.

(5) A QTIP election has estate, gift, and generation-skipping transfer tax consequences for the surviving spouse. Section 2044(a) and (b) provides generally that the value of the gross estate includes the value of any property in which the decedent (the deceased surviving spouse) has a qualifying income interest for life and with respect to which a deduction was allowed for the transfer of the property to that decedent under § 2056(b)(7). Similarly, under § 2519(a) and (b), any disposition of all or part of a qualifying income interest for life in any property with respect to which a deduction was allowed under § 2056(b)(7) is treated as a transfer of all interests in the property other than the qualifying income interest. Finally, in the absence of a “reverse QTIP” election under § 2652(a)(3), the surviving spouse will be treated as the transferor of the property for generation-skipping transfer tax purposes under § 2652(a).

(6) Rev. Proc. 2001–38 provided relief from unnecessary QTIP elections. An example of an unnecessary QTIP election is one that was made when the value of the taxable estate, before allowance of the marital deduction, was less than the applicable exclusion amount under § 2010(c), so that no estate tax would have been imposed whether or not the QTIP election was made. Rev. Proc. 2001–38 also provided a second example where the decedent’s will provided for a “credit shelter trust” to be funded with an amount equal to the applicable exclusion amount under § 2010(c), with the balance of the estate passing to a trust intended to qualify for the marital deduction, and the estate made QTIP elections for both the credit shelter trust and the marital trust. The QTIP election for the credit shelter trust was not necessary because no estate tax would have been imposed on the value of that trust whether or not the QTIP election was made for that trust. In these situations, before the issuance of Rev. Proc. 2001–38, the unnecessary QTIP election caused the property subject to the election to be included in the surviving spouse’s gross estate under § 2044(a), or to be subject to gift tax upon the surviving spouse’s inter vivos disposition of the income interest, and, in the absence of a “reverse QTIP” election under § 2652(a)(3), would cause the surviving spouse to be treated as the transferor of the property for generation-skipping transfer tax purposes. Therefore, when Rev. Proc. 2001–38 was issued (specifically, before the availability of portability), an unnecessary QTIP election produced adverse tax consequences and no benefit for taxpayers. Rev. Proc. 2001–38 provided relief by treating the unnecessary QTIP election as a nullity for federal estate, gift, and generation-skipping transfer tax purposes.

.02 Section 2010(c) and the Introduction of Portability Elections.

(1) In 2010, Congress amended § 2010(c) of the Code, and made conforming amendments to §§ 2505(a), 2631(c), and 6018(a)(1), to permit the executor of an estate to make a portability election allowing a decedent’s unused applicable exclusion amount to benefit a surviving spouse. See §§ 302(a)(1) and 303(a) of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, Pub. L. No. 111–312, 124 Stat. 3296, 3302 (Dec. 17, 2010). A portability election allows the surviving spouse to apply the DSUE amount of a deceased spouse to the surviving spouse’s subsequent transfers during life and at death.

(2) Section 2010(c)(1) describes the applicable credit amount as the amount of the tentative tax that would be determined under § 2001(c) if the amount with respect to which such tentative tax is to be computed were equal to the applicable exclusion amount. Generally, the applicable credit amount effectively exempts from federal estate and gift tax a person’s taxable transfers with a cumulative value not exceeding the applicable exclusion amount.

(3) Under § 2010(c)(2), the applicable exclusion amount is the sum of the basic exclusion amount and, in the case of a surviving spouse, the DSUE amount, if any.

(4) Section 2010(c)(3) defines the basic exclusion amount as $5,000,000, subject to annual adjustments after 2011 for inflation.

(5) Section 2010(c)(4), as amended by § 101(c) of the American Taxpayer Relief Act of 2012, Pub. L. No. 112–240, 126 Stat. 2313, defines the DSUE amount as the lesser of (A) the basic exclusion amount, or (B) the excess of the applicable exclusion amount of the last deceased spouse of the surviving spouse over the amount with respect to which the tentative tax is determined under § 2001(b)(1) on the estate of such deceased spouse. Excluded from the definition of the term “DSUE amount” is any unused exclusion amount from a deceased spouse who died before January 1, 2011.

(6) Section 2010(c)(5)(A) provides certain requirements that the executor of the estate of a deceased spouse must satisfy to allow the decedent’s surviving spouse to apply the decedent’s DSUE amount to the surviving spouse’s transfers. In particular, the executor of the estate of the deceased spouse must make a portability election on an estate tax return, which must include a computation of the DSUE amount. Under § 2010(c)(5)(A), a portability election is effective only if made on an estate tax return that is filed within the time prescribed by law (including extensions) for filing such return.

(7) Section 20.2010–2(a)(2) provides that an executor of an estate of a decedent survived by a spouse makes a portability election upon the timely filing of a complete and properly prepared estate tax return, unless the executor satisfies the requirement in § 20.2010–2(a)(3)(i) to not be considered to make the portability election.

(8) Section 20.2010–2(a)(3) provides that the executor of the decedent’s estate will not make or be considered to make the portability election if—(i) the executor makes an affirmative statement to that effect on a timely filed estate tax return, as set forth in the instructions for such form (“Instructions for Form 706”) or (ii) the executor does not timely file an estate tax return.

(9) Section 20.2010–3(c)(1) and § 25.2505–2(d)(1) of the Gift Tax Regulations provide that a portability election made by the executor of a decedent’s estate applies as of the date of the decedent’s death and, therefore, the DSUE amount of a decedent survived by a spouse generally is included in determining the applicable exclusion amount of the surviving spouse under § 2010(c)(2) with respect to transfers occurring after the death of the decedent. Accordingly, when the executor of a decedent’s estate makes a portability election, the surviving spouse may apply the decedent’s DSUE amount to the surviving spouse’s subsequent transfers during life and at death.

.03 Planning with QTIP Trusts after Enactment of Portability.

(1) Rev. Proc. 2001–38 was premised on the belief that an executor would never purposefully elect QTIP treatment for property if the election was not necessary to reduce the decedent’s estate tax liability.

(2) With the amendment of §§ 2010(c) and 2505(a) to provide for portability elections, an executor of a deceased spouse’s estate may wish to elect QTIP treatment for property even where the election is not necessary to reduce the estate tax liability. A QTIP election would reduce the amount of the taxable estate and the tax imposed by § 2001(a) (if any), resulting in less use of the decedent’s applicable credit amount and producing a greater DSUE amount than would exist if no QTIP election was made for the property. An increased DSUE amount available to the surviving spouse increases the applicable credit amount available to the surviving spouse to wholly or partially offset the surviving spouse’s gift or estate tax liability that is attributable to the QTIP or any other property.

(3) In view of the foregoing, the Treasury Department and the IRS have determined that it is appropriate to continue to provide procedures by which the IRS will disregard an unnecessary QTIP election and treat such election as null and void, but only for estates in which the executor neither made nor was considered to have made the portability election. In estates in which the executor made the portability election, QTIP elections will not be treated as void.

SECTION 3. SCOPE

.01 This revenue procedure treats as void QTIP elections made in cases where all of the following requirements are satisfied:

(1) The estate’s federal estate tax liability was zero, regardless of the QTIP election, based on values as finally determined for federal estate tax purposes, thus making the QTIP election unnecessary to reduce the federal estate tax liability;

(2) The executor of the estate neither made nor was considered to have made the portability election as provided in § 2010(c)(5)(A) and the regulations thereunder; and

(3) The requirements of section 4.02 of this revenue procedure are satisfied.

.02 This revenue procedure does not treat as void QTIP elections made to treat property as QTIP in cases where:

(1) A partial QTIP election was required with respect to a trust to reduce the estate tax liability and the executor made the election with respect to more trust property than was necessary to reduce the estate tax liability to zero;

(2) A QTIP election was stated in terms of a formula designed to reduce the estate tax to zero. See, for example, § 20.2056(b)–7(h), Examples 7 and 8;

(3) The QTIP election was a protective election under § 20.2056(b)–7(c);

(4) The executor of the estate made a portability election in accordance with § 2010(c)(5)(A) and the regulations thereunder, even if the decedent’s DSUE amount was zero based on values as finally determined for federal estate tax purposes; or

(5) The requirements of section 4.02 of this revenue procedure are not satisfied.

.03 The procedures described in section 4 of this revenue procedure must be used in lieu of requesting a letter ruling under the provisions of Rev. Proc. 2016–1, 2016–1 I.R.B. 1 (or its successors). Accordingly, user fees do not apply to corrective action under this revenue procedure.

.04 QTIP elections for which relief has been granted under the procedures of Rev. Proc. 2001–38 are not within the scope of this revenue procedure.

SECTION 4. PROCEDURE

.01 Relief for Unnecessary QTIP Election. In the case of a QTIP election within the scope of section 3.01 of this revenue procedure, the IRS will disregard the QTIP election and treat it as null and void for purposes of §§ 2044(a), 2056(b)(7), 2519(a), and 2652. The property for which the QTIP election is disregarded under this revenue procedure will not be includible in the gross estate of the surviving spouse under § 2044, and the spouse will not be treated as making a gift under § 2519 if the spouse disposes of part or all of the income interest with respect to the property. Finally, the surviving spouse will not be treated as the transferor of the property for generation-skipping transfer tax purposes under § 2652(a).

.02 Procedural Requirements for Relief to Treat QTIP Election As Void.

(1) Taxpayer satisfies the requirements of this section by submitting the information required by this section in connection with (a) a supplemental Form 706 filed for the estate of the predeceased spouse, (b) a Form 709 (United States Gift (and Generation-Skipping Transfer) Tax Return) filed by the surviving spouse, or (c) a Form 706 filed for the estate of the surviving spouse. A supplemental Form 706 filed for the estate of the predeceased spouse may be filed only by a person permitted to do so (see § 20.6018–2) and only if the applicable period of limitations (whether on assessments or claims for credit or refund) has not expired with respect to the return of the predeceased spouse.

(2) Taxpayer must notify the IRS that a QTIP election is within the scope of section 3.01 of this revenue procedure. Notice is provided by entering at the top of the Form 706 or Form 709 the notation “Filed pursuant to Revenue Procedure 2016–49.”

(3) Taxpayer must identify the QTIP election that should be treated as void under this revenue procedure and provide an explanation of why the QTIP election falls within the scope of section 3.01 of this revenue procedure. The explanation should include all the relevant facts, including the value of the predeceased spouse’s taxable estate without regard to the allowance of the marital deduction for the QTIP at issue compared to the applicable exclusion amount in effect for the year of the predeceased spouse’s death. The explanation should state that the portability election was not made in the predeceased spouse’s estate and include the relevant facts to support this statement.

(4) Taxpayer must provide sufficient evidence that the QTIP election is within the scope of section 3.01 of this revenue procedure. Evidence sufficient to establish that the QTIP election was not necessary to reduce the estate tax liability to zero based on values as finally determined for federal estate tax purposes and that the executor opted not to elect portability of the DSUE amount may include a copy of the predeceased spouse’s estate tax return filed with the IRS. If the executor of the predeceased spouse’s estate was not considered to have made a portability election because of a late filing of that return, evidence may consist of the account transcript reflecting the date the estate tax return was filed.

SECTION 5. EFFECT ON OTHER DOCUMENTS

Rev. Proc. 2001–38 is modified and superseded.

SECTION 6. EFFECTIVE DATE

This revenue procedure is effective September 27, 2016 and applies to QTIP elections within the scope of this revenue procedure.

SECTION 7. DRAFTING INFORMATION

The principal author of this revenue procedure is Juli Ro Kim of the Office of Associate Chief Counsel (Passthroughs & Special Industries). For further information regarding this revenue procedure contact Ms. Kim on (202) 317-6859 (not a toll-free number).

Rev. Proc. 2016–51

TABLE OF CONTENTS

PART I. INTRODUCTION TO EMPLOYEE PLANS COMPLIANCE RESOLUTION SYSTEM
SECTION 1. PURPOSE AND OVERVIEW
.01 Purpose ............................................................................................ 468
.02 General principles underlying EPCRS ............................................. 468
.03 Overview .......................................................................................... 468
SECTION 2. EFFECT OF THIS REVENUE PROCEDURE ON PROGRAMS
.01 Effect on programs ........................................................................... 468
.02 Modifications relating to changes in the determination letter program . . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . ... . .. . .. . .. . .. . .. . .. . .. . .. . .. 468
.03 Description of modifications relating to user fees . . .. . .. . .. . .. . .. . .. . ... 469
.04 Description of modifications . . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .... 469
.05 Future enhancements ... . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . ..... . . 470
PART II. PROGRAM EFFECT AND ELIGIBILITY
SECTION 3. EFFECT OF EPCRS; RELIANCE
.01 Effect of EPCRS on retirement plans . . .. . .. . .. . .. . ............................. 471
.02 Compliance statement ..................................................................... 471
.03 Excise and other taxes . . .................................................................. 471
.04 Reliance ........................................................................................... 471
SECTION 4. PROGRAM ELIGIBILITY
.01 EPCRS Programs . . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . ....... 471
.02 Effect of examination ...................................................................... 471
.03 SCP eligibility requirements relating to plan documents ................ 471
.04 Established practices and procedures ........................................... 472
.05 Correction by plan amendment ...................................................... 472
.06 Availability of correction for Employer Eligibility Failure ................. 472
.07 Availability of correction for a terminated plan . . .. . .... . .. . .. . ......... . .. 472
.08 Availability of correction for an Orphan Plan . . .... . ... . .. . .... . .. . ... . ... . . 472
.09 Availability of correction for § 457(b) plans . . .... . .. . .. . .. . .. . .. . .. . ... . .... 472
.10 Egregious failures . . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . 473
.11 Diversion or misuse of plan assets . . ............................................ 473
.12 Abusive tax avoidance transactions . . .. . .. . .. . .. . .... . .. . .... . .. . .. . .. . ... 473
PART III. DEFINITIONS, CORRECTION PRINCIPLES, AND RULES OF GENERAL APPLICABILITY
SECTION 5. DEFINITIONS
.01 Definitions for Qualified Plans ........................................................ 473
.02 Definitions for 403(b) Plans ............................................................ 475
.03 Definitions for Orphan Plans .... . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . ...... 476
.04 Earnings . . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . ... . .... . ... 476
.05 IRA . . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .... . .. 476
.06 SEP . . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . ... . .. . .. . .. 476
.07 SIMPLE IRA Plan . . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . ... . .. . .. . .. 476
.08 Under Examination ......................................................................... 476
SECTION 6. CORRECTION PRINCIPLES AND RULES OF GENERAL APPLICABILITY
.01 Correction principles; rules of general applicability ........................ 477
.02 Correction principles ...................................................................... 477
.03 Correction of an Employer Eligibility Failure .................................. 480
.04 Correction of a failure to obtain spousal consent . . .. . .. . .. . .. . ... . .... 480
.05 Determination letter application not permitted . . .. . .. . .... . .. . .. . ........ 481
.06 Special rules relating to Excess Amounts ..................................... 481
.07 Rules relating to reporting plan loan failures . . .. . .. . .. . .. . .... . .. . .. . ... 482
.08 Correction under statute or regulations ......................................... 483
.09 Matters subject to excise or other taxes ........................................ 483
.10 Correction for 403(b) Plans ........................................................... 484
.11 Correction for SEPs and SIMPLE IRA Plans ................................. 484
.12 Confidentiality and disclosure ......................................................... 485
.13 No effect on other law ..................................................................... 485
PART IV. SELF-CORRECTION (SCP)
SECTION 7. IN GENERAL................................................................................ 486
SECTION 8. SELF-CORRECTION OF INSIGNIFICANT OPERATIONAL FAILURES
.01 Requirements ................................................................................ 487
.02 Factors .......................................................................................... 487
.03 Multiple failures ............................................................................. 487
.04 Examples ...................................................................................... 487
SECTION 9. SELF-CORRECTION OF SIGNIFICANT OPERATIONAL FAILURES
.01 Requirements ................................................................................. 487
.02 Correction period ............................................................................ 487
.03.Substantial completion of correction . . .. . .. . .. . .. . .. . .. . .. . ................... 488
.04 Examples ........................................................................................ 488
PART V. VOLUNTARY CORRECTION PROGRAM WITH IRS APPROVAL (VCP)
SECTION 10. VCP PROCEDURES
.01 VCP requirements ........................................................................ 488
.02 Identification of failures ................................................................. 488
.03 Effect of VCP submission on examination .................................... 488
.04 No concurrent examination activity ............................................... 488
.05 Determination letter applications not related to a VCP submission . . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . ... . .. . .. 489
.06 Processing of submission ............................................................... 489
.07 Compliance statement .................................................................... 490
.08 Effect of compliance statement on examination . . .. . ... . .. . .. . ............ 491
.09 Special rules relating to Anonymous Submissions . . ........ . .. . .. . .. . .. 491
.10 Special rules relating to Group Submissions ................................... 491
.11 Multiemployer and multiple employer plans ..................................... 492
SECTION 11. SUBMISSION PROCEDURES FOR VCP
.01 General rules ................................................................................... 492
.02 Use of model forms . . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .... . ... . ..... . ... 492
.03 Submission requirements ................................................................ 493
.04 Required documents . . ... . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .... . .. 493
.05 Date user fee due generally . . ......................................................... 493
.06 Additional amount due for SEPs, SIMPLE IRA Plans and Group Submissions .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .... . .. . .. . .. 493
.07 Power of attorney requirements . . ................................................... 494
.08 Penalty of perjury statement ............................................................ 494
.09 Procedural Requirements Checklist . . .. . .. . .. . .. . .. . .. . ......................... 494
.10 Orphan Plan ... . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .... . .. . .. 494
.11 Acknowledgement letter . . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . ... . .. . .... . ... 494
.12 VCP mailing addresses .................................................................... 494
.13 Maintenance of copies of submissions . . .......................................... 494
.14 Assembling the submission . . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . ... . .. . .. . ... . .. . .. 494
SECTION 12. VCP USER FEES
.01 User fees .......................................................................................... 495
PART VI. CORRECTION ON AUDIT (AUDIT CAP)
SECTION 13. DESCRIPTION OF AUDIT CAP
.01 Audit CAP requirements ................................................................... 495
.02 Payment of sanction ......................................................................... 495
.03 Additional requirements .................................................................... 495
.04 Failure to reach resolution ................................................................ 495
.05 Effect of closing agreement .............................................................. 495
.06 Other procedural rules ...................................................................... 495
SECTION 14. AUDIT CAP SANCTION
.01 Determination of sanction ................................................................. 495
.02 Factors considered ........................................................................... 495
.03 Transferred Assets ............................................................................ 496
.04 Sanction for Nonamender Failures discovered during the determination letter application process . . .. . .. . .. . .. . .. . .. . .. . .. . .... . .. . . 496
PART VII. EFFECT ON OTHER DOCUMENTS; EFFECTIVE DATE; PAPERWORK REDUCTION ACT
SECTION 15. EFFECT ON OTHER DOCUMENTS . . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . . 496
SECTION 16. EFFECTIVE DATE ....................................................................... 496
SECTION 17. PUBLIC COMMENTS . . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . . 496
SECTION 18. PAPERWORK REDUCTION ACT .............................................. 496
DRAFTING INFORMATION...................................................................................... 497
APPENDIX A: OPERATIONAL FAILURES AND CORRECTION METHODS
.01 General rule ...................................................................................... 497
.02 Failure to properly provide the minimum top-heavy benefit under § 416 to non-key employees . . .. . .. . ....................... 497
.03 Failure to satisfy the ADP test set forth in § 401(k)(3), the ACP test set forth in § 401(m)(2), or, for plan years beginning on or before December 31, 2001, the multiple use test of § 401(m)(9) . . .. . .. . .. . .. . .. . .. . .. . .. . .. . .......................... 497
.04 Failure to distribute elective deferrals in excess of the § 402(g) limit (in contravention of § 401(a)(30)) . . .. . .. . .. . ............................................... 498
.05 Exclusion of an eligible employee from all contributions or accruals under the plan for one or more plan years .......................................... 498
.06 Failure to timely pay the minimum distribution required under § 401(a)(9) . . .. . .. . .. . .. . .......................................................................... 502
.07 Failure to obtain participant or spousal consent for a distribution subject to the participant and spousal consent rules under §§ 401(a)(11), 411(a)(11), and 417 . . .. . .. . .. . .. . .. . .. . .................................................................. 502
.08 Failure to satisfy the § 415 limits in a defined contribution plan . . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . . 503
.09 Orphan Plans; orphan contracts and other assets . . .. . .. . .. . .. . .. . ... 503
APPENDIX B: CORRECTION METHODS AND EXAMPLES; EARNINGS ADJUSTMENT METHODS AND EXAMPLES
SECTION 1. PURPOSE, ASSUMPTIONS FOR EXAMPLES AND SECTION
REFERENCES
.01 Purpose .......................................................................................... 504
.02 Assumptions for Examples .............................................................. 504
.03 Designated Roth contributions ......................................................... 504
.04 Section references . . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .... . ... . .. . .. . .. . .. . .. . . 504
SECTION 2. CORRECTION METHODS AND EXAMPLES
.01 ADP/ACP Failures ........................................................................... 504
.02 Exclusion of Otherwise Eligible Employees .................................... 506
.03 Vesting Failures . . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . ... . .. . .. . ..... . ... 513
.04 § 415 Failures .................................................................................. 513
.05 Correction of Other Overpayment Failures ... . .. . .. . ... . .. . .... . ... . ... . .. 515
.06 § 401(a)(17) Failures .... . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .... . .. . .. . .. . ..... 515
.07 Correction by Amendment . . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .. . .... . ....... 515
SECTION 3. EARNINGS ADJUSTMENT METHODS AND EXAMPLES
.01 Earnings Adjustment Methods ........................................................ 516
.02 Examples ......................................................................................... 518

PART I. INTRODUCTION TO EMPLOYEE PLANS COMPLIANCE RESOLUTION SYSTEM

SECTION 1. PURPOSE AND OVERVIEW

.01 Purpose. This revenue procedure updates the comprehensive system of correction programs for sponsors of retirement plans that are intended to satisfy the requirements of § 401(a), 403(a), 403(b), 408(k), or 408(p) of the Internal Revenue Code (the “Code”), but that have not met these requirements for a period of time. This system, the Employee Plans Compliance Resolution System (“EPCRS”), permits Plan Sponsors to correct these failures and thereby continue to provide their employees with retirement benefits on a tax-favored basis. The components of EPCRS are the Self-Correction Program (“SCP”), the Voluntary Correction Program (“VCP”), and the Audit Closing Agreement Program (“Audit CAP”).

.02 General principles underlying EPCRS. EPCRS is based on the following general principles:

  • Sponsors and other administrators of eligible plans should be encouraged to establish administrative practices and procedures that ensure that these plans are operated properly in accordance with the applicable requirements of the Code.

  • Sponsors and other administrators of eligible plans should satisfy the applicable plan document requirements of the Code.

  • Sponsors and other administrators should make voluntary and timely correction of any plan failures, whether involving discrimination in favor of highly compensated employees, plan operations, the terms of the plan document, or adoption of a plan by an ineligible employer. Timely and efficient correction protects participating employees by providing them with their expected retirement benefits, including favorable tax treatment.

  • Voluntary compliance is promoted by establishing limited fees for voluntary corrections approved by the Internal Revenue Service (“IRS”), thereby reducing employers’ uncertainty regarding their potential tax liability and participants’ potential tax liability.

  • Fees and sanctions should be graduated in a series of steps so that there is always an incentive to correct promptly.

  • Sanctions for plan failures identified on audit should be reasonable in light of the nature, extent, and severity of the violation.

  • Administration of EPCRS should be consistent and uniform.

  • Sponsors should be able to rely on the availability of EPCRS in taking corrective actions to maintain the tax-favored status of their plans.

.03 Overview. EPCRS includes the following basic elements:

  • Self-correction (SCP). A Plan Sponsor that has established compliance practices and procedures may, at any time without paying any fee or sanction, correct insignificant Operational Failures under a Qualified Plan, a 403(b) Plan, a SEP, or a SIMPLE IRA Plan. For a SEP or SIMPLE IRA Plan, however, SCP is available only if the SEP or SIMPLE IRA Plan is established and maintained on a document approved by the IRS. In the case of a Qualified Plan or 403(b) Plan that satisfies the requirements of sections 4.03 and 4.04, the Plan Sponsor generally may correct even significant Operational Failures without payment of any fee or sanction if the correction is made within the time specified in section 9.02.

  • Voluntary correction with IRS approval (VCP). A Plan Sponsor, at any time before audit, may pay a limited fee and receive the IRS’s approval for correction of a Qualified Plan, 403(b) Plan, SEP, or SIMPLE IRA Plan failure. Under VCP, there are special procedures for Anonymous Submissions and Group Submissions.

  • Correction on audit (Audit CAP). If a failure (other than a failure corrected through SCP or VCP) is identified on audit, the Plan Sponsor may correct the failure and pay a sanction. The sanction imposed will bear a reasonable relationship to the nature, extent, and severity of the failure, taking into account the extent to which correction occurred before audit.

SECTION 2. EFFECT OF THIS REVENUE PROCEDURE ON PROGRAMS

.01 Effect on programs. This revenue procedure modifies and supersedes Rev. Proc. 2013–12, 2013–4 I.R.B. 313, the prior consolidated statement of the correction programs under EPCRS. This revenue procedure also incorporates certain modifications set forth in Rev. Proc. 2015–27, 2015–16 I.R.B. 914 (correction of overpayments and certain other topics), and Rev. Proc. 2015–28, 2015–16 I.R.B. 920 (correction of failures with respect to automatic contribution features and encouraging the early correction of employee elective deferral failures), two prior revenue procedures modifying Rev. Proc. 2013–12. In addition, this revenue procedure incorporates modifications to Rev. Proc. 2013–12 set forth in Rev. Proc. 2016–8, 2016–1 I.R.B. 243 (fees for VCP submissions generally moved to annual Employee Plans (EP) revenue procedure on user fees).

.02 Modifications relating to changes in the determination letter program. (1) In general. Effective January 1, 2017, the staggered 5-year remedial amendment cycles for individually designed plans will be eliminated, and the scope of the determination letter program for individually designed plans will be limited to initial plan qualification, qualification upon plan termination, and certain other circumstances. For further information, see Rev. Proc. 2016–37, 2016–29 I.R.B. 136. EPCRS is being modified to take into account the changes in the determination letter program. For information on how to submit comments regarding changes made in EPCRS to take into account changes in the determination letter program, see section 17.

(2) Changes to Audit CAP. Section 14 of Rev. Proc. 2013–12 sets forth guidance on determining the sanction under Audit CAP. This revenue procedure provides a revised approach for determining Audit CAP sanctions. Section 14.01 no longer provides that the sanction will be a negotiated percentage of the Maximum Payment Amount, but instead will be determined based on the facts and circumstances, including the relevant factors described in section 14.02. The Maximum Payment Amount is one such factor that may be considered. Section 14.01 also provides that, in general, the sanction will not be less than the VCP user fee applicable to the plan. Section 14.02(2) sets forth additional factors for Nonamender Failures discovered while the plan is Under Examination, and section 14.04 significantly modifies the sanction for Nonamender Failures discovered during the determination letter application process. In section 14.04(3), the sanction for failing to timely adopt an amendment that is corrected within three months after the expiration of the remedial amendment period has been reduced to $750, regardless of the number of plan participants.

.03 Modifications relating to user fees. Prior to Rev. Proc. 2016–8, section 12 of Rev. Proc. 2013–12 set forth the user fees for VCP submissions. Rev. Proc. 2016–8 modified Rev. Proc. 2013–12 by setting forth the general user fees for VCP submissions in 2016. In addition, Rev. Proc. 2016–8 included cross-references to Rev. Proc. 2013–12 for special rules relating to determining the user fees for VCP submissions (such as special user fees for Group Submissions and rules relating to establishing the number of plan participants). Beginning in 2017, all user fees and rules relating to user fees for VCP submissions will be published in the annual EP revenue procedure that sets forth user fees, including VCP user fees. Accordingly, most of section 12 has been deleted. In addition, rules relating to certain amounts that are not user fees have been moved from section 12 to other sections in this revenue procedure (see the description of modifications in section 2.04).

.04 Description of modifications. The modifications to Rev. Proc. 2013–12 that are reflected in this revenue procedure include the following changes —

  • Revising section 4.03 to address modifications to the eligibility requirement for SCP with regard to the Favorable Letter requirement.

  • Incorporating changes made by Rev. Proc. 2015–27, which revised section 4.04 to extend SCP eligibility so that repeated corrections of excess annual additions under § 415 will not prevent certain plans from satisfying the SCP requirement to have established practices and procedures, as long as the plan corrects excess annual additions through the return of elective deferrals to affected employees within 9½ months after the end of the plan’s limitation year.

  • Revising section 4.08 to include a sentence providing that the user fee for a terminating Orphan Plan may be waived at the discretion of the IRS and that the request for a waiver should be made at the time of the submission.

  • Removing section 4.10 in Rev. Proc. 2013–12 relating to the submission of a determination letter in light of the changes to the determination letter program.

  • Adding new section 4.10 relating to egregious failures to set forth the effect of egregious failures on the various correction programs. In addition, section 4.10(3) provides that the IRS reserves the right to impose a sanction that may be larger than the VCP user fee.

  • Revising section 5.01(2)(a) to clarify that the term Plan Document Failure includes Good Faith Amendments, Interim Amendments, and Nonamender Failures, and moving the definitions of those terms from section 6.05 to section 5.01(2)(a)(ii).

  • Revising section 5.01(2)(b) to reflect changes made by Rev. Proc. 2016–37.

  • Revising the definition of “Favorable Letter” in section 5.01(4) to provide that a determination letter for an individually designed plan need not be current to be a Favorable Letter.

  • Moving the concept that the Maximum Payment Amount includes the tax that the IRS could collect for any plan loan that did not meet the requirements of § 72(p)(2) from section 14 to the definition of Maximum Payment Amount in section 5.01(5).

  • Deleting a definition for References to Rev. Proc. 2007–44, previously in § 5.06 of Rev. Proc. 2013–12.

  • Incorporating changes made in Rev. Proc. 2015–27 by revising section 6.02(5)(d) to delete a reference to the Social Security letter forwarding program because the Social Security Administration has announced that the program is no longer available as a method for locating lost plan participants who are owed additional retirement benefits.

  • Modifying section 6.05 to provide that determination letter applications may no longer be submitted with VCP submissions and to clarify that the issuance of a compliance statement with regard to a VCP submission that involves the correction of a Plan Document Failure or an Operational Failure through a plan amendment does not constitute a determination that the plan amendment satisfies the qualification requirements.

  • Incorporating changes made in Rev. Proc. 2015–27 by revising sections 6.06(3) and 6.06(4) to clarify that that there is flexibility in correcting an Overpayment under EPCRS. For example, depending on the nature of the Overpayment failure (such as an Overpayment failure resulting from a benefit calculation error), an appropriate correction method may include using rules similar to the correction methods of sections 6.06(3) and 6.06(4) in Rev. Proc. 2013–12, but having the employer or another person contribute the amount of the Overpayment (with appropriate interest) to the plan instead of seeking recoupment from plan participants and beneficiaries. Any correction method used must be consistent with the correction principles in section 6.02 and any applicable rules under EPCRS.

  • Revising section 6.11(5)(b) to clarify that a sanction, in addition to the user fee, equal to 10% of the Excess Amount will apply when a failure involves an Excess Amount under a SEP or a SIMPLE IRA Plan and the Plan Sponsor retains the Excess Amount in the SEP or SIMPLE IRA Plan.

  • Deleting rules (previously in § 9.03 of Rev. Proc. 2013–12) relating to submitting a determination letter application when correcting by plan amendment under SCP.

  • Modifying section 10.01 to reflect that the user fees for EPCRS are now published in an annual revenue procedure that sets forth user fees, including VCP user fees.

  • Deleting rules (previously in § 10.05 of Rev. Proc. 2013–12) relating to the procedure for filing a determination letter application as part of the VCP submission to reflect changes to the determination letter program.

  • Revising renumbered section 10.06(7) to reflect that, in the case of the failure to reach resolution with regard to an Anonymous Submission, the IRS will no longer refund 50% of the applicable user fee.

  • Modifying renumbered section 10.06(9) to clarify that the correction of Interim Amendment and Nonamender Failures must be made by the date of submission and that corrective plan amendments required as part of a VCP submission must be adopted no later than 150 days after the date of the compliance statement, and to include special correction timing rules for governmental plans.

  • Adding section 10.07(2)(b) to clarify that a compliance statement issued with regard to the correction of a Nonamender Failure is a determination that the corrective amendment was timely adopted, and not a determination that the corrective amendment as drafted complies with the qualification requirements or conforms to the plan’s prior operation.

  • Adding section 10.07(2)(c) to clarify that the compliance statement issued with regard to a corrective amendment made to correct an Operational Failure is a determination that the Operational Failure has been corrected, but is not a determination that the plan, including the plan amendment, satisfies the qualification requirements.

  • Revising renumbered section 10.09 to reflect that a determination letter application should not be requested as part of an Anonymous Submission.

  • Reorganizing renumbered section 10.10 with regard to Group Submissions for purposes of clarity.

  • Incorporating changes made in Rev. Proc. 2015–27 by revising section 11.02 to provide that applicants may use model VCP submission documents by submitting Form 14568, Model VCP Compliance Statement, and Forms 14568–A through 14568–I. A link to the IRS website is provided in section 11.02(4) for the most current versions of Form 14568 and Forms 14568–A through 14568–I.

  • Removing section 11.04(3) to delete a determination letter application as a required document for a VCP submission in order to reflect changes made by Rev. Proc. 2016–37.

  • Revising section 11.05 to delete procedures for the payment of the user fee for a determination letter application filed as part of the VCP submission to reflect changes made by Rev. Proc. 2016–37.

  • Revising section 11.06 to reflect that VCP user fees are no longer set forth in section 12 but now are published in an annual revenue procedure that sets forth user fees, including VCP user fees.

  • Revising section 11.11 to provide that an applicant wishing to obtain an acknowledgement of receipt of a VCP submission must use IRS Letter 5265 and attach it to the VCP submission.

  • Modifying section 11.14(1) to delete procedures for including a determination letter application with a VCP submission in order to reflect the changes made by Rev. Proc. 2016–37.

  • Modifying section 11.14(2)5 to reflect that the Model Compliance Statement and Schedules previously provided in Appendix C are now Forms 14568 and Forms 14569–A through Form 14568–I.

  • Modifying section 11.14(2)6 to reflect that the Acknowledgement Letter previously provided in Appendix D is now Letter 5265.

  • Modifying section 11.14(2)8 to delete procedures for including a determination letter application with a VCP submission in order to reflect the changes made by Rev. Proc. 2016–37.

  • Deleting section 11.14(2)10 to reflect the changes made by Rev. Proc. 2016–37.

  • Deleting most of section 12. For a description of the modifications, see section 2.03.

  • Moving section 12.06(2) to section 6.11(5)(b).

  • Moving section 12.07 to section 4.10.

  • Modifying section 14 regarding sanctions under Audit CAP (including sanctions for Nonamender Failures discovered Under Examination and during the determination letter process). For a description of the modifications, see section 2.02(2).

  • Adding section .01(2) to Appendix A to clarify that a Plan Sponsor may choose any correction method in the appendices to correct a failure, as long as the plan can satisfy the eligibility requirements for that correction method.

  • Incorporating changes made in Rev. Proc. 2015–28 by revising section .05 of Appendix A to add new section .05(8) to provide a safe harbor correction method for certain Employee Elective Deferral Failures associated with missed elective deferrals for eligible employees who are subject to an automatic contribution feature in a § 401(k) plan or 403(b) Plan (including employees who made affirmative elections in lieu of automatic contributions but whose elections were not implemented correctly).

  • Incorporating changes made in Rev. Proc. 2015–28 by revising section.05 of Appendix A to add new section .05(9) to provide two safe harbor correction methods for certain Employee Elective Deferral Failures, one for failures that do not exceed three months and a second for failures that exceed three months but do not extend beyond the SCP correction period for significant failures. In incorporating this change, the term “corrective contributions” was changed to “corrective allocations” to reflect the correction principals described in section 6.02(4).

  • Incorporating changes made in Rev. Proc. 2015–28 by revising section .05 of Appendix A to add a definition of Employee Elective Deferral Failures in new section .05(10).

  • Incorporating changes made in Rev. Proc. 2015–27 by deleting Appendices C and D.

  • Correcting various citations and cross references.

.05 Future enhancements.

(1) Future updates. It is expected that the IRS and the Department of the Treasury (Treasury Department) will continue to update the EPCRS revenue procedure, in whole or in part, from time to time, including further improvements to EPCRS based on comments received. Accordingly, the IRS and Treasury Department continue to invite further comments on how to improve EPCRS. For information on how to submit comments, see section 17.

(2) Comments relating to the recoupment of Overpayments failures. Section 4.05 of Rev. Proc. 2015–27 modified §§ 6.06(3) and 6.06(4) of Rev. Proc. 2013–12 to clarify that there is flexibility in correcting an Overpayment under EPCRS in light of the concern that some Plan Sponsors may be incorrectly interpreting the correction rules under EPCRS as requiring a demand for recoupment from plan participants and beneficiaries in all cases of Overpayment failures. Those clarifications are incorporated in this revenue procedure. For a further description of the clarifications, see § 3.02 of Rev. Proc. 2015–27. Section 3.02(4) of Rev. Proc. 2015–27 stated that the IRS intends to make further revisions regarding the correction of Overpayments and solicited comments from the public on revisions to EPCRS relating to the recoupment of Overpayments. The Treasury Department and the IRS are in the process of reviewing the comments received. Comments continue to be requested on this issue and will be shared with the Department of Labor. For information on how to submit comments, see section 17.

PART II. PROGRAM EFFECT AND ELIGIBILITY

SECTION 3. EFFECT OF EPCRS; RELIANCE

.01 Effect of EPCRS on retirement plans. For a Qualified Plan, a 403(b) Plan, a SEP, or a SIMPLE IRA Plan, if the eligibility requirements of section 4 are satisfied and the Plan Sponsor corrects a failure in accordance with the applicable requirements of SCP in section 7, VCP in sections 10 and 11, or Audit CAP in section 13, the IRS will not treat the plan as failing to meet the requirements of § 401(a), 403(b), 408(k), or 408(p), as applicable, because of the failure. Thus, for example, if the Plan Sponsor corrects a failure in accordance with the requirements of this revenue procedure, the plan will not thereby be treated as failing to satisfy § 401(a), 403(b), 408(k), or 408(p), as applicable, for purposes of applying §§ 3121(a)(5) (FICA taxes) and 3306(b)(5) (FUTA taxes).

.02 Compliance statement. If a Plan Sponsor or Eligible Organization receives a compliance statement under VCP, the compliance statement is binding upon the IRS and the Plan Sponsor or Eligible Organization as provided in section 10.07.

.03 Excise and other taxes. See section 6.09 for rules relating to excise and other taxes.

.04 Reliance. Taxpayers may rely on this revenue procedure, including the relief described in section 3.01.

SECTION 4. PROGRAM ELIGIBILITY

.01 EPCRS Programs. (1) SCP. SCP is available only for Operational Failures. Qualified Plans and 403(b) Plans are eligible for SCP with respect to significant and insignificant Operational Failures. SEPs and SIMPLE IRA Plans are eligible for SCP only with respect to insignificant Operational Failures.

(2) VCP. Qualified Plans, 403(b) Plans, SEPs, and SIMPLE IRA Plans are eligible for VCP. VCP provides general procedures for correction of all Qualification Failures: Operational, Plan Document, Demographic, and Employer Eligibility. VCP also provides general procedures for the correction of participant loans that did not comply with the requirements of § 72(p)(2).

(3) Audit CAP. Unless otherwise provided, Audit CAP is available for Qualified Plans, 403(b) Plans, SEPs, and SIMPLE IRA Plans for correction of all failures found on examination that have not been corrected in accordance with SCP or VCP. Audit CAP also provides general procedures for the correction of participant loans that did not comply with the requirements of § 72(p)(2).

(4) Eligibility for other arrangements. The IRS may extend EPCRS to other arrangements.

(5) Appropriate use of programs. In a particular case, the IRS may decline to make available one or more correction programs under EPCRS in the interest of sound tax administration.

.02 Effect of examination. If the plan or Plan Sponsor is Under Examination, VCP is not available and SCP is only available as follows: while the plan or Plan Sponsor is Under Examination, insignificant Operational Failures can be corrected under SCP; and, if correction of significant Operational Failures has been completed or substantially completed (as described in section 9.03) before the plan or Plan Sponsor is Under Examination, correction of those failures can be completed under SCP.

.03 SCP eligibility requirements relating to plan documents. (1) Requirements for individually designed Qualified Plans. The provisions of SCP relating to significant Operational Failures (see section 9) are available for a Qualified Plan that is an individually designed plan only if, as of the date of correction, the plan is the subject of a Favorable Letter.

(2) Requirements for qualified master or prototype or volume submitter plans, and 403(b) Plans. The provisions of SCP relating to significant Operational Failures (see section 9) are available for a Qualified Plan that is a master or prototype plan or volume submitter plan and a 403(b) Plan (whether or not a 403(b) pre-approved plan as described in Rev. Proc. 2013–22, 2013–18 I.R.B. 985)) only if such plan is the subject of a Favorable Letter. (See section 6.10(2) for rules treating a 403(b) Plan as having a Favorable Letter.)

(3) Requirements for SEPs and SIMPLE IRAs. The provisions of SCP relating to insignificant Operational Failures (see section 8) are available for a SEP only if the plan document consists of either (i) a valid Model Form 5305–SEP, Simplified Employee Pension—Individual Retirement Accounts Contribution Agreement, or 5305A–SEP, Salary Reduction Simplified Employee Pension—Individual Retirement Accounts Contribution Agreement, adopted by an employer in accordance with the instructions on the applicable form (see Rev. Proc. 2002–10, 2002–1 C.B. 401) or (ii) a prototype SEP that has a current favorable opinion letter and that has been amended in accordance with the procedures set forth in Rev. Proc. 2002–10. The provisions of SCP relating to insignificant Operational Failures are available for a SIMPLE IRA Plan only if the plan document consists of either (i) a valid Model Form 5305–SIMPLE, Savings Incentive Match Plan for Employees of Small Employers (SIMPLE)—for Use with a Designated Financial Institution, or 5304–SIMPLE, Savings Incentive Match Plan for Employees of Small Employers (SIMPLE)—Not for Use with a Designated Financial Institution, adopted by an employer in accordance with the instructions on the applicable form (see Rev. Proc. 2002–10) or (ii) a prototype SIMPLE IRA Plan that has a current favorable opinion letter and that has been amended in accordance with the procedures set forth in Rev. Proc. 2002–10.

.04 Established practices and procedures. To be eligible for SCP, the Plan Sponsor or administrator of a plan must have established practices and procedures (formal or informal) reasonably designed to promote and facilitate overall compliance in form and operation with applicable Code requirements. For example, the plan administrator of a Qualified Plan that may be top-heavy under § 416 may include in its plan operating manual a specific annual step to determine whether the plan is top-heavy and, if so, to ensure that the minimum contribution requirements of the top-heavy rules are satisfied. A plan document alone does not constitute evidence of established procedures. In order for a Plan Sponsor or administrator to use SCP, these established procedures must have been in place and routinely followed, and an Operational Failure must have occurred through an oversight or mistake in applying them. SCP may also be used in situations where the Operational Failure occurred because the procedures that were in place, while reasonable, were not sufficient to prevent the occurrence of the failure. A plan that provides for elective deferrals and nonelective employer contributions that are not matching contributions is not treated as failing to have established practices and procedures to prevent the occurrence of a § 415(c) violation in the case of a plan under which excess annual additions under § 415(c) are regularly corrected by return of elective deferrals to the affected employee within 9½ months after the end of the plan’s limitation year. The correction, however, should not violate another applicable Code requirement. In the case of a failure that relates to Transferred Assets or to a plan assumed in connection with a corporate merger, acquisition, or other similar employer transaction between the Plan Sponsor and the sponsor of the transferor plan or the prior Plan Sponsor of an assumed plan, the plan is considered to have established practices and procedures for the Transferred Assets if such practices and procedures are in effect for the Transferred Assets by the end of the first plan year that begins after the corporate merger, acquisition, or other similar transaction. (See section 6.10(2) for special rules regarding established practices and procedures for 403(b) Plans.)

.05 Correction by plan amendment. (1) Availability of correction by plan amendment in VCP and Audit CAP. A Plan Sponsor may use VCP and Audit CAP for a Qualified Plan or 403(b) Plan to correct Plan Document, Demographic, and Operational Failures by a plan amendment, including correcting an Operational Failure by a plan amendment to conform the terms of the plan to the plan’s prior operations, provided that the amendment complies with the applicable Code requirements, including, for a Qualified Plan, § 401(a) (including the requirements of §§ 401(a)(4), 410(b), and 411(d)(6)). In addition, a Plan Sponsor may adopt a plan amendment to reflect the corrective action. For example, if the plan failed to satisfy the actual deferral percentage (ADP) test required under § 401(k)(3) and the Plan Sponsor must make qualified nonelective contributions not already provided for under the plan, the plan may be amended to provide for qualified nonelective contributions. As explained further in sections 6.05 and 10.07(2), the issuance of a compliance statement constitutes a determination that the failure identified has been corrected, but does not constitute a determination that the terms of the plan, including the corrective plan amendment, satisfy the qualification requirements in form.

(2) Availability of correction by plan amendment in SCP. A Plan Sponsor may use SCP for a Qualified Plan or 403(b) Plan to correct an Operational Failure by a plan amendment in order to conform the terms of the plan to the plan’s prior operations only with respect to Operational Failures listed in section 2.07 of Appendix B. These failures must be corrected in accordance with the correction methods set forth in section 2.07 of Appendix B. Any plan amendment must comply with the requirements of § 401(a), including the requirements of §§ 401(a)(4), 410(b), and 411(d)(6), to the extent applicable to the plan. If a Plan Sponsor corrects an Operational Failure in accordance with the approved correction methods under Appendix B, it may amend the plan to reflect the corrective action. For example, if the plan failed to satisfy the ADP test required under § 401(k)(3) and the Plan Sponsor makes qualified nonelective contributions not already provided for under the plan, the plan may be amended to provide for qualified nonelective contributions. SCP is not otherwise available for a Plan Sponsor to correct an Operational Failure by a plan amendment.

.06 Availability of correction for Employer Eligibility Failure. SCP is not available for a Plan Sponsor to correct an Employer Eligibility Failure.

.07 Availability of correction for a terminated plan. Correction of Qualification Failures and 403(b) Failures in a terminated plan may be made under VCP and Audit CAP, whether or not the plan trust or contract is still in existence.

.08 Availability of correction for an Orphan Plan. A failure in an Orphan Plan that is terminating may only be corrected under VCP and Audit CAP, provided that the party acting on behalf of the plan is an Eligible Party, as defined in section 5.03(2). See generally section 6.02(2)(e)(i). SCP is not available for correcting failures in Orphan Plans. In the case of a terminating Orphan Plan, the IRS may, in its discretion, waive the user fee. In such a case, the submission must include a request for a waiver of the user fee. See section 11.03(13).

.09 Availability of correction for § 457(b) plans. The IRS will accept submissions relating to § 457(b) plans on a provisional basis outside of EPCRS through standards that are similar to EPCRS. The availability of correction is generally limited to plans that are sponsored by governmental entities described in § 457(e)(1)(A). In the case of a § 457(b) plan that is an unfunded deferred compensation plan established for the benefit of top hat employees of a tax-exempt entity described in § 457(e)(1)(B), the IRS generally will not enter into an agreement to address problems associated with such a plan. However, the IRS may consider a submission where, for example, the plan was erroneously established to benefit the entity’s nonhighly compensated employees and the plan has been operated in a manner that is similar to a Qualified Plan.

.10 Egregious failures. (1) In general. Egregious failures include: (a) a plan that has consistently and improperly covered only highly compensated employees; (b) a plan that provides more favorable benefits for an owner of the employer based on a purported collective bargaining agreement where there has in fact been no good faith bargaining between bona fide employee representatives and the employer (see Notice 2003–24, 2003–1 C.B. 853, with respect to good faith bargaining and welfare benefit funds); or (c) a defined contribution plan where a contribution is made on behalf of a highly compensated employee that is several times greater than the dollar limit set forth in § 415(c).

(2) SCP. SCP is not available to correct Operational Failures that are egregious.

(3) VCP. VCP is available to correct egregious failures. However, the IRS reserves the right to impose a sanction that may be larger than the user fee described in the annual revenue procedure that sets forth user fees, including VCP user fees. For this purpose, an egregious failure would include any case in which the IRS concludes that the parties controlling the plan recognized that the action taken would constitute a failure and the failure either involves a substantial number of participants or beneficiaries or involves participants who are predominantly highly compensated employees.

(4) Audit CAP. Audit CAP also is available to correct egregious failures.

.11 Diversion or misuse of plan assets. SCP, VCP, and Audit CAP are not available to correct failures relating to the diversion or misuse of plan assets.

.12 Abusive tax avoidance transactions. (1) Effect on Programs. (a) SCP. With respect to SCP, in the event that the plan or the Plan Sponsor has been a party to an abusive tax avoidance transaction (as defined in section 4.12(2)), SCP is not available to correct any Operational Failure that is directly or indirectly related to the abusive tax avoidance transaction.

(b) VCP. With respect to VCP, if the IRS determines that a plan or Plan Sponsor was, or may have been, a party to an abusive tax avoidance transaction (as defined in section 4.12(2)), then the matter will be referred to the IRS Employee Plans Tax Shelter Coordinator. Upon receiving a response from the Tax Shelter Coordinator, the IRS may determine that the plan or the Plan Sponsor has been a party to an abusive tax avoidance transaction, and that the failures addressed in the VCP submission are related to that transaction. In those situations, the IRS will conclude the review of the submission without issuing a compliance statement and will refer the case for examination. However, if the Tax Shelter Coordinator determines that the plan failures are unrelated to the abusive tax avoidance transaction or that no abusive tax avoidance transaction occurred, then the IRS will continue to address the failures identified in the VCP submission, and may issue a compliance statement with respect to those failures. In no event may a compliance statement be relied on for the purpose of concluding that the plan or Plan Sponsor was not a party to an abusive tax avoidance transaction. In addition, even if it is concluded that the failures can be addressed pursuant to a VCP submission, the IRS reserves the right to make a referral of the abusive tax avoidance transaction matter for examination.

(c) Audit CAP and SCP (for plans Under Examination). For plans Under Examination, if the IRS determines that the plan or Plan Sponsor was, or may have been, a party to an abusive tax avoidance transaction, the matter may be referred to the IRS Employee Plans Tax Shelter Coordinator. With respect to plans Under Examination, an abusive tax avoidance transaction includes a transaction described in section 4.12(2) and any other transaction that the IRS determines was designed to facilitate the impermissible avoidance of tax. Upon receiving a response from the Tax Shelter Coordinator, (i) if the IRS determines that a failure is related to the abusive tax avoidance transaction, the IRS reserves the right to conclude that neither Audit CAP nor SCP is available for that failure or (ii) if the IRS determines that satisfactory corrective actions have not been taken with regard to the transaction, the IRS reserves the right to conclude that neither Audit CAP nor SCP is available to the plan.

(2) Abusive tax avoidance transaction defined. For purposes of section 4.12(1) (except to the extent otherwise provided in section 4.12(1)(c)), an abusive tax avoidance transaction means any listed transaction under § 1.6011–4(b)(2) and any other transaction identified as an abusive transaction on the IRS web site entitled “EP Abusive Tax Transactions.”

PART III. DEFINITIONS, CORRECTION PRINCIPLES, AND RULES OF GENERAL APPLICABILITY

SECTION 5. DEFINITIONS

The following definitions apply for purposes of this revenue procedure:

.01 Definitions for Qualified Plans. The definitions in this section 5.01 apply to Qualified Plans.

(1) Qualified Plan. The term “Qualified Plan” means a plan intended to satisfy the requirements of § 401(a) or 403(a).

(2) Qualification Failure. The term “Qualification Failure” means any failure that adversely affects the qualification of a plan. There are four types of Qualification Failures: (a) Plan Document Failures; (b) Operational Failures; (c) Demographic Failures; and (d) Employer Eligibility Failures.

(a) Plan Document Failure. (i) In general. The term “Plan Document Failure” means a plan provision (or the absence of a plan provision) that, on its face, violates the requirements of § 401(a) or 403(a). A Plan Document Failure includes any Qualification Failure that is a violation of the requirements of § 401(a) or 403(a) and that is not an Operational Failure, Demographic Failure, or Employer Eligibility Failure. This term includes a Nonamender Failure, a failure to adopt Good Faith Amendments, and a failure to adopt Interim Amendments. Failure to adopt a discretionary plan amendment by the plan amendment deadline set forth in § 8.02 of Rev. Proc. 2016–37 (or § 5.05(2) of Rev. Proc. 2007–44) is not considered a plan document failure.

(ii) Specific definitions relating to Plan Document Failures:

(A) “Good Faith Amendment” includes the EGTRRA good faith amendments described in Notice 2001–42, 2001–2 C.B. 70, the amendment required for the plan to comply with the final regulations under § 401(a)(9) of the Code (see Rev. Proc. 2002–29, 2002–1 C.B. 1176, as modified by Rev. Proc. 2003–10, 2003–1 C.B. 259), the amendment updating the mortality table to reflect the guidance in Rev. Rul. 2001–62, 2001–2 C.B. 632, and the amendment updating the definition of compensation, for purposes of § 415(c)(3), to include “deemed § 125 compensation” pursuant to Rev. Rul. 2002–27, 2002–1 C.B. 925. For rules relating to a failure to adopt a Good Faith Amendment, see Rev. Proc. 2013–12.

(B) “Interim Amendment” means an amendment with respect to a disqualifying provision that results in the failure of the plan to satisfy the qualification requirements of the Code by reason of a change in those requirements that is effective after December 31, 2001, or that is integral to such disqualifying provision. See § 15.02 of Rev. Proc. 2016–37 for interim amendment requirements for preapproved plans. For interim amendments required to be adopted in individually designed plans before January 1, 2017 (or before February 1, 2017 for Cycle A plans), see § 5.04 of Rev. Proc. 2007–44.

(C) “Nonamender Failure” means a failure to adopt an amendment that corrects a disqualifying provision described in § 1.401(b)–1(b) within the applicable remedial amendment period. In general, a disqualifying provision includes a provision in the plan document that violates a qualification requirement of the Code or the absence of a provision that causes the plan to fail to satisfy a qualification requirement of the Code. A disqualifying provision also includes any provision designated by the Commissioner as a disqualifying provision under § 1.401(b)–1(b)(3). See §§ 5 and 15 of Rev. Proc. 2016–37. For an individually designed plan, a Nonamender Failure includes the failure to timely amend for provisions that appear on the Required Amendments List, as described in Rev. Proc. 2016–37.

(b) Operational Failure. The term “Operational Failure” means a Qualification Failure (other than an Employer Eligibility Failure) that arises solely from the failure to follow plan provisions. A failure to follow the terms of the plan providing for the satisfaction of the requirements of § 401(k) and (m) is considered to be an Operational Failure. A plan does not have an Operational Failure to the extent the plan is permitted to be amended retroactively to reflect the plan’s operations (for example, pursuant to § 401(b)). In the situation where a Plan Sponsor timely adopted an amendment and the plan was not operated in accordance with the terms of such amendment, the plan is considered to have an Operational Failure.

(c) Demographic Failure. The term “Demographic Failure” means a failure to satisfy the requirements of § 401(a)(4), 401(a)(26), or 410(b) that is not an Operational Failure or an Employer Eligibility Failure. The correction of a Demographic Failure generally requires a corrective amendment to the plan adding more benefits or increasing existing benefits (see § 1.401(a)(4)–11(g)).

(d) Employer Eligibility Failure. The term “Employer Eligibility Failure” means the adoption of a plan intended to include a qualified cash or deferred arrangement under § 401(k) by an employer that fails to meet the employer eligibility requirements to establish a § 401(k) plan. An Employer Eligibility Failure is not a Plan Document, Operational, or Demographic Failure.

(3) Excess Amount; Excess Allocations; Overpayment. (a) Excess Amount. The term “Excess Amount” means a Qualification Failure due to a contribution, allocation, or similar credit that is made on behalf of a participant or beneficiary to a plan in excess of the maximum amount permitted to be contributed, allocated, or credited on behalf of the participant or beneficiary under the terms of the plan or that exceeds a limitation on contributions or allocations provided in the Code or regulations. Excess Amounts include: (i) an elective deferral or after-tax employee contribution that is in excess of the maximum contribution under the plan; (ii) an elective deferral or after-tax employee contribution made in excess of the limitation under § 415; (iii) an elective deferral in excess of the limitation of § 402(g); (iv) an excess contribution or excess aggregate contribution under § 401(k) or (m); (v) an elective deferral or after-tax employee contribution that is made with respect to compensation in excess of the limitation of § 401(a)(17); and (vi) any other employer contribution that exceeds a limitation under § 401(m) (but only with respect to the forfeiture of nonvested matching contributions that are excess aggregate contributions), 411(a)(3)(G), or 415, or that is made with respect to compensation in excess of the limitation under § 401(a)(17). However, an Excess Amount does not include a contribution, allocation, or other credit that is made pursuant to a correction method provided under this revenue procedure for a different Qualification Failure. Excess Amounts are limited to contributions, allocations, or annual additions under a defined contribution plan, after-tax employee contributions to a defined benefit plan, and contributions or allocations that are to be made to a separate account (with actual Earnings) under a defined benefit plan. See generally section 6.06 for the treatment and correction of certain Excess Amounts.

(b) Excess Allocation. The term “Excess Allocation” means an Excess Amount for which the Code or regulations do not provide any corrective mechanism. Excess Allocations include Excess Amounts as defined in section 5.01(3)(a) (i), (ii), (v), and (vi) (except with respect to § 401(m) or 411(a)(3)(G) violations). Excess Allocations must be corrected in accordance with section 6.06(2).

(c) Overpayment. The term “Overpayment” means a Qualification Failure due to a payment being made to a participant or beneficiary that exceeds the amount payable to the participant or beneficiary under the terms of the plan or that exceeds a limitation provided in the Code or regulations. Overpayments include both payments from a defined benefit plan and payments from a defined contribution plan (either not made from the participant’s or beneficiary’s account under the plan or not permitted to be paid under the Code, the regulations, or the terms of the plan). However, an Overpayment does not include a payment that is made pursuant to a correction method provided under this revenue procedure for a different Qualification Failure. Overpayments must be corrected in accordance with section 6.06(3) for defined benefit plans and section 6.06(4) for defined contribution plans and 403(b) Plans.

(4) Favorable Letter. With respect to a particular Qualified Plan, the term “Favorable Letter” is defined in the following manner.

(a) Favorable Letter for individually designed plans. In the case of an individually designed plan, the term “Favorable Letter” means a determination letter issued with respect to the plan.

(b) Favorable Letter for master or prototype plans and volume submitter plans. In the case of a master or prototype plan, the term “Favorable Letter” means a current favorable opinion letter with respect to the master or prototype plan (standardized or nonstandardized) adopted by the Plan Sponsor. In the case of a volume submitter plan, the term “Favorable Letter” means a current favorable advisory letter with respect to the volume submitter plan adopted by the Plan Sponsor. For this purpose, a master or prototype plan or a volume submitter plan has a current favorable opinion letter or advisory letter if the letter considers the law changes incorporated during the most recently expired six-year remedial amendment cycle under the provisions of Rev. Proc. 2016–37.

(c) Terminated plans. In the case of a master or prototype plan or a volume submitter plan, the plan is treated as having a current favorable opinion letter or advisory letter if the plan is terminated prior to the expiration of the plan’s current remedial amendment cycle determined under the provisions of Rev. Proc. 2016–37, and the plan was amended to reflect the qualification requirements that applied as of the date of termination.

(5) Maximum Payment Amount. The term “Maximum Payment Amount” means a monetary amount that is approximately equal to the tax the IRS could collect upon plan disqualification and is the sum for the open taxable years of the:

(a) tax on the trust (Form 1041, U.S. Income Tax Return for Estates and Trusts) (and any interest or penalties applicable to the trust return);

(b) additional income tax resulting from the loss of employer deductions for plan contributions (and any interest or penalties applicable to the Plan Sponsor’s return);

(c) additional income tax resulting from income inclusion for participants in the plan (Form 1040, U.S. Individual Income Tax Return), including the tax on plan distributions that have been rolled over to other qualified trusts (as defined in § 402(c)(8)(A)) or eligible retirement plans (as defined in § 402(c)(8)(B)) and any interest or penalties applicable to the participants’ returns;

(d) in the case of any participant loan that did not comply with the requirements of § 72(p)(2), the tax the IRS could collect as a result of the loan not being excluded from gross income under § 72(p)(2); and

(e) any other tax that results from a Qualification Failure that would apply but for correction under this revenue procedure.

(6) Plan Sponsor. The term “Plan Sponsor” means the employer that establishes or maintains a Qualified Plan for its employees.

(7) Transferred Assets. The term “Transferred Assets” means plan assets that were received, in connection with a corporate merger, acquisition, or other similar employer transaction, by the plan in a transfer (including a merger or consolidation of plan assets) under § 414(l) from a plan sponsored by an employer that was not a member of the same controlled group as the Plan Sponsor immediately prior to the corporate merger, acquisition, or other similar employer transaction. If a transfer of plan assets related to the same employer transaction is accomplished through several transfers, then the date of the transfer is the date of the first transfer.

.02 Definitions for 403(b) Plans. The definitions in this section 5.02 apply to 403(b) Plans. For 403(b) Plans, the definitions under Rev. Proc. 2008–50 apply to failures that occurred in taxable years beginning before January 1, 2009.

(1) 403(b) Plan. The term “403(b) Plan” means a plan or program intended to satisfy the requirements of § 403(b).

(2) 403(b) Failure. The term “403(b) Failure” means a failure that adversely affects the exclusion from income provided by § 403(b). There are four types of 403(b) Failures: (a) Plan Document Failures; (b) Operational Failures; (c) Demographic Failures; and (d) Employer Eligibility Failures.

(a) Plan Document Failure. The term “Plan Document Failure” means a plan provision (or the absence of a plan provision) that, on its face, violates the requirements of § 403(b). Thus, for example, the failure of a plan to be adopted in written form or to be amended to reflect a new requirement within the plan’s applicable remedial amendment period is a Plan Document Failure. If a plan has not been timely or properly amended during an applicable remedial amendment period with respect to provisions required to maintain the status of the plan under § 403(b), the plan has a Plan Document Failure. For purposes of this revenue procedure, a Plan Document Failure includes any 403(b) Failure that adversely affects the status of the plan under § 403(b) and that is not an Operational Failure, Demographic Failure, or Employer Eligibility Failure.

(b) Operational Failure. The term “Operational Failure” means a 403(b) Failure (other than an Employer Eligibility Failure) that arises solely from the failure to follow plan provisions. A failure to follow the terms of the plan providing for the satisfaction of the requirements of §§ 403(b)(12)(ii) (relating to the availability of elective deferral contributions) and 401(m) (as applied to 403(b) Plans pursuant to § 403(b)(12)(A)(i)) is an Operational Failure. A plan does not have an Operational Failure to the extent the plan is permitted to be amended retroactively to reflect the plan’s operations.

(c) Demographic Failure. The term “Demographic Failure” means a failure to satisfy the requirements of § 401(a)(4), 401(a)(26), or 410(b) (as applied to 403(b) Plans pursuant to § 403(b)(12)(A)(i)) that is not an Operational Failure or an Employer Eligibility Failure. The correction of a Demographic Failure generally requires a corrective amendment to the plan adding more benefits or increasing existing benefits (see § 1.401(a)(4)–11(g)).

(d) Employer Eligibility Failure. The term “Employer Eligibility Failure” means the adoption of a plan intended to satisfy the requirements of § 403(b) by a Plan Sponsor that is not a tax-exempt organization described in § 501(c)(3) or a public educational organization described in § 170(b)(1)(A)(ii). An Employer Eligibility Failure is not a Plan Document, Operational, or Demographic Failure.

(3) Excess Amount. The term “Excess Amount” means a contribution or other credit that is made on behalf of a participant or beneficiary to a plan in excess of the maximum amount permitted to be contributed or credited on behalf of the participant or beneficiary under the terms of the plan or that exceeds a limitation on contributions provided in the Code or regulations. The term “Excess Amount” includes any amount in excess of the amount permitted under the requirements of § 402(g), 401(m), or 415. A contribution in excess of the limitation of § 415(c) is not an Excess Amount (or a 403(b) Failure) if that excess is maintained in a separate account in accordance with the rules in the regulations under §§ 403(b) and 415. Such separate account is considered to be a § 403(c) annuity contract (or, if applicable, an amount to which § 61, 83, or 402(b) applies). A contribution in excess of the limitation of § 415(c) that is not maintained in a separate account in accordance with the rules set forth in regulations under §§ 403(b) and 415 is an Excess Amount. Thus, the correction principles in section 6.06 apply.

(4) Overpayment. The term “Overpayment” means a 403(b) Failure due to a payment being made to a participant or beneficiary that exceeds the amount payable to the participant or beneficiary under the terms of the plan or that exceeds a limitation provided in the Code or regulations. Overpayments include payments made from the participant’s or beneficiary’s 403(b) custodial account or annuity contract under the plan that are not permitted to be paid under the Code, the regulations, or the terms of the plan. However, an Overpayment does not include a payment that is made pursuant to a correction method provided under this revenue procedure for a different 403(b) Failure. Overpayments must be corrected in accordance with section 6.06(4).

(5) Favorable Letter. The term “Favorable Letter” means a Favorable Letter as described in section 6.10(2).

(6) Maximum Payment Amount. The term "Maximum Payment Amount” means a monetary amount that is approximately equal to the tax the IRS could collect as a result of the 403(b) Failure and is the sum for the open taxable years of the:

(a) additional income tax resulting from income inclusion for employees or other participants (Form 1040), including the tax on distributions that have been rolled over to other qualified trusts (as defined in § 402(c)(8)(A)) or eligible retirement plans (as defined in § 402(c)(8)(B)) and any interest or penalties applicable to the participants’ returns; and

(b) any other tax that results from a 403(b) Failure that would apply but for correction under this revenue procedure.

(7) Plan Sponsor. The term "Plan Sponsor” means the employer that offers a 403(b) Plan to its employees.

.03 Definitions for Orphan Plans.

(1) Orphan Plan. With respect to VCP and Audit CAP, the term “Orphan Plan” means any Qualified Plan, 403(b) Plan, or other plan with respect to which an “Eligible Party” (defined in section 5.03(2)) has determined that the Plan Sponsor (a) no longer exists, (b) cannot be located, or (c) is unable to maintain the plan. However, the term “Orphan Plan” does not include any plan subject to Title I of the Employee Retirement Income Security Act of 1974 (“ERISA”) that is terminated pursuant to 29 CFR 2578.1 of the Department of Labor regulations governing the termination of abandoned individual account plans.

(2) Eligible Party. The term “Eligible Party” means:

(a) A court appointed representative with authority to terminate the plan and dispose of the plan’s assets;

(b) In the case of an Orphan Plan under investigation by the Department of Labor, a person or entity determined by the Department of Labor to have accepted responsibility for terminating the plan and distributing the plan’s assets; or

(c) In the case of a Qualified Plan to which Title I of ERISA has never applied, a surviving spouse who is the sole beneficiary of a plan that provided benefits to a participant who was (i) the sole owner of the business that sponsored the plan and (ii) the only participant in the plan.

.04 Earnings. The term “Earnings” refers to the adjustment of a principal amount to reflect subsequent investment gains and losses, unless otherwise provided in a specific section of this revenue procedure.

.05 IRA. The term “IRA” means an individual retirement account (as defined in § 408(a)) or an individual retirement annuity (as defined in § 408(b)).

.06 SEP. The term “SEP” means a plan intended to satisfy the requirements of § 408(k). For purposes of this revenue procedure, the term SEP also includes a salary reduction SEP (“SARSEP”) described in § 408(k)(6), if applicable.

.07 SIMPLE IRA Plan. The term “SIMPLE IRA Plan” means a plan intended to satisfy the requirements of § 408(p).

.08 Under Examination. (1) The term “Under Examination” means: (a) a plan that is under an Employee Plans examination (that is, an examination of a Form 5500 series or other Employee Plans examination); (b) a Plan Sponsor that is under an Exempt Organizations examination (that is, an examination of a Form 990 series or other Exempt Organizations examination); or (c) a plan that is under investigation by the Criminal Investigation Division of the IRS.

(2) A plan that is under an Employee Plans examination includes any plan for which the Plan Sponsor, or a representative, has received verbal or written notification from Employee Plans of an impending Employee Plans examination, or of an impending referral for an Employee Plans examination, and also includes any plan that has been under an Employee Plans examination and is in Appeals or in litigation for issues raised in an Employee Plans examination. A plan is considered to be Under Examination if it is aggregated for purposes of satisfying the nondiscrimination requirements of § 401(a)(4), the minimum participation requirements of § 401(a)(26), the minimum coverage requirements of § 410(b), or the requirements of § 403(b)(12)(A)(i), with any plan that is Under Examination. In addition, a plan is considered to be Under Examination with respect to a failure of a qualification requirement (other than those described in the preceding sentence) if the plan is aggregated with another plan for purposes of satisfying that qualification requirement (for example, § 401(a)(30), 415, or 416) and that other plan is Under Examination. For example, assume Plan A has a § 415 failure, Plan A is aggregated with Plan B only for purposes of § 415, and Plan B is Under Examination. In this case, Plan A is considered to be Under Examination with respect to the § 415 failure. However, if Plan A has a failure relating to the spousal consent rules under § 417 or the vesting rules of § 411, Plan A is not considered to be Under Examination with respect to the § 417 or 411 failure. For purposes of this revenue procedure, the term aggregation does not include consideration of benefits provided by various plans for purposes of the average benefits test set forth in § 410(b)(2).

(3) An Employee Plans examination also includes a case in which a Plan Sponsor has submitted any Form 5300 (Application for Determination for Employee Benefit Plan), Form 5307 (Application for Determination for Adopters of Modified Volume Submitter Plans), or Form 5310 (Application for Determination for Terminating Plan) and the Employee Plans agent notifies the Plan Sponsor, or a representative, of possible failures, whether or not the Plan Sponsor is officially notified of an “examination.” This would include a case where, for example, a Plan Sponsor has applied for a determination letter on plan termination, and an Employee Plans agent notifies the Plan Sponsor that there are partial termination concerns. In addition, if, during the review process, the agent requests additional information that indicates the existence of a failure not previously identified by the Plan Sponsor, the plan is considered to be under an Employee Plans examination. If, in such a case, the determination letter request under review is subsequently withdrawn, the plan is nevertheless considered to be under an Employee Plans examination for purposes of eligibility under SCP and VCP with respect to those issues raised by the agent reviewing the determination letter application. The fact that a Plan Sponsor voluntarily submits a determination letter application does not constitute a voluntary identification of a failure to the IRS. In order to be eligible for VCP, the Plan Sponsor (or the authorized representative) must identify each failure, in writing, to the reviewing agent before the agent recognizes the existence of the failure or addresses the failure in communications with the Plan Sponsor (or the authorized representative).

(4) A Plan Sponsor that is under an Exempt Organizations examination includes any Plan Sponsor that has received (or whose representative has received) verbal or written notification from Exempt Organizations of an impending Exempt Organizations examination or of an impending referral for an Exempt Organizations examination and also includes any Plan Sponsor that has been under an Exempt Organizations examination and is now in Appeals or in litigation for issues raised in an Exempt Organizations examination.

SECTION 6. CORRECTION PRINCIPLES AND RULES OF GENERAL APPLICABILITY

.01 Correction principles; rules of general applicability. The general correction principles in section 6.02 and rules of general applicability in sections 6.03 through 6.13 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 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. 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 correction. 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 and 403(b) Plans, any correction method permitted under Appendix A or Appendix B is deemed to be a reasonable and appropriate method of correcting the related failure. Any correction method permitted under Appendix A or Appendix B applicable to a SEP, or a SIMPLE IRA Plan is similarly deemed to be a reasonable and appropriate method of correcting the related failure. If a plan has a different but analogous failure to one set forth in Appendix A or B (such as the failure to provide a matching contribution by a governmental plan that is not subject to § 401(m)), then the analogous correction method under Appendix A or B is generally available to correct any 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, or other guidance of general applicability. For example, for Qualified Plans and 403(b) Plans, 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 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. 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 § 401(k) plan), the excess should be reallocated to other participants or, depending on the facts and circumstances, used to reduce future employer contributions.

(c) 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) or 401(m)(2), or, for plan years beginning on or before December 31, 2001, the multiple use test of § 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.

(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), 408(k) for SEPs, or 408(p) for SIMPLE IRA Plans, or a parallel requirement in Part 2 of Subtitle B of Title I of ERISA (for plans that are subject to Part 2 of Subtitle B of Title I of ERISA). If an additional failure is nevertheless 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.

(e) If a correction method is one that another government agency has authorized with respect to a violation of legal requirements within its interpretive authority and that correction relates to a violation for which there is a failure to which this revenue procedure applies, then the IRS may take the correction method of the other governmental agency into account for purposes of this revenue procedure. For example:

(i) If the plan is subject to ERISA, for a failure that results from the employer having ceased to exist, the employer no longer maintaining the plan, or similar reasons, the permitted correction is to terminate the plan and distribute plan assets to participants and beneficiaries in accordance with standards and procedures substantially similar to those set forth in 29 CFR 2578.1 of the Department of Labor regulations (relating to abandoned plans). This correction must satisfy four conditions. First, the correction must comply with standards and procedures substantially similar to those set forth in 29 CFR 2578.1. Second, the qualified termination administrator, based on plan records located and updated in accordance with the Department of Labor regulations, must have reasonably determined whether, and to what extent, the survivor annuity requirements of §§ 401(a)(11) and 417 apply to any benefit payable under the plan and must take reasonable steps to comply with those requirements (if applicable). Third, each participant and beneficiary must have been provided a nonforfeitable right to his or her accrued benefits as of the date of deemed termination under the Department of Labor regulations, subject to Earnings between that date and the date of distribution. Fourth, participants and beneficiaries must receive notification of their rights under § 402(f). In addition, notwithstanding correction under this revenue procedure, the IRS reserves the right to pursue appropriate remedies under the Code against any party who is responsible for the plan, such as the Plan Sponsor, plan administrator, or owner of the business, even in its capacity as a participant or beneficiary under the plan. See also section .09(1) of Appendix A for parallel rules for plans that are not subject to ERISA.

(ii) In the case of a violation of the fiduciary standards imposed by Part 4 of Subtitle B of Title I of ERISA, correction under the Voluntary Fiduciary Correction Program established by the Department of Labor (at 71 FR 20262) for a fiduciary violation for which there is a similar failure under this revenue procedure would generally be taken into account as correction under this revenue procedure. (See also section 7.3(b) of the Department of Labor’s Voluntary Fiduciary Correction Program under which correction of a defaulted participant loan that provides for repayment in accordance with § 72(p)(2) requires only submission of the correction under VCP and inclusion of the VCP compliance statement (with proof of any required corrective payment).

(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. In the case of a Group Submission, the consistency requirement applies on a plan by plan basis.

(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 and forfeitures that would have been allocated to the participant’s account if the failure had not occurred. However, a corrective allocation is not required to be adjusted for losses. Accordingly, corrective allocations must include gains and may be adjusted for losses. For additional information, see Appendix B section 3, Earnings Adjustment Methods And Examples.

(b) A corrective allocation to a participant’s account because of a failure to make a required allocation in a prior limitation year is not considered an annual addition with respect to the participant for the limitation year in which the correction is made, but is 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 nonelective contributions (including forfeitures if the plan permits their use to reduce employer contributions). For purpose of correcting a failed ADP, actual contribution percentage (ACP), or multiple use test, any amounts used to fund qualified nonelective contributions (QNECs) must satisfy the definition of QNEC in § 1.401(k)–6.

(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, in accordance with the plan’s provisions for actuarial equivalence (after considering the applicable requirements of §§ 417(e)(3) and 415(b) or any other applicable provision) that were in effect on the date that the distribution should have been made. A corrective distribution is not subject to the requirements of § 417(e)(3) if it is made to make up for missed payments with respect to a benefit that is not subject to the requirements of § 417(e)(3).

(e)(i) In the case of a single employer defined benefit plan, a payment of benefits that fails to satisfy the requirements of § 436(b), (c), or (e) can be corrected by the Plan Sponsor (including another person acting on behalf of the Plan Sponsor) making a contribution to the plan equal to the following amount (with interest up to the date of the contribution): (A) in the case of a failure to satisfy § 436(b) with respect to an unpredictable contingent event benefit, the amount described in § 436(b)(2) with respect to that benefit; (B) in the case of a failure to satisfy § 436(c) with respect to an amendment, the amount described in § 436(c)(2) with respect to that amendment; and (C) in the case of a failure to satisfy § 436(e), the amount described in § 436(e)(2) with respect to that failure. See also section 6.06(3) for correction of an Overpayment (including a payment of benefits that exceeds the limitations imposed by § 436(d) or 436(b), (c), or (e)).

(ii) A corrective distribution or a corrective amendment (where a correction is accomplished through a plan amendment) is not subject to the requirements of § 436, but, if the plan is subject to a restriction pursuant to § 436 at the time of the correction, generally the Plan Sponsor must make a contribution to the plan at the time of the correction in the following amount: (A) if a corrective distribution is made in a single-sum payment or other prohibited payment (as defined in § 436(d)(5)) at a time when the plan is subject to a restriction pursuant to § 436(d), the Plan Sponsor must generally contribute to the plan the amount of that corrective distribution (but only half of the corrective distribution must be contributed if the payment is made at a time when the plan is subject to a restriction pursuant to § 436(d)(3)); and (B) if a corrective amendment is made at a time when the plan is subject to a restriction pursuant to § 436(c), the Plan Sponsor must generally contribute to the plan an amount equal to the increase in the funding target of the plan (as defined in § 430) attributable to that amendment. No contribution is required to be made under this paragraph (e)(ii) if the corrective distribution is made in a form that is not a prohibited payment (for example, if the correction is made by actuarially increasing future payments that are made in a form that is not a prohibited payment).

(iii) Any contribution made by the Plan Sponsor pursuant to this paragraph (e) is treated in the same manner as a “section 436 contribution” (as defined in § 1.436–1(j)(7)). Thus, the contribution is treated as separate from a minimum required contribution under § 430 and is disregarded in determining the amount added to a prefunding balance under § 430(f)(6). See § 1.436–1(f)(2) generally for rules relating to § 436 contributions.

(f) In the case of a defined contribution plan, a corrective contribution or distribution should be adjusted for Earnings from the date of the failure (determined without regard to any Code provision which permits a corrective contribution or distribution to be made at a later date).

(5) Special exceptions to full correction. 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 if 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 either (i) it is possible to make a precise calculation but 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 or (ii) it is not possible to make a precise calculation (for example, where it is impossible to provide plan data), reasonable estimates may be used in calculating appropriate correction. If it is not feasible to make a reasonable estimate of what the actual investment results would have been, a reasonable interest rate may be used. For this purpose, the interest rate used by the Department of Labor’s Voluntary Fiduciary Correction Program Online Calculator (“VFCP Online Calculator”) is deemed to be a reasonable interest rate. The VFCP Online Calculator can be found on the internet at http://www.dol.gov/ebsa/calculator.

(b) Delivery of small benefits. If the total corrective distribution due a participant or beneficiary is $75 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. This section 6.02(5)(b) does not apply to corrective contributions. Corrective contributions are required to be made with respect to a participant with an account under the plan.

(c) Recovery of small Overpayments. Generally, if the total amount of an Overpayment to a participant or beneficiary is $100 or less, the Plan Sponsor is not required to seek the return of the Overpayment from the participant or beneficiary. The Plan Sponsor is not required to notify the participant or beneficiary that the Overpayment is not eligible for favorable tax treatment accorded to distributions from the plan (and, specifically, is not eligible for tax-free rollover).

(d) Locating lost participants. (i) 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, but are not limited to, a mailing to the individual’s last known address using certified mail, and, if that is unsuccessful, an additional search method, such as the use of a commercial locator service, a credit reporting agency, or Internet search tools. Depending on the facts and circumstances, the use of more than one of these additional search methods may be appropriate. A plan will not be considered to have failed to correct a failure due to the inability to locate an individual if reasonable actions to locate the individual have been undertaken in accordance with this paragraph; provided that, if the individual is later located, the additional benefits are provided to the individual at that time.

(ii) The IRS Letter Forwarding Program is no longer available as a means to search for participants and beneficiaries to whom additional benefits under the plan are due. Any request for locater services received by the IRS on or after August 31, 2012 will not be processed. See Rev. Proc. 2012–35, 2012–37 I.R.B. 341.

(iii) A Plan Sponsor described in (A) or (B) of this section 6.02(5)(d)(iii)) that is correcting failures that require payment of additional benefits to participants and beneficiaries will have until the earlier of: a) May 30, 2013, or b) if a request under the IRS Letter Forwarding Program has been submitted on or after August 31, 2012, 150 days after the date of notification by the IRS that the request to locate missing participants and beneficiaries will not be processed, to take other reasonable actions in accordance with section 6.02(5)(d)(i) to locate participants and beneficiaries to whom additional benefits are due. A Plan Sponsor is described in this section 6.02(5)(d)(iii) if it:

  • (A) received a VCP compliance statement for which the 150-day correction period set forth in section 10.06(9) has not expired, or

  • (B) is correcting failures under SCP and is within 150 days of the expiration of the correction period set forth in section 9.02(1).

(e) Small Excess Amounts. Generally, if the total amount of an Excess Amount with respect to the benefit of a participant or beneficiary is $100 or less, the Plan Sponsor is not required to distribute or forfeit such Excess Amount. However, if the Excess Amount exceeds a statutory limit, the participant or beneficiary must be notified that the Excess Amount, including any investment gains, is not eligible for favorable tax treatment accorded to distributions from the plan (and, specifically, is not eligible for tax-free rollover). See section 6.06(1) for such notice requirements.

(f) Orphan Plans. The IRS retains the discretion to determine under VCP and Audit CAP whether full correction will be required with respect to a terminating Orphan Plan.

(6) Correction principle for loan failures. In the case of a loan failure corrected in accordance with section 6.07(2)(b) or (c) and section 6.07(3), the participant is generally responsible for paying the corrective payment. However, with respect to the failure listed in section 6.07(3), the employer should pay a portion of the correction payment on behalf of the participant equal to the interest that accumulates as a result of such failure — generally determined at a rate equal to the greater of the plan loan interest rate or the rate of return under the plan.

(7) Correction for exclusion of employees with respect to elective deferrals or after-tax employee contributions. If a Qualified Plan or 403(b) Plan has an Operational Failure that consists of excluding an employee that should have been eligible to make an elective deferral or an after-tax employee contribution, the employer should contribute to the plan on behalf of the excluded employee an amount that makes up for the value of the lost opportunity for the employee to have a portion of his or her compensation contributed to the plan accumulated with earnings tax deferred in the future. This correction principle applies solely to this limited circumstance. It does not, for example, extend to the correction of a failure to satisfy a nondiscrimination test, such as, the ADP test pursuant to § 401(k)(3) and the ACP test pursuant to § 401(m)(2). Specific methods and examples to correct this failure are provided in Appendix A, section .05, and Appendix B, section 2.02. Similarly, the methods and examples provided for correcting this failure do not extend to other failures. Thus, the correction methods and the examples in Appendix A, section .05, and Appendix B, section 2.02, cannot, for example, be used to correct ADP/ACP failures.

(8) Correction by plan amendment in VCP, Audit CAP, and SCP. For the availability of correction by plan amendment, see section 4.05.

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

.03 Correction of an Employer Eligibility Failure. (1) The permitted correction of an Employer Eligibility Failure is the cessation of all contributions (including elective deferrals and after-tax employee contributions). For VCP submissions, the cessation must occur no later than the date the submission under VCP is filed. 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, for example, for 403(b) Plans, an event 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).

(2) Cessation of contributions is not required if continuation of contributions would not be an Employer Eligibility Failure (for example, with respect to a tax-exempt employer that may maintain a § 401(k) plan after 1996). In the case of a 403(b) Failure which is an Employer Eligibility Failure, correction may include treating contributions as not being excluded under § 403(b) (and thus the contributions would be treated as having been contributed, for example, to an annuity contract to which § 403(c) applies).

(3) A plan that is corrected through VCP or Audit CAP is treated as subject to all of the requirements and provisions of §§ 401(a) for a Qualified Plan, 403(b) for a 403(b) Plan, 408(k) for a SEP, and 408(p) for a SIMPLE IRA Plan (including Code provisions relating to rollovers). Therefore, the Plan Sponsor must also correct all other failures in accordance with this revenue procedure.

(4) If correction is accomplished under VCP or Audit CAP in accordance with the requirements of this section 6.03, then any rollovers made from the plan pursuant to a distributable event are deemed to have been made from an eligible retirement plan under § 402(c)(8)(B) for the purpose of determining whether the amounts qualify as an eligible rollover distribution under § 402(c) or 403(b)(8) (including the determination of excess contributions that are subject to the § 4973 excise tax).

.04 Correction of a failure to obtain spousal consent. (1) Normally, the correction method under VCP for a failure to obtain spousal consent for a distribution that is subject to the spousal consent rules under §§ 401(a)(11) and 417 is similar to the correction method described in Appendix A, section .07. The Plan Sponsor must notify the affected participant and spouse (to whom the participant was married at the time of the distribution), so that the spouse can provide spousal consent to the distribution actually made or the participant may repay the distribution and receive a qualified joint and survivor annuity.

(2)(a) As alternatives to the correction method in section 6.04(1), correction for a failure to obtain spousal consent may be made under either section 6.04(2)(b) or section 6.04(2)(c).

(b) In the event that spousal consent to the prior distribution is not obtained (for example, because the spouse chooses not to consent, the spouse does not respond to the notice, or the spouse cannot be located), the spouse is entitled to a benefit under the plan equal to the portion of the qualified joint and survivor annuity that would have been payable to the spouse upon the death of the participant had a qualified joint and survivor annuity been provided to the participant under the plan at the annuity starting date for the prior distribution. Such spousal benefit must be provided if a claim is made by the spouse.

(c) In the event that spousal consent to the prior distribution is not obtained, the plan may offer the spouse the choice between (i) the survivor annuity benefit described in section 6.04(2)(b) or (ii) a single-sum payment equal to the actuarial present value of that survivor annuity benefit (calculated using the applicable interest rate and mortality table under § 417(e)(3)). Any such single-sum payment is treated in the same manner as a distribution under § 402(c)(9) for purposes of rolling over the payment to an IRA or other eligible retirement plan. In the event that the plan is subject to a restriction on the payment of single sums pursuant to § 436(d) at the time the plan offers this choice to the spouse and the spouse elects to receive a single-sum payment, the plan sponsor must contribute to the plan the applicable amount under section 6.02(4)(e)(ii)(A).

.05 Determination letter application not permitted. (1) In general. A determination letter application may not be submitted with a VCP submission.

(a) Issuance of compliance statement or closing agreement for Plan Document Failures corrected through plan amendment under VCP or Audit CAP. The issuance of a compliance statement or closing agreement for Plan Document Failures corrected through plan amendment under VCP or Audit CAP does not constitute a determination that the terms of the plan, including the corrective plan amendment, satisfy the qualification requirements in form. See section 10.07(2)(a) and (b).

(b) Issuance of compliance statement or closing agreement for Operational Failures corrected through plan amendment under VCP and Audit CAP. If a Plan Sponsor submits a VCP filing correcting an Operational Failure through a plan amendment or corrects such a failure under Audit CAP, and the plan amendment is accepted as a proper correction, then the compliance statement under VCP or closing agreement issued under Audit CAP constitutes a determination that the Operational Failure has been corrected, but is not a determination that the terms of the plan, including the corrective plan amendment, satisfy the qualification requirements in form. See section 10.07(2)(c).

(2) Corrective amendments to pre-approved plans. (a) Effect of corrective amendment. Generally, under VCP or Audit CAP, a Plan Sponsor that is an adopter of a pre-approved plan (that is, a master or prototype, or volume submitter plan) is able to amend its plan to correct a Qualification Failure (provided the amendment satisfies the requirements of the Code). In some cases, the corrective amendment is not provided for among plan provision options that were pre-approved when the opinion or advisory letter was issued with respect to the plan. As a result, adopting such a corrective amendment would cause the Plan Sponsor to lose reliance on the plan’s opinion or advisory letter, except in the limited circumstances provided in section 6.05(2)(b).

(b) Exception for certain amendments. In the case of a pre-approved plan, the adoption of a plan provision not provided for in the adoption agreement which is required to correct a failure under VCP or Audit CAP will not cause the Plan Sponsor to lose its reliance on the plan’s opinion or advisory letter, provided that: (i) the corrective amendment would otherwise be permitted under the rules for pre-approved plans and (ii) no other modification has been made to the plan that would cause the plan to lose its reliance on the opinion or advisory letter. If these conditions are satisfied, the Plan Sponsor will be allowed to continue to rely on the plan’s opinion or advisory letter. In addition, the adoption of the corrective amendment will not cause the plan to lose its eligibility to remain within the six-year remedial amendment cycle provided for in Rev. Proc. 2016–37 on a continuing basis until the expiration of the next six-year remedial amendment cycle described in section 18.01 of Rev. Proc. 2016–37.

.06 Special rules relating to Excess Amounts. (1) Treatment of Excess Amounts. Except as otherwise provided in section 6.02(5)(c) with respect to recovery of small Overpayments, a distribution of an Excess Amount is not eligible for the favorable tax treatment accorded to distributions from Qualified Plans or 403(b) Plans (such as eligibility for tax-free rollover). Thus, for example, if such a distribution was contributed to an 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 Form 1099–R, Distributions From Pensions, Annuities, Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc., for the year of distribution with respect to each participant or beneficiary receiving such a distribution. Except as otherwise provided in section 6.02(5)(c), where an Excess Amount has been or is being distributed, the Plan Sponsor must notify the recipient that (a) an Excess Amount has been or will be distributed and (b) an Excess Amount is not eligible for favorable tax treatment accorded to distributions from an eligible retirement plan under § 402(c)(8)(B) (and, specifically, is not eligible for rollover).

(2) Correction of Excess Allocations. In general, an Excess Allocation is corrected in accordance with the Reduction of Account Balance Correction Method set forth in this paragraph. Under this method, the account balance of an employee who received an Excess Allocation is reduced by the Excess Allocation (adjusted for Earnings). If the Excess Allocation would have been allocated to other employees in the year of the failure had the failure not occurred, then that amount (adjusted for Earnings) is reallocated to those employees in accordance with the plan’s allocation formula. If the improperly allocated amount would not have been allocated to other employees absent the failure, that amount (adjusted for Earnings) is placed in a separate account that is not allocated on behalf of any participant or beneficiary (an unallocated account) established for the purpose of holding Excess Allocations, adjusted for Earnings, to be used to reduce employer contributions (other than elective deferrals) in the current year or succeeding year. While such amounts remain in the unallocated account, the employer is not permitted to make contributions to the plan other than elective deferrals. Excess Allocations that are attributable to elective deferrals or after-tax employee contributions (adjusted for Earnings) must be distributed to the participant. For qualification purposes, an Excess Allocation that is corrected pursuant to this paragraph is disregarded for purposes of §§ 402(g) and 415, the ADP test of § 401(k)(3), and the ACP test of § 401(m)(2). If an Excess Allocation resulting from a violation of § 415 consists of annual additions attributable to both employer contributions and elective deferrals or after-tax employee contributions, then the correction of the Excess Allocation is completed by first distributing the unmatched employee’s after-tax contributions (adjusted for Earnings) and then the unmatched employee’s elective deferrals (adjusted for Earnings). If any excess remains, and is attributable to either elective deferrals or after-tax employee contributions that are matched, the excess is apportioned first to after-tax employee contributions with the associated matching employer contributions and then to elective deferrals with the associated matching employer contributions. Any matching contribution or nonelective employer contribution (adjusted for Earnings) which constitutes an Excess Allocation is then forfeited and placed in an unallocated account established for the purpose of holding Excess Allocations to be used to reduce employer contributions in the current year and succeeding year. Such unallocated account is adjusted for Earnings. While such amounts remain in the unallocated account, the employer is not permitted to make contributions (other than elective deferrals) to the plan.

(3) Correction of Overpayment (defined benefit plans). An Overpayment from a defined benefit plan is corrected in accordance with rules similar to the Return of Overpayment and Adjustment of Future Payments correction methods described in section 2.04(1) of Appendix B or any other appropriate correction method. Depending on the nature of the Overpayment, an appropriate correction method may include using rules similar to the correction method described in section 2.04(1) of Appendix B but having the employer or another person contribute the amount of the Overpayment (with appropriate interest) to the plan instead of seeking recoupment from a plan participant or beneficiary. Another example of an appropriate correction method includes a Plan Sponsor adopting a retroactive amendment to conform the plan document to the plan’s operations (subject to the requirements of section 4.05). Any other correction method used must satisfy the correction principles of section 6.02 and any other applicable rules in this revenue procedure.

(4) Correction of Overpayment (defined contribution plans and 403(b) Plans). (a) In general. An Overpayment from a defined contribution plan or 403(b) Plan is corrected in accordance with the Return of Overpayment method set forth in this section 6.06(4). Under this method, the employer takes reasonable steps to have the Overpayment, adjusted for Earnings at the plan’s earnings rate from the date of the distribution to the date of the correction of the Overpayment.

(b) Make-whole contribution. To the extent the amount of an Overpayment adjusted for Earnings at the plan’s earnings rate is not repaid to the plan, the employer or another person must contribute the difference to the plan. The preceding sentence does not apply when the failure arose solely because a payment was made from the plan to a participant or beneficiary in the absence of a distributable event (but was otherwise determined in accordance with the terms of the plan (for example, an impermissible in-service distribution)).

(c) Unallocated account. Except as provided in section 6.06(4)(d), a corrected Overpayment, adjusted for Earnings at the plan’s earnings rate to the date of the repayment, is to be placed in an unallocated account, as described in section 6.06(2), to be used to reduce employer contributions (other than elective deferrals) in the current year and succeeding year(s) (or, if the amount would have been allocated to other eligible employees who were in the plan for the year of the failure if the failure had not occurred, then that amount is reallocated to the other eligible employees in accordance with the plan’s allocation formula).

(d) Repayment by the participant or beneficiary. To the extent an Overpayment was solely considered a distribution in the absence of a distributable event but was otherwise determined in accordance with the terms of the plan, any amount returned to the plan by the participant or beneficiary is to be allocated to his or her account.

(e) Notification of employee. Except as provided in section 6.02(5)(c) with respect to the recovery of small overpayments, the employer must notify the employee that the Overpayment was not eligible for favorable tax treatment accorded to distributions from an eligible retirement plan under § 402(c)(8)(B) (and, specifically, was not eligible for tax-free rollover).

(f) Other correction methods. Other appropriate correction methods may be used to correct Overpayment failures from a defined contribution plan. Depending on the nature of the Overpayment, an appropriate correction method may include using rules similar to the correction method in section 6.06(4)(a) but having the employer or another person contribute the amount of the Overpayment (with appropriate interest) to the plan instead of seeking recoupment from a plan participant or beneficiary. Another example of an appropriate correction method includes a Plan Sponsor adopting a retroactive amendment to conform the plan document to the plan’s operations (subject to the requirements of section 4.05). Any other correction method used must satisfy the correction principles of section 6.02 and any other applicable rules of this revenue procedure.

.07 Rules relating to reporting plan loan failures. (1) General rules for loans. Unless correction is made in accordance with section 6.07(2) or (3), a deemed distribution under § 72(p)(1) in connection with a failure relating to a loan to a participant made from a plan must be reported on Form 1099–R with respect to the affected participant and any applicable income tax withholding amount that was required to be paid in connection with the failure (see § 1.72(p)–1, Q&A-15) must be paid by the employer. As part of VCP and Audit CAP, the deemed distribution may be reported on Form 1099–R with respect to the affected participant for the year of correction (instead of the year of the failure). The relief of reporting the participant’s loan as a deemed distribution on Form 1099–R in the year of correction, as described in the preceding sentence, applies only if the Plan Sponsor specifically requests such relief.

(2) Special rules for loans. (a) In general. The correction methods set forth in section 6.07(2)(b) and (c) and section 6.07(3) are available for plan loans that do not comply with one or more requirements of § 72(p)(2) and are corrected through VCP or Audit CAP. The correction methods described in section 6.07(2)(b) and (c) and section 6.07(3) are not available if the maximum period for repayment of the loan pursuant to § 72(p)(2)(B) has expired. The IRS reserves the right to limit the use of the correction methods listed in section 6.07(2)(b) and (c) and section 6.07(3) to situations that it considers appropriate; for example, where the loan failure is caused by employer action. A deemed distribution corrected under section 6.07(2)(b) or (c) or under section 6.07(3) is not required to be reported on Form 1099–R and repayments made by correction under sections 6.07(2) and 6.07(3) do not result in the affected participant having additional basis in the plan for purposes of determining the tax treatment of subsequent distributions from the plan to the affected participant. The relief from reporting the participant’s loan as a deemed distribution on Form 1099–R, as described in the preceding sentence, applies only if the Plan Sponsor specifically requests such relief and provides an explanation supporting the request.

(b) Loans in excess of § 72(p)(2)(A). A failure to comply with plan provisions requiring that loans comply with § 72(p)(2)(A) may be corrected by a corrective repayment to the plan based on the excess of the loan amount over the maximum loan amount under § 72(p)(2)(A). In the event that loan repayments were made in accordance with the amortization schedule for the loan before correction, such prior repayments may be applied (i) solely to reduce the portion of the loan that did not exceed the maximum loan amount under § 72(p)(2)(A) (so that the corrective repayment would equal the original loan excess plus interest thereon), (ii) to reduce the loan excess to the extent of the interest thereon, with the remainder of the repayments applied to reduce the portion of the loan that did not exceed the maximum loan amount under § 72(p)(2)(A) (so that the corrective repayment would equal the original loan excess), or (iii) pro rata against the loan excess and the maximum loan amount under § 72(p)(2)(A) (so that the corrective repayment would equal the outstanding balance remaining on the original loan excess on the date that corrective repayment is made). After the corrective payment is made, the loan may be reformed to amortize the remaining principal balance as of the date of repayment over the remaining period of the original loan. This is permissible as long as the recalculated payments over the remaining period would not cause the loan to violate the maximum duration permitted under § 72(p)(2)(B). The maximum duration is determined from the date the original loan was made. In addition, the amortization payments determined for the remaining period must comply with the level amortization requirements of § 72(p)(2)(C).

(c) Loan terms that do not satisfy § 72(p)(2)(B) or (C). For a failure of loan repayment terms to provide for a repayment schedule that complies with § 72(p)(2)(B) or (C), the failure may be corrected by a reamortization of the loan balance in accordance with § 72(p)(2)(C) over the remaining period that is the maximum period that complies with § 72(p)(2)(B) measured from the original date of the loan.

(d) No requirement for plan provisions. This section 6.07 applies even if the plan does not require loans to satisfy the requirements of § 72(p)(2). However, under the Department of Labor’s Voluntary Fiduciary Correction Program, to correct the ERISA fiduciary violations associated with the failures described in section 6.07(2)(b) and (c) and section 6.07(3) of this revenue procedure, the plan must contain plan provisions requiring that loans comply with § 72(p)(2)(A), (B), and (C).

(3) Defaulted loans. A failure to repay the loan in accordance with the loan terms where the terms satisfy § 72(p)(2) may be corrected by (i) a single-sum repayment equal to the additional repayments that the affected participant would have made to the plan if there had been no failure to repay the plan, plus interest accrued on the missed repayments, (ii) reamortizing the outstanding balance of the loan, including accrued interest, over the remaining payment schedule of the original term of the loan or the period remaining had the loan been amortized over the maximum period that complies with § 72(p)(2)(B), measured from the original date of the loan, or (iii) any combination of (i) or (ii).

.08 Correction under statute or regulations. 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 under provisions of the Code through retroactive remedial amendment.

.09 Matters subject to excise or other taxes. (1) General rule. Except as provided in this revenue procedure, 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 series cannot be corrected under this revenue procedure.

(2) Section 4974. As part of VCP and Audit CAP, if a failure involves the failure to satisfy the minimum required distribution requirements of § 401(a)(9), in appropriate cases, the IRS will waive the excise tax under § 4974 applicable to plan participants or beneficiaries. The waiver will be included in the compliance statement or in the closing agreement in the case of Audit CAP. Under VCP, the Plan Sponsor, as part of the submission, must request the waiver and, in cases where the participant subject to the excise tax is either an owner-employee as defined in § 401(c)(3) or a 10% owner of a corporation, the Plan Sponsor must also provide an explanation supporting the request. Under Audit CAP, the Plan Sponsor must make a specific request for waiver of the excise tax under § 4974. The Plan Sponsor should also provide an explanation supporting the request for a waiver. Upon reviewing the request, the reasons for the failure, and other facts or circumstances of the case under examination, the IRS will determine whether it is appropriate to approve the waiver of the excise tax as part of the closing agreement negotiated under Audit CAP.

(3) Section 4972. As part of VCP, if the failure involves a correction that requires the Plan Sponsor to make a plan contribution that is not deductible, in appropriate cases, the IRS will not pursue the excise tax under § 4972 on such nondeductible contributions. The Plan Sponsor, as part of the submission must request the relief and provide an explanation supporting the request.

(4) Section 4979. As part of VCP, if a failure results in excess contributions as defined in § 4979(c) or excess aggregate contributions as defined in § 4979(d) under a plan, in appropriate cases, the IRS will not pursue the excise tax under § 4979, for example, where correction is made for any case in which the ADP test was timely performed but, due to reliance on inaccurate data, resulted in an insufficient amount of excess elective deferrals having been distributed to HCEs. The Plan Sponsor, as part of the submission, must request the relief and provide an explanation supporting the request.

(5) Section 4973. Subject to section 6.03(4), as part of VCP, in appropriate cases, the IRS will not pursue the excise tax under § 4973 relating to excess contributions made to a 403(b) Plan or IRA under any of the following circumstances:

(a) As part of the proposed correction for Overpayments, the participant or beneficiary (“recipient”) removes the Overpayment (adjusted for Earnings) from the recipient’s 403(b) Plan or IRA and returns that amount to the plan.

(b) As part of the proposed correction for Excess Amounts, the recipient removes the Excess Amount (adjusted for Earnings) from the recipient’s 403(b) Plan or IRA and reports that amount (reduced by any applicable after-tax employee contribution) as a taxable distribution for the year in which the Excess Amount (adjusted for Earnings) is removed from the recipient’s 403(b) Plan or IRA. The amount removed is generally taxed in a manner that is similar to the manner in which the corrective disbursement of elective deferrals is taxed, as described in section 3 of Rev. Proc. 92–93.

(c) The Plan Sponsor, as part of the submission, must request relief from the § 4973 excise tax and provide an explanation supporting the request.

(6) Section 72(t). As part of VCP, in appropriate cases, the IRS will not pursue the 10% additional income tax under § 72(t) (or will pursue only a portion thereof) if, as part of the proposed correction of an Overpayment that occurred solely because an employee received a distribution from his or her vested account balance that was not a distributable event, the participant or beneficiary (“recipient”) returns the improperly distributed amount, adjusted for Earnings, to the plan. If the improperly distributed amount was rolled over to the recipient’s IRA, then correction will include removing the amount improperly distributed and rolled over (adjusted for Earnings) from the recipient’s IRA and returning that amount to the plan. In appropriate cases, as a condition for not pursuing all or a portion of the additional tax, the IRS may require the Plan Sponsor to pay an additional fee under VCP not in excess of the 10% additional income tax under § 72(t). The Plan Sponsor, as part of the submission, must request the relief and provide an explanation supporting the request.

.10 Correction for 403(b) Plans. (1) Correction for 403(b) Plans generally. Except as provided in sections 6.03(2) and 6.10(2), the correction for a 403(b) Plan is expected to be the same as the correction required for a Qualified Plan with the same Failure (that is, Plan Document Failure, Operational Failure, Demographic Failure, and Employer Eligibility Failure).

(2) Special correction principles. In general, a 403(b) Failure can be corrected by treating a contract as a § 403(c) annuity contract (or, if applicable, as an amount to which § 61, 83, or 402(b) applies), such as for purposes of correcting an Employer Eligibility Failure, a failure to provide for full vesting (including a failure to maintain a separate account), or an exchange made to a vendor which is not part of the plan (and for which there is no information sharing agreement). In addition, for purposes of this revenue procedure, pending additional guidance, a 403(b) Plan generally will be treated as having a Favorable Letter if either (a) the employer is an eligible employer and, on or before December 31, 2009 (or the date a 403(b) Plan is established, if later), the employer has adopted a written 403(b) Plan that is intended to satisfy § 403(b) (including the regulations thereunder) effective as of January 1, 2009 (or the first day of the plan year in which a 403(b) Plan is established, if later), or (b) the employer has failed to adopt a written 403(b) Plan timely and corrects the failure in accordance with section 6.10(3) below. In addition, for purposes of section 4.04 (requiring that the Plan Sponsor or administrator of the plan have established practices and procedures reasonably designed to promote and facilitate overall compliance with applicable Code requirements in order to be eligible for SCP to be available to correct Operational Failures), the requirement to have established practices and procedures only applies for failures during periods after December 31, 2009.

(3) Correction for failure to adopt a written 403(b) Plan timely. A failure to adopt a written 403(b) Plan timely in accordance with the final regulations under § 403(b) and Notice 2009–3 may be corrected under VCP and Audit CAP. The issuance of a compliance statement or closing agreement for the failure to adopt a written 403(b) Plan timely will result in the written 403(b) Plan being treated as if it had been adopted timely for the purpose of making available the extended remedial amendment period set forth in Announcement 2009–89. However, the issuance of a compliance statement or closing agreement does not constitute a determination as to whether the written plan, as drafted, complies with the applicable requirements of § 403(b) of the Code and the final 403(b) regulations.

.11 Correction for SEPs and SIMPLE IRA Plans. (1) Correction for SEPs and SIMPLE IRA Plans generally. Generally, the correction for a SEP or a SIMPLE IRA Plan is expected to be similar to the correction required for a Qualified Plan with a similar Qualification Failure (that is, a Plan Document Failure, Operational Failure, Demographic Failure, or Employer Eligibility Failure).

(2) Special correction for SEPs and SIMPLE IRA Plans. In any case in which correction under section 6.11(1) is not feasible for a SEP or SIMPLE IRA Plan or in any other case determined by the IRS in its discretion (including failures relating to § 402(g), 415, or 401(a)(17), failures relating to deferral percentages, discontinuance of contributions to a SARSEP or SIMPLE IRA Plan, and retention of Excess Amounts for cases in which there has been no violation of a statutory limitation with respect to a SEP or SIMPLE IRA Plan), the IRS may provide for a different correction.

(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, the failure may be corrected in either 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 to an amount sufficient to pass the test. This amount may be calculated as the same percentage of compensation (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 distributed. 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 or a SIMPLE IRA Plan. (a) Make-up contributions; Earnings. The Plan Sponsor should correct undercontributions to a SEP or a SIMPLE IRA Plan by contributing make-up amounts that are fully vested, adjusted for Earnings from the date of the failure to the date of correction.

(b) Earnings adjustment methods. Insofar as SEP and SIMPLE IRA Plan assets are held in IRAs, there is no earnings rate under the SEP or SIMPLE IRA Plan as a whole. If it is not feasible to make a reasonable estimate of what the actual investment results would have been, a reasonable interest rate may be used.

(5) Treatment of Excess Amounts under a SEP or a SIMPLE IRA Plan. (a) Distribution of Excess Amounts. For purposes of this section 6.11, an Excess Amount is an amount contributed on behalf of an employee that is in excess of an employee’s benefit under the plan, or an elective deferral in excess of the limitations of § 402(g) or 408(k)(6)(A)(iii). If an Excess Amount is attributable to elective deferrals, the Plan Sponsor may effect distribution of the Excess Amount, adjusted for Earnings through the date of correction, to the affected participant. The amount distributed to the affected participant is includible in gross income in the year of distribution. The distribution is reported on Form 1099–R for the year of distribution with respect to each participant receiving the distribution. In addition, the Plan Sponsor must inform affected participants that the distribution of an Excess Amount is not eligible for favorable tax treatment accorded to distributions from a SEP or a SIMPLE IRA Plan (and, specifically, is not eligible for tax-free rollover). If the Excess Amount is attributable to employer contributions, the Plan Sponsor may effect distribution of the employer Excess Amount, adjusted for Earnings through the date of correction, to the Plan Sponsor. The amount distributed to the Plan Sponsor is not includible in the gross income of the affected participant. The Plan Sponsor is not entitled to a deduction for such employer Excess Amount. The distribution is reported on Form 1099–R issued to the participant indicating the taxable amount as zero.

(b) Retention of Excess Amounts. If the failure involves an Excess Amount under a SEP or a SIMPLE IRA Plan and the Plan Sponsor retains the Excess Amount in the SEP or SIMPLE IRA Plan, a sanction applies, in addition to the SEP or SIMPLE IRA Plan user fee described in the annual revenue procedure that sets forth user fees, including VCP user fees. A sanction equal to at least 10% of the Excess Amount with no adjustment for Earnings is imposed. In addition, the Plan Sponsor is not entitled to a deduction for an Excess Amount retained in the SEP or SIMPLE IRA Plan. In the case of an Excess Amount retained in a SEP that is attributable to a § 415 failure, the Excess Amount, adjusted for Earnings through the date of correction, must reduce an affected participant’s 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.

(c) De minimis Excess Amounts. If the total Excess Amount in a SEP or SIMPLE IRA Plan, whether attributable to elective deferrals or employer contributions, is $100 or less, the Plan Sponsor is not required to distribute the Excess Amount and the sanction described in 6.11(5)(b) does not apply.

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

.13 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 ERISA. The Department of Labor maintains a Voluntary Fiduciary Correction Program under which certain ERISA fiduciary violations may be corrected. The Department of Labor also maintains a Delinquent Filer Voluntary Compliance Program under which certain failures to comply with the annual reporting requirements (Form 5500 series) under ERISA may be corrected.

PART IV. SELF-CORRECTION (SCP)

SECTION 7. IN GENERAL

The requirements of this section 7 are satisfied with respect to an Operational Failure if the Plan Sponsor of a Qualified Plan, a 403(b) Plan, a SEP, or a SIMPLE IRA Plan satisfies the requirements of section 8 (relating to insignificant Operational Failures) or, in the case of a Qualified Plan or a 403(b) Plan, section 9 (relating to significant Operational Failures).

SECTION 8. SELF-CORRECTION OF INSIGNIFICANT OPERATIONAL FAILURES

.01 Requirements. The requirements of this section 8 are satisfied with respect to an Operational Failure if the Operational Failure is corrected and, given all the facts and circumstances, the Operational Failure is insignificant. This section 8 is available for correcting an insignificant Operational Failure even if the plan or Plan Sponsor is Under Examination and even if the Operational Failure is discovered on examination.

.02 Factors. The factors to be considered in determining whether an Operational Failure under a plan is insignificant include, but are not limited to: (1) whether other failures occurred during the period being examined (for this purpose, a failure is not considered to have occurred more than once merely because more than one participant is affected by the failure); (2) the percentage of plan assets and contributions involved in the failure; (3) the number of years the failure occurred; (4) the number of participants affected relative to the total number of participants in the plan; (5) the number of participants affected as a result of the failure relative to the number of participants who could have been affected by the failure; (6) whether correction was made within a reasonable time after discovery of the failure; and (7) the reason for the failure (for example, data errors such as errors in the transcription of data, the transposition of numbers, or minor arithmetic errors). No single factor is determinative. Additionally, factors (2), (4), and (5) should not be interpreted to exclude small businesses.

.03 Multiple failures. In the case of a plan with more than one Operational Failure in a single year, or Operational Failures that occur in more than one year, the Operational Failures are eligible for correction under this section 8 only if all of the Operational Failures are insignificant in the aggregate. Operational Failures that have been corrected under SCP in section 9 and VCP in sections 10 and 11 are not taken into account for purposes of determining if Operational Failures are insignificant in the aggregate.

.04 Examples. The following examples illustrate the application of this section 8. It is assumed, in each example, that the eligibility requirements of section 4 relating to SCP (for example, the requirements of section 4.04 relating to established practices and procedures) have been satisfied and that no Operational Failures occurred other than the Operational Failures identified below.

Example 1: In 1991, Employer X established Plan A, a profit-sharing plan that satisfies the requirements of § 401(a) in form. In 2005, the benefits of 50 of the 250 participants in Plan A were limited by § 415(c). However, when the IRS examined Plan A in 2008, it discovered that, during the 2005 limitation year, the annual additions allocated to the accounts of 3 of these employees exceeded the maximum limitations under § 415(c). Employer X contributed $3,500,000 to the plan for the plan year. The amount of the excesses totaled $4,550. Under these facts, because the number of participants affected by the failure relative to the total number of participants who could have been affected by the failure, and the monetary amount of the failure relative to the total employer contribution to the plan for the 2005 plan year, are insignificant, the § 415(c) failure in Plan A that occurred in 2005 would be eligible for correction under this section 8.

Example 2: The facts are the same as in Example 1, except that the failure to satisfy § 415 occurred during each of the 2005 and 2007 limitation years. In addition, the three participants affected by the § 415 failure were not identical each year. The fact that the § 415 failures occurred during more than one limitation year does not cause the failures to be significant; accordingly, the failures are still eligible for correction under this section 8.

Example 3: The facts are the same as in Example 1, except that the annual additions of 18 of the 50 employees whose benefits were limited by § 415(c) nevertheless exceeded the maximum limitations under § 415(c) during the 2005 limitation year, and the amount of the excesses ranged from $1,000 to $9,000, and totaled $150,000. Under these facts, taking into account the number of participants affected by the failure relative to the total number of participants who could have been affected by the failure for the 2005 limitation year (and the monetary amount of the failure relative to the total employer contribution), the failure is significant. Accordingly, the § 415(c) failure in Plan A that occurred in 2005 is ineligible for correction under this section 8 as an insignificant failure.

Example 4: Employer J maintains Plan C, a money purchase pension plan established in 1992. The plan document satisfies the requirements of § 401(a). The formula under the plan provides for an employer contribution equal to 10% of compensation, as defined in the plan. During its examination of the plan for the 2005 plan year, the IRS discovered that the employee responsible for entering data into the employer’s computer made minor arithmetic errors in transcribing the compensation data with respect to 6 of the plan’s 40 participants, resulting in excess allocations to those 6 participants’ accounts. Under these facts, the number of participants affected by the failure relative to the number of participants that could have been affected is insignificant, and the failure is due to minor data errors. Thus, the failure occurring in 2005 is insignificant and therefore eligible for correction under this section 8.

Example 5: Public School maintains for its 200 employees a salary reduction 403(b) Plan (“Plan B”) that is intended to satisfy the requirements of § 403(b). The business manager has primary responsibility for administering Plan B, in addition to other administrative functions within Public School. During the 2005 plan year, a former employee should have received an additional minimum required distribution of $278 under § 403(b)(10). Another participant received an impermissible hardship withdrawal of $2,500. Another participant made elective deferrals of which $1,000 was in excess of the § 402(g) limit. Under these facts, even though multiple failures occurred in a single plan year, the failures are eligible for correction under this section 8 because in the aggregate the failures are insignificant.

SECTION 9. SELF-CORRECTION OF SIGNIFICANT OPERATIONAL FAILURES

.01 Requirements. The requirements of this section 9 are satisfied with respect to an Operational Failure (even if significant) if the Operational Failure is corrected and the correction is either completed or substantially completed (in accordance with section 9.03) by the last day of the correction period described in section 9.02.

.02 Correction period. (1) End of correction period. The last day of the correction period for an Operational Failure is the last day of the second plan year following the plan year for which the failure occurred. However, in the case of a failure to satisfy the requirements of § 401(k)(3), 401(m)(2), or, for plan years beginning on or before December 31, 2001, the multiple use test of § 401(m)(9), the correction period does not end until the last day of the second plan year following the plan year that includes the last day of the additional period for correction permitted under § 401(k)(8) or 401(m)(6). If a 403(b) Plan does not have a designated plan year, the plan year is deemed to be the calendar year for purposes of this section 9.02. See section 6.02(5)(d)(ii) for a limited extension of the correction period set forth in this paragraph for Plan Sponsors taking action to locate lost participants.

(2) Extension of correction period for Transferred Assets. In the case of an Operational Failure that relates only to Transferred Assets, or to a plan assumed in connection with a corporate merger, acquisition, or other similar employer transaction, the correction period does not end until the last day of the first plan year that begins after the corporate merger, acquisition, or other similar employer transaction between the Plan Sponsor and the sponsor of the transferor plan or the prior sponsor of an assumed plan.

(3) Effect of examination. The correction period for an Operational Failure that occurs for any plan year ends, in any event, on the first date the plan or Plan Sponsor is Under Examination for that plan year (determined without regard to the second sentence of section 9.02). (But see section 9.03 for special rules permitting completion of correction after the end of the correction period.)

.03 Substantial completion of correction. Correction of an Operational Failure is substantially completed by the last day of the correction period only if the requirements of either paragraph (1) or (2) of this section 9.03 are satisfied.

(1) The requirements of this paragraph (1) are satisfied if:

(a) during the correction period, the Plan Sponsor is reasonably prompt in identifying the Operational Failure, formulating a correction method, and initiating correction in a manner that demonstrates a commitment to completing correction of the Operational Failure as expeditiously as practicable; and

(b) within 120 days after the last day of the correction period, the Plan Sponsor completes correction of the Operational Failure.

(2) The requirements of this paragraph (2) are satisfied if:

(a) during the correction period, correction is completed with respect to 65% of all participants affected by the Operational Failure; and

(b) thereafter, the Plan Sponsor completes correction of the Operational Failure with respect to the remaining affected participants in a diligent manner.

.04 Examples. The following examples illustrate the application of this section 9. It is assumed, in each example, that the eligibility requirements of section 4 relating to SCP have been met.

Example 1: Employer Z established a qualified defined contribution plan in 2003 and received a favorable determination letter. During 2007, while doing a self-audit of the operation of the plan for the 2006 plan year, the plan administrator discovered that, despite the practices and procedures established by Employer Z with respect to the plan, several employees eligible to participate in the plan were excluded from participation. The administrator also found that for 2006 Operational Failures occurred because the elective deferrals of additional employees exceeded the § 402(g) limit and Employer Z failed to make the required top-heavy minimum contribution. In addition, during the review of the administration for the 2006 year, it was found that the plan administrator intended to implement correction for the failure to satisfy the ADP test (as described in § 401(k)(3)) for the 2005 plan year. During the 2008 plan year, the Plan Sponsor made QNECs on behalf of the excluded employees, distributed the excess deferrals to the affected participants, and made a top-heavy minimum contribution to all participants entitled to that contribution for the 2006 plan year. Each corrective contribution and distribution was credited with Earnings at a rate appropriate for the plan from the date the corrective contribution or distribution should have been made to the date of correction. The failed ADP test for 2005 was corrected by making corrective contributions, adjusted for Earnings, on behalf of nonhighly compensated employees using the method described in Appendix A, section .03 of this revenue procedure. Under these facts, the Plan Sponsor has corrected the ADP test failure for the 2005 plan year and the Operational Failures for the 2006 plan year within the correction period and thus satisfied the requirements of this section 9.

Example 2: Employer A established a qualified defined contribution plan, Plan A, in 1993 and has received a favorable determination letter for the applicable law changes. In April 2007, Employer A purchased all of the stock of Employer B, a wholly-owned subsidiary of Employer C. Employees of Employer B participated in Plan C, a qualified defined contribution plan sponsored by Employer C. Following Employer A’s review of Plan C, Employer A and Employer C agreed that Plan A would accept a transfer of plan assets from Plan C attributable to the account balances of the employees of Employer B who had participated in Plan C. As part of this agreement, Employer C represented to Employer A that Plan C was tax qualified. Employers A and C also agreed that such transfer would be in accordance with § 414(l) and § 1.414(l)–1 and addressed issues related to costs associated with the transfer. Following the transaction, the employees of Employer B began participation in Plan A. Effective July 1, 2007, Plan A accepted the transfer of plan assets from Plan C. After the transfer, Employer A determined that all the participants in one division of Employer B had been incorrectly excluded from allocation of the profit sharing contributions for the 2002 and 2003 plan years. During 2008, Employer A made corrective contributions on behalf of the affected participants. The corrective contributions were credited with Earnings at a rate appropriate for the plan from the date the corrective contributions should have been made to the date of correction and Employer A otherwise complied with the requirements of SCP. Under these facts, Employer A has, within the correction period, corrected the Operational Failures for the 2002 and 2003 plan years with respect to the assets transferred to Plan A, and thus satisfied the requirements of this section 9.

PART V. VOLUNTARY CORRECTION PROGRAM WITH IRS APPROVAL (VCP)

SECTION 10. VCP PROCEDURES

.01 VCP requirements. The requirements of this section 10 are satisfied with respect to failures submitted in accordance with the requirements of this section 10 if the Plan Sponsor pays the user fee required under section 6.08 of Rev. Proc. 2016–8, or any subsequent guidance that sets forth user fees for VCP submissions, and implements the corrective actions and satisfies any other conditions in the compliance statement described in section 10.07.

.02 Identification of failures. VCP is not based upon an examination of the plan by the IRS. Only the failures raised by the Plan Sponsor or failures identified by the IRS in processing the submission are addressed under VCP, and only those failures are covered by a VCP compliance statement. The IRS will not make any investigation or finding under VCP concerning whether there are failures.

.03 Effect of VCP submission on examination. Because VCP does not arise out of an examination, consideration under VCP does not preclude or impede (under § 7605(b) or any administrative provisions adopted by the IRS) a subsequent examination of the Plan Sponsor or the plan by the IRS with respect to the taxable year (or years) involved with respect to matters that are outside the compliance statement. However, a Plan Sponsor’s statements describing failures are made only for purposes of VCP and will not be regarded by the IRS as an admission of a failure for purposes of any subsequent examination. See section 5.08 for the definition of Under Examination.

.04 No concurrent examination activity. Except in unusual circumstances, a plan that has been properly submitted under VCP will not be examined while the submission is pending. Notwithstanding the above, a plan that is eligible for a Group Submission under section 10.10 may be examined while the Group Submission is pending with respect to issues not identified in the Group Submission at the time such plan comes Under Examination. In addition, if it is determined that either the plan or the Plan Sponsor was, or may have been, a party to an abusive tax avoidance transaction (as defined under section 4.12(2)), the IRS may authorize the examination of the plan, even if a submission pursuant to VCP is pending. This practice regarding concurrent examinations does not extend to other plans of the Plan Sponsor. Thus, any plan of the Plan Sponsor that is not pending under VCP could be subject to examination.

.05 Determination letter applications not related to a VCP submission. (1) The IRS may process a determination letter application (including an application requested on Form 5310) submitted under the determination letter program (as set forth in Rev. Proc. 2016–6, and Rev. Proc. 2016–37, and any subsequent guidance issued in the Internal Revenue Bulletin) while separately processing a VCP submission for the same plan. Generally, issuance of the determination letter in response to an application made on a Form 5310 will be suspended pending the closure of the VCP submission.

(2) A submission of a plan under the determination letter program does not constitute a submission under VCP. If the Plan Sponsor discovers a failure, the failure may not be corrected as part of the determination letter process. The Plan Sponsor may use SCP and VCP instead, as applicable. If the IRS, in connection with a determination letter application, discovers failures, the IRS may issue a closing agreement with respect to the failures identified or, if appropriate, refer the case to Employee Plans Examinations. In such a case, the VCP user fee does not apply. Except as provided in section 10.05(3), the sanction in section 14.01 relating to Audit CAP applies. See section 5.08 for a description of when a plan submitted for a determination letter is considered to be Under Examination for purposes of EPCRS.

(3) If the IRS in connection with a determination letter application discovers the plan has not been amended timely for tax legislation changes, the fee structure in section 14.04 applies.

.06 Processing of submission.

(1) Screening of submission. Upon receipt of a VCP submission, the IRS will review whether the eligibility requirements of section 4 and the submission requirements of section 11 are satisfied, including whether completed Form 8950, Application for Voluntary Correction Program (VCP) Submission Under the Employee Plans Compliance Resolution System and Form 8951, User Fee for Application for Voluntary Correction Program (VCP) Under the Employee Plans Compliance Resolution System, have been included with the VCP submission.

(2) Eligibility of submission. If, at any stage of the review process the IRS determines that a VCP submission is seriously deficient or that the application of VCP would be inappropriate or impracticable, the IRS reserves the right to return the submission without contacting the Plan Sponsor. A VCP submission that does not include a Form 8950 or Form 8951 will be considered to be seriously deficient. If no substantive processing of the case has occurred, the IRS will refund the user fee submitted with the request.

(3) Review of submission. Once the IRS determines that the submission is complete under VCP, the IRS will contact the Plan Sponsor or the Plan Sponsor’s representative to discuss the proposed corrections and the plan’s administrative procedures.

(4) Additional information required. If additional information is required, an IRS representative will generally contact the Plan Sponsor or the Plan Sponsor’s representative and explain what is needed to complete the submission. The Plan Sponsor will have 21 calendar days from the date of this contact to provide the requested information. If the information is not received within 21 days, the matter will be closed, the user fee will not be returned, and the case may be referred to Employee Plans Examinations. Any request for an extension of the 21-day time period must be made in writing within the 21-day time period and must be approved by the IRS (by the applicable group manager).

(5) Additional failures discovered after initial submission. (a) A Plan Sponsor that discovers additional unrelated failures after its initial submission may request that such failures be added to its submission. However, the IRS retains the discretion to reject the inclusion of such failures if the request is not timely (for example, if the Plan Sponsor makes its request when processing of the submission is substantially complete) or the application of VCP would be inappropriate or impracticable.

(b) If the IRS discovers an unrelated failure while the request is pending, the failure generally will be added to the failures under consideration. However, the IRS retains the discretion to determine that a failure is outside the scope of the voluntary request for consideration because the Plan Sponsor did not voluntarily bring this failure forward. In this case, if the additional failure is significant, all aspects of the plan may be examined and the rules pertaining to Audit CAP will apply.

(6) Conference right. If the IRS initially determines that it cannot issue a compliance statement because the parties cannot agree upon correction or a change in administrative procedures, the Plan Sponsor (generally through the Plan Sponsor’s representative) will be contacted by the IRS representative and offered a conference with the IRS. The conference can be held either in person or by telephone and must be held within 21 calendar days of the date of contact. The Plan Sponsor will have 21 calendar days after the date of the conference to submit additional information in support of the submission. Any request for an extension of the 21-day time period must be made in writing within the 21-day time period and must be approved by the IRS (by the applicable group manager). Additional conferences may be held at the discretion of the IRS.

(7) Failure to reach resolution. If the IRS and the Plan Sponsor cannot reach agreement with respect to the submission, the matter will be closed, the user fee will not be returned, and the case may be referred to Employee Plans Examinations.

(8) Issuance of compliance statement. (a) In general. If agreement has been reached and all applicable user fees have been paid, the IRS will send to the Plan Sponsor a compliance statement signed by the IRS specifying the corrective action required. However, the IRS reserves the right to require the Plan Sponsor to sign the compliance statement. In such a case, the IRS will send to the Plan Sponsor an unsigned compliance statement. Within 30 calendar days of the date the compliance statement is sent, the Plan Sponsor must sign and return the compliance statement along with any outstanding user fee that may be required. The IRS will then issue a signed copy of the compliance statement to the Plan Sponsor. If the Plan Sponsor does not return the compliance statement (along with any outstanding user fee) within 30 calendar days, the VCP submission will be closed, and no further action will be taken with respect to the submission. In appropriate circumstances, the plan may be referred to Employee Plans Examinations.

(b) Model VCP Compliance Statement. If the Plan Sponsor included Form 14568 with its VCP submission, then the IRS will sign and send to the Plan Sponsor the compliance statement specifying the corrective action required. The format and content of the Form 14568 may not be modified or changed in any way. The IRS reserves the right to issue an individually drafted compliance statement in appropriate circumstances.

(c) Modifications to VCP Submission. If a Plan Sponsor materially modifies a VCP submission that was previously filed with the IRS, then, unless the Plan Sponsor has submitted a penalty of perjury statement (see section 11.08(1)) with respect to such subsequent modifications, the Plan Sponsor will be required to sign and return the compliance statement under the general procedures described in section 10.06(8)(a).

(9) Timing of correction. (a) In general. The Plan Sponsor must implement the specific corrections and administrative changes set forth in the compliance statement within 150 days of the date of the compliance statement. Any request for an extension of this time period must be made prior to the expiration of the correction period in writing and must be approved by the IRS.

(b) Interim Amendments and Nonamender Failures. Correction of the failure to timely adopt Interim Amendments or other required amendments, as described in section 5.01(2)(a)(ii)(B) and (C), must be made by the date of the submission. Thus, the submission must include the executed amendments that would correct this failure.

(c) Other plan amendments. If a corrective plan amendment is required as part of a VCP submission, the corrective plan amendment must be adopted no later than 150 days after the date of the compliance statement. However, for a governmental plan (within the meaning of § 414(d)), the corrective amendment must be adopted by the later of 150 days after the date of the compliance statement or the close of the first regular legislative session of the legislative body with the authority to amend the plan that begins on or after 91 days after the date of the compliance statement.

(10) Modification of compliance statement. Once the compliance statement has been issued (based on the information provided), the Plan Sponsor cannot request a modification of the compliance terms except by a new request for a compliance statement, accompanied by an additional user fee. However, if the requested modification is minor and is postmarked within the correction period provided for in the compliance statement, a reduced user fee will apply. For more information, see the annual EP revenue procedure that sets forth the user fees for VCP submissions. The request should be sent to the VCP mailing address provided for in section 11.12. The request should include a letter explaining the modification, a copy of the original compliance statement and related VCP submission, any other correspondence relating to the issuance of the original compliance statement, and a check for the user fee payable to the United States Treasury, along with completed Forms 8950 and 8951.

(11) Verification. Once the compliance statement has been issued, the IRS may require verification that the plan has complied with the correction methods and that any plan administrative procedures required by the compliance statement have been implemented. This verification does not constitute an examination of the books and records of the employer or the plan (within the meaning of § 7605(b)). If the IRS determines that the Plan Sponsor did not implement the corrections and procedures within the stated time period, the plan may be referred to Employee Plans Examinations.

.07 Compliance statement. (1) General description of compliance statement. The compliance statement issued for a VCP submission only addresses the failures identified in the submission, the terms of correction (including any revision of administrative procedures), and the time period within which proposed corrections must be implemented (including any changes in administrative procedures). The compliance statement also provides that the IRS will not treat the plan as failing to satisfy the applicable requirements of the Code on account of the failures described in the compliance statement if the conditions of the compliance statement are satisfied. The reliance provided by a compliance statement is limited to the specific failures and years specified and does not provide reliance for any other failure or year.

(2) Correction through plan amendment. (a) Interim Amendment Failures. With respect to a failure to amend a plan timely for Interim Amendments, as described in section 5.01(2)(a)(ii)(B) of this revenue procedure, the issuance of a compliance statement will result in the corrective amendments being treated as if they had been adopted timely for the purpose of determining the availability of the remedial amendment period in Rev. Proc. 2007–44 and Rev. Proc. 2016–37. However, the issuance of such a compliance statement does not constitute a determination as to whether the Interim Amendment, as drafted, complies with the change in qualification requirement. The compliance statement does not constitute a determination that the terms of the plan, including the corrective plan amendment, satisfy the qualification requirements in form.

(b) Nonamender Failures. With respect to a failure to amend a plan timely for disqualifying provisions or a failure to timely adopt applicable required amendments provided on the Required Amendments List, as described in section 5.01(2)(a)(ii)(C)(the definition of Nonamender Failure), the issuance of a compliance statement will result in the corrective amendments being treated as if they had been timely adopted during the applicable remedial amendment period. However, the issuance of such a compliance statement does not constitute a determination as to whether the corrective plan amendment as drafted complies with the change in qualification requirement. The compliance statement does not constitute a determination as to whether the corrective plan amendment conforms the terms of the plan to the plan’s prior operations or whether the terms of the plan, including the corrective plan amendment, satisfy the qualification requirements in form.

(c) Operational Failures. If a Plan Sponsor submits a VCP filing correcting an Operational Failure through a plan amendment and the plan amendment is accepted as a proper correction of the Operational Failure, then the compliance statement issued under VCP constitutes a determination that the Operational Failure has been corrected, but is not a determination that the terms of the plan, including the corrective plan amendment, satisfy the qualification requirements in form.

(d) Failure to adopt 403(b) Plan timely. A failure to adopt a 403(b) Plan in accordance with the final regulations under § 403(b) and Notice 2009–3 may be corrected under VCP. The issuance of a compliance statement will result in the 403(b) Plan being treated as if it had been adopted timely for the purpose of making available the extended remedial amendment period set forth in Announcement 2009–89 and Rev. Proc. 2013–22. However, the issuance of a compliance statement does not constitute a determination as to whether the written plan, as drafted, complies with the applicable requirements of § 403(b) and the final § 403(b) regulations.

(3) Administrative procedures required. Where current procedures are inadequate for operating the plan in conformance with the applicable requirements of the Code, the compliance statement will be conditioned upon the implementation of stated administrative procedures. The IRS may prescribe appropriate administrative procedures in the compliance statement.

(4) Compliance statement conditioned upon timely correction. The compliance statement is conditioned on (i) there being no misstatement or omission of material facts in connection with the submission and (ii) the implementation of the specific corrections and satisfaction of any other conditions in the compliance statement.

(5) Authority delegated. Compliance statements (including relief from any excise tax or other penalty as provided under section 6.09) are authorized to be signed by managers within Employee Plans Rulings and Agreements, under the Tax Exempt and Government Entities Operating Division of the IRS.

.08 Effect of compliance statement on examination. The compliance statement is binding upon both the IRS and the Plan Sponsor or Eligible Organization (as defined in section 10.10(1)) with respect to the specific tax matters identified therein for the periods specified, but does not preclude or impede an examination of the plan by the IRS relating to matters outside the compliance statement, even with respect to the same taxable year or years to which the compliance statement relates.

.09 Special rules relating to Anonymous Submissions. (1) The Anonymous Submission procedure in this section 10.09 permits submission of a Qualified Plan, 403(b) Plan, SEP, and SIMPLE IRA Plan under VCP without initially identifying the applicable plan, the Plan Sponsor, or the Eligible Organization. The requirements of this revenue procedure relating to VCP, including sections 10, 11, and 12, apply to these submissions. Information identifying the plan or the Plan Sponsor may be redacted (and the power of attorney statement and the penalty of perjury statement need not be included with the initial submission). For purposes of processing the submission, the State of the Plan Sponsor must be identified in the initial submission. All Anonymous Submissions must be numbered or labeled on the first page of the VCP submission by the Plan Sponsor or its representative to facilitate identification and tracking of the submission. The identification number must be unique to the submission and should not be used with respect to any other Anonymous Submission of the Plan Sponsor or representative. If the submission is made by an individual who represents the Plan Sponsor, such individual must satisfy the power of attorney requirements described in section 11.07. As part of the submission, the representative must, under penalty of perjury, assert that the representative complies with the power of attorney requirements described in section 11.07 and that the representative will submit an executed copy of a Form 2848, Power of Attorney and Declaration of Representation, upon the disclosure of the identity of the Plan Sponsor to the IRS. Once the IRS and the plan representative reach agreement with respect to the submission, the IRS will contact the plan representative in writing indicating the terms of the agreement. The Plan Sponsor will have 21 calendar days from the date of the letter of agreement to identify the plan and Plan Sponsor. If the Plan Sponsor does not submit the identifying material (including the power of attorney statement and the penalty of perjury statement) within 21 calendar days from the date of the letter of agreement, the matter will be closed and the user fee will not be returned.

(2) Notwithstanding section 10.04, until each plan and Plan Sponsor is identified to the IRS, a submission under this subsection does not preclude or impede an examination of the Plan Sponsor or its plan. Thus, a plan submitted under the Anonymous Submission procedure that comes Under Examination prior to the date the identifying materials of each plan and Plan Sponsor are received by the IRS will no longer be eligible under VCP.

.10 Special rules relating to Group Submissions. (1) Eligible Organizations. For purposes of a Group Submission, the term “Eligible Organization” means either (a) a sponsor (as that term is defined in section 4.07 of Rev. Proc. 2015–36, 2015–27 I.R.B. 20) of a master or prototype plan, (b) a volume submitter practitioner, as that term is defined in section 13.05 of Rev. Proc. 2015–36, (c) an insurance company or other entity that has issued annuity contracts or provides services with respect to assets for 403(b) Plans, or (d) an entity that provides its clients with administrative services with respect to Qualified Plans, 403(b) Plans, SEPs, or SIMPLE IRA Plans. An Eligible Organization is not eligible to make a Group Submission unless the failures in the submission result from a systemic error involving the Eligible Organization that affects at least 20 plans and results in at least 20 plans implementing correction. If, at any time before the IRS issues the compliance statement, the number of plans falls below 20, the Eligible Organization must notify the IRS that it is no longer eligible to make a Group Submission. Under these circumstances the user fee may be retained by the IRS.

(2) General rules. An Eligible Organization may submit a VCP request for a Qualified Plan, a 403(b) Plan, a SEP, or a SIMPLE IRA Plan under a Group Submission for Plan Document, Operational, and Employer Eligibility Failures. If a sponsor of a master or prototype plan submits failures with respect to more than one master or prototype plan, each plan will be treated as a separate submission and a separate user fee must be submitted for each master or prototype plan. Similarly, if a volume submitter practitioner submits failures with respect to more than one volume submitter specimen plan, each plan will be treated as a separate submission and a separate user fee must be submitted for each specimen plan. For this purpose, in the case of either the master or prototype plan or volume submitter specimen plan, the number of plans is determined with reference to the number of basic plan documents, not adoption agreements.

(3) Special Group Submission procedures. (a) In general, a Group Submission is subject to the same procedures as any VCP submission in accordance with sections 10 and 11, except that the Eligible Organization is responsible for performing the procedural obligations imposed on the Plan Sponsor under sections 10 and 11. See section 11.03(12) for a special submission requirement with respect to Group Submissions.

(b) The Eligible Organization must provide notice to all Plan Sponsors of the plans included in the Group Submission. The notice must be provided at least 90 days before the Eligible Organization provides the IRS with the information required in section 10.10(3)(c). The purpose of the notice is to provide each Plan Sponsor with information relating to the Group Submission request. The notice should explain the reason for the Group Submission and inform the Plan Sponsor that the Plan Sponsor’s plan will be included in the Group Submission unless the Plan Sponsor responds within the 90-day period requesting that the Plan Sponsor’s plan be excluded from the Group Submission.

(c) When an Eligible Organization receives an unsigned compliance statement on the proposed correction and agrees to the terms of the compliance statement, the Eligible Organization must return to the IRS within 120 calendar days not only the signed compliance statement and any additional user fee required under the annual revenue procedure that sets forth user fees, including VCP user fees, but also a list containing (i) the employer tax identification numbers for the Plan Sponsors of the plans to which the compliance statement may be applicable, (ii) the plans by name, plan number, type of plan, and number of plan participants, (iii) a certification that each Plan Sponsor received notice of the Group Submission, and (iv) a certification that each Plan Sponsor timely filed the Form 5500 series return for the most recent plan year for which the Form 5500 series return was required to have been filed. This list can be submitted at any stage of the submission process provided that the requirements of section 10.10(3)(b) have been satisfied. Applicants are encouraged to submit the list on a computer disk in Microsoft Word. Only those plans for which correction is actually made within 240 calendar days of the date of the signed compliance statement (or within such longer period as may be agreed to by the IRS at the request of the Eligible Organization) will be covered by the compliance statement.

(d) Notwithstanding section 4.02, if a Plan Sponsor of a plan that is eligible to be included in the Group Submission and has not requested to be excluded from the Group Submission pursuant to section 10.10(3)(b) is notified of an impending Employee Plans examination after the Eligible Organization filed the Group Submission with the IRS, the Plan Sponsor’s plan will be included in the Group Submission. However, with respect to such plan, the Group Submission will not preclude or impede an examination of the plan with respect to any failures not identified in the Group Submission at the time the plan comes Under Examination.

.11 Multiemployer and multiple employer plans. (1) In the case of a multiemployer or multiple employer plan, the plan administrator (rather than any contributing or adopting employer) must request consideration of the plan under VCP. The request must be with respect to the plan, rather than a portion of the plan affecting any particular employer.

(2) If a VCP submission for a multiemployer or multiple employer plan has failures that apply to fewer than all of the employers under the plan, the plan administrator may choose to have the user fee (described in the annual revenue procedure that sets forth user fees, including VCP user fees) or the sanction (described in section 14) calculated separately for each employer based on the participants attributable to that employer, rather than having the user fee calculated based on the participants of the entire plan. For example, the plan administrator may choose to apply the provisions of this paragraph when the failure is attributable in whole or in part to data, information, actions, or inactions that are within the control of the employers rather than the multiemployer or multiple employer plan (such as a failure attributable in whole or in part to the failure of an employer to provide the plan administrator with full and complete information).

SECTION 11. SUBMISSION PROCEDURES FOR VCP

.01 General rules. (1) A VCP submission must satisfy the requirements of this section 11.

(2) A VCP submission must include completed Forms 8950 and 8951.

(3) A VCP submission must include a description of the failures, a description of the proposed methods of correction, and other procedural items set forth in this section 11.

.02 Use of model forms. (1) Schedules 1 through 9 (Forms 14568–A through 14568–I) provide descriptions of common qualification failures and standardized correction methods that may be submitted in lieu of individually drafted descriptions. For applicants that do not choose to use the Form 14568, the schedules can be used to satisfy certain requirements of this revenue procedure.

(2) Multiple schedules may be included in a single VCP submission.

(3) A schedule may be used only if its printed content applies without modification to the applicant’s situation.

(4) Applicants may use the current versions of Form 14568 and Forms 14568–A through 14568–I, which are available on the IRS website (https://www.irs.gov/retirement-plans/correcting-plan-errors-fill-in-vcp-submission-documents). The IRS reserves the right to modify the Form 14568 series to improve usability, reflect changes in law, or create additional schedules by adding new forms to the Form 14568 series.

.03 Submission requirements. A VCP submission must include the following information:

(1) Identification of failures. A complete description of the failures, the years in which the failures occurred, including closed years (that is, years for which the statutory period has expired), and the number of employees affected by each failure.

(2) Explanation. An explanation of how and why the failures arose, including a description of the administrative procedures applicable to the failures in effect at the time the failures occurred.

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(3) Proposed method of correction. A detailed description of the method for correcting the failures that the Plan Sponsor has implemented or proposes to implement. Each step of the correction method must be described in narrative form. The description must include the specific information needed to support the proposed correction method. This information includes, for example, the number of employees affected and the expected cost of correction (both of which may be approximated if the exact number cannot be determined at the time of the request), the years involved, and calculations or assumptions the Plan Sponsor used to determine the amounts needed for correction.

(4) Earnings or actuarial adjustments. A description of the methodology that will be used to calculate Earnings or actuarial adjustments on any corrective contributions or distributions (indicating the computation periods and the basis for determining Earnings or actuarial adjustments, in accordance with section 6.02(4)).

(5) Computations. Specific calculations for each affected employee or a representative sample of affected employees. The sample calculations must be sufficient to demonstrate each aspect of the correction method proposed. For example, if a Plan Sponsor requests a compliance statement with respect to a failure to satisfy the contribution limits of § 415(c) and proposes a correction method that involves elective deferrals (whether matched or unmatched) and matching contributions, the Plan Sponsor must submit calculations illustrating the correction method proposed with respect to each type of contribution. As another example, with respect to a failure to satisfy the ADP test in § 401(k)(3), the Plan Sponsor must submit the ADP test results both before the correction and after the correction.

(6) Former employees or beneficiaries. The method(s) that will be used to locate and notify former employees and beneficiaries, or an affirmative statement that no former employees or beneficiaries were affected by the failures or will be affected by the correction.

(7) Change in administrative procedures. A description of the measures that have been or will be implemented to ensure that the same failures will not recur.

(8) Request for excise tax relief (§ 4972, 4973, 4974, or 4979) or additional tax relief under § 72(t). If excise tax or additional tax relief is sought, a specific request for relief should be included in the submission, along with explanations, where applicable, supporting such request.

(9) Loan failures and income tax reporting relief. A specific request for relief needs to be made if the applicant either wants relief from reporting a corrected participant loan as a deemed distribution or wants to report the loan as a deemed distribution in the year of correction instead of the year in which the deemed distribution occurred.

(10) Transferred Assets. If a submission includes a failure that relates to Transferred Assets and the failure occurred prior to the transfer, a description of the transaction (including the dates of the employer change and the plan transfer).

(11) 403(b) Plans. In the case of a 403(b) Plan submission, a statement that the Plan Sponsor has contacted all other entities involved with the plan and has been assured of cooperation in implementing the applicable correction, to the extent necessary. For example, if the plan’s failure is the failure to satisfy the requirements of § 403(b)(1)(E) regarding elective deferrals, the Plan Sponsor must, prior to making the VCP submission, contact the insurance company or custodian with control over the plan’s assets to assure cooperation in effecting a distribution of the excess deferrals adjusted for Earnings thereon. A submission under VCP must also contain a statement as to the type of employer (for example, a tax-exempt organization described in § 501(c)(3)) that is making the VCP submission.

(12) Group Submissions. A Group Submission must be signed by the Eligible Organization or the Eligible Organization’s authorized representative and accompanied by a copy of the relevant portions of the plan document(s).

(13) Orphan Plans. If the plan is an Orphan Plan, the applicant should indicate whether relief from correction or from the user fee is being requested and the support for such relief. See sections 4.08 and 6.02(5)(f).

.04 Required documents. A VCP submission must be accompanied by the following documents:

(1) Forms 8950 and 8951. Forms 8950 and 8951 must be included with a VCP submission.

(2) Plan document. A copy of the entire plan document or the relevant portions of the plan document. For example, in a case involving an improper exclusion of eligible employees from a profit-sharing plan with a cash or deferred arrangement, relevant portions of the plan document include the eligibility, allocation, and cash or deferred arrangement provisions of the basic plan document (and the adoption agreement, if applicable), along with applicable definitions in the plan. In the case of a SEP and a SIMPLE IRA Plan, the entire plan document should be submitted.

.05 Date user fee due generally. Except as provided in sections 4.08 and 11.06, the user fee described under the annual revenue procedure that sets forth user fees (including VCP user fees), must be included with the submission. The user fee must be paid by check made payable to the United States Treasury. Include a photocopy of the check with the submission. If the appropriate user fee is not included in the submission, the submission may be returned.

.06 Additional amount due for SEPs, SIMPLE IRA Plans, and Group Submissions. In the case of a SEP, a SIMPLE IRA Plan, or a Group Submission, the initial user fee (described in the annual revenue procedure that sets forth user fees, including VCP user fees) must be included in the submission and any additional amount is due at the time the compliance statement is signed by the Plan Sponsor and returned to the IRS, or when agreement has been reached between the IRS and the Plan Sponsor regarding correction of the failure(s).

.07 Power of attorney requirements. To appear before the IRS in connection with the submission, the Plan Sponsor’s representative must comply with the requirements of section 9.02(11) and (12) of Rev. Proc. 2016–4, 2016–1 I.R.B. 142, as updated annually, and submit Form 2848. A Form 2848 that designates a representative not qualified to sign Part II of the Form 2848, for example, an unenrolled return preparer, will not be accepted. However, a Plan Sponsor may authorize an individual, such as an unenrolled return preparer, to inspect or receive confidential information using Form 8821, Tax Information Authorization. (See Form 8821 and Instructions) See section 10.09 for special rules relating to Anonymous Submissions.

.08 Penalty of perjury statement. (1) The Plan Sponsor must sign the penalty of perjury statement on the Form 8950 as part of a VCP submission. In addition, the following declaration must accompany any new factual information or change in the VCP submission made at a later time: “Under penalties of perjury, I declare that I have examined this submission, including accompanying documents, and, to the best of my knowledge and belief, the facts presented in support of this submission are true, correct, and complete.” The declaration must be signed by the Plan Sponsor, not the Plan Sponsor’s representative.

(2) If the VCP submission is an Anonymous Submission made pursuant to section 10.09, and the submission is made by an individual authorized to represent the Plan Sponsor, the individual must submit the following statement: “Under penalties of perjury, I declare that I am an authorized representative of the Plan Sponsor who complies with the Power of Attorney requirements described in section 11.07 of Revenue Procedure 2016–51. I will submit an executed Form 2848 upon the disclosure of the identity of the Plan Sponsor to the IRS.”

.09 Procedural Requirements Checklist. The IRS will be able to respond more quickly to a VCP submission if the submission is carefully prepared and complete. The checklist provided on Form 8950 and the instructions to Forms 8950 and 8951 are designed to assist Plan Sponsors and their representatives in preparing the information and documents required under this revenue procedure.

.10 Orphan Plan. The VCP submission should indicate, if applicable, that it concerns an Orphan Plan and should include information that establishes that the applicant is an Eligible Party, as defined in section 5.03(2).

.11 Acknowledgement letter. The IRS will acknowledge receipt of a VCP submission (or non-VCP submission for a § 457(b) plan, as permitted by section 4.09) only if the Plan Sponsor or the Plan Sponsor’s representative completes IRS Letter 5265 and includes it in the submission. A separate Letter 5265 should be included for each plan submitted.

.12 VCP mailing addresses. Use the following addresses for VCP submissions:

First class mail:

  • Internal Revenue Service

  • P.O. Box 12192

  • Covington, KY 41012-0192

Express mail or private delivery service:

  • Internal Revenue Service

  • 201 West Rivercenter Blvd.

  • Attn: Extracting Stop 312

  • Covington, KY 41011

.13 Maintenance of copies of submissions. Plan Sponsors and their representatives should maintain copies of all correspondence submitted to the IRS with respect to their VCP submissions.

.14 Assembling the submission. (1) The documents comprising a VCP submission must be mailed to the IRS in a single package.

(2) The IRS will be able to process a VCP submission more quickly if it is assembled in the following order:

  • 1. Form 8951, with the check for the user fee attached to the front of the form. Include a photocopy of the check.

  • 2. Signed Form 8950.

  • 3. Power of Attorney (Form 2848) or Tax Information Authorization (Form 8821) attached to Form 8950.

  • 4. The following narrative information:

    • Description of the failures (if the failures relate to Transferred Assets, include a description of the related employer transaction).

    • An explanation of how and why the failures occurred.

    • Description of the method for correcting failures, including Earnings methodology (if applicable) and supporting computations (if applicable).

    • Description of the method(s) used to locate or notify former employees or beneficiaries affected by the failures or corrections. If no former employees or beneficiaries are affected by the failures or corrections, then affirmatively state that position when addressing this issue.

    • Description of the administrative procedures that have been or will be implemented to ensure that the failures do not recur.

    • Whether a request is being made in order for participant loans corrected under this revenue procedure to not be treated as deemed distributions under § 72(p) and the supporting rationale for such request. Alternatively, whether a request is being made for participant loans corrected under this revenue procedure to be treated as deemed distributions under § 72(p) in the year of correction.

    • Whether relief is being requested from imposition of the excise taxes under § 4972, 4973, 4974, or 4979, or the 10% additional income tax under § 72(t), and the supporting rationale for such relief.

    • If the plan is an Orphan Plan, whether relief from the user fee is being requested on Form 8951, and the supporting rationale for such relief.

  • 5. If the VCP submission includes either Form 14568 or any schedule (Forms 14568–A through 14568–I) include any required information and enclosures, and any related schedules.

  • 6. Letter 5265.

  • 7. Copy of opinion, advisory or determination letter (if applicable).

  • 8. Relevant plan document language or plan document (if applicable).

  • 9. Any other items that may be relevant to the VCP submission.

SECTION 12. VCP USER FEES

.01 User fees. (1) In general. The general user fees for all submissions under VCP are determined under section 6.08 of Rev. Proc. 2016–8. All user fees must be paid upon filing the VCP submission (except as provided in sections 4.08 and 11.06).

(2) User fees to be published in annual revenue procedure. Beginning in 2017 and each year thereafter, the user fees for VCP submissions will be published as part of an annual revenue procedure that sets forth user fees, including VCP user fees. Plan Sponsors should refer to the annual revenue procedure in effect at the time they file their submission with the IRS to determine the VCP user fee.

PART VI. CORRECTION ON AUDIT (AUDIT CAP)

SECTION 13. DESCRIPTION OF AUDIT CAP

.01 Audit CAP requirements. If the IRS identifies a Qualification or 403(b) Failure (other than a failure that has been corrected in accordance with SCP or VCP) upon an Employee Plans or Exempt Organizations examination of a Qualified Plan, 403(b) Plan, SEP, or SIMPLE IRA Plan, the requirements of this section 13 are satisfied with respect to the failure if the Plan Sponsor corrects the failure, pays a sanction in accordance with section 14, satisfies any additional requirements of section 13.03, and enters into a closing agreement with the IRS. This section 13 also applies if the IRS identifies a participant loan that did not comply with the requirements of § 72(p)(2) (other than a loan failure that is corrected in accordance with SCP or VCP) upon an Employee Plans or Exempt Organizations examination of a Qualified Plan or 403(b) Plan.

.02 Payment of sanction. Payment of the sanction under section 14 generally is required at the time the closing agreement is signed. All sanction amounts should be submitted by certified check or cashier’s check made payable to the United States Treasury. However, at the Plan Sponsor’s option, the sanction may be paid by credit or debit card or directly from a checking or savings account through www.pay.gov.

.03 Additional requirements. Depending on the nature of the failure, the IRS will discuss the appropriateness of the plan’s existing administrative procedures with the Plan Sponsor. If existing administrative procedures are inadequate for operating the plan in conformance with the applicable requirements of the Code, the closing agreement may be conditioned upon the implementation of stated procedures.

.04 Failure to reach resolution. If the IRS and the Plan Sponsor cannot reach an agreement with respect to the correction of the failure(s) or the amount of the sanction then the plan will be disqualified, the plan or contract will be treated as if it did not comply with § 403(b), the SEP will be treated as if it did not comply with § 408(k), or the SIMPLE IRA Plan will be treated as if it did not comply with § 408(p), as applicable.

.05 Effect of closing agreement. A closing agreement constitutes an agreement between the IRS and the Plan Sponsor that is binding with respect to the tax matters identified in the agreement for the periods specified.

.06 Other procedural rules. The procedural rules for Audit CAP are set forth in Internal Revenue Manual (“IRM”) 7.2.2. EPCRS.

SECTION 14. AUDIT CAP SANCTION

.01 Determination of sanction. The sanction under Audit CAP is a negotiated amount that is determined based on the facts and circumstances, including the relevant factors described in section 14.02. Sanctions will not be excessive and will bear a reasonable relationship to the nature, extent, and severity of the failures, based on the factors below. The sanction generally will not be less than the VCP user fee applicable to the plan. See section 14.04 for special rules relating to the sanction for Nonamender Failures discovered during the determination letter application process.

.02 Factors considered. Factors include:

(1) For all plans (as appropriate):

(a) the steps taken by the Plan Sponsor to ensure that the plan had no failures;

(b) the steps taken by the Plan Sponsor to identify failures that may have occurred;

(c) the extent to which correction had progressed before the examination was initiated, including full correction;

(d) the number and type of employees affected by the failure;

(e) the number of nonhighly compensated employees who would be adversely affected if the plan were not treated as qualified or as satisfying the requirements of § 403(b), 408(k), or 408(p);

(f) whether the failure is a failure to satisfy the requirements of § 401(a)(4), 401(a)(26), or 410(b), either directly or through § 403(b)(12);

(g) whether the failure is solely an Employer Eligibility Failure;

(h) the period over which the failure occurred (for example, the time that has elapsed since the end of the applicable remedial amendment period under § 401(b) for a Plan Document Failure);

(i) the reason for the failure (for example, data errors such as errors in transcription of data, the transposition of numbers, or minor arithmetic errors), and

(j) the Maximum Payment Amount.

(2) Additional factors for Nonamender Failures in Qualified Plans. The factors considered for Nonamender Failures in Qualified Plans also include:

(a) whether the plan is the subject of a Favorable Letter;

(b) the internal controls implemented by the Plan Sponsor to ensure the timely adoption of required amendments;

(c) the extent to which the Plan Sponsor had adopted a timely plan amendment which later is found not to satisfy the qualification requirements of the Code;

(d) the extent to which the Plan Sponsor had otherwise adopted applicable amendments identified on the Required Amendments List described in § 9 of Rev. Proc. 2016–37 and published annually in the Internal Revenue Bulletin; and

(e) the extent to which the Plan Sponsor had reasonably determined that a provision on the Required Amendments List described in § 9 of Rev. Proc. 2016–37 was not applicable to the Plan Sponsor’s plan.

(3) Participant loan failure. An additional factor taken into account with respect to a participant loan that did not comply with the requirements of § 72(p)(2) is the extent to which the failure is a result solely of action (or inaction) of the employer or its agents (or the extent to which the failure is a result of the employee’s or beneficiary’s actions or inaction).

.03 Transferred Assets. If the examination involves a plan with Transferred Assets and the IRS determines that no new incidents of the failures that relate to the Transferred Assets occurred after the end of the second plan year that begins after the corporate merger, acquisition, or other similar employer transaction, the sanction under Audit CAP will not exceed the sanction that would apply if the Transferred Assets were maintained as a separate plan.

.04 Sanction for Nonamender Failures discovered during the determination letter application process. (1) Except as provided in section 14.04(2) and (3), if the only failure identified by the IRS during the determination letter application process is a Nonamender Failure that was not voluntarily identified by the Plan Sponsor:

(a) The sanction for an individually designed plan is determined as follows:

(i) 150% of the applicable VCP user fee described in § 6.08 of Rev. Proc. 2016–8 (or subsequent guidance that sets forth VCP user fees) if the Nonamender Failure arose in connection with an amendment that was required to be adopted after the end of the plan’s last remedial amendment cycle to which Rev. Proc. 2007–44 applied, and

(ii) 250% of the applicable VCP user fee described in § 6.08 of Rev. Proc. 2016–8 (or subsequent guidance that sets forth VCP user fees) if the Nonamender Failure arose in connection with an amendment that was required to be adopted at any time before the end of the plan’s last remedial amendment cycle to which Rev. Proc. 2007–44 applied.

(b) The sanction for a pre-approved plan is determined as follows:

(i) 150% of the applicable VCP user fee described in § 6.08 of Rev. Proc. 2016–8 (or subsequent guidance that sets forth VCP user fees) if the Nonamender Failure arose in connection with an amendment that was required to be adopted after the end of the plan’s second six-year remedial amendment cycle, and

(ii) 250% of the applicable VCP user fee described in § 6.08 of Rev. Proc. 2016–8 (or subsequent guidance that sets forth VCP user fees) if the Nonamender Failure arose in connection with an amendment that was required to be adopted at any time before the end of the plan’s second six-year remedial amendment cycle

(2) The sanction prescribed in section 14.04(1) may be reduced or increased in the following circumstances:

(a) If a plan amendment was timely adopted in order to maintain the plan’s qualified status but is found not to satisfy the qualification requirements of the Code, the applicable sanction described in section 14.04(1) may be reduced based on the facts and circumstances, including the factors described in section 14.02(2)(a), (b) and (c). However, the sanction generally will not be less than the VCP user fee applicable to the plan.

(b) If a Nonamender Failure is egregious, the sanction will be determined under section 14.01. Whether a Nonamender Failure is egregious will be determined based on the facts and circumstances, including:

(i) the number of plan amendments that were not timely adopted;

(ii) the number of years that had elapsed from the end of the remedial amendment period until amendments were adopted (if at all); and

(iii) the extent to which the plan lacked internal controls to facilitate the timely adoption of amendments.

(3) If the sole failure consists of a failure to timely adopt an amendment (upon which a favorable determination letter was conditioned) within the applicable remedial amendment period, the sanction is $750 regardless of the number of plan participants, provided the required amendment is adopted within three months of the expiration of the remedial amendment period for adopting the amendment.

PART VII. EFFECT ON OTHER DOCUMENTS; EFFECTIVE DATE; PAPERWORK REDUCTION ACT

SECTION 15. EFFECT ON OTHER DOCUMENTS

Rev. Proc. 2013–12, Rev. Proc. 2015–27, and Rev. Proc. 2015–28 are modified and superseded by this revenue procedure.

SECTION 16. EFFECTIVE DATE

This revenue procedure is effective January 1, 2017.

SECTION 17. PUBLIC COMMENTS

The Treasury Department and the IRS invite comments on this revenue procedure. Send submissions to CC:PA:LPD:PR, (Rev. Proc. 2016–51), Room 5203, Internal Revenue Service, PO Box 7604, Ben Franklin Station, Washington, D.C. 20044. Comments may also be hand delivered Monday through Friday between the hours of 8 a.m. and 4:00 p.m. to: Internal Revenue Service, CC:PA:LPD:PR, (Rev. Proc. 2016–51), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, N.W., Washington DC. Alternatively, comments may be submitted via the Internet at notice.comments@irscounsel.treas.gov (Rev. Proc. 2016–51). All comments will be available for public inspection.

SECTION 18. PAPERWORK REDUCTION ACT

The collection of information contained in this revenue procedure has been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under control number 1545-1673.

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless the collection of information displays a valid OMB control number.

The collection of information in this revenue procedure is in sections 4.05, 6.02(5)(d), 6.09(5), 6.09(6), 10.01, 10.02, 10.05–.07, 10.09–10.11, 11.01–11.05, 11.07–11.14, 13.01, sections .05(8)(c) and .05(9)(c) of Appendix A, and sections 2.01–2.07 of Appendix B. This information is required to enable the Commissioner, Tax Exempt and Government Entities Division of the IRS to consider the issuance of various types of closing agreements and compliance statements. This information will be used to issue closing agreements and compliance statements to allow individual plans to continue to maintain their tax favored status. As a result, favorable tax treatment of the benefits of the eligible employees is retained. The likely respondents are individuals, state or local governments, businesses or other for-profit institutions, nonprofit institutions, and small businesses or organizations.

The estimated total annual reporting or recordkeeping burden is 91,791 hours.

The estimated annual burden per respondent/recordkeeper varies from .5 to 45.5 hours, depending on individual circumstances, with an estimated average of 25.28 hours. The estimated number of respondents or recordkeepers is 5,375.

The estimated frequency of responses is occasional.

Books or records relating to a collection of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally tax returns and tax return information are confidential, as required by 26 U.S.C. § 6103.

DRAFTING INFORMATION

The principal authors of this revenue procedure are Kathleen Herrmann and Pamela R. Kinard of the Office of the Associate Chief Counsel (Tax Exempt and Government Entities). For further information regarding this revenue procedure, please contact the Employee Plans’ taxpayer assistance telephone service at 877-829-5500 (a toll-free number) between the hours of 8:30 a.m. and 4:30 p.m. Eastern Time, Monday through Friday.

APPENDIX A

OPERATIONAL FAILURES AND CORRECTION METHODS

.01 General rule. (1) In general. This appendix sets forth Operational Failures and Correction Methods relating to Qualified Plans. In each case, the method described corrects the Operational Failure identified in the headings below. Corrective allocations and distributions should reflect Earnings and actuarial adjustments in accordance with section 6.02(4) of this revenue procedure. The correction methods in this appendix are acceptable to correct Qualification Failures under VCP, and to correct Qualification Failures under SCP that occurred notwithstanding that the plan has established practices and procedures reasonably designed to promote and facilitate overall compliance with the Code, as provided in section 4.04 of this revenue procedure. To the extent a failure listed in this appendix could occur under a 403(b) Plan, a SEP, or a SIMPLE IRA Plan, the correction method listed for such failure, such as the correction method for an Employee Elective Deferral failure in section .05(9), may similarly be used to correct the failure.

(2) Correction methods permitted in Appendix A and Appendix B are safe harbors. Correction methods permitted in Appendix A and Appendix B are deemed to be reasonable and appropriate methods of correcting a failure. Both Appendices set forth various correction methods that may be used to correct a failure, depending on the facts and circumstances. A Plan Sponsor may choose any correction method by which the plan can satisfy the eligibility requirements. For example, a § 401(k) plan that improperly excluded an employee may use the general correction method under .05(2). However, if the § 401(k) plan has an automatic contribution feature, the plan may use the correction method under .05(8), assuming the plan meets the eligibility requirements in .05(8)(a). If the § 401(k) plan doesn’t have an automatic contribution feature but corrects the failure within a specified time period, the plan may use the correction method under .05(9)(a) or (b), assuming the plan meets the eligibility requirements in .05(9)(a) or (b).

(3) Other reasonable correction methods permitted. As provided in section 6.02(2), there may be more than one reasonable and appropriate correction of a failure. Any correction method used that is not described in Appendix A or Appendix B would need to satisfy the correction principles of section 6.02. For example, the sponsor of a 403(b) Plan that failed to satisfy the universal availability requirement of § 403(b)(12)(A)(ii) might propose to determine the missed deferral for an excluded employee using a percentage based on the average deferrals for all employees in the plan instead of using the rule for calculating missed deferrals set out in .05(6)(b). In doing so, the proposed correction method would fall outside Appendix A, and the Plan Sponsor would need to satisfy the general correction principles of section 6.02 and other applicable rules in this revenue procedure.

.02 Failure to properly provide the minimum top-heavy benefit under § 416 to non-key employees. In a defined contribution plan, the permitted correction method is to properly contribute and allocate the required top-heavy minimums to the plan in the manner provided for in the plan on behalf of the non-key employees (and any other employees required to receive top-heavy allocations under the plan). In a defined benefit plan, the minimum required benefit must be accrued in the manner provided in the plan.

.03 Failure to satisfy the ADP test set forth in § 401(k)(3), the ACP test set forth in § 401(m)(2), or, for plan years beginning on or before December 31, 2001, the multiple use test of § 401(m)(9). The permitted correction method is to make QNECs (as defined in § 1.401(k)–6) on behalf of the nonhighly compensated employees to the extent necessary to raise the actual deferral percentage or actual contribution percentage of the nonhighly compensated employees to the percentage needed to pass the test or tests. For purposes of correcting a failed ADP, ACP, or multiple use test, any amounts used to fund QNECs must satisfy the definition of QNEC in § 1.401(k)–6). The contributions must be made on behalf of all eligible nonhighly compensated employees (to the extent permitted under § 415) and must be the same percentage of compensation. QNECs contributed to satisfy the ADP test need not be taken into account for determining additional contributions (for example, a matching contribution), if any. For purposes of this section .03, employees who would have received a matching contribution had they made elective deferrals must be counted as eligible employees for the ACP test, and the plan must satisfy the ACP test. Under this correction method, a plan may not be treated as two separate plans, one covering otherwise excludable employees and the other covering all other employees (as permitted in § 1.410(b)–6(b)(3)), in order to reduce the number of employees eligible to receive QNECs. Likewise, under this correction method, the plan may not be restructured into component plans in order to reduce the number of employees eligible to receive QNECs.

.04 Failure to distribute elective deferrals in excess of the § 402(g) limit (in contravention of § 401(a)(30)). The permitted correction method is to distribute the excess deferral to the employee and to report the amount as taxable in the year of deferral and in the year distributed. The inclusion of the deferral and the distribution in gross income applies whether or not any portion of the excess deferral is attributable to a designated Roth contribution (see § 402A(d)(3)). In accordance with § 1.402(g)–1(e)(1)(ii), a distribution to a highly compensated employee is included in the ADP test and a distribution to a nonhighly compensated employee is not included in the ADP test.

.05 Exclusion of an eligible employee from all contributions or accruals under the plan for one or more plan years. (1) Improperly excluded employees: employer provided contributions or benefits. For plans with employer provided contributions or benefits (which are neither elective deferrals under a qualified cash or deferred arrangement under § 401(k) nor matching or after-tax employee contributions that are subject to § 401(m)), the permitted correction method is to make a contribution to the plan on behalf of the employees excluded from a defined contribution plan or to provide benefit accruals for the employees excluded from a defined benefit plan.

(2) Improperly excluded employees: contributions subject to § 401(k) or 401(m). (a) For plans providing benefits subject to § 401(k) or 401(m), the corrective contribution for an improperly excluded employee is described in the following paragraphs of this section .05(2). (See Examples 3 through 12 of Appendix B.)

(b) If the employee was not provided the opportunity to elect and make elective deferrals (other than designated Roth contributions) to a § 401(k) plan that does not satisfy § 401(k)(3) by applying the safe harbor contribution requirements of § 401(k)(12) or 401(k)(13), the employer must make a QNEC to the plan on behalf of the employee that replaces the “missed deferral opportunity.” The missed deferral opportunity is equal to 50% of the employee’s “missed deferral.” The missed deferral is determined by multiplying the actual deferral percentage for the year of exclusion (whether or not the plan is using current or prior year testing) for the employee’s group in the plan (either highly compensated or nonhighly compensated) by the employee’s compensation for that year. The employee’s missed deferral amount is reduced further to the extent necessary to ensure that the missed deferral does not exceed applicable plan limits, including the annual deferral limit under § 402(g) for the calendar year in which the failure occurred. Under this correction method, a plan may not be treated as two separate plans, one covering otherwise excludable employees and the other covering all other employees (as permitted in § 1.410(b)–6(b)(3)) in order to reduce the applicable ADP, the corresponding missed deferral, and the required QNEC. Likewise, restructuring the plan into component plans is not permitted in order to reduce the applicable ADP, the corresponding missed deferral, and the required QNEC. The QNEC required for the employee for the missed deferral opportunity for the year of exclusion is adjusted for Earnings to the date the corrective QNEC is made on behalf of the affected employee.

(c) If the employee should have been eligible for but did not receive an allocation of employer matching contributions under a non-safe harbor plan because he or she was not given the opportunity to make elective deferrals, the employer must make a corrective employer nonelective contribution on behalf of the affected employee. The corrective employer nonelective contribution is equal to the matching contribution the employee would have received had the employee made a deferral equal to the missed deferral determined under section .05(2)(b). The corrective employer nonelective contribution must be adjusted for Earnings to the date the corrective contribution is made on behalf of the affected employee.

(d)(i) If the employee was not provided the opportunity to elect and make elective deferrals (other than designated Roth contributions) to a safe harbor § 401(k) plan that uses a rate of matching contributions to satisfy the safe harbor requirements of § 401(k)(12), then the missed deferral is deemed equal to the greater of 3% of compensation or the maximum deferral percentage for which the employer provides a matching contribution rate that is at least as favorable as 100% of the elective deferral made by the employee. If the employee was not provided the opportunity to elect and make elective deferrals (other than Roth contributions) to a safe harbor § 401(k) plan that uses nonelective contributions to satisfy the safe harbor requirements of § 401(k)(12), then the missed deferral is deemed equal to 3% of compensation. In either event, this estimate of the missed deferral replaces the estimate based on the ADP test in a traditional § 401(k) plan. The required QNEC on behalf of the excluded employee is equal to (i) 50% of the missed deferral, plus (ii) either (A) an amount equal to the contribution that would have been required as a matching contribution based on the missed deferral in the case of a safe harbor § 401(k) plan that uses a rate of matching contributions to satisfy the safe harbor requirements of § 401(k)(12) or (B) the nonelective contribution that would have been made on behalf of the employee in the case of a safe harbor § 401(k) plan that uses nonelective contributions to satisfy the safe harbor requirements of § 401(k)(12). The QNEC required to replace the employee’s missed deferral opportunity and the corresponding matching or nonelective contribution is adjusted for Earnings to the date the corrective QNEC is made on behalf of the employee.

(ii) If the employee was not provided the opportunity to make an affirmative election with respect to elective deferrals (other than designated Roth contributions) to a safe harbor § 401(k) plan that uses an automatic contribution arrangement to satisfy the safe harbor requirements of § 401(k)(13) and the failure occurs for a period that does not extend past the last day of the first plan year which begins after the date on which the first deferral would have been made (but for the failure), then the missed deferral is deemed to equal 3% of the employee’s compensation under the plan. If the failure occurs for a plan year or plan years subsequent to the period described in the prior sentence, then the missed deferral for each subsequent plan year is equal to the qualified percentage specified in the plan document to comply with § 401(k)(13)(C)(iii). The missed deferral determined in accordance with this section .05(2)(d)(ii) replaces the estimate based on the ADP test in a traditional § 401(k) plan. The required corrective employer contribution on behalf of the excluded employee is equal to (i) the missed deferral opportunity, which is an amount equal to 50% of the missed deferral, plus (ii) an amount equal to either the matching contribution that would apply under § 401(k)(13) based on the missed deferral or the nonelective contribution that would have been made on behalf of the employee under § 401(k)(13), whichever applies under the plan. The employer contribution for the missed deferral opportunity must be a QNEC. The corrective employer contribution consisting of the QNEC required to replace the employee’s missed deferral opportunity and the corresponding matching or nonelective contribution is adjusted for Earnings to the date the corrective employer contribution is made on behalf of the employee.

(iii) In the case of a failure to make the required nonelective contribution for a plan year under a safe harbor § 401(k) plan that uses the nonelective contribution under § 401(k)(12)(C) to satisfy the safe harbor requirements of § 401(k)(12) or that uses the nonelective contribution under § 401(k)(13)(D)(i)(I) to satisfy the safe harbor requirements of § 401(k)(13), the nonelective contribution (which must be a QNEC in the case of a plan that uses § 401(k)(12) to satisfy ADP) required to be made on behalf of the employee is equal to 3% of the employee’s compensation during the period of the failure. For this purpose, the period of the failure for any plan year ends at the end of the plan year or, if earlier, the later of June 18, 2009 or the date 30 days after notice was provided to employees as required under applicable Treasury Regulations (see § 1.401(k)–3(g)(ii) of the proposed regulations, at 74 FR 23134).

(e) If the employee should have been eligible to elect and make after-tax employee contributions (other than designated Roth contributions), the employer must make a QNEC to the plan on behalf of the employee that is equal to the “missed opportunity for making after-tax employee contributions.” The missed opportunity for making after-tax employee contributions is equal to 40% of the employee’s “missed after-tax contributions.” The employee’s missed after-tax contributions are equal to the actual contribution percentage (ACP) for the employee’s group (either highly compensated or nonhighly compensated) times the employee’s compensation, but with the resulting amount not to exceed applicable plan limits. If the ACP consists of both matching and after-tax employee contributions, then, in lieu of basing the employee’s missed after-tax employee contributions on the ACP for the employee’s group, the employer is permitted to determine separately the portion of the ACP that is attributable to after-tax employee contributions for the employee’s group (either highly compensated or nonhighly compensated), multiplied by the employee’s compensation for the year of exclusion. The QNEC must be adjusted for Earnings to the date the corrective QNEC is made on behalf of the affected employee.

(f) If the employee was improperly excluded from an allocation of employer matching contributions because he or she was not given the opportunity to make after-tax employee contributions (other than designated Roth contributions), the employer must make a corrective employer nonelective contribution on behalf of the affected employee. The corrective employer nonelective contribution is equal to the matching contribution the employee would have received had the employee made an after-tax employee contribution equal to the missed after-tax employee contribution determined under section .05(2)(e). The corrective employer nonelective contribution must be adjusted for Earnings to the date the corrective contribution is made on behalf of the affected employee.

(g) The methods for correcting the failures described in this section .05(2) do not apply until after the correction of other qualification failures. Thus, for example, if, in addition to the failure of excluding an eligible employee, the plan also failed the ADP or ACP test, the correction methods described in section .05(2)(b) through (f) cannot be used until after correction of the ADP or ACP test failures. For purposes of this section .05(2), in order to determine whether the plan passed the ADP or ACP test, the plan may rely on a test performed with respect to those eligible employees who were provided with the opportunity to make elective deferrals or after-tax employee contributions and receive an allocation of employer matching contributions, in accordance with the terms of the plan, and may disregard the employees who were improperly excluded.

(3) Improperly excluded employees: designated Roth contributions. For employees who were improperly excluded from plans that (i) are subject to § 401(k) (as described in section .05(2)) and (ii) provide for the optional treatment of elective deferrals as designated Roth contributions, the correction is the same as described under section .05(2). Thus, for example, the corrective employer contribution required to replace the missed deferral opportunity is made in accordance with the method described in section .05(2)(b) in the case of a § 401(k) plan that is not a safe harbor § 401(k) plan or .05(2)(d) in the case of a safe harbor § 401(k) plan. However, none of the corrective contributions made by the employer may be treated as designated Roth contributions (and may not be included in an employee’s gross income) and thus may not be contributed or allocated to a Roth account (as described in § 402A(b)(2)). The corrective employer contribution must be allocated to an account established for receiving a QNEC or any other employer contribution in which the employee is fully vested and subject to the withdrawal restrictions that apply to elective deferrals.

(4) Improperly excluded employees: catch-up contributions only. (a) Correction for missed catch-up contributions. If an eligible employee was not provided the opportunity to elect and make catch-up contributions to a § 401(k) plan, the employer must make a QNEC to the plan on behalf of the employee that replaces the “missed deferral opportunity” attributable to the failure to permit an eligible employee to make a catch-up contribution pursuant to § 414(v). The missed deferral opportunity for catch-up contributions is equal to 50% of the employee’s missed deferral attributable to catch-up contributions. For this purpose, the missed deferral attributable to catch-up contributions is one half of the applicable catch-up contribution limit for the year in which the employee was improperly excluded. Thus, for example if an eligible employee was improperly precluded from electing and making catch-up contributions in 2006, the missed deferral attributable to catch-up contributions is $2,500, which is one half of $5,000, the 2006 catch-up contribution limit for a § 401(k) plan. The eligible employee’s missed deferral opportunity is $1,250 (that is, 50% of the missed deferral attributable to catch-up contributions of $2,500). The QNEC required to replace the missed deferral opportunity for the year of exclusion is adjusted for Earnings to the date the corrective QNEC is made on behalf of the affected employee. For purposes of this correction, an eligible employee, pursuant to § 414(v)(5), refers to any participant who (i) would have attained age 50 by the end of the plan’s taxable year and (ii) in the absence of the plan’s catch-up provision, could not make additional elective deferrals on account of the plan or statutory limitations described in § 414(v)(3) and § 1.414(v)–1(b)(1).

(b) Correction for missed matching contributions on catch-up contributions. If an employee was precluded from making catch-up contributions under this section .05(4), the Plan Sponsor should ascertain whether the affected employee would have been entitled to an additional matching contribution on account of the missed deferral. If the employee would have been entitled to an additional matching contribution, then the employer must make a corrective employer nonelective contribution for the matching contribution on behalf of the affected employee. The corrective employer nonelective contribution is equal to the additional matching contribution the employee would have received had the employee made a deferral equal to the missed deferral determined under paragraph (a) of this section .05(4). The corrective employer nonelective contribution must be adjusted for Earnings to the date the corrective contribution is made on behalf of the affected employee. If in addition to the failure to provide matching contributions under this section .05(4)(b), the plan also failed the ACP test, the correction methods described in this section cannot be used until after correction of the ACP test failure. For purposes of this section, in order to determine whether the plan passed the ACP test the plan may rely on a test performed with respect to those eligible employees who were provided with the opportunity to make elective deferrals or after-tax employee contributions and receive an allocation of employer matching contributions, in accordance with the terms of the plan, and may disregard any employer matching contribution that was not made on account of the plan’s failure to provide an eligible employee with the opportunity to make a catch-up contribution.

(5) Failure to implement an employee election. (a) Missed opportunity for elective deferrals. For eligible employees who filed elections to make elective deferrals under the Plan which the Plan Sponsor failed to implement on a timely basis, the Plan Sponsor must make a QNEC to the plan on behalf of the employee to replace the “missed deferral opportunity.” The missed deferral opportunity is equal to 50% of the employee’s “missed deferral.” The missed deferral is determined by multiplying the employee’s elected deferral percentage by the employee’s compensation. If the employee elected a dollar amount for an elective deferral, the missed deferral would be the specified dollar amount. The employee’s missed deferral amount is reduced further to the extent necessary to ensure that the missed deferral does not exceed applicable plan limits, including the annual deferral limit under § 402(g) for the calendar year in which the failure occurred. The QNEC must be adjusted for Earnings to the date the corrective QNEC is made on behalf of the affected employee.

(b) Missed opportunity for after-tax employee contributions. For eligible employees who filed elections to make after-tax employee contributions under the Plan which the Plan Sponsor failed to implement on a timely basis, the Plan Sponsor must make a QNEC to the plan on behalf of the employee to replace the employee’s missed opportunity for after-tax employee contributions. The missed opportunity for making after-tax employee contributions is equal to 40% of the employee’s “missed after-tax contributions.” The missed after-tax employee contribution is determined by multiplying the employee’s elected after-tax employee contribution percentage by the employee’s compensation. The QNEC must be adjusted for Earnings to the date the corrective QNEC is made on behalf of the affected employee.

(c) Missed opportunity affecting matching contributions. In the event of failure described in paragraph (a) or (b) of this section .05(5), if the employee would have been entitled to an additional matching contribution had either the missed deferral or after-tax employee contribution been made, then the Plan Sponsor must make a corrective employer nonelective contribution for the matching contribution on behalf of the affected employee, or a corrective QNEC in the case of a safe harbor plan under § 401(k)(12). The corrective employer nonelective contribution or QNEC is equal to the matching contribution the employee would have received had the employee made a deferral equal to the missed deferral determined under this paragraph. The corrective employer nonelective contribution or QNEC must be adjusted for Earnings to the date the corrective contribution or QNEC is made on behalf of the affected employee.

(d) Coordination with correction of other Qualification Failures. The method for correcting the failures described in this section .05(5) does not apply until after the correction of other qualification failures. Thus, for example, if in addition to the failure to implement an employee’s election, the plan also failed the ADP test or ACP test, the correction methods described in section .05(5)(a), (b), or (c) cannot be used until after correction of the ADP or ACP test failures. For purposes of this section .05(5), in order to determine whether the plan passed the ADP or ACP test the plan may rely on a test performed with respect to those eligible employees who were not impacted by the Plan Sponsor’s failure to implement employee elections and received allocations of employer matching contributions, in accordance with the terms of the plan, and may disregard employees whose elections were not properly implemented.

(6) Failure of a 403(b) Plan to satisfy the universal availability requirement of § 403(b)(12)(A)(ii). (a) Subject to the specific rules in this section .05(6), the correction methods set forth in this section .05 (and section 2.02 of Appendix B) for a Qualified Plan also apply to a 403(b) Plan that has a similar failure.

(b) If the employee was not provided the opportunity to elect and make elective deferrals to a 403(b) Plan, then, in lieu of determining the missed deferral based on the actual deferral percentage as described in section .05(2)(b), the missed deferral is deemed equal to the greater of 3% of compensation or the maximum deferral percentage for which the Plan Sponsor provides a matching contribution rate that is at least as favorable as 100% of the elective deferral made by the employee.

(7) Improper exclusion of an eligible employee from a SIMPLE IRA plan subject to the requirements of § 408(p). (a) Subject to the specific rules in this section .05(7), the correction methods set forth in this section .05 for a Qualified Plan also apply to a SIMPLE IRA plan that has a similar failure.

(b) If the employee was not provided the opportunity to elect and make elective deferrals to a SIMPLE IRA plan, then, in lieu of determining the missed deferral based on the actual deferral percentage as described in section .05(2)(b), the missed deferral is deemed to be 3% of compensation.

(8) Special safe harbor correction method for failures related to automatic contribution features in a § 401(k) plan or a 403(b) Plan. (a) Eligibility to use safe harbor correction method. This safe harbor correction method is available for certain Employee Elective Deferral Failures (as defined in section .05(10) of this appendix associated with missed elective deferrals for eligible employees who are subject to an automatic contribution feature in a § 401(k) plan or 403(b) Plan (including employees who made affirmative elections in lieu of automatic contributions but whose elections were not implemented correctly). If the failure to implement an automatic contribution feature for an affected eligible employee or the failure to implement an affirmative election of an eligible employee who is otherwise subject to an automatic contribution feature does not extend beyond the end of the 9½-month period after the end of the plan year of the failure (which is generally the filing deadline of the Form 5500 series return, including automatic extensions), no QNEC for the missed elective deferrals is required, provided that the following conditions are satisfied:

(i) Correct deferrals begin no later than the earlier of the first payment of compensation made on or after the last day of the 9½-month period after the end of the plan year in which the failure first occurred for the affected eligible employee or, if the Plan Sponsor was notified of the failure by the affected eligible employee, the first payment of compensation made on or after the end of the month after the month of notification;

(ii) Notice of the failure that satisfies the content requirements of section .05(8)(c) of this appendix is given to the affected eligible employee not later than 45 days after the date on which correct deferrals begin; and

(iii) If the eligible employee would have been entitled to additional matching contributions had the missed deferrals been made, the Plan Sponsor makes a corrective allocation (adjusted for Earnings) on behalf of the employee equal to the matching contributions that would have been required under the terms of the plan as if the missed deferrals had been contributed to the plan in accordance with timing requirements under SCP for significant operational failures (described in section 9.02).

(b) Calculation of Earnings for certain failures to implement automatic contribution features. This correction method provides an alternative safe harbor method for calculating Earnings for Employee Elective Deferral Failures under § 401(k) plans or 403(b) Plans that have automatic contribution features and that are corrected in accordance with the procedures in this section .05(8). If an affected eligible employee has not affirmatively designated an investment alternative, missed Earnings may be calculated based on the plan’s default investment alternative, provided that, with respect to a correction made in accordance with the procedures in this section .05(8), any cumulative losses reflected in the Earnings calculation will not result in a reduction in the required corrective contributions relating to any matching contributions. The Plan Sponsor may also use the Earnings adjustment methods set forth in section 3 of Appendix B.

(c) Content of notice requirement. The notice required under section .05(8)(a)(ii) of this appendix must include the following information:

(i) General information relating to the failure, such as the percentage of eligible compensation that should have been deferred and the approximate date that the compensation should have begun to be deferred. The general information need not include a statement of the dollar amounts that should have been deferred.

(ii) A statement that appropriate amounts have begun to be deducted from compensation and contributed to the plan (or that appropriate deductions and contributions will begin shortly).

(iii) A statement that corrective allocations relating to missed matching contributions have been made (or that corrective allocations will be made). Information relating to the date and the amount of corrective allocations need not be provided.

(iv) An explanation that the affected participant may increase his or her deferral percentage in order to make up for the missed deferral opportunity, subject to applicable limits under § 402(g).

(v) The name of the plan and plan contact information (including name, street address, e-mail address, and telephone number of a plan contact).

(d) Sunset of safe harbor correction method. The safe harbor correction method described in this section .05(8) of this appendix is available for plans only with respect to failures that begin on or before December 31, 2020.

(9) Safe harbor correction methods for Employee Elective Deferral Failures in § 401(k) plans or 403(b) Plans. (a) Safe harbor correction method for Employee Elective Deferral Failures that do not exceed three months. Under this safe harbor correction method, an Employee Elective Deferral Failure (as defined in section .05(10) of this appendix ) can be corrected without a QNEC for missed elective deferrals if the following conditions are satisfied:

(i) Correct deferrals begin no later than the earlier of the first payment of compensation made on or after the last day of the three-month period that begins when the failure first occurred for the affected eligible employee or, if the Plan Sponsor was notified of the failure by the affected eligible employee, the first payment of compensation made on or after the end of the month after the month of notification;

(ii) Notice of the failure that satisfies the content requirements of section .05(9)(c) of this appendix is given to the affected eligible employee not later than 45 days after the date on which correct deferrals begin; and

(iii) If the eligible employee would have been entitled to additional matching contributions had the missed deferrals been made, the Plan Sponsor makes a corrective allocation (adjusted for Earnings, which may be calculated as described in section .05(8)(b) of this appendix) on behalf of the employee equal to the matching contributions that would have been required under the terms of the plan as if the missed deferrals had been contributed to the plan in accordance with the timing requirements under SCP for significant operational failures (described in section 9.02).

(b) Safe harbor correction method for Employee Elective Deferral Failures that extend beyond three months but do not extend beyond the SCP correction period for significant failures. This safe harbor correction is for failures that exceed three months (or the conditions for the safe harbor correction method described in section .05(8) or .05(9)(a) of this appendix are not met by the Plan Sponsor). Under this safe harbor correction, the required corrective employer contribution is equal to 25% of the missed deferrals (25% QNEC) in lieu of the higher QNEC required in sections .05(2)(b) and .05(5)(a) of this appendix. In order to use this safe harbor correction method, the Plan Sponsor must satisfy the following conditions:

(i) Correct deferrals begin no later than the earlier of the first payment of compensation made on or after the last day of the second plan year following the plan year in which the failure occurred or, if the Plan Sponsor was notified of the failure by the affected eligible employee, the first payment of compensation made on or after the end of the month after the month of notification;

(ii) Notice of the failure that satisfies the content requirements of section .05(9)(c) of this Appendix A is given to an affected participant not later than 45 days after the date on which correct deferrals begin; and

(iii) Corrective allocations, as described in section 6.02(4) of this revenue procedure (including the 25% QNEC and employer contributions to make up for any missed matching contributions), are made in accordance with timing requirements under SCP for significant operational failures (described in section 9.02 of this revenue procedure), including adjustments for Earnings, which may be calculated as described in section .05(8)(b) of this appendix.

(c) Content of notice requirement. The notice required under section .05(9)(a)(ii) and section .05(9)(b)(ii) of this appendix must include the following information:

(i) General information relating to the failure, such as the percentage of eligible compensation that should have been deferred and the approximate date that the compensation should have begun to be deferred. The general information need not include a statement of the dollar amounts that should have been deferred.

(ii) A statement that appropriate amounts have begun to be deducted from compensation and contributed to the plan (or that appropriate deductions and contributions will begin shortly).

(iii) A statement that corrective allocations have been made (or that corrective allocations will be made). Information relating to the date and the amount of corrective allocations need not be provided.

(iv) An explanation that the affected participant may increase his or her deferral percentage in order to make up for the missed deferral opportunity, subject to applicable limits under § 402(g).

(v) The name of the plan and plan contact information (including name, street address, e-mail address, and telephone number of a plan contact).

(10) Employee Elective Deferral Failure. For purposes of sections .05(8) and .05(9) of this appendix, an “Employee Elective Deferral Failure” is a failure to implement elective deferrals correctly in a § 401(k) plan or 403(b) Plan, including elective deferrals pursuant to an affirmative election or pursuant to an automatic contribution feature under a § 401(k) plan or 403(b) Plan, and a failure to afford an employee the opportunity to make an affirmative election because the employee was improperly excluded from the plan. Automatic contribution features include automatic enrollment and automatic escalation features (including automatic escalation features that were affirmatively elected).

.06 Failure to timely pay the minimum distribution required under § 401(a)(9). In a defined contribution plan, the permitted correction method is to distribute the required minimum distributions (with Earnings from the date of the failure to the date of the distribution). The amount required to be distributed for each year in which the initial failure occurred should be determined by dividing the adjusted account balance on the applicable valuation date by the applicable distribution period. For this purpose, adjusted account balance means the actual account balance, determined in accordance with § 1.401(a)(9)–5, Q&A-3, reduced by the amount of the total missed minimum distributions for prior years. In a defined benefit plan, the permitted correction method is to distribute the required minimum distributions, plus an interest payment based on the plan’s actuarial equivalence factors in effect on the date that the distribution should have been made. See section 6.02(4)(d) of this revenue procedure. If this correction is made at the time the plan is subject to a restriction on single-sum payments pursuant to § 436(d), the Plan Sponsor must contribute to the plan the applicable amount under section 6.02(4)(e)(ii)(A) as part of the correction.

.07 Failure to obtain participant or spousal consent for a distribution subject to the participant and spousal consent rules under §§ 401(a)(11), 411(a)(11), and 417. (1) The permitted correction method is to give each affected participant a choice between providing informed consent for the distribution actually made or receiving a qualified joint and survivor annuity. In the event that participant or spousal consent is required but cannot be obtained, the participant must receive a qualified joint and survivor annuity based on the monthly amount that would have been provided under the plan at his or her retirement date. This annuity may be actuarially reduced to take into account distributions already received by the participant. However, the portion of the qualified joint and survivor annuity payable to the spouse upon the death of the participant may not be actuarially reduced to take into account prior distributions to the participant. Thus, for example, if, in accordance with the automatic qualified joint and survivor annuity option under a plan, a married participant who retired would have received a qualified joint and survivor annuity of $600 per month payable for life with $300 per month payable to the spouse for the spouse’s life beginning upon the participant’s death, but instead received a single-sum distribution equal to the actuarial present value of the participant’s accrued benefit under the plan, then the $600 monthly annuity payable during the participant’s lifetime may be actuarially reduced to take the single-sum distribution into account. However, the spouse must be entitled to receive an annuity of $300 per month payable for life beginning at the participant’s death.

(2) An alternative permitted correction method is to give each affected participant a choice between (i) providing informed consent for the distribution actually made, (ii) receiving a qualified joint and survivor annuity (both (i) and (ii) of this section .07(2) are described in section .07(1) of this Appendix A), or (iii) a single-sum payment to the participant’s spouse equal to the actuarial present value of that survivor annuity benefit (calculated using the applicable interest rate and mortality table under § 417(e)(3)). For example, assuming the actuarial present value of a $300 per month annuity payable to the spouse for the spouse’s life beginning upon the participant’s death was $7,837 (calculated using the applicable interest rate and applicable mortality table under § 417(e)(3)), the single-sum payment to the spouse under clause (iii) of this section .07(2) is equal to $7,837. If the single-sum payment is made to the spouse, then the payment is treated in the same manner as a distribution under § 402(c)(9) for purposes of rolling over the payment to an IRA or other eligible retirement plan. If correction is made at the time the plan is subject to a restriction on single-sum payments pursuant to § 436(d), then the alternative permitted correction in this section .07(2) is available only if the Plan Sponsor (or other person) contributes to the plan the applicable amount under section 6.02(4)(e)(ii)(A) as part of the correction.

.08 Failure to satisfy the § 415 limits in a defined contribution plan. For limitation years beginning before January 1, 2009, the permitted correction for failure to limit annual additions (other than elective deferrals and after-tax employee contributions) allocated to participants in a defined contribution plan as required in § 415 (even if the excess did not result from the allocation of forfeitures or from a reasonable error in estimating compensation) is to place the excess annual additions into an unallocated account, similar to the suspense account described in § 1.415–6(b)(6)(iii) (as it appeared in the April 1, 2007 edition of 26 CFR part 1) prior to amendments made by the final regulations under § 415, to be used as an employer contribution, other than elective deferrals, in the succeeding year(s). While such amounts remain in the unallocated account, the Plan Sponsor is not permitted to make additional contributions to the plan. The permitted correction for failure to limit annual additions that are elective deferrals or after-tax employee contributions (even if the excess did not result from a reasonable error in determining compensation, the amount of elective deferrals or after-tax employee contributions that could be made with respect to an individual under the § 415 limits) is to distribute the elective deferrals or after-tax employee contributions using a method similar to that described under § 1.415–6(b)(6)(iv) (as it appeared in the April 1, 2007 edition of 26 CFR part 1) prior to amendments made by the final regulations under § 415. Elective deferrals and after-tax employee contributions that are matched may be returned to the employee, provided that the matching contributions relating to such contributions are forfeited (which will also reduce excess annual additions for the affected individuals). The forfeited matching contributions are to be placed into an unallocated account to be used as an employer contribution, other than elective deferrals, in succeeding periods. For limitation years beginning on or after January 1, 2009, the failure to limit annual additions allocated to participants in a defined contribution plan as required in § 415 is corrected in accordance with section 6.06(2) and (4).

.09 Orphan Plans; orphan contracts and other assets. (1) Orphan Plans. If (a) a plan has one or more failures (whether a Qualification Failure or a 403(b) Failure) that result from the Plan Sponsor having ceased to exist, the Plan Sponsor no longer maintaining the plan, or similar reasons and (b) the plan is an Orphan Plan, as defined in section 5.03, the permitted correction is to terminate the plan and distribute plan assets to participants and beneficiaries (in accordance with title IV of ERISA, if applicable). This correction must satisfy four conditions. First, the correction must comply with conditions, standards, and procedures substantially similar to those set forth in section 2578.1 of the Department of Labor regulations (relating to abandoned plans). Second, the qualified termination administrator, as defined in 2578.1(g) of the Department of Labor regulations, based on plan records located and updated in accordance with the Department of Labor regulations, must have reasonably determined whether, and to what extent, the survivor annuity requirements of §§ 401(a)(11) and 417 apply to any benefit payable under the plan and take reasonable steps to comply with those requirements (if applicable). Third, each participant and beneficiary must have been provided a nonforfeitable right to his or her accrued benefits as of the date of deemed termination under the Department of Labor regulations, subject to income, expenses, gains, and losses between that date and the date of distribution. Fourth, participants and beneficiaries must receive notification of their rights under § 402(f). In addition, notwithstanding correction under this revenue procedure, the IRS reserves the right to pursue appropriate remedies under the Code against any party who is responsible for the plan, such as the Plan Sponsor, plan administrator, or owner of the business, even in its capacity as a participant or beneficiary under the plan. However, with respect to the first through third conditions above, notice need not be furnished to the Department of Labor, and notices furnished to the Plan Sponsor, participants, or beneficiaries need not indicate that the procedures followed or notices furnished actually comply with, or are required under, Department of Labor regulations.

(2) 403(b) Failures for orphan contracts or other assets. (a) Former employees or beneficiaries. In any case in which a 403(b) Failure results from the Plan Sponsor having ceased involvement with respect to specific assets (including an insurance annuity contract) held under a defined contribution plan on behalf of a participant who is a former employee or on behalf of a beneficiary, a permitted correction is to distribute those plan assets to the participant or beneficiary. Compliance with the distribution rules of section 2578.1(d)(2)(vii) of the Department of Labor regulations satisfies this paragraph .09(2))

(b) Failures Relating to Information Sharing Agreements. In any case in which a 403(b) Failure results from a contract issued in an exchange not being part of a 403(b) Plan due to the failure to have an information sharing agreement pursuant to § 1.403(b)–10(b)(2)(i)(C), a permitted correction is for the assets held under the contract to be transferred to another vendor to which contributions are being made under the plan in order to become a contract which is held under the plan without regard to the special rules in § 1.403(b)–10(b).

APPENDIX B

CORRECTION METHODS AND EXAMPLES; EARNINGS ADJUSTMENT METHODS AND EXAMPLES

SECTION 1. PURPOSE, ASSUMPTIONS FOR EXAMPLES AND SECTION REFERENCES

.01 Purpose. (1) This appendix sets forth correction methods relating to Operational Failures under Qualified Plans. This appendix also sets forth Earnings adjustment methods. In each case, the method described corrects the Operational Failure identified in the headings below. Corrective allocations and distributions should reflect Earnings and actuarial adjustments in accordance with section 6.02(4) of this revenue procedure. The correction methods in this appendix are acceptable to correct Qualification Failures under VCP, and to correct Qualification Failures under SCP that occurred notwithstanding that the plan has established practices and procedures reasonably designed to promote and facilitate overall compliance with the Code, as provided in section 4.04 of this revenue procedure.

(2) To the extent a failure listed in this appendix could occur under a 403(b) Plan, SEP, or SIMPLE IRA Plan, the correction method listed for such failure may similarly be used to correct the failure.

.02 Assumptions for Examples. Unless otherwise specified, for ease of presentation, the examples assume that:

(1) the plan year and the § 415 limitation year are the calendar year;

(2) the Plan Sponsor maintains a single plan intended to satisfy § 401(a) and has never maintained any other plan;

(3) in a defined contribution plan, the plan provides that forfeitures are used to reduce future employer contributions;

(4) the Qualification Failures are Operational Failures and the eligibility and other requirements for SCP, VCP, or Audit CAP, whichever applies, are satisfied; and

(5) there are no Qualification Failures other than the described Operational Failures, and if a corrective action would result in any additional Qualification Failure, appropriate corrective action is taken for that additional Qualification Failure in accordance with EPCRS.

.03 Designated Roth contributions. The examples in this Appendix B generally do not identify whether the plan offers designated Roth contributions. The results in the examples, including corrective contributions, would be the same whether or not the plan offered designated Roth contributions.

.04 Section references. References to section 2 and section 3 are references to section 2 and 3 in this appendix.

SECTION 2. CORRECTION METHODS AND EXAMPLES

.01 ADP/ACP Failures. (1) Correction Methods. (a) Appendix A Correction Method. Appendix A.03 sets forth a correction method for a failure to satisfy the actual deferral percentage (“ADP”), actual contribution percentage (“ACP”), or, for plan years beginning on or before December 31, 2001, multiple use test set forth in §§ 401(k)(3), 401(m)(2), and 401(m)(9), respectively.

(b) One-to-One Correction Method. (i) General. In addition to the correction method in Appendix A, a failure to satisfy the ADP test or ACP test may be corrected by using the one-to-one correction method set forth in this section 2.01(1)(b). Under the one-to-one correction method, an excess contribution amount is determined and assigned to highly compensated employees as provided in paragraph (1)(b)(ii) below. That excess contribution amount (adjusted for Earnings) is either distributed to the highly compensated employees or forfeited from the highly compensated employees’ accounts as provided in paragraph (1)(b)(iii) below. That same dollar amount (that is, the excess contribution amount, adjusted for Earnings) is contributed to the plan and allocated to nonhighly compensated employees as provided in paragraph (1)(b)(iv) below. Under this correction method, a plan may not be treated as two separate plans, one covering otherwise excludable employees and the other covering all other employees (as permitted in § 1.410(b)– 6(b)(3)). Likewise, restructuring the plan into component plans is not permitted. This correction method may also be used to correct a failure to satisfy the multiple use test for plan years beginning on or before December 31, 2001.

(ii) Determination of the Excess Contribution Amount. The excess contribution amount for the year is equal to the excess of (A) the sum of the excess contributions (as defined in § 401(k)(8)(B)), the excess aggregate contributions (as defined in § 401(m)(6)(B)), and for plan years beginning on or before December 31, 2001 the amount treated as excess contributions or excess aggregate contributions under the multiple use test for the year, as assigned to each highly compensated employee in accordance with §§ 401(k)(8)(C) and 401(m)(6)(C), over (B) previous corrections that complied with §§ 401(k)(8) and 401(m)(6), and, for plan years beginning on or before December 31, 2001, the multiple use test.

(iii) Distributions and Forfeitures of the Excess Contribution Amount. (A) The portion of the excess contribution amount assigned to a particular highly compensated employee under paragraph (1)(b)(ii) is adjusted for Earnings from the end of the plan year of the year of the failure through the date of correction. The amount assigned to a particular highly compensated employee, as adjusted, is distributed or, to the extent the amount was forfeitable as of the close of the plan year of the failure, is forfeited. If the amount is forfeited, it is used in accordance with the plan provisions relating to forfeitures that were in effect for the year of the failure. If the amount so assigned to a particular highly compensated employee has been previously distributed, the amount is an Excess Amount within the meaning of section 5.01(3) of this revenue procedure. Thus, pursuant to section 6.06 of this revenue procedure, the Plan Sponsor must notify the employee that the Excess Amount is not eligible for favorable tax treatment accorded to distributions from qualified plans (and, specifically, is not eligible for tax-free rollover).

(B) If any matching contributions (adjusted for Earnings) are forfeited in accordance with § 411(a)(3)(G), the forfeited amount is used in accordance with the plan provisions relating to forfeitures that were in effect for the year of the failure.

(C) If a payment was made to an employee and that payment is a forfeitable match described in either paragraph (1)(b)(iii)(A) or (B), then it is an Overpayment defined in section 5.01(3)(c) of this revenue procedure that must be corrected (see sections 2.04 and 2.05 below).

(iv) Contribution and Allocation of Equivalent Amount. (A) The Plan Sponsor makes a contribution to the plan that is equal to the aggregate amounts distributed and forfeited under paragraph (1)(b)(iii)(A) (that is, the excess contribution amount adjusted for Earnings, as provided in paragraph (1)(b)(iii)(A), which does not include any matching contributions forfeited in accordance with § 411(a)(3)(G) as provided in paragraph (1)(b)(iii)(B)). The contribution must be a QNEC as defined in § 1.401(k)–6.

(B)(1) This paragraph (1)(b)(iv)(B)(1) applies to a plan that uses the current year testing method described in §§ 1.401(k)–2(a)(2), 1.401(m)–2(a)(2), and, for periods prior to the effective date of those regulations, Notice 98–1, 1998–1 C.B. 327. The contribution made under paragraph (1)(b)(iv)(A) is allocated to the account balances of those individuals who were either (I) the eligible employees for the year of the failure who were nonhighly compensated employees for that year or (II) the eligible employees for the year of the failure who were nonhighly compensated employees for that year and who also are nonhighly compensated employees for the year of correction. Alternatively, the contribution is allocated to account balances of eligible employees described in (I) or (II) of the preceding sentence, except that the allocation is made only to the account balances of those employees who are employees on a date during the year of the correction that is no later than the date of correction. Regardless of which of these four options (described in the two preceding sentences) the Plan Sponsor selects, eligible employees must receive a uniform allocation (as a percentage of compensation) of the contribution. (See Examples 1 and 2.) Under the one-to-one correction method, the amount allocated to the account balance of an employee (that is, the employee’s share of the total amount contributed under paragraph (1)(b)(iv)(A)) is not further adjusted for Earnings and is treated as an annual addition under § 415 for the year of the failure for the employee for whom it is allocated.

(2) This paragraph (1)(b)(iv)(B)(2) applies to a plan that uses the prior year testing method described in §§ 1.401(k)–2(a)(2) and 1.401(m)–2(a)(2) and, for periods prior to the effective date of those regulations, Notice 98–1. Paragraph (1)(b)(iv)(B)(1) is applied by substituting “the year prior to the year of the failure” for “the year of the failure.”

(2) Examples.

Example 1:

Employer A maintains a profit-sharing plan with a cash or deferred arrangement that is intended to satisfy § 401(k) using the current year testing method. The plan does not provide for matching contributions or after-tax employee contributions. In 2007, it was discovered that the ADP test for 2005 was not performed correctly. When the ADP test was performed correctly, the test was not satisfied for 2005. For 2005, the ADP for highly compensated employees was 9% and the ADP for nonhighly compensated employees was 4%. Accordingly, the ADP for highly compensated employees exceeded the ADP for nonhighly compensated employees by more than two percentage points (in violation of § 401(k)(3)). There were two highly compensated employees eligible under the § 401(k) plan during 2005, Employee P and Employee Q. Employee P made elective deferrals of $10,000, which is equal to 10% of Employee P’s compensation of $100,000 for 2005. Employee Q made elective deferrals of $9,500, which is equal to 8% of Employee Q’s compensation of $118,750 for 2005.

Correction:

On June 30, 2007, Employer A uses the one-to-one correction method to correct the failure to satisfy the ADP test for 2005. Accordingly, Employer A calculates the dollar amount of the excess contributions for the two highly compensated employees in the manner described in § 401(k)(8)(B). The amount of the excess contribution for Employee P is $4,000 (4% of $100,000) and the amount of the excess contribution for Employee Q is $2,375 (2% of $118,750), or a total of $6,375. In accordance with § 401(k)(8)(C), $6,375, the excess contribution amount, is assigned $3,437.50 to Employee P and $2,937.50 to Employee Q. It is determined that the Earnings on the assigned amounts through June 30, 2007 are $687 and $587 for Employees P and Q, respectively. The assigned amounts and the Earnings are distributed to Employees P and Q. Therefore, Employee P receives $4,124.50 ($3,437.50 + $687) and Employee Q receives $3,524.50 ($2,937.50 + $587). In addition, on the same date, Employer A makes a corrective contribution to the § 401(k) plan equal to $7,649 (the sum of the $4,124.50 distributed to Employee P and the $3,524.50 distributed to Employee Q). The corrective contribution is allocated to the account balances of eligible nonhighly compensated employees for 2005, pro rata based on their compensation for 2005 (subject to § 415 for 2005).

Example 2:

The facts are the same as in Example 1, except that for 2005 the plan also provides for (1) after-tax employee contributions and (2) matching contributions equal to 50% of the sum of an employee’s elective deferrals and after-tax employee contributions that do not exceed 10% of the employee’s compensation. The plan provides that matching contributions are subject to the plan’s 20% per year of service vesting schedule and that matching contributions are forfeited and used to reduce employer contributions if associated elective deferrals or after-tax employee contributions are distributed to correct an ADP or ACP test failure. For 2005, nonhighly compensated employees made after-tax employee contributions and no highly compensated employee made any after-tax employee contributions. Employee P received a matching contribution of $5,000 (50% of $10,000) and Employee Q received a matching contribution of $4,750 (50% of $9,500). Employees P and Q were 100% vested in 2005. It was determined that the plan satisfied the requirements of the ACP test for 2005.

Correction:

The same corrective actions are taken as in Example 1. In addition, in accordance with the plan’s terms, corrective action is taken to forfeit Employee P’s and Employee Q’s matching contributions associated with their distributed excess contributions. Employee P’s distributed excess contributions and associated matching contributions are $3,437.50 and $1,718.75, respectively. Employee Q’s distributed excess contributions and associated matching contributions are $2,937.50 and $1,468.75, respectively. Thus, $1,718.75 is forfeited from Employee P’s account and $1,468.75 is forfeited from Employee Q’s account. In addition, the Earnings on the forfeited amounts are also forfeited. It is determined that the respective Earnings on the forfeited amount for Employee P is $250 and for Employee Q is $220. The total amount of the forfeitures of $3,657.50 (Employee P’s $1,718.75 + $250 and Employee Q’s $1,468.75 + $220) is used to reduce contributions for 2007 and subsequent years.

.02 Exclusion of Otherwise Eligible Employees. (1) Exclusion of Eligible Employees in a § 401(k) or (m) Plan. (a) Correction Method. (i) Appendix A Correction Method for Full Year Exclusion. Appendix A, section .05(2) sets forth the correction method for the exclusion of an eligible employee from electing and making elective deferrals (other than designated Roth contributions) and after-tax employee contributions to a plan that provides benefits that are subject to the requirements of § 401(k) or 401(m) for one or more full plan years. (See Example 3.) Appendix A, section .05(2) also specifies the method for determining missed elective deferrals and the corrective contributions for employees who were improperly excluded from electing and making elective deferrals to a safe harbor § 401(k) plan for one or more full plan years. (See Examples 8, 9, and 10.) Appendix A, section .05(3) sets forth the correction method for the exclusion of an eligible employee from electing and making elective deferrals in a plan that (i) is subject to § 401(k) and (ii) provides employees with the opportunity to make designated Roth contributions. Appendix A, section .05(4) sets forth the correction method for the situation where an eligible employee was permitted to make an elective deferral, but was not provided with the opportunity to make catch-up contributions under the terms of the plan and § 414(v), and correction is being made by making a QNEC on behalf of the excluded employee. (See Example 11.) Appendix A, section .05(5) sets forth the correction method for the failure by a plan to implement an employee’s election with respect to elective deferrals (including designated Roth contributions) or after-tax employee contributions. (See Example 12.) In section 2.02(1)(a)(ii) below, the correction methods for (I) the exclusion of an eligible employee from all contributions (including designated Roth contributions) under a § 401(k) or (m) plan for a full year, as described in Appendix A, sections .05(2) and .05(3), (II) the exclusion of an eligible employee who was permitted to make elective deferrals, but was not permitted to make catch-up contributions for a full plan year as described in Appendix A, section .05(4), and (III) the exclusion of an eligible employee on account of the failure to implement an employee’s election to make elective deferrals or after-tax employee contributions to the plan as described in Appendix A, section .05(5) are expanded to include correction for the exclusion from these contributions (including designated Roth contributions) under a § 401(k) or (m) plan for a partial plan year. This correction for a partial year exclusion may be used in conjunction with the correction for a full year exclusion.

(ii) Expansion of Correction Method to Partial Year Exclusion. (A) In General. The correction method in Appendix A, section .05, is expanded to cover an employee who was improperly excluded from electing and making elective deferrals (including designated Roth contributions) or after-tax employee contributions for a portion of a plan year or from receiving matching contributions (on either elective deferrals or after-tax employee contributions) for a portion of a plan year. In such a case, a permitted correction method for the failure is for the Plan Sponsor to satisfy this section 2.02(1)(a)(ii). The Plan Sponsor makes a QNEC on behalf of the excluded employee. The method and examples described to correct the failure to include otherwise eligible employees do not apply until after correction of other qualification failures. Thus, for example, in the case of a § 401(k) plan that does not apply the safe harbor contribution requirements of § 401(k)(12) or 401(k)(13) the correction for improperly excluding an employee from making elective deferrals, as described in the narrative and the examples in this section cannot be used until after correction of the ADP test failure. (See Appendix A, section .05(2)(g).)

(B) Elective Deferral Failures. (1) The appropriate QNEC for the failure to allow an employee to elect and make elective deferrals (including designated Roth contributions) for a portion of the plan year is equal to the missed deferral opportunity which is an amount equal to 50% of the employee’s missed deferral. The employee’s missed deferral is determined by multiplying the ADP of the employee’s group (either highly or nonhighly compensated), determined prior to correction under this section 2.02(1)(a)(ii), by the employee’s plan compensation for the portion of the year during which the employee was improperly excluded. In a safe harbor § 401(k) plan, the employee’s missed deferral is determined by multiplying 3% (or, if greater, whatever percentage of the participant’s compensation which, if contributed as an elective deferral, would have been matched at a rate of 100% or more) by the employee’s plan compensation for the portion of the year during which the employee was improperly excluded. The missed deferral for the portion of the plan year during which the employee was improperly excluded from being eligible to make elective deferrals is reduced to the extent that (i) the sum of the missed deferral (as determined in the preceding two sentences of this paragraph) and any elective deferrals actually made by the employee for that year would exceed (ii) the maximum elective deferrals permitted under the plan for the employee for that plan year (including the § 402(g) limit). The corrective contribution is adjusted for Earnings. For purposes of correcting other failures under this revenue procedure (including determination of any required matching contribution) after correction has occurred under this section 2.02(1)(a)(ii)(B), the employee is treated as having made pre-tax elective deferrals equal to the employee’s missed deferral for the portion of the year during which the employee was improperly excluded. (See Examples 4 and 5.)

(2) The appropriate corrective contribution for the plan’s failure to implement an employee’s election with respect to elective deferrals is equal to the missed deferral opportunity which is an amount equal to 50% of the employee’s missed deferral. Corrective contributions are adjusted for Earnings. The missed deferral is determined by multiplying the employee’s deferral percentage by the employee’s plan compensation for the portion of the year during which the employee was improperly excluded. If the employee elected a fixed dollar amount that can be attributed to the period of exclusion, then the flat dollar amount for the period of exclusion may be used for this purpose. If the employee elected a fixed dollar amount to be deferred for the entire plan year, then that dollar amount is multiplied by a fraction. The fraction is equal to the number of months, including partial months where applicable, during which the eligible employee was excluded from making elective deferral contributions divided by 12. The missed deferral for the portion of the plan year during which the eligible employee was improperly excluded from making elective deferrals is reduced to the extent that (i) the sum of the missed deferral (as determined in the preceding three sentences) and any elective deferrals actually made by the employee for that year would exceed (ii) the maximum elective deferrals permitted under the plan for the employee for that plan year (including the § 402(g) limit). The corrective contribution is adjusted for Earnings. The requirements relating to the passage of the ADP test before this correction method can be used, as described in Appendix A, section .05(5)(d), still apply.

(C) After-Tax Employee Contribution Failures. (1) The appropriate corrective contribution for the failure to allow employees to elect and make after-tax employee contributions for a portion of the plan year is equal to the missed after-tax employee contributions opportunity, which is an amount equal to 40% of the employee’s missed after-tax employee contributions. The employee’s missed after-tax employee contributions are determined by multiplying the ACP of the employee’s group (either highly or nonhighly compensated), determined prior to correction under this section 2.02(1)(a)(ii)(C), by the employee’s plan compensation for the portion of the year during which the employee was improperly excluded. If the ACP consists of both matching and after-tax employee contributions, then, for purposes of the preceding sentence, in lieu of basing the missed after-tax employee contributions on the ACP for the employee’s group (either highly compensated or nonhighly compensated), the Plan Sponsor is permitted to determine separately the portions of the ACP that are attributable to matching contributions and after-tax employee contributions and base the missed after-tax employee contributions on the portion of the ACP that is attributable to after-tax employee contributions. The missed after-tax employee contribution is reduced to the extent that (i) the sum of that contribution and the actual total after-tax employee contributions made by the employee for the plan year would exceed (ii) the sum of the maximum after-tax employee contributions permitted under the plan for the employee for the plan year. The corrective contribution is adjusted for Earnings. The requirements relating to the passage of the ACP test before this correction method can be used, as described in Appendix A, section .05(2)(g), still apply.

(2) The appropriate corrective contribution for the plan’s failure to implement an employee’s election with respect to after-tax employee contributions for a portion of the plan year is equal to the missed after-tax employee contributions opportunity, which is an amount equal to 40% of the employee’s missed after-tax employee contributions. Corrective contributions are adjusted for Earnings. The missed after-tax employee contribution is determined by multiplying the employee’s elected after-tax employee contribution percentage by the employee’s plan compensation for the portion of the year during which the employee was improperly excluded. If the employee elected a flat dollar amount that can be attributed to the period of exclusion, then the flat dollar amount for the period of exclusion may be used for this purpose. If the employee elected a flat dollar amount to be contributed for the entire plan year, then that dollar amount is multiplied by a fraction. The fraction is equal to the number of months, including partial months where applicable, during which the eligible employee was excluded from making after-tax employee contributions divided by 12. The missed after-tax employee contribution is reduced to the extent that (i) the sum of that contribution and the actual total after-tax employee contributions made by the employee for the plan year would exceed (ii) the sum of the maximum after-tax employee contributions permitted under the plan for the employee for the plan year. The requirements relating to the passage of the ACP test before this correction method can be used, as described in Appendix A, section .05(5)(d), still apply.

(D) Matching Contribution Failures. (1) The appropriate corrective contribution for the failure to make matching contributions for an employee because the employee was precluded from making elective deferrals (including designated Roth contributions) or after-tax employee contributions for a portion of the plan year is equal to the matching contribution that would have been made for the employee if (1) the employee’s elective deferrals for that portion of the plan year had equaled the employee’s missed deferrals (determined under section 2.02(1)(a)(i)(B)) or (2) the employee’s after-tax contribution for that portion of the plan year had equaled the employee’s missed after-tax employee contribution (determined under section 2.02(1)(a)(ii)(C)). This matching contribution is reduced to the extent that (i) the sum of this contribution and other matching contributions actually made on behalf of the employee for the plan year would exceed (ii) the maximum matching contribution permitted if the employee had made the maximum matchable contributions permitted under the plan for the plan year. The corrective contribution is adjusted for Earnings. The requirements relating to the passage of the ACP test before this correction method can be used, as described in Appendix A, section .05(2)(g), still apply.

(2) The appropriate corrective contribution for the failure to make matching contributions for an employee because of the failure by the plan to implement an employee’s election with respect to elective deferrals (including designated Roth contributions) or, where applicable, after-tax employee contributions for a portion of the plan year is equal to the matching contribution that would have been made for the employee if the employee made the elective deferral as determined under section 2.02(1)(a)(ii)(B)(2), or where applicable, the after-tax employee contribution determined under section 2.02(1)(a)(ii)(C)(2). This matching contribution is reduced to the extent that (i) the sum of this contribution and other matching contributions actually made on behalf of the employee for the plan year would exceed (ii) the maximum matching contribution permitted if the employee had made the maximum matchable contributions permitted under the plan for the plan year. The corrective contribution is adjusted for Earnings. The requirements relating to the passage of the ACP test before this correction method can be used, as described in Appendix A, section .05(5)(d), still apply.

(E) Use of Prorated Compensation. For purposes of this paragraph (1)(a)(ii), for administrative convenience, in lieu of using the employee’s actual plan compensation for the portion of the year during which the employee was improperly excluded, a pro rata portion of the employee’s plan compensation that would have been taken into account for the plan year, if the employee had not been improperly excluded, may be used.

(F) Special Rule for Brief Exclusion from Elective Deferrals and After-Tax Employee Contributions. An Plan Sponsor is not required to make a corrective contribution with respect to elective deferrals (including designated Roth contributions) or after-tax employee contributions, as provided in sections 2.02(1)(a)(ii)(B) and (C), but is required to make a corrective contribution with respect to any matching contributions, as provided in section 2.02(1)(a)(ii)(D), for an employee for a plan year if the employee has been provided the opportunity to make elective deferrals or after-tax employee contributions under the plan for a period of at least the last 9 months in that plan year and during that period the employee had the opportunity to make elective deferrals or after-tax employee contributions in an amount not less than the maximum amount that would have been permitted if no failure had occurred. (See Examples 6 and 7.)

(b) Examples.

Example 3:

Employer B maintains a § 401(k) plan. The plan provides for matching contributions for eligible employees equal to 100% of elective deferrals that do not exceed 3% of an employee’s compensation. The plan allows employees to make after-tax employee contributions up to a maximum of the lesser of 2% of compensation or $1,000. The after-tax employee contributions are not matched. The plan provides that employees who complete one year of service are eligible to participate in the plan on the next designated entry date. The entry dates are January 1, and July 1. In 2007, it is discovered that Employee V, an NHCE with compensation of $30,000, was excluded from the plan for the 2006 plan year even though she satisfied the plan’s eligibility requirements as of January 1, 2006.

For the 2006 plan year, the relevant employee and contribution information is as follows:

Compensation Elective deferral Match After-Tax Employee Contribution
Highly Compensated Employees (HCEs):
R $200,000 $6,000 $6,000 $0
S $150,000 $12,000 $4,500 $1,000
Nonhighly Compensated Employees (NHCEs):
T $80,000 $12,000 $2,400 $1,000
U $50,000 $500 $500 $0

HCEs:

ADP - 5.5%

ACP - 3.33%

ACP attributable to matching contributions - 3%

ACP attributable to after-tax employee contributions - 0.33%

NHCEs:

ADP - 8%

ACP -2.63%

ACP attributable to matching contributions - 2%

ACP attributable to after-tax employee contributions - 0.63%

Correction:

Employer B uses the correction method for a full year exclusion, described in Appendix A, section .05(2), to correct the failure to include Employee V in the plan for the full plan year beginning January 1, 2006. Employer B calculates the corrective QNEC to be made on behalf of Employee V as follows:

Elective deferrals: Employee V was eligible to, but was not provided with the opportunity to, elect and make elective deferrals in 2006. Thus, Employer B must make a QNEC to the plan on behalf of Employee V equal to the missed deferral opportunity for Employee V, which is 50% of Employee V’s missed deferral. The QNEC is adjusted for Earnings. The missed deferral for Employee V is determined by using the ADP for NHCEs for 2006 and multiplying that percentage by Employee V’s compensation for 2006. Accordingly, the missed deferral for Employee V on account of the employee’s improper exclusion from the plan is $2,400 (8% x $30,000). The missed deferral opportunity is $1,200 (that is, 50% x $2,400). Thus, the required corrective contribution for the failure to provide Employee V with the opportunity to make elective deferrals to the plan is $1,200 (plus Earnings). The corrective contribution is made to a pre-tax QNEC account for Employee V (not to a designated Roth contributions account even if the plan offers designated Roth contributions, as provided in section .05(3) of Appendix A).

Matching contributions: Employee V should have been eligible for, but did not receive, an allocation of employer matching contributions because Employee V was not provided the opportunity to make elective deferrals in 2006. Thus, Employer B must make a corrective employer nonelective contribution to the plan on behalf of Employee V that is equal to the matching contribution Employee V would have received had the missed deferral been made. The corrective employer nonelective contribution is adjusted for Earnings. Under the terms of the plan, if Employee V had made an elective deferral of $2,400 or 8% of compensation ($30,000), the employee would have been entitled to a matching contribution equal to 100% of the first 3% of Employee V’s compensation ($30,000) or $900. Accordingly, the contribution required to replace the missed employer matching contribution is $900 (plus Earnings).

After-tax employee contributions: Employee V was eligible to, but was not provided with the opportunity to, elect and make after-tax employee contributions in 2006. Employer B must make a QNEC to the plan equal to the missed opportunity for making after-tax employee contributions for Employee V, which is 40% of Employee V’s missed after-tax employee contribution. The QNEC is adjusted for Earnings. The missed after-tax employee contribution for Employee V is estimated by using the ACP for NHCEs (to the extent that the ACP is attributable to after-tax employee contributions) for 2006 and multiplying that percentage by Employee V’s compensation for 2006. Accordingly, the missed after-tax employee contribution for Employee V, on account of the employee’s improper exclusion from the plan is $189 (0.63% x $30,000). The missed opportunity to make after-tax employee contributions to the plan is $76 (40% x $189). Thus, the required corrective contribution for the failure to provide Employee V with the opportunity to make the $189 after-tax employee contribution to the plan is $76 (plus Earnings).

The total required corrective contribution, before adjustments for Earnings, on behalf of Employee V is $2,176 ($1,200 for the missed deferral opportunity plus $900 for the missed matching contribution plus $76 for the missed opportunity to make after-tax employee contributions). The required corrective contribution is further adjusted for Earnings. The corrective contribution for the missed deferral opportunity ($1,200), the missed opportunity for after-tax employee contributions ($76), and related Earnings must be made in the form of a QNEC.

Example 4:

Employer C maintains a § 401(k) plan. The plan provides for matching contributions for each payroll period that are equal to 100% of an employee’s elective deferrals that do not exceed 2% of the eligible employee’s plan compensation during the payroll period. The plan provides for after-tax employee contributions. The after-tax employee contribution cannot exceed $1,000 for the plan year. The plan provides that employees who complete one year of service are eligible to participate in the plan on the next January 1 or July 1 entry date. Employee X, a nonhighly compensated employee, who met the eligibility requirements and should have entered the plan on January 1, 2006, was not offered the opportunity to elect to have elective contributions made on his behalf to the plan. In August of 2006, the error was discovered and Employer C offered Employee X the opportunity to make elective deferrals and after-tax employee contributions as of September 1, 2006. Employee X made elective deferrals equal to 4% of the employee’s plan compensation for each payroll period from September 1, 2006 through December 31, 2006 (resulting in elective deferrals of $400). Employee X’s plan compensation for 2006 was $36,000 ($26,000 for the first eight months and $10,000 for the last four months). Employer C made matching contributions equal to $200 on behalf of Employee X, which is 2% of Employee X’s plan compensation for each payroll period from September 1, 2006 through December 31, 2006 ($10,000). After being allowed to participate in the plan, Employee X made $250 of after-tax employee contributions for the 2006 plan year. The ADP for nonhighly compensated employees for 2006 was 3% and the ACP for nonhighly compensated employees for 2006 was 2.3%. The ACP attributable to matching contributions for nonhighly compensated employees for 2006 was 1.8%. The ACP attributable to employee contributions for nonhighly compensated employees for 2006 was 0.5%.

Correction:

In accordance with section 2.02(1)(a)(ii), Employer C uses the correction method described in Appendix A, section .05, to correct for the failure to provide Employee X the opportunity to elect and make elective deferrals and after-tax employee contributions, and, as a result, the failure of Employee X to receive matching contributions for a portion of the plan year (January 1, 2006 through August 31, 2006). Thus, Employer C makes a corrective contribution on behalf of Employee X that satisfies the requirements of section 2.02(1)(a)(ii). Employer C elects to utilize the provisions of section 2.02(1)(a)(ii)(E) to determine Employee X’s compensation for the portion of the year in which Employee X was not provided the opportunity to make elective deferrals and after-tax employee contributions. Thus, for administrative convenience, in lieu of using actual plan compensation of $26,000 for the period Employee X was excluded, Employee X’s annual plan compensation is prorated for the 8-month period that the employee was excluded from participating in the plan. The corrective contribution is determined as follows:

(1) Corrective contribution for missed deferral: Employee X was eligible to, but was not provided with the opportunity to, elect and make elective deferrals from January 1 through August 31 of 2006. Employer C must make a QNEC to the plan on behalf of Employee X equal to Employee X’s missed deferral opportunity for that period, which is 50% of Employee X’s missed deferral. The corrective contribution is adjusted for Earnings. Employee X’s missed deferral is determined by multiplying the 3% ADP for nonhighly compensated employees by $24,000 (8/12ths of the employee’s 2006 compensation of $36,000). Accordingly, the missed deferral is $720. The missed deferral is not reduced because when this amount is added to the amount already deferred, no plan limit (including § 402(g)) was exceeded. Accordingly, the required QNEC is $360 (that is 50% multiplied by the missed deferral amount of $720). The required QNEC is adjusted for Earnings.

(2) Corrective contribution for missed matching contribution: Under the terms of the plan, if Employee X had made an elective deferral of $720 or 3% of compensation for the period of exclusion ($24,000), the employee would have been entitled to a matching contribution equal to 2% of $24,000 or $480. The missed matching contribution is not reduced because no plan limit is exceeded when this amount is added to the matching contribution already contributed for the 2006 plan year. Accordingly, the required corrective employer contribution is $480. The required corrective employer contribution is adjusted for Earnings.

(3) Corrective contribution for missed after-tax employee contribution: Employee X was eligible to, but was not provided with the opportunity to elect and make after-tax employee contributions from January 1 through August 31 of 2006. Employer C must make a QNEC to the plan on behalf of Employee X equal to the missed opportunity to make after-tax employee contributions. The missed opportunity to make after-tax employee contributions is equal to 40% of Employee X’s missed after-tax employee contributions. The QNEC is adjusted for Earnings. The missed after-tax employee contribution amount is equal to the 0.5% ACP attributable to employee contributions for nonhighly compensated employees multiplied by $24,000 (8/12ths of the employee’s 2006 plan compensation of $36,000). Accordingly, the missed after-tax employee contribution amount is $120. The missed after-tax employee contribution is not reduced because the sum of $120 and the previously made after-tax employee contribution of $250 is less than the overall plan limit of $1,000. Therefore, the required QNEC is $48 (that is, 40% multiplied by the missed after-tax employee contribution of $120). The QNEC is adjusted for Earnings.

The total required corrective contribution, before adjustments for Earnings, on behalf of Employee X is $888 ($360 for the missed deferral opportunity plus $480 for the missed matching contribution plus $48 for the missed opportunity to make after-tax employee contributions). The corrective contribution for the missed deferral opportunity ($360), the missed opportunity for after-tax employee contributions ($48), and related Earnings must be made in the form of a QNEC.

Example 5:

The facts (including the ADP and ACP results) are the same as in Example 4, except that it is now determined that Employee X, after being included in the plan in 2006, made after-tax employee contributions of $950.

Correction:

The correction is the same as in Example 4, except that the QNEC required to replace the missed after-tax employee contribution is re-calculated to take into account applicable plan limits in accordance with the provisions of section 2.02(1)(a)(ii)(C). The QNEC is determined as follows:

The missed after-tax employee contribution amount is equal to the 0.5% ACP attributable to after-tax employee contributions for nonhighly compensated employees multiplied by $24,000 (8/12ths of the employee’s 2006 plan compensation of $36,000). The missed after-tax employee contribution amount, based on this calculation, is $120. However, the sum of this amount ($120) and the previously made after-tax employee contribution ($950) is $1,070. Because the plan limit for after-tax employee contributions is $1,000, the missed after-tax employee contribution needs to be reduced by $70, to ensure that the total after-tax employee contributions comply with the plan limit. Accordingly, the missed after-tax employee contribution is $50 ($120 minus $70) and the required QNEC is $20 (that is, 40% multiplied by the missed after-tax employee contribution of $50). The QNEC is adjusted for Earnings.

Example 6:

Employer D sponsors a § 401(k) plan. The plan has a one year of service eligibility requirement and provides for January 1 and July 1 entry dates. Employee Y, who should have been provided the opportunity to elect and make elective deferrals for the plan year beginning on January 1, 2006, was not provided the opportunity to elect and make elective deferrals until July 1, 2006. Employee Y made $5,000 in elective deferrals to the plan in 2006. Employee Y was a highly compensated employee with compensation for 2006 of $200,000. Employee Y’s compensation from January 1 through June 30, 2006 was $130,000. The ADP for highly compensated employees for 2006 was 10%. The ADP for nonhighly compensated employees for 2006 was 8%. The § 402(g) limit for deferrals made in 2006 was $15,000.

Correction:

QNEC for missed deferral: Employee Y’s missed deferral is equal to the 10% ADP for highly compensated employees multiplied by $130,000 (compensation earned for the portion of the year in which Employee Y was erroneously excluded, that is, January 1, 2006 through June 30, 2006). The missed deferral amount, based on this calculation is $13,000. However, the sum of this amount ($13,000) and the previously made elective contribution ($5,000) is $18,000. The 2006 § 402(g) limit for elective deferrals is $15,000. In accordance with the provisions of section 2.02(1)(a)(ii)(B), the missed deferral needs to be reduced by $3,000 to ensure that the total elective contribution complies with the applicable § 402(g) limit. Accordingly, the missed deferral is $10,000 ($13,000 minus $3,000) and the required QNEC is $5,000 (that is, 50% multiplied by the missed deferral of $10,000). The QNEC is adjusted for Earnings.

Example 7:

Employer E maintains a § 401(k) plan. The plan provides for matching contributions for each payroll period that are equal to 100% of an employee’s elective deferrals that do not exceed 2% of the eligible employee’s plan compensation during the payroll period. The plan also provides that the annual limit on matching contributions is $750. The plan provides for after-tax employee contributions. The after-tax employee contribution cannot exceed $1,000 during a plan year. The plan provides that employees who complete one year of service are eligible to participate in the plan on the next January 1 or July 1 entry date. Employee Z, a nonhighly compensated employee who met the eligibility requirements and should have entered the plan on January 1, 2006, was not offered the opportunity to elect to have elective contributions made on his behalf to the plan. In March of 2006, the error was discovered and Employer E offered the employee an election opportunity as of April 1, 2006. Employee Z had the opportunity to make the maximum elective deferrals and/or after-tax employee contributions that could have been made under the terms of the plan for the entire 2006 plan year. The employee made elective deferrals equal to 3% of the employee’s plan compensation for each payroll period from April 1, 2006 through December 31, 2006 (resulting in elective deferrals of $960). The employee’s plan compensation for 2006 was $40,000 ($8,000 for the first three months and $32,000 for the last nine months). Employer E made matching contributions equal to $640 for the excluded employee, which is 2% of the employee’s plan compensation for each payroll period from April 1, 2006 through December 31, 2006 ($32,000). After being allowed to participate in the plan, the employee made $500 in after-tax employee contributions. The ADP for nonhighly compensated employees for 2006 was 3% and the ACP for nonhighly compensated employees for 2006 was 2.3%. The portion of the ACP attributable to matching contributions for nonhighly compensated employees for 2006 was 1.8%. The portion of the ACP attributable to after-tax employee contributions for nonhighly compensated employees for 2006 was 0.5%.

Correction:

Employer E uses the correction method for partial year exclusions, pursuant to section 2.02(1)(a)(ii), to correct the failure to include an eligible employee in the plan. Because Employee Z was given an opportunity to make elective deferrals and after-tax employee contributions to the plan for at least the last 9 months of the plan year (and the amount of the elective deferrals or after-tax employee contributions that the employee had the opportunity to make was not less than the maximum elective deferrals or after-tax employee contributions that the employee could have made if the employee had been given the opportunity to make elective deferrals and after-tax employee contributions on January 1, 2006), under the special rule set forth in section 2.02(1)(a)(ii)(F), Employer E is not required to make a QNEC for the failure to provide the employee with the opportunity to make either elective deferrals or after-tax employee contributions. The employer only needs to make a corrective employer nonelective contribution for the failure to provide the employee with the opportunity to receive matching contributions on deferrals that could have been made during the first 3 months of the plan year. The calculation of the corrective employer contribution required to correct this failure is shown as follows:

The missed matching contribution is determined by calculating the matching contribution that the employee would have received had the employee been provided the opportunity to make elective deferrals during the period of exclusion, that is, January 1, 2006 through March 31, 2006. Assuming that the employee elected to defer an amount equal to 3% of compensation (which is the ADP for the nonhighly compensated employees for the plan year), then, under the terms of the plan, the employee would have been entitled to a matching contribution of 2% of compensation. Pursuant to the provisions of section 2.02(1)(a)(ii)(E), Employer E determines compensation by prorating Employee Z’s annual compensation for the portion of the year that Employee Z was not given the opportunity to make elective deferrals or after-tax employee contributions. Accordingly, the missed matching contribution for the period of exclusion is obtained by multiplying 2% by Employee Z’s compensation of $10,000 (3/12ths of the employee’s 2006 plan compensation of $40,000). Based on this calculation, the missed matching contribution is $200. However, when this amount is added to the matching contribution already received ($640), the total ($840) exceeds the $750 plan limit on matching contributions by $90. Accordingly, pursuant to section 2.02(1)(a)(ii)(D), the missed matching contribution figure is reduced to $110 ($200 minus $90). The required corrective employer contribution is $110. The corrective contribution is adjusted for Earnings.

Example 8:

Employer G maintains a safe harbor § 401(k) plan that requires matching contributions that satisfy the requirements of § 401(k)(12), which are equal to: 100% of elective deferrals that do not exceed 3% of an employee’s compensation and 50% of elective deferrals that exceed 3% but do not exceed 5% of an employee’s compensation. Employee M, a nonhighly compensated employee who met the eligibility requirements and should have entered the plan on January 1, 2006, was not offered the opportunity to defer under the plan and was erroneously excluded for all of 2006. Employee M’s compensation for 2006 was $20,000.

Correction:

In accordance with the provisions of section 2.02(1)(a)(ii)(B), Employee M’s missed deferral on account of exclusion from the safe harbor § 401(k) plan is 3% of compensation. Thus, the missed deferral is equal to 3% multiplied by $20,000, or $600. Accordingly, the required QNEC for Employee M’s missed deferral opportunity in 2006 is $300, that is, 50% of $600. The missed matching contribution, based on the missed deferral of $600, is $600. The required corrective contribution for Employee M’s missed matching contribution is $600. Since the matching contribution is required to satisfy the requirements of § 401(k)(12), the corrective contribution must be made in the form of a QNEC. The total QNEC, before adjustments for Earnings, on behalf of Employee M is $900 (that is, $300 for the missed deferral opportunity, plus $600 for the missed matching contribution). The QNEC is adjusted for Earnings.

Example 9:

Same facts as Example 8, except that the plan provides for matching contributions equal to 100% of elective deferrals that do not exceed 4% of an employee’s compensation.

Correction:

In accordance with the provisions of section 2.02(1)(a)(ii)(B), Employee M’s missed deferral on account of exclusion from the safe harbor § 401(k) plan is 4% of compensation. The missed deferral is 4% of compensation because the plan provides for a 100% match for deferrals up to that level of compensation. (See Appendix A, section .05(2)(d).) Therefore, in this case, Employee M’s missed deferral is equal to 4% multiplied by $20,000, or $800. The QNEC for Employee M’s missed deferral opportunity in 2006 is $400, that is, 50% multiplied by $800. The missed matching contribution, based on the missed deferral of $800, is $800. Thus, the required corrective contribution for Employee M’s missed matching contribution is $800. Since the matching contribution is required to satisfy the requirements of § 401(k)(12), the corrective contribution must be made in the form of a QNEC. The total QNEC, before adjustments for Earnings, on behalf of Employee M is $1,200 (that is, $400 for the missed deferral opportunity plus $800 for the missed matching contribution). The QNEC is adjusted for Earnings.

Example 10:

Same facts as Example 8, except that the plan uses a rate of nonelective contributions to satisfy the requirements of § 401(k)(12) and provides for a nonelective contribution equal to 3% of compensation.

Correction:

In accordance with the provisions of section 2.02(1)(a)(ii)(B), Employee M’s missed deferral on account of exclusion from the safe harbor § 401(k) plan is 3% of compensation. Thus, the missed deferral is equal to 3% multiplied by $20,000, or $600. Thus, the QNEC for Employee M’s missed deferral opportunity in 2006 is $300 (50% of $600). The required nonelective contribution, based on the plan’s formula of 3% of compensation for nonelective contributions, is $600. Since the nonelective contribution is required to satisfy the requirements of § 401(k)(12), the corrective contribution is made in the form of a QNEC. The total required QNEC, before adjustments for Earnings, on behalf of Employee M is $900 (that is, $300 for the missed deferral opportunity, plus $600 for the missed nonelective contribution). The QNEC is adjusted for Earnings.

Example 11:

Employer H maintains a § 401(k) plan. The plan limit on deferrals is the lesser of the deferral limit under § 401(a)(30) or the limitation under § 415. The plan also provides that eligible participants (as defined in § 414(v)(5)) may make contributions in excess of the plan’s deferral limits, up to the limitations on catch-up contributions for the year. The plan also provides for a 60% matching contribution on elective deferrals. The deferral limit under § 401(a)(30) for 2006 is $15,000. The limitation on catch-up contributions under the terms of the plan and § 414(v)(2)(B)(i) is $5,000. Employee R, age 55, was provided with the opportunity to make elective deferrals up to the plan limit, but was not provided the option to make catch-up contributions. Employee R is a nonhighly compensated employee who earned $60,000 in compensation and made elective deferrals totaling $15,000 in 2006.

Correction:

In accordance with the provisions of Appendix A, section .05(4), Employee R’s missed deferral on account of the plan’s failure to offer the opportunity to make catch-up contributions is $2,500 (or one half of the limitation on catch-up contributions for 2006). The missed deferral opportunity is $1,250 (or 50% of $2,500). Thus, the required QNEC for Employee R’s missed deferral opportunity relating to catch-up contributions in 2006 is $1,250 adjusted for Earnings. In addition, Employee R was entitled to an additional matching contribution, under the terms of the plan, equal to 60% of the missed deferral that is attributable to the catch-up contribution that the employee would have made had the failure not occurred. In this case, the missed deferral is $2,500 and the corresponding matching contribution is $1,500 (that is, 60% of $2,500). Thus, the required corrective contribution for the additional matching contribution that should have been made on behalf of Employee R is $1,500 adjusted for Earnings.

Example 12:

Employer K maintains a § 401(k) plan. The plan provides for matching contributions for eligible employees equal to 100% of elective deferrals that do not exceed 3% of an employee’s compensation. On January 1, 2006, Employee T made an election to contribute 10% of compensation for the 2006 plan year. However, Employee T’s election was not processed, and the required amounts were not withheld from Employee T’s salary in 2006. Employee T’s salary was $30,000 in 2006.

Correction:

Employer K uses the correction method described in Appendix A, section .05(5), to correct the failure to implement Employee T’s election to make elective deferrals under the plan for the full plan year beginning January 1, 2006. Employer K calculates the corrective QNEC to be made on behalf of Employee T as follows:

(1) Elective deferrals: Employee T’s election to make elective deferrals, pursuant to an election, in 2006 was not implemented. Thus, pursuant to section .05(5)(a) of Appendix A, Employer K must make a QNEC to the plan on behalf of Employee T equal to the missed deferral opportunity for Employee T, which is 50% of Employee T’s missed deferral. The QNEC is adjusted for Earnings. The missed deferral for Employee T is determined by using T’s elected deferral percentage (10%) for 2006 and multiplying that percentage by Employee T’s compensation for 2006 ($30,000). Accordingly, the missed deferral for Employee V, on account of the employee’s improper exclusion from the plan is $3,000 (10% x $30,000). The missed deferral opportunity is $1,500 (that is, 50% x $3,000). Thus, the required QNEC for the failure to provide Employee V with the opportunity to make elective deferrals to the plan is $1,500 (adjusted for Earnings).

(2) Matching contributions: Employee T should have been eligible for but did not receive an allocation of employer matching contributions because no elective deferrals were made on behalf of Employee T in 2006. Thus, pursuant to section .05(5)(c) of Appendix A, Employer K must make a corrective employer nonelective contribution to the plan on behalf of Employee T that is equal to the matching contribution Employee T would have received had the missed deferral been made. The corrective employer nonelective contribution is adjusted for Earnings. Under the terms of the plan, if Employee T had made an elective deferral of $3,000 or 10% of compensation ($30,000), the employee would have been entitled to a matching contribution equal to 100% of the first 3% of Employee T’s compensation ($30,000) or $900. Accordingly, the contribution required to replace the missed employer matching contribution is $900 (adjusted for Earnings).

The total required corrective contribution, before adjustments for Earnings, on behalf of Employee T is $2,400 ($1,500 for the missed deferral opportunity plus $900 for the missed matching contribution). The corrective contribution for the missed deferral opportunity ($1,500) and related Earnings must be made in the form of a QNEC.

(2) Exclusion of Eligible Employees In a Profit-Sharing Plan. (a) Correction Methods. (i) Appendix A Correction Method. Appendix A, section .05, sets forth the correction method for correcting the failure to make a contribution on behalf of the employees improperly excluded from a defined contribution plan or to provide benefit accruals for the employees improperly excluded from a defined benefit plan. In the case of a defined contribution plan, the correction method is to make a contribution on behalf of the excluded employee. Section 2.02(2)(a)(ii) of this Appendix B clarifies the correction method in the case of a profit-sharing or stock bonus plan that provides for nonelective contributions (within the meaning of § 1.401(k)–6).

(ii) Additional Requirements for Appendix A Correction Method as applied to Profit-Sharing Plans. To correct for the exclusion of an eligible employee from nonelective contributions in a profit-sharing or stock bonus plan under the Appendix A correction method, an allocation amount is determined for each excluded employee on the same basis as the allocation amounts were determined for the other employees under the plan’s allocation formula (for example, the same ratio of allocation to compensation), taking into account all of the employee’s relevant factors (for example, compensation) under that formula for that year. The Plan Sponsor makes a corrective contribution on behalf of the excluded employee that is equal to the allocation amount for the excluded employee. The corrective contribution is adjusted for Earnings. If, as a result of excluding an employee, an amount was improperly allocated to the account balance of an eligible employee who shared in the original allocation of the nonelective contribution, no reduction is made to the account balance of the employee who shared in the original allocation on account of the improper allocation. (See Example 15.)

(iii) Reallocation Correction Method. (A) In General. Subject to the limitations set forth in section 2.02(2)(a)(iii)(F) below, in addition to the Appendix A correction method, the exclusion of an eligible employee for a plan year from a profit-sharing or stock bonus plan that provides for nonelective contributions may be corrected using the reallocation correction method set forth in this section 2.02(2)(a)(iii). Under the reallocation correction method, the account balance of the excluded employee is increased as provided in paragraph (2)(a)(iii)(B) below, the account balances of other employees are reduced as provided in paragraph (2)(a)(iii)(C) below, and the increases and reductions are reconciled, as necessary, as provided in paragraph (2)(a)(iii)(D) below. (See Examples 16 and 17.)

(B) Increase in Account Balance of Excluded Employee. The account balance of the excluded employee is increased by an amount that is equal to the allocation the employee would have received had the employee shared in the allocation of the nonelective contribution. The amount is adjusted for Earnings.

(C) Reduction in Account Balances of Other Employees. (1) The account balance of each employee who was an eligible employee who shared in the original allocation of the nonelective contribution is reduced by the excess, if any, of (I) the employee’s allocation of that contribution over (II) the amount that would have been allocated to that employee’s account had the failure not occurred. This amount is adjusted for Earnings taking into account the rules set forth in section 2.02(2)(a)(iii)(C)(2) and (3) below. The amount after adjustment for Earnings is limited in accordance with section 2.02(2)(a)(iii)(C)(4) below.

(2) This paragraph (2)(a)(iii)(C)(2) applies if most of the employees with account balances that are being reduced are nonhighly compensated employees. If there has been an overall gain for the period from the date of the original allocation of the contribution through the date of correction, no adjustment for Earnings is required to the amount determined under section 2.02(2)(a)(iii)(C)(1) for the employee. If the amount for the employee is being adjusted for Earnings and the plan permits investment of account balances in more than one investment fund, for administrative convenience, the reduction to the employee’s account balance may be adjusted by the lowest rate of return of any fund for the period from the date of the original allocation of the contribution through the date of correction.

(3) If an employee’s account balance is reduced and the original allocation was made to more than one investment fund or there was a subsequent distribution or transfer from the fund receiving the original allocation, then reasonable, consistent assumptions are used to determine the Earnings adjustment.

(4) The amount determined in section 2.02(2)(a)(iii)(C)(1) for an employee after the application of section 2.02(2)(a)(iii)(C)(2) and (3) may not exceed the account balance of the employee on the date of correction, and the employee is permitted to retain any distribution made prior to the date of correction.

(D) Reconciliation of Increases and Reductions. If the aggregate amount of the increases under section 2.02(2)(a)(iii)(B) exceeds the aggregate amount of the reductions under section 2.02(2)(a)(iii)(C), the Plan Sponsor makes a corrective contribution to the plan for the amount of the excess. If the aggregate amount of the reductions under section 2.02(2)(a)(iii)(C) exceeds the aggregate amount of the increases under section 2.02(2)(a)(iii)(B), then the amount by which each employee’s account balance is reduced under section 2.02(2)(a)(iii)(C) is decreased on a pro rata basis.

(E) Reductions Among Multiple Investment Funds. If an employee’s account balance is reduced and the employee’s account balance is invested in more than one investment fund, then the reduction may be made from the investment funds selected in any reasonable manner.

(F) Limitations on Use of Reallocation Correction Method. If any employee would be permitted to retain any distribution pursuant to section 2.02(2)(a)(iii)(C)(4), then the reallocation correction method may not be used unless most of the employees who would be permitted to retain a distribution are nonhighly compensated employees.

(b) Examples.

Example 13:

Employer D maintains a profit-sharing plan that provides for discretionary nonelective employer contributions. The plan provides that the employer’s contributions are allocated to account balances in the ratio that each eligible employee’s compensation for the plan year bears to the compensation of all eligible employees for the plan year and, therefore, the only relevant factor for determining an allocation is the employee’s compensation. The plan provides for self-directed investments among four investment funds and daily valuations of account balances. For the 2006 plan year, Employer D made a contribution to the plan of a fixed dollar amount. However, five employees who met the eligibility requirements were inadvertently excluded from participating in the plan. The contribution resulted in an allocation on behalf of each of the eligible employees, other than the excluded employees, equal to 10% of compensation. Most of the employees who received allocations under the plan for the year of the failure were nonhighly compensated employees. No distributions have been made from the plan since 2006. If the five excluded employees had shared in the original allocation, the allocation made on behalf of each employee would have equaled 9% of compensation. The excluded employees began participating in the plan in the 2007 plan year.

Correction:

Employer D uses the Appendix A correction method to correct the failure to include the five eligible employees. Thus, Employer D makes a corrective contribution to the plan. The amount of the corrective contribution on behalf of the five excluded employees for the 2006 plan year is equal to 10% of compensation of each excluded employee, the same allocation that was made for other eligible employees, adjusted for Earnings. The excluded employees receive an allocation equal to 10% of compensation (adjusted for Earnings) even though, had the excluded employees originally shared in the allocation for the 2006 contribution, their account balances, as well as those of the other eligible employees, would have received an allocation equal to only 9% of compensation.

Example 14:

The facts are the same as in Example 13.

Correction:

Employer D uses the reallocation correction method to correct the failure to include the five eligible employees. Thus, the account balances are adjusted to reflect what would have resulted from the correct allocation of the employer contribution for the 2006 plan year among all eligible employees, including the five excluded employees. The inclusion of the excluded employees in the allocation of that contribution would have resulted in each eligible employee, including each excluded employee, receiving an allocation equal to 9% of compensation. Accordingly, the account balance of each excluded employee is increased by 9% of the employee’s 2006 compensation, adjusted for Earnings. The account balance of each of the eligible employees other than the excluded employees is reduced by 1% of the employee’s 2006 compensation, adjusted for Earnings. Employer D determines the adjustment for Earnings using the rate of return of each eligible employee’s excess allocation (using reasonable, consistent assumptions). Accordingly, for an employee who shared in the original allocation and directed the investment of the allocation into more than one investment fund or who subsequently transferred a portion of a fund that had been credited with a portion of the 2006 allocation to another fund, reasonable, consistent assumptions are followed to determine the adjustment for Earnings. It is determined that the total of the initially determined reductions in account balances exceeds the total of the required increases in account balances. Accordingly, these initially determined reductions are decreased pro rata so that the total of the actual reductions in account balances equals the total of the increases in the account balances, and Employer D does not make any corrective contribution. The reductions from the account balances are made on a pro rata basis among all of the funds in which each employee’s account balance is invested.

Example 15:

The facts are the same as in Example 13.

Correction:

The correction is the same as in Example 14, except that, because most of the employees whose account balances are being reduced are nonhighly compensated employees, for administrative convenience, Employer D uses the rate of return of the fund with the lowest rate of return for the period of the failure to adjust the reduction to each account balance. It is determined that the aggregate amount (adjusted for Earnings) by which the account balances of the excluded employees is increased exceeds the aggregate amount (adjusted for Earnings) by which the other employees’ account balances are reduced. Accordingly, Employer D makes a contribution to the plan in an amount equal to the excess. The reduction from account balances is made on a pro rata basis among all of the funds in which each employee’s account balance is invested.

.03 Vesting Failures. (1) Correction Methods. (a) Contribution Correction Method. A failure in a defined contribution plan to apply the proper vesting percentage to an employee’s account balance that results in forfeiture of too large a portion of the employee’s account balance may be corrected using the contribution correction method set forth in this paragraph. The Plan Sponsor makes a corrective contribution on behalf of the employee whose account balance was improperly forfeited in an amount equal to the improper forfeiture. The corrective contribution is adjusted for Earnings. If, as a result of the improper forfeiture, an amount was improperly allocated to the account balance of another employee, no reduction is made to the account balance of that employee. (See Example 16.)

(b) Reallocation Correction Method. In lieu of the contribution correction method, in a defined contribution plan under which forfeitures of account balances are reallocated among the account balances of the other eligible employees in the plan, a failure to apply the proper vesting percentage to an employee’s account balance which results in forfeiture of too large a portion of the employee’s account balance may be corrected under the reallocation correction method set forth in this paragraph. A corrective reallocation is made in accordance with the reallocation correction method set forth in section 2.02(2)(a)(iii), subject to the limitations set forth in section 2.02(2)(a)(iii)(F). In applying section 2.02(2)(a)(iii)(B), the account balance of the employee who incurred the improper forfeiture is increased by an amount equal to the amount of the improper forfeiture and the amount is adjusted for Earnings. In applying section 2.02(2)(a)(iii)(C)(1), the account balance of each employee who shared in the allocation of the improper forfeiture is reduced by the amount of the improper forfeiture that was allocated to that employee’s account. The Earnings adjustments for the account balances that are being reduced are determined in accordance with sections 2.02(2)(a)(iii)(C)(2) and (3) and the reductions after adjustments for Earnings are limited in accordance with section 2.02(2)(a)(iii)(C)(4). In accordance with section 2.02(2)(a)(iii)(D), if the aggregate amount of the increases exceeds the aggregate amount of the reductions, the Plan Sponsor makes a corrective contribution to the plan for the amount of the excess. In accordance with section 2.02(2)(a)(iii)(D), if the aggregate amount of the reductions exceeds the aggregate amount of the increases, then the amount by which each employee’s account balance is reduced is decreased on a pro rata basis. (See Example 17.)

(2) Examples.

Example 16:

Employer E maintains a profit-sharing plan that provides for nonelective contributions. The plan provides for self-directed investments among four investment funds and daily valuation of account balances. The plan provides that forfeitures of account balances are reallocated among the account balances of other eligible employees on the basis of compensation. During the 2006 plan year, Employee R terminated employment with Employer E and elected and received a single-sum distribution of the vested portion of his account balance. No other distributions have been made since 2006. However, an incorrect determination of Employee R’s vested percentage was made resulting in Employee R receiving a distribution of less than the amount to which he was entitled under the plan. The remaining portion of Employee R’s account balance was forfeited and reallocated (and these reallocations were not affected by the limitations of § 415). Most of the employees who received allocations of the improper forfeiture were nonhighly compensated employees.

Correction:

Employer E uses the contribution correction method to correct the improper forfeiture. Thus, Employer E makes a contribution on behalf of Employee R equal to the incorrectly forfeited amount (adjusted for Earnings) and Employee R’s account balance is increased accordingly and subsequently distributed to Employee R. No reduction is made from the account balances of the employees who received an allocation of the improper forfeiture.

Example 17:

The facts are the same as in Example 16.

Correction:

Employer E uses the reallocation correction method to correct the improper forfeiture. Thus, Employee R’s account balance is increased by the amount that was improperly forfeited (adjusted for Earnings) and such increase will be distributed to Employee R. The account of each employee who shared in the allocation of the improper forfeiture is reduced by the amount of the improper forfeiture that was allocated to that employee’s account (adjusted for Earnings). Because most of the employees whose account balances are being reduced are nonhighly compensated employees, for administrative convenience, Employer E uses the rate of return of the fund with the lowest rate of return for the period of the failure to adjust the reduction to each account balance. It is determined that the amount (adjusted for Earnings) by which the account balance of Employee R is increased exceeds the aggregate amount (adjusted for Earnings) by which the other employees’ account balances are reduced. Accordingly, Employer E makes a contribution to the plan in an amount equal to the excess. The reduction from the account balances is made on a pro rata basis among all of the funds in which each employee’s account balance is invested.

.04 § 415 Failures. (1) Failures Relating to a § 415(b) Excess. (a) Correction Methods. (i) Return of Overpayment Correction Method. Overpayments as a result of amounts being paid in excess of the limits of § 415(b) may be corrected using the return of Overpayment correction method set forth in this paragraph (1)(a)(i). The Plan Sponsor takes reasonable steps to have the Overpayment (with appropriate interest) returned by the recipient to the plan and reduces future benefit payments (if any) due to the employee to reflect § 415(b). To the extent the amount returned by the recipient is less than the Overpayment, adjusted for Earnings at the plan’s earnings rate, then the Plan Sponsor or another person contributes the difference to the plan. In addition, in accordance with section 6.06 of this revenue procedure, the Plan Sponsor must notify the recipient that the Overpayment was not eligible for favorable tax treatment accorded to distributions from qualified plans (and, specifically, was not eligible for tax-free rollover). (See Examples 20 and 21.)

(ii) Adjustment of Future Payments Correction Method. (A) In General. In addition to the return of overpayment correction method, in the case of plan benefits that are being distributed in the form of periodic payments, Overpayments as a result of amounts being paid in excess of the limits in § 415(b) may be corrected by using the adjustment of future payments correction method set forth in this paragraph (1)(a)(ii). Future payments to the recipient are reduced so that they do not exceed the § 415(b) maximum limit and an additional reduction is made to recoup the Overpayment (over a period not longer than the remaining payment period) so that the actuarial present value of the additional reduction is equal to the Overpayment plus interest at the interest rate used by the plan to determine actuarial equivalence. (See Examples 18 and 19.)

(B) Joint and Survivor Annuity Payments. If the employee is receiving payments in the form of a joint and survivor annuity, with the employee’s spouse to receive a life annuity upon the employee’s death equal to a percentage (for example, 75%) of the amount being paid to the employee, the reduction of future annuity payments to reflect § 415(b) reduces the amount of benefits payable during the lives of both the employee and spouse, but any reduction to recoup Overpayments made to the employee does not reduce the amount of the spouse’s survivor benefit. Thus, the spouse’s benefit will be based on the previous specified percentage (for example, 75%) of the maximum permitted under § 415(b), instead of the reduced annual periodic amount payable to the employee.

(C) Overpayment Not Treated as an Excess Amount. An Overpayment corrected under this adjustment of future payment correction method is not treated as an Excess Amount as defined in section 5.01(3) of this revenue procedure.

(b) Examples.

Example 18:

Employer F maintains a defined benefit plan funded solely through employer contributions. The plan provides that the benefits of employees are limited to the maximum amount permitted under § 415(b), disregarding cost-of-living adjustments under § 415(d) after benefit payments have commenced. At the beginning of the 2006 plan year, Employee S retired and started receiving an annual straight life annuity of $185,000 from the plan. Due to an administrative error, the annual amount received by Employee S for 2006 included an Overpayment of $10,000 (because the § 415(b)(1)(A) limit for 2006 was $175,000). This error was discovered at the beginning of 2007.

Correction:

Employer F uses the adjustment of future payments correction method to correct the failure to satisfy the limit in § 415(b). Future annuity benefit payments to Employee S are reduced so that they do not exceed the § 415(b) maximum limit, and, in addition, Employee S’s future benefit payments from the plan are actuarially reduced to recoup the Overpayment. Accordingly, Employee S’s future benefit payments from the plan are reduced to $175,000 and further reduced by $1,000 annually for life, beginning in 2007. The annual benefit amount is reduced by $1,000 annually for life because, for Employee S, the actuarial present value of a benefit of $1,000 annually for life commencing in 2007 is equal to the sum of $10,000 and interest at the rate used by the plan to determine actuarial equivalence beginning with the date of the first Overpayment and ending with the date the reduced annuity payment begins. Thus, Employee S’s remaining benefit payments are reduced so that Employee S receives $174,000 for 2007, and for each year thereafter.

Example 19:

The facts are the same as in Example 18.

Correction:

Employer F uses the adjustments of future payments correction method to correct the § 415(b) failure, by recouping the entire excess payment made in 2006 from Employee S’s remaining benefit payments for 2007. Thus, Employee S’s annual annuity benefit for 2007 is reduced to $164,400 to reflect the excess benefit amounts (increased by interest) that were paid from the plan to Employee S during the 2006 plan year. Beginning in 2008, Employee S begins to receive annual benefit payments of $175,000.

Example 20:

The facts are the same as in Example 18, except that the benefit was paid to Employee S in the form of a single-sum distribution in 2006, which exceeded the maximum § 415(b) limits by $110,000.

Correction:

Employer F uses the return of overpayment correction method to correct the § 415(b) failure. Thus, Employer F notifies Employee S of the $110,000 Overpayment and that the Overpayment was not eligible for favorable tax treatment accorded to distributions from qualified plans (and, specifically, was not eligible for tax-free rollover). The notice also informs Employee S that the Overpayment (with interest at the rate used by the plan to calculate the single-sum payment) is owed to the plan. Employer F takes reasonable steps to have the Overpayment (with interest at the rate used by the plan to calculate the single-sum payment) paid to the plan. Employee S pays the $110,000 (plus the requested interest) to the plan. It is determined that the plan’s rate of return for the relevant period was 2 percentage points more than the rate used by the plan to calculate the single-sum payment. Accordingly, Employer F contributes the difference to the plan.

Example 21:

The facts are the same as in Example 20.

Correction:

Employer F uses the return of overpayment correction method to correct the § 415(b) failure. Thus, Employer F notifies Employee S of the $110,000 Overpayment and that the Overpayment was not eligible for favorable tax treatment accorded to distributions from qualified plans (and, specifically, was not eligible for tax-free rollover). The notice also informs Employee S that the Overpayment (with interest at the rate used by the plan to calculate the single-sum payment) is owed to the plan. Employer F takes reasonable steps to have the Overpayment (with interest at the rate used by the plan to calculate the single-sum payment) paid to the plan. As a result of Employer F’s recovery efforts, some, but not all, of the Overpayment (with interest) is recovered from Employee S. It is determined that the amount returned by Employee S to the plan is less than the Overpayment adjusted for Earnings at the plan’s rate of return. Accordingly, Employer F contributes the difference to the plan.

(2) Failures Relating to a § 415(c) Excess. (a) Correction Methods. (i) Appendix A Correction Method. Appendix A, section .08, sets forth the correction method for correcting the failure to satisfy the § 415(c) limits on annual additions.

(ii) Forfeiture Correction Method. In addition to the Appendix A correction method, the failure to satisfy § 415(c) with respect to a nonhighly compensated employee (A) who in the limitation year of the failure had annual additions consisting of both (I) either elective deferrals or after-tax employee contributions or both and (II) either matching or nonelective contributions or both, (B) for whom the matching and nonelective contributions equal or exceed the portion of the employee’s annual addition that exceeds the limits under § 415(c) (“§ 415(c) excess”) for the limitation year, and (C) who has terminated with no vested interest in the matching and nonelective contributions (and has not been reemployed at the time of the correction), may be corrected by using the forfeiture correction method set forth in this paragraph. The § 415(c) excess is deemed to consist solely of the matching and nonelective contributions. If the employee’s § 415(c) excess (adjusted for Earnings) has previously been forfeited, the § 415(c) failure is deemed to be corrected. If the § 415(c) excess (adjusted for Earnings) has not been forfeited, that amount is placed in an unallocated account, as described in section 6.06(2) of this revenue procedure, to be used to reduce employer nonelective contributions in succeeding year(s) (or if the amount would have been allocated to other employees who were in the plan for the year of the failure if the failure had not occurred, then that amount is reallocated to the other employees in accordance with the plan’s allocation formula). Note that while this correction method will permit more favorable tax treatment of elective deferrals for the employee than the Appendix A correction method, this correction method could be less favorable to the employee in certain cases, for example, if the employee is subsequently reemployed and becomes vested. (See Examples 22 and 23.)

(iii) Return of Overpayment Correction Method. A failure to satisfy § 415(c) that includes a distribution of the § 415(c) excess attributable to nonelective contributions and matching contributions may be corrected using the return of Overpayment correction method set forth in section 6.06(3) of this revenue procedure.

(b) Examples.

Example 22:

Employer G maintains a § 401(k) plan. The plan provides for nonelective employer contributions, elective deferrals, and after-tax employee contributions. The plan provides that the nonelective contributions vest under a 5-year cliff vesting schedule. The plan provides that when an employee terminates employment, the employee’s nonvested account balance is forfeited five years after a distribution of the employee’s vested account balance and that forfeitures are used to reduce employer contributions. For the 1998 limitation year, the annual additions made on behalf of two nonhighly compensated employees in the plan, Employees T and U, exceeded the limit in § 415(c). For the 1998 limitation year, Employee T had § 415 compensation of $60,000, and, accordingly, a § 415(c)(1)(B) limit of $15,000. Employee T made elective deferrals and after-tax employee contributions. For the 1998 limitation year, Employee U had § 415 compensation of $40,000, and, accordingly, a § 415(c)(1)(B) limit of $10,000. Employee U made elective deferrals. Also, on January 1, 1999, Employee U, who had three years of service with Employer G, terminated his employment and received his entire vested account balance (which consisted of his elective deferrals). The annual additions for Employees T and U consisted of:

T U
Nonelective Contributions $7,500 $4,500
Elective Deferrals $10,000 $5,800
After-tax Contributions $500 $0
Total Contributions $18,000 $10,300
§ 415(c) Limit $15,000 $10,000
§ 415(c) Excess $3,000 $300

Correction:

Employer G uses the Appendix A correction method to correct the § 415(c) excess with respect to Employee T (that is, $3,000). Thus, a distribution of plan assets (and corresponding reduction of the account balance) consisting of $500 (adjusted for Earnings) of after-tax employee contributions and $2,500 (adjusted for Earnings) of elective deferrals is made to Employee T. Employer G uses the forfeiture correction method to correct the § 415(c) excess with respect to Employee U. Thus, the § 415(c) excess is deemed to consist solely of the nonelective contributions. Accordingly, Employee U’s nonvested account balance is reduced by $300 (adjusted for Earnings) which is placed in an unallocated account, as described in section 6.06(2) of this revenue procedure, to be used to reduce employer contributions in succeeding year(s). After correction, it is determined that the ADP and ACP tests for 1998 were satisfied.

Example 23:

Employer H maintains a § 401(k) plan. The plan provides for nonelective employer contributions, matching contributions, and elective deferrals. The plan provides for matching contributions that are equal to 100% of an employee’s elective deferrals that do not exceed 8% of the employee’s plan compensation for the plan year. For the 1998 limitation year, Employee V had § 415 compensation of $50,000, and, accordingly, a § 415(c)(1)(B) limit of $12,500. During that limitation year, the annual additions for Employee V totaled $15,000, consisting of $5,000 in elective deferrals, a $4,000 matching contribution (8% of $50,000), and a $6,000 nonelective employer contribution. Thus, the annual additions for Employee V exceeded the § 415(c) limit by $2,500.

Correction:

Employer H uses the Appendix A correction method to correct the § 415(c) excess with respect to Employee V (that is, $2,500). Accordingly, $1,000 of the unmatched elective deferrals (adjusted for Earnings) are distributed to Employee V. The remaining $1,500 excess is apportioned equally between the elective deferrals and the associated matching employer contributions, so Employee V’s account balance is further reduced by distributing to Employee V $750 (adjusted for Earnings) of the elective deferrals and forfeiting $750 (adjusted for Earnings) of the associated employer matching contributions. The forfeited matching contributions are placed in an unallocated account, as described in section 6.06(2) of this revenue procedure, to be used to reduce employer contributions in succeeding year(s). After correction, it is determined that the ADP and ACP tests for 1998 were satisfied.

.05 Correction of Other Overpayment Failures. An Overpayment, other than one described in section 2.04(1) (relating to a § 415(b) excess) or section 2.04(2) (relating to a § 415(c) excess), may be corrected in accordance with this section 2.05. An Overpayment from a defined benefit plan is corrected in accordance with the rules in section 2.04(1). An Overpayment from a defined contribution plan is corrected in accordance with the rules in section 2.04(2)(a)(iii).

.06 § 401(a)(17) Failures. (1) Reduction of Account Balance Correction Method. The allocation of contributions or forfeitures under a defined contribution plan for a plan year on the basis of compensation in excess of the limit under § 401(a)(17) for the plan year may be corrected using the reduction of account balance correction method set forth in section 6.06(2) of this revenue procedure.

(2) Example.

Example 24:

Employer J maintains a money purchase pension plan. Under the plan, an eligible employee is entitled to an employer contribution of 8% of the employee’s compensation up to the § 401(a)(17) limit ($220,000 for 2006). During the 2006 plan year, an eligible employee, Employee W, inadvertently was credited with a contribution based on compensation above the § 401(a)(17) limit. Employee W’s compensation for 2006 was $250,000. Employee W received a contribution of $20,000 for 2006 (8% of $250,000), rather than the contribution of $17,600 (8% of $220,000) provided by the plan for that year, resulting in an improper allocation of $2,400.

Correction:

The § 401(a)(17) failure is corrected using the reduction of account balance method by reducing Employee W’s account balance by $2,400 (adjusted for Earnings) and crediting that amount to an unallocated account, as described in section 6.06(2) of this revenue procedure, to be used to reduce employer contributions in succeeding year(s).

.07 Correction by Amendment. (1) Section 401(a)(17) Failures. (a) Contribution Correction Method. In addition to the reduction of account balance correction method under section 6.06(2) of this revenue procedure, a Plan Sponsor may correct a § 401(a)(17) failure for a plan year under a defined contribution plan by using the contribution correction method set forth in this paragraph. The Plan Sponsor contributes an additional amount on behalf of each of the other employees (excluding each employee for whom there was a § 401(a)(17) failure) who received an allocation for the year of the failure, and amends the plan (as necessary) to provide for the additional allocation. The amount contributed for an employee is equal to the employee’s plan compensation for the year of the failure multiplied by a fraction, the numerator of which is the improperly allocated amount made on behalf of the employee with the largest improperly allocated amount, and the denominator of which is the limit under § 401(a)(17) applicable to the year of the failure. The resulting additional amount for each of the other employees is adjusted for Earnings. (See Example 25.)

(b) Example.

Example 25:

The facts are the same as in Example 24.

Correction:

Employer J corrects the failure under VCP using the contribution correction method by (1) amending the plan to increase the contribution percentage for all eligible employees (other than Employee W) for the 2003 plan year and (2) contributing an additional amount (adjusted for Earnings) for those employees for that plan year. To determine the increase in the plan’s contribution percentage (and the additional amount contributed on behalf of each eligible employee), the improperly allocated amount ($2,400) is divided by the § 401(a)(17) limit for 2006 ($220,000). Accordingly, the plan is amended to increase the contribution percentage by 1.09 percentage points ($2,400/$220,000) from 8% to 9.09%. In addition, each eligible employee for the 2006 plan year (other than Employee W) receives an additional contribution of 1.09% multiplied by that employee’s plan compensation for 2006. This additional contribution is adjusted for Earnings.

(2) Hardship Distribution Failures and Plan Loan Failures. (a) Plan Amendment Correction Method. The Operational Failure of making hardship distributions to employees under a plan that does not provide for hardship distributions may be corrected using the plan amendment correction method set forth in this paragraph. The plan is amended retroactively to provide for the hardship distributions that were made available. This paragraph does not apply unless (i) the amendment satisfies § 401(a), and (ii) the plan as amended would have satisfied the qualification requirements of § 401(a) (including the requirements applicable to hardship distributions under § 401(k), if applicable) had the amendment been adopted when hardship distributions were first made available. (See Example 26.) The Plan Amendment Correction Method is also available for the Operational Failure of permitting plan loans to employees under a plan that does not provide for plan loans. The plan is amended retroactively to provide for the plan loans that were made available. This paragraph does not apply unless (i) the amendment satisfies § 401(a), and (ii) the plan as amended would have satisfied the qualification requirements of § 401(a) (and the requirements applicable to plan loans under § 72(p)) had the amendment been adopted when plan loans were first made available.

(b) Example.

Example 26:

Employer K, a for-profit corporation, maintains a § 401(k) plan. Although plan provisions in 2005 did not provide for hardship distributions, beginning in 2005 hardship distributions of amounts allowed to be distributed under § 401(k) were made currently and effectively available to all employees (within the meaning of § l.401(a)(4)–4). The standard used to determine hardship satisfied the deemed hardship distribution standards in § 1.401(k)–1(d). Hardship distributions were made to a number of employees during the 2005 and 2006 plan years, creating an Operational Failure. The failure was discovered in 2007.

Correction:

Employer K corrects the failure under VCP by adopting a plan amendment in 2007, effective January 1, 2005, to provide a hardship distribution option that satisfies the rules applicable to hardship distributions in § 1.401(k)–1(d). The amendment provides that the hardship distribution option is available to all employees. Thus, the amendment satisfies § 401(a), and the plan as amended in 2007 would have satisfied § 401(a) (including § 1.401(a)(4)–4 and the requirements applicable to hardship distributions under § 401(k)) if the amendment had been adopted in 2005.

(3) Early Inclusion of Otherwise Eligible Employee Failure. (a) Plan Amendment Correction Method. The Operational Failure of including an otherwise eligible employee in the plan who either (i) has not completed the plan’s minimum age or service requirements, or (ii) has completed the plan’s minimum age or service requirements but became a participant in the plan on a date earlier than the applicable plan entry date, may be corrected by using the plan amendment correction method set forth in this paragraph. The plan is amended retroactively to change the eligibility or entry date provisions to provide for the inclusion of the ineligible employee to reflect the plan’s actual operations. The amendment may change the eligibility or entry date provisions with respect to only those ineligible employees that were wrongly included, and only to those ineligible employees, provided (i) the amendment satisfies § 401(a) at the time it is adopted, (ii) the amendment would have satisfied § 401(a) had the amendment been adopted at the earlier time when it is effective, and (iii) the employees affected by the amendment are predominantly nonhighly compensated employees. For a defined benefit plan, a contribution may have to be made to the plan for a correction that is accomplished through a plan amendment if the plan is subject to the requirements of § 436(c) at the time of the amendment, as described in section 6.02(4)(e)(ii).

(b) Example.

Example 27:

Employer L maintains a § 401(k) plan applicable to all of its employees who have at least six months of service. The plan is a calendar year plan. The plan provides that Employer L will make matching contributions based upon an employee’s salary reduction contributions. In 2007, it is discovered that all four employees who were hired by Employer L in 2006 were permitted to make salary reduction contributions to the plan effective with the first weekly paycheck after they were employed. Three of the four employees are nonhighly compensated. Employer L matched these employees’ salary reduction contributions in accordance with the plan’s matching contribution formula. Employer L calculates the ADP and ACP tests for 2006 (taking into account the salary reduction and matching contributions that were made for these employees) and determines that the tests were satisfied.

Correction:

Employer L corrects the failure under SCP by adopting a plan amendment, effective for employees hired on or after January 1, 2006, to provide that there is no service eligibility requirement under the plan and submitting the amendment to the IRS for a determination letter.

SECTION 3. EARNINGS ADJUSTMENT METHODS AND EXAMPLES

.01 Earnings Adjustment Methods. (1) In general. (a) Under section 6.02(4)(a) of this revenue procedure, whenever the appropriate correction method for an Operational Failure in a defined contribution plan includes a corrective contribution or allocation that increases one or more employees’ account balances (now or in the future), the contribution or allocation is adjusted for Earnings and forfeitures. This section 3 provides Earnings adjustment methods (but not forfeiture adjustment methods) that may be used by a Plan Sponsor to adjust a corrective contribution or allocation for Earnings in a defined contribution plan. Consequently, these Earnings adjustment methods may be used to determine the Earnings adjustments for corrective contributions or allocations made under the correction methods in section 2 and under the correction methods in Appendix A. If an Earnings adjustment method in this section 3 is used to adjust a corrective contribution or allocation, that adjustment is treated as satisfying the Earnings adjustment requirement of section 6.02(4)(a) of this revenue procedure. Other Earnings adjustment methods, different from those illustrated in this section 3, may also be appropriate for adjusting corrective contributions or allocations to reflect Earnings.

(b) Under the Earnings adjustment methods of this section 3, a corrective contribution or allocation that increases an employee’s account balance is adjusted to reflect an “earnings amount” that is based on the Earnings rate(s) (determined under section 3.01(3)) for the period of the failure (determined under section 3.01(2)). The Earnings amount is allocated in accordance with section 3.01(4).

(c) The rule in section 6.02(5)(a) of this revenue procedure permitting reasonable estimates in certain circumstances applies for purposes of this section 3. For this purpose, a determination of Earnings made in accordance with the rules of administrative convenience set forth in this section 3 is treated as a precise determination of Earnings. Thus, if the probable difference between an approximate determination of Earnings and a determination of Earnings under this section 3 is insignificant and the administrative cost of a precise determination would significantly exceed the probable difference, reasonable estimates may be used in calculating the appropriate Earnings.

(d) This section 3 does not apply to corrective distributions or corrective reductions in account balances. Thus, for example, while this section 3 applies in increasing the account balance of an improperly excluded employee to correct the exclusion of the employee under the reallocation correction method described in section 2.02(2)(a)(iii)(B), this section 3 does not apply in reducing the account balances of other employees under the reallocation correction method. (See section 2.02(2)(a)(iii)(C) for rules that apply to the Earnings adjustments for such reductions.) In addition, this section 3 does not apply in determining Earnings adjustments under the one-to-one correction method described in section 2.01(1)(b)(iii).

(2) Period of the Failure. (a) General Rule. For purposes of this section 3, the “period of the failure” is the period from the date that the failure began through the date of correction. For example, in the case of an improper forfeiture of an employee’s account balance, the beginning of the period of the failure is the date as of which the account balance was improperly reduced. See section 6.02(4)(f) of this revenue procedure.

(b) Rules for Beginning Date for Exclusion of Eligible Employees from Plan. (i) General Rule. In the case of an exclusion of an eligible employee from a plan contribution, the beginning of the period of the failure is the date on which contributions of the same type (for example, elective deferrals, matching contributions, or discretionary nonelective employer contributions) were made for other employees for the year of the failure. In the case of an exclusion of an eligible employee from an allocation of a forfeiture, the beginning of the period of the failure is the date on which forfeitures were allocated to other employees for the year of the failure.

(ii) Exclusion from a § 401(k) or (m) Plan. For administrative convenience, for purposes of calculating the Earnings rate for corrective contributions for a plan year (or the portion of the plan year) during which an employee was improperly excluded from making periodic elective deferrals or after-tax employee contributions, or from receiving periodic matching contributions, the Plan Sponsor may treat the date on which the contributions would have been made as the midpoint of the plan year (or the midpoint of the portion of the plan year) for which the failure occurred. Alternatively, in this case, the Plan Sponsor may treat the date on which the contributions would have been made as the first date of the plan year (or the portion of the plan year) during which an employee was excluded, provided that the Earnings rate used is one half of the Earnings rate applicable under section 3.01(3) for the plan year (or the portion of the plan year) for which the failure occurred.

(3) Earnings Rate. (a) General Rule. For purposes of this section 3, the Earnings rate generally is based on the investment results that would have applied to the corrective contribution or allocation if the failure had not occurred.

(b) Multiple Investment Funds. If a plan permits employees to direct the investment of account balances into more than one investment fund, the Earnings rate is based on the rate applicable to the employee’s investment choices for the period of the failure. For administrative convenience, if most of the employees for whom the corrective contribution or allocation is made are nonhighly compensated employees, the rate of return of the fund with the highest rate of return under the plan for the period of the failure may be used to determine the Earnings rate for all corrective contributions or allocations. If the employee had not made any applicable investment choices, the Earnings rate may be based on the rate of return under the plan as a whole (that is, the average of the rates earned by all of the funds in the valuation periods during the period of the failure weighted by the portion of the plan assets invested in the various funds during the period of the failure).

(c) Other Simplifying Assumptions. For administrative convenience, the Earnings rate applicable to the corrective contribution or allocation for a valuation period with respect to any investment fund may be assumed to be the actual Earnings rate for the plan’s investments in that fund during that valuation period. For example, the Earnings rate may be determined without regard to any special investment provisions that vary according to the size of the fund. Further, the Earnings rate applicable to the corrective contribution or allocation for a portion of a valuation period may be a pro rata portion of the Earnings rate for the entire valuation period, unless the application of this rule would result in either a significant understatement or overstatement of the actual Earnings during that portion of the valuation period.

(4) Allocation Methods. (a) In General. For purposes of this section 3, the Earnings amount generally may be allocated in accordance with any of the methods set forth in this paragraph (4). The methods under paragraph (4)(c), (d), and (e) are intended to be particularly helpful where corrective contributions are made at dates between the plan’s valuation dates.

(b) Plan Allocation Method. Under the plan allocation method, the Earnings amount is allocated to account balances under the plan in accordance with the plan’s method for allocating Earnings as if the failure had not occurred. (See, Example 28.)

(c) Specific Employee Allocation Method. Under the specific employee allocation method, the entire Earnings amount is allocated solely to the account balance of the employee on whose behalf the corrective contribution or allocation is made (regardless of whether the plan’s allocation method would have allocated the Earnings solely to that employee). In determining the allocation of plan Earnings for the valuation period during which the corrective contribution or allocation is made, the corrective contribution or allocation (including the Earnings amount) is treated in the same manner as any other contribution under the plan on behalf of the employee during that valuation period. Alternatively, where the plan’s allocation method does not allocate plan Earnings for a valuation period to a contribution made during that valuation period, plan Earnings for the valuation period during which the corrective contribution or allocation is made may be allocated as if that employee’s account balance had been increased as of the last day of the prior valuation period by the corrective contribution or allocation, including only that portion of the Earnings amount attributable to Earnings through the last day of the prior valuation period. The employee’s account balance is then further increased as of the last day of the valuation period during which the corrective contribution or allocation is made by that portion of the Earnings amount attributable to Earnings after the last day of the prior valuation period. (See Example 29.)

(d) Bifurcated Allocation Method. Under the bifurcated allocation method, the entire Earnings amount for the valuation periods ending before the date the corrective contribution or allocation is made is allocated solely to the account balance of the employee on whose behalf the corrective contribution or allocation is made. The Earnings amount for the valuation period during which the corrective contribution or allocation is made is allocated in accordance with the plan’s method for allocating other Earnings for that valuation period in accordance with section 3.01(4)(b). (See Example 30.)

(e) Current Period Allocation Method. Under the current period allocation method, the portion of the Earnings amount attributable to the valuation period during which the period of the failure begins (“first partial valuation period”) is allocated in the same manner as Earnings for the valuation period during which the corrective contribution or allocation is made in accordance with section 3.01(4)(b). The Earnings for the subsequent full valuation periods ending before the beginning of the valuation period during which the corrective contribution or allocation is made are allocated solely to the employee for whom the required contribution should have been made. The Earnings amount for the valuation period during which the corrective contribution or allocation is made (“second partial valuation period”) is allocated in accordance with the plan’s method for allocating other Earnings for that valuation period in accordance with section 3.01(4)(b). (See Example 31.)

.02 Examples.

Example 28:

Employer L maintains a profit-sharing plan that provides only for nonelective contributions. The plan has a single investment fund. Under the plan, assets are valued annually (the last day of the plan year) and Earnings for the year are allocated in proportion to account balances as of the last day of the prior year, after reduction for distributions during the current year but without regard to contributions received during the current year (the “prior year account balance”). Plan contributions for 1997 were made on March 31, 1998. On April 20, 2000, Employer L determines that an operational failure occurred for 1997 because Employee X was improperly excluded from the plan. Employer L decides to correct the failure by using the Appendix A correction method for the exclusion of an eligible employee from nonelective contributions in a profit-sharing plan. Under this method, Employer L determines that this failure is corrected by making a contribution on behalf of Employee X of $5,000 (adjusted for Earnings). The Earnings rate under the plan for 1998 was +20%. The Earnings rate under the plan for 1999 was +10%. On May 15, 2000, when Employer L determines that a contribution to correct for the failure will be made on June 1, 2000, a reasonable estimate of the Earnings rate under the plan from January 1, 2000 to June 1, 2000 is +12%.

Earnings Adjustment on the Corrective Contribution:

The $5,000 corrective contribution on behalf of Employee X is adjusted to reflect an earnings amount based on the Earnings rates for the period of the failure (March 31, 1998 through June 1, 2000) and the earnings amount is allocated using the plan allocation method. Employer L determines that a pro rata simplifying assumption may be used to determine the Earnings rate for the period from March 31, 1998 to December 31, 1998, because that rate does not significantly understate or overstate the actual investment return for that period. Accordingly, Employer L determines that the Earnings rate for that period is 15% (9/12 of the plan’s 20% Earnings rate for the year). Thus, applicable Earnings rates under the plan during the period of the failure are:

Time Periods Earnings Rate
3/31/98 – 12/31/98 (First Partial Valuation Period) +15%
1/1/99 – 12/31/99 +10%
1/1/00 – 6/1/00 (Second Partial Valuation Period) +12%

If the $5,000 corrective contribution had been contributed for Employee X on March 31, 1998, (1) Earnings for 1998 would have been increased by the amount of the Earnings on the additional $5,000 contribution from March 31, 1998 through December 31, 1998 and would have been allocated as 1998 Earnings in proportion to the prior year (December 31, 1997) account balances, (2) Employee X’s account balance as of December 31, 1998 would have been increased by the additional $5,000 contribution, (3) Earnings for 1999 would have been increased by the 1999 Earnings on the additional $5,000 contribution (including 1998 Earnings thereon) allocated in proportion to the prior year (December 31, 1998) account balances along with other 1999 Earnings, and (4) Earnings for 2000 would have been increased by the Earnings on the additional $5,000 (including 1998 and 1999 Earnings thereon) from January 1 to June 1, 2000 and would be allocated in proportion to the prior year (December 31, 1999) account balances along with other 2000 Earnings. Accordingly, the $5,000 corrective contribution is adjusted to reflect an Earnings amount of $2,084 ($5,000[(1.15)(1.10)(1.12)–1]) and the earnings amount is allocated to the account balances under the plan allocation method as follows:

(a) Each account balance that shared in the allocation of Earnings for 1998 is increased, as of December 31, 1998, by its appropriate share of the Earnings amount for 1998, $750 ($5,000(.15)).

(b) Employee X’s account balance is increased, as of December 31, 1998, by $5,000.

(c) The resulting December 31, 1998 account balances will share in the 1999 Earnings, including the $575 for 1999 Earnings included in the corrective contribution ($5,750(.10)), to determine the account balances as of December 31, 1999. However, each account balance other than Employee X’s account balance has already shared in the 1999 Earnings, excluding the $575. Accordingly, Employee X’s account balance as of December 31, 1999 will include $500 of the 1999 portion of the earnings amount based on the $5,000 corrective contribution allocated to Employee X’s account balance as of December 31, 1998 ($5,000(.10)). Then each account balance that originally shared in the allocation of Earnings for 1999 (that is, excluding the $5,500 additions to Employee X’s account balance) is increased by its appropriate share of the remaining 1999 portion of the earnings amount, $75.

(d) The resulting December 31, 1999 account balances (including the $5,500 additions to Employee X’s account balance) will share in the 2000 portion of the earnings amount based on the estimated January 1, 2000 to June 1, 2000 Earnings included in the corrective contribution equal to $759 ($6,325(.12)). (See Table 1.)

TABLE 1

CALCULATION AND ALLOCATION OF THE CORRECTIVE AMOUNT ADJUSTED FOR EARNINGS

Earnings Rate Amount Allocated to
Corrective Contribution $5,000 Employee X
First Partial Valuation Period Earnings 15% $7501 All 12/31/1997 Account Balances4
1999 Earnings 10% $5752 Employee X ($500)/ All 12/31/1998 Account Balances ($75)4
Second Partial Valuation Period Earnings 12% $7593 All 12/31/1999 Account Balances (including Employee X’s $5,500)4
Total Amount Contributed $7,084
1$5,000 × 15%
2$5,750 ($5,000 + $750) × 10%
3$6,325 ($5,000 + $750 + $575) × 12%
4After reduction for distributions during the year for which Earnings are being determined but without regard to contributions received during the year for which Earnings are being determined.

Example 29:

The facts are the same as in Example 28.

Earnings Adjustment on the Corrective Contribution:

The earnings amount on the corrective contribution is the same as in Example 28, but the earnings amount is allocated using the specific employee allocation method. Thus, the entire earnings amount for all periods through June 1, 2000 (that is, $750 for March 31, 1998 to December 31, 1998, $575 for 1999, and $759 for January 1, 2000 to June 1, 2000) is allocated to Employee X. Accordingly, Employer L makes a contribution on June 1, 2000 to the plan of $7,084 ($5,000(1.15)(1.10)(1.12)). Employee X’s account balance as of December 31, 2000 is increased by $7,084. Alternatively, Employee X’s account balance as of December 31, 1999 is increased by $6,325 ($5,000(1.15)(1.10)), which shares in the allocation of Earnings for 2000, and Employee X’s account balance as of December 31, 2000 is increased by the remaining $759. (See Table 2.)

TABLE 2

CALCULATION AND ALLOCATION OF THE

CORRECTIVE AMOUNT ADJUSTED FOR EARNINGS

Earnings Rate Amount Allocated to:
Corrective Contribution $5,000 Employee X
First Partial Valuation Period Earnings 15% $7501 Employee X
1999 Earnings 10% $5752 Employee X
Second Partial Valuation Period Earnings 12% $7593 Employee X
Total Amount Contributed $7,084
1$5,000 x 15%
2$5,750($5,000 +$750) x 10%
3$6,325($5,000 +$750 + $575) x 12%

Example 30:

The facts are the same as in Example 28.

Earnings Adjustment on the Corrective Contribution:

The earnings amount on the corrective contribution is the same as in Example 28, but the earnings amount is allocated using the bifurcated allocation method. Thus, the Earnings for the first partial valuation period (March 31, 1998 to December 31, 1998) and the Earnings for 1999 are allocated to Employee X. Accordingly, Employer L makes a contribution on June 1, 2000 to the plan of $7,084 ($5,000(1.15)(1.10)(1.12)). Employee X’s account balance as of December 31, 1999 is increased by $6,325 ($5,000(1.15)(1.10)); and the December 31, 1999 account balances of employees (including Employee X’s increased account balance) will share in estimated January 1, 2000 to June 1, 2000 Earnings on the corrective contribution equal to $759 ($6,325(.12)). (See, Table 3.)

TABLE 3

CALCULATION AND ALLOCATION OF THE CORRECTIVE AMOUNT ADJUSTED FOR EARNINGS

Earnings Rate Amount Allocated to:
Corrective Contribution $5,000 Employee X
First Partial Valuation Period Earnings 15% $7501 Employee X
1999 Earnings 10% $5752 Employee X
Second Partial Valuation Period Earnings 12% $7593 12/31/99 Account Balances (including Employee X’s $6,325)4
Total Amount Contributed $7,084
1$5,000 x 15%
2$5,750($5,000 + $750) x 10%
3$6,325($5,000 +$750 +$575) x 12%
4After reduction for distributions during the 2000 year but without regard to contributions received during the 2000 year.

Example 31:

The facts are the same as in Example 28.

Earnings Adjustment on the Corrective Contribution:

The earnings amount on the corrective contribution is the same as in Example 28, but the earnings amount is allocated using the current period allocation method. Thus, the Earnings for the first partial valuation period (March 31, 1998 to December 31, 1998) are allocated as 2000 Earnings. Accordingly, Employer L makes a contribution on June 1, 2000 to the plan of $7,084 ($5,000 (1.15)(1.10)(1.12)). Employee X’s account balance as of December 31, 1999 is increased by the sum of $5,500 ($5,000(1.10)) and the remaining 1999 Earnings on the corrective contribution equal to $75 ($5,000(.15)(.10)). Further, both (1) the estimated March 31, 1998 to December 31, 1998 Earnings on the corrective contribution equal to $750 ($5,000(.15)) and (2) the estimated January 1, 2000 to June 1, 2000 Earnings on the corrective contribution equal to $759 ($6,325(.12)) are treated in the same manner as 2000 Earnings by allocating these amounts to the December 31, 2000 account balances of employees in proportion to account balances as of December 31, 1999 (including Employee X’s increased account balance). (See, Table 4.) Thus, Employee X is allocated the Earnings for the full valuation period during the period of the failure.

TABLE 4

CALCULATION AND ALLOCATION OF THE CORRECTIVE AMOUNT ADJUSTED FOR EARNINGS

Earnings Rate Amount Allocated to:
Corrective Contribution $5,000 Employee X
First Partial Valuation Period Earnings 15% $7501 12/31/99 Account Balances (including Employee X’s $5,575)4
1999 Earnings 10% $5752 Employee X
Second Partial Valuation Period Earnings 12% $7593 12/31/99 Account Balances (including Employee X’s $5,575)1
Total Amount Contributed $7,084
1$5,000 x 15%
2$5,750 ($5,000 +$750) x 10%
3$6,325 ($5,000 +$750 +$575) x 12%
4After reduction for distributions during the year for which Earnings are being determined but without regard to contributions received during the year for which Earnings are being determined.

Rev. Proc. 2016–52

SECTION 1. PURPOSE

This revenue procedure publishes the amounts of unused housing credit carryovers allocated to qualified states under § 42(h)(3)(D) of the Internal Revenue Code for calendar year 2016.

SECTION 2. BACKGROUND

Rev. Proc. 92–31, 1992–1 C.B. 775, provides guidance to state housing credit agencies of qualified states on the procedure for requesting an allocation of unused housing credit carryovers under § 42(h)(3)(D). Section 4.06 of Rev. Proc. 92–31 provides that the Internal Revenue Service will publish in the Internal Revenue Bulletin the amount of unused housing credit carryovers allocated to qualified states for a calendar year from a national pool of unused credit authority (the National Pool). This revenue procedure publishes these amounts for calendar year 2016.

SECTION 3. PROCEDURE

The unused housing credit carryover amount allocated from the National Pool by the Secretary to each qualified state for calendar year 2016 is as follows:

Qualified State Amount Allocated
Alabama 51,684
Arizona 72,629
California 416,376
Connecticut 38,196
Delaware 10,062
Florida 215,622
Georgia 108,654
Idaho 17,603
Illinois 136,789
Kansas 30,971
Kentucky 47,069
Louisiana 49,682
Maine 14,140
Maryland 63,889
Massachusetts 72,271
Michigan 105,545
Minnesota 58,392
Nebraska 20,169
Nevada 30,749
New Jersey 95,285
New Mexico 22,179
New York 210,564
North Carolina 106,823
North Dakota 8,051
Ohio 123,530
Oklahoma 41,604
Oregon 42,855
Pennsylvania 136,178
South Dakota 9,131
Utah 31,867
Virginia 89,168
Washington 76,270
West Virginia 19,616
Wisconsin 61,389

EFFECTIVE DATE

This revenue procedure is effective for allocations of housing credit dollar amounts attributable to the National Pool component of a qualified state’s housing credit ceiling for calendar year 2016.

DRAFTING INFORMATION

The principal author of this revenue procedure is James A. Holmes of the Office of Associate Chief Counsel (Passthroughs and Special Industries). For further information regarding this revenue procedure, contact Mr. Holmes at (202) 317-4137 (not a toll-free number).

Definition of Terms and Abbreviations

Definition of Terms

Revenue rulings and revenue procedures (hereinafter referred to as “rulings”) that have an effect on previous rulings use the following defined terms to describe the effect:

Amplified describes a situation where no change is being made in a prior published position, but the prior position is being extended to apply to a variation of the fact situation set forth therein. Thus, if an earlier ruling held that a principle applied to A, and the new ruling holds that the same principle also applies to B, the earlier ruling is amplified. (Compare with modified, below).

Clarified is used in those instances where the language in a prior ruling is being made clear because the language has caused, or may cause, some confusion. It is not used where a position in a prior ruling is being changed.

Distinguished describes a situation where a ruling mentions a previously published ruling and points out an essential difference between them.

Modified is used where the substance of a previously published position is being changed. Thus, if a prior ruling held that a principle applied to A but not to B, and the new ruling holds that it applies to both A and B, the prior ruling is modified because it corrects a published position. (Compare with amplified and clarified, above).

Obsoleted describes a previously published ruling that is not considered determinative with respect to future transactions. This term is most commonly used in a ruling that lists previously published rulings that are obsoleted because of changes in laws or regulations. A ruling may also be obsoleted because the substance has been included in regulations subsequently adopted.

Revoked describes situations where the position in the previously published ruling is not correct and the correct position is being stated in a new ruling.

Superseded describes a situation where the new ruling does nothing more than restate the substance and situation of a previously published ruling (or rulings). Thus, the term is used to republish under the 1986 Code and regulations the same position published under the 1939 Code and regulations. The term is also used when it is desired to republish in a single ruling a series of situations, names, etc., that were previously published over a period of time in separate rulings. If the new ruling does more than restate the substance of a prior ruling, a combination of terms is used. For example, modified and superseded describes a situation where the substance of a previously published ruling is being changed in part and is continued without change in part and it is desired to restate the valid portion of the previously published ruling in a new ruling that is self contained. In this case, the previously published ruling is first modified and then, as modified, is superseded.

Supplemented is used in situations in which a list, such as a list of the names of countries, is published in a ruling and that list is expanded by adding further names in subsequent rulings. After the original ruling has been supplemented several times, a new ruling may be published that includes the list in the original ruling and the additions, and supersedes all prior rulings in the series.

Suspended is used in rare situations to show that the previous published rulings will not be applied pending some future action such as the issuance of new or amended regulations, the outcome of cases in litigation, or the outcome of a Service study.

Abbreviations

The following abbreviations in current use and formerly used will appear in material published in the Bulletin.

A—Individual.

Acq.—Acquiescence.

B—Individual.

BE—Beneficiary.

BK—Bank.

B.T.A.—Board of Tax Appeals.

C—Individual.

C.B.—Cumulative Bulletin.

CFR—Code of Federal Regulations.

CI—City.

COOP—Cooperative.

Ct.D.—Court Decision.

CY—County.

D—Decedent.

DC—Dummy Corporation.

DE—Donee.

Del. Order—Delegation Order.

DISC—Domestic International Sales Corporation.

DR—Donor.

E—Estate.

EE—Employee.

E.O.—Executive Order.

ER—Employer.

ERISA—Employee Retirement Income Security Act.

EX—Executor.

F—Fiduciary.

FC—Foreign Country.

FICA—Federal Insurance Contributions Act.

FISC—Foreign International Sales Company.

FPH—Foreign Personal Holding Company.

F.R.—Federal Register.

FUTA—Federal Unemployment Tax Act.

FX—Foreign corporation.

G.C.M.—Chief Counsel’s Memorandum.

GE—Grantee.

GP—General Partner.

GR—Grantor.

IC—Insurance Company.

I.R.B.—Internal Revenue Bulletin.

LE—Lessee.

LP—Limited Partner.

LR—Lessor.

M—Minor.

Nonacq.—Nonacquiescence.

O—Organization.

P—Parent Corporation.

PHC—Personal Holding Company.

PO—Possession of the U.S.

PR—Partner.

PRS—Partnership.

PTE—Prohibited Transaction Exemption.

Pub. L.—Public Law.

REIT—Real Estate Investment Trust.

Rev. Proc.—Revenue Procedure.

Rev. Rul.—Revenue Ruling.

S—Subsidiary.

S.P.R.—Statement of Procedural Rules.

Stat.—Statutes at Large.

T—Target Corporation.

T.C.—Tax Court.

T.D.—Treasury Decision.

TFE—Transferee.

TFR—Transferor.

T.I.R.—Technical Information Release.

TP—Taxpayer.

TR—Trust.

TT—Trustee.

U.S.C.—United States Code.

X—Corporation.

Y—Corporation.

Z—Corporation.

Numerical Finding List

Numerical Finding List

A cumulative list of all revenue rulings, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 2016–01 through 2016–26 is in Internal Revenue Bulletin 2016–26, dated June 27, 2016.

Bulletin 2016–27 through 2016–42

Action on Decision:

Article Issue Link Page
2016-01 2016-16 I.R.B. 2016-16 580
2016-02 2016-31 I.R.B. 2016-31 193
2016-03 2016-40 I.R.B. 2016-40 424


Announcements:

Article Issue Link Page
2016-21 2016-27 I.R.B. 2016-27 8
2016-23 2016-27 I.R.B. 2016-27 10
2016-24 2016-30 I.R.B. 2016-30 170
2016-25 2016-31 I.R.B. 2016-31 205
2016-26 2016-38 I.R.B. 2016-38 389
2016-27 2016-33 I.R.B. 2016-33 238
2016-28 2016-34 I.R.B. 2016-34 272
2016-29 2016-34 I.R.B. 2016-34 272
2016-30 2016-37 I.R.B. 2016-37 355
2016-31 2016-38 I.R.B. 2016-38 392
2016-32 2016-40 I.R.B. 2016-40 434
2016-33 2016-39 I.R.B. 2016-39 422
2016-34 2016-39 I.R.B. 2016-39 422
2016-35 2016-39 I.R.B. 2016-39 423
2016-36 2016-39 I.R.B. 2016-39 423
2016-37 2016-39 I.R.B. 2016-39 423


Notices:

Article Issue Link Page
2016-40 2016-27 I.R.B. 2016-27 4
2016-41 2016-27 I.R.B. 2016-27 5
2016-42 2016-29 I.R.B. 2016-29 67
2016-43 2016-29 I.R.B. 2016-29 132
2016-44 2016-29 I.R.B. 2016-29 132
2016-45 2016-29 I.R.B. 2016-29 135
2016-46 2016-31 I.R.B. 2016-31 202
2016-47 2016-35 I.R.B. 2016-35 276
2016-48 2016-33 I.R.B. 2016-33 235
2016-49 2016-34 I.R.B. 2016-34 265
2016-50 2016-38 I.R.B. 2016-38 384
2016-51 2016-37 I.R.B. 2016-37 344
2016-52 2016-40 I.R.B. 2016-40 425
2016-53 2016-39 I.R.B. 2016-39 421
2016-54 2016-40 I.R.B. 2016-40 429
2016-55 2016-40 I.R.B. 2016-40 432
2016-57 2016-40 I.R.B. 2016-40 432
2016-58 2016-41 I.R.B. 2016-41 438
2016-59 2016-42 I.R.B. 2016-42 457
2016-60 2016-42 I.R.B. 2016-42 458


Proposed Regulations:

Article Issue Link Page
REG-163113-02 2016-36 I.R.B. 2016-36 329
REG-147196-07 2016-29 I.R.B. 2016-29 32
REG-123854-12 2016-28 I.R.B. 2016-28 15
REG-131418-14 2016-33 I.R.B. 2016-33 248
REG-102516-15 2016-32 I.R.B. 2016-32 231
REG-109086-15 2016-30 I.R.B. 2016-30 171
REG-134016-15 2016-31 I.R.B. 2016-31 205
REG-101689-16 2016-30 I.R.B. 2016-30 170
REG-103058-16 2016-33 I.R.B. 2016-33 238
REG-105005-16 2016-38 I.R.B. 2016-38 380
REG-108792-16 2016-36 I.R.B. 2016-36 320


Revenue Procedures:

Article Issue Link Page
2016-37 2016-29 I.R.B. 2016-29 136
2016-39 2016-30 I.R.B. 2016-30 164
2016-40 2016-32 I.R.B. 2016-32 228
2016-41 2016-30 I.R.B. 2016-30 165
2016-42 2016-34 I.R.B. 2016-34 269
2016-43 2016-36 I.R.B. 2016-36 316
2016-44 2016-36 I.R.B. 2016-36 316
2016-45 2016-37 I.R.B. 2016-37 344
2016-46 2016-37 I.R.B. 2016-37 345
2016-47 2016-37 I.R.B. 2016-37 346
2016-48 2016-37 I.R.B. 2016-37 348
2016-49 2016-42 I.R.B. 2016-42 462
2016-51 2016-42 I.R.B. 2016-42 465
2016-52 2016-42 I.R.B. 2016-42 520


Revenue Rulings:

Article Issue Link Page
2016-17 2016-27 I.R.B. 2016-27 1
2016-18 2016-31 I.R.B. 2016-31 194
2016-19 2016-35 I.R.B. 2016-35 273
2016-20 2016-36 I.R.B. 2016-36 279
2016-23 2016-39 I.R.B. 2016-39 382
2016-24 2016-39 I.R.B. 2016-39 395
2016-25 2016-41 I.R.B. 2016-41 435


Treasury Decisions:

Article Issue Link Page
9773 2016-29 I.R.B. 2016-29 56
9774 2016-30 I.R.B. 2016-30 151
9775 2016-30 I.R.B. 2016-30 159
9776 2016-32 I.R.B. 2016-32 222
9777 2016-36 I.R.B. 2016-36 282
9778 2016-31 I.R.B. 2016-31 196
9779 2016-33 I.R.B. 2016-33 233
9781 2016-35 I.R.B. 2016-35 274
9782 2016-36 I.R.B. 2016-36 301
9783 2016-39 I.R.B. 2016-39 396
9784 2016-39 I.R.B. 2016-39 402
9785 2016-38 I.R.B. 2016-38 375
9786 2016-42 I.R.B. 2016-42 442


Effect of Current Actions on Previously Published Items

Finding List of Current Actions on Previously Published Items

A cumulative list of all revenue rulings, revenue procedures, Treasury decisions, etc., published in Internal Revenue Bulletins 2016–01 through 2016–26 is in Internal Revenue Bulletin 2016–26, dated June 27, 2016.

Bulletin 2016–27 through 2016–42

Notices:

Old Article Action New Article Issue Link Page
2009-89 Modified by Notice 2016-51 2016-37 I.R.B. 2016-37 344
2012-54 Obsoleted by Notice 2016-51 2016-37 I.R.B. 2016-37 344
2013-1 Modified by Notice 2016-41 2016-27 I.R.B. 2016-27 5
2013-1 Superseded by Notice 2016-41 2016-27 I.R.B. 2016-27 5
2013-67 Modified by Notice 2016-51 2016-37 I.R.B. 2016-37 344
2015-63 Superseded by Notice 2016-58 2016-41 I.R.B. 2016-41 438


Revenue Procedures:

Old Article Action New Article Issue Link Page
2003-16 Modified by Rev. Proc. 2016-47 2016-37 I.R.B. 2016-37 346
2007-44 Clarified by Rev. Proc. 2016-37 2016-29 I.R.B. 2016-29 136
2007-44 Modified by Rev. Proc. 2016-37 2016-29 I.R.B. 2016-29 136
2007-44 Superseded by Rev. Proc. 2016-37 2016-29 I.R.B. 2016-29 136
2009-33 Modified by Rev. Proc. 2016-48 2016-37 I.R.B. 2016-37 348
2015-36 Modified by Rev. Proc. 2016-37 2016-29 I.R.B. 2016-29 136
2016-3 Modified by Rev. Proc. 2016-40 2016-32 I.R.B. 2016-32 228
2016-3 Modified by Rev. Proc. 2016-45 2016-37 I.R.B. 2016-37 228
2016-29 Modified by Rev. Proc. 2016-39 2016-30 I.R.B. 2016-30 164


Treasury Decisions:

Old Article Action New Article Issue Link Page
2013-17 Obsoleted by T.D. 9785 2016-38 I.R.B. 2016-38 375
2014-12 Modified by T.D. 9776 2016-32 I.R.B. 2016-32 222


INTERNAL REVENUE BULLETIN

The Introduction at the beginning of this issue describes the purpose and content of this publication. The weekly Internal Revenue Bulletins are available at www.irs.gov/irb/.

We Welcome Comments About the Internal Revenue Bulletin

If you have comments concerning the format or production of the Internal Revenue Bulletin or suggestions for improving it, we would be pleased to hear from you. You can email us your suggestions or comments through the IRS Internet Home Page (www.irs.gov) or write to the

Internal Revenue Service, Publishing Division, IRB Publishing Program Desk, 1111 Constitution Ave. NW, IR-6230 Washington, DC 20224.