Internal Revenue Bulletin 2016-42 (PDF rendition): IRS Notices

Preserve advance releases and the authoritative Internal Revenue Bulletin rendition; directory timestamps are file-publication metadata, not legal effective dates. HTML bulletins begin June 2003; earlier available issues require full PDF parsing. Whole bulletin rendition: numbered items are identified below; other legal material and publisher context remain included. This is not a new standalone advance release.

# INTERNAL REVENUE BULLETIN

IRS

Bulletin No. 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, page 458.

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, page 442.

This document contains final regulations concerning the appli-
cation of the credit for increasing research activities and pro-
vide guidance on software that is developed by (or for the
benefit of) the taxpayer primarily for internal use by the tax-
payer (internal use software). These final regulations also in-
clude examples to illustrate the application of the process of
experimentation requirement to software.

## EMPLOYEE PLANS

Rev. Proc. 2016-51, page 465.

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 Resolu-
tion 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 mod-
ifications 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, page 462.

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 unavail-
able where QTIP elections are made in estates in which the
executor elected portability of the deceased spousal unused ex-
clusion (DSUE) amount under § 2010(c)(5)(A). This guidance mod-
ifies and supersedes Rev. Proc. 2001-38, 2001-1 C.B. 1335.

## GIFT TAX

Rev. Proc. 2016-49, page 462.

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 unavail-
able where QTIP elections are made in estates in which the
executor elected portability of the deceased spousal unused ex-
clusion (DSUE) amount under § 2010(c)(5)(A). This guidance mod-
ifies and supersedes Rev. Proc. 2001-38, 2001-1 C.B. 1335.

(Continued on the next page)

Finding Lists begin on page ii.

<!-- PageBreak -->

## ADMINISTRATIVE

### Rev. Proc. 2016-52, page 519.

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, page 457.

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 Agree-
ments stated in paragraph (A)(3)(e) of Appendix A of Rev. Proc.
2016-1.

<!-- PageBreak -->

## The IRS Mission

Provide America's taxpayers top-quality service by helping
them understand and meet their tax responsibilities and en-
force 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 Conven-
tions, 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 other-
wise indicated. Procedures relating solely to matters of internal
management are not published; however, statements of inter-
nal 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, identify-
ing 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, Legisla-
tion 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 Rul-
ings. Bank Secrecy Act Administrative Rulings are issued by
the Department of the Treasury's Office of the Assistant Sec-
retary (Enforcement).

### Part IV .- Items of General Interest.

This part includes notices of proposed rulemakings, disbar-
ment 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.

The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.

<!-- PageFooter="October 17, 2016" -->
<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

#### Part I. Rulings and Decisions Under the Internal Revenue Code of 1986 T.D. 9786

DEPARTMENT OF THE
TREASURY
Internal Revenue Service
26 CFR Part 1

### Credit for Increasing Research Activities

AGENCY: Internal Revenue Service
(IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains fi-
nal regulations concerning the application
of the credit for increasing research activ-
ities. These final regulations provide guid-
ance 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 applica-
tion of the process of experimentation re-
quirement to software. These final regula-
tions 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 applicabil-
ity see § 1.41-4(e).

FOR FURTHER INFORMATION CON-
TACT: Martha Garcia or Jennifer Records
of the IRS Office of the Associate Chief
Counsel (Passthroughs and Special Indus-
tries) at (202) 317-6853 (not a toll-free
number).

### SUPPLEMENTARY INFORMATION: Background

This document contains final regula-
tions that amend the Income Tax Regula-
tions (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 re-
spect to software that is developed by (or
for the benefit of) the taxpayer primarily

for internal use by the taxpayer is ex-
cluded from the definition of qualified re-
search 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 de-
veloped 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 re-
search and are not subject to these regu-
lations.

On January 20, 2015, the Treasury De-
partment 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) un-
der 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 consider-
ation 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 ben-
efit of) the taxpayer primarily for internal
use if the software is developed by the
taxpayer for use in general and adminis-
trative functions that facilitate or support
the conduct of the taxpayer's trade or
business. General and administrative
functions, as defined in the proposed reg-
ulations, are limited to (1) financial man-
agement 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 re-
source management functions are func-
tions that manage the taxpayer's work-
force. Support services functions are
functions that support the day-to-day op-

erations of the taxpayer, such as data pro-
cessing or facilities services.

Commenters expressed concern that
the list of general and administrative func-
tions 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 ser-
vices 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 com-
menter noted that modern inventory man-
agement software usually requires interac-
tion 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 in-
herently customer facing because it pro-
vides the proper amount of inventory to
customers at the point of sale at the right
time. Another commenter added that mar-
keting is an external-facing function by
nature, and software that supports market-
ing 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 com-
monly provide benefits to vendors and
include functions that are customer facing.
Additionally, software with functions
such as marketing or inventory manage-
ment 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 sit-
uations, the proposed regulations pro-
vided rules under § 1.41-4(c)(6)(iv)(C)
(dual function rules) to evaluate whether

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

software that has both back-office and
front-office functions is developed pri-
marily for internal use. The Treasury De-
partment and the IRS continue to believe
that functions such as inventory manage-
ment, marketing, legal services, and gov-
ernment compliance services provide
support to day-to-day operations of a tax-
payer 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 second-
ary. In addition, the Treasury Department
and the IRS believe the dual function rules
in these final regulations sufficiently ad-
dress these comments by allowing taxpay-
ers to identify subsets of elements of dual
function software that only enable a tax-
payer to interact with third parties or al-
low third parties to initiate functions or
review data. Accordingly, the list of gen-
eral and administrative functions provided
in the proposed regulations remains un-
changed 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 en-
gaged in providing tax services to its cus-
tomers 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 admin-
istrative 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 depend-
ing 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 de-
veloped primarily for internal use depends
on the intent of the taxpayer and the facts
and circumstances at the beginning of
software development, the Treasury De-
partment and the IRS believe that addi-
tional 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 inter-
act with third parties or to allow third
parties to initiate functions or review data
on the taxpayer's system. After consider-
ation of the comments described herein,
these final regulations clarify that (1) soft-
ware is not developed primarily for the
taxpayer's internal use if it is not devel-
oped for use in general and administrative
functions that facilitate or support the con-
duct 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 devel-
oped 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 regula-
tions 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 par-
ties. (Emphasis added.) The commenter
also recommended additional language to
further define "otherwise marketed" to in-
clude transactions where the taxpayer ef-
fectively 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 Depart-
ment and the IRS understand that a tax-
payer may develop software where the
full functionality of that software is pro-
vided 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 illus-
trate 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 clarifi-
cation on the terms "interact," "initiate,"
or "review," and recommended additional
examples illustrating the terms. One com-
menter noted that a common example that
should be clarified is whether a third party
reviewing a website constitutes “interac-
tion," "initiate functions," or "review
data." In response to these comments, the
final regulations clarify that software that
is developed to enable a taxpayer to inter-
act 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 de-
termination of whether software is inter-
nal 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 soft-
ware development. Accordingly, Example
3 of the proposed regulations, now desig-
nated as Example 4 in these final regula-
tions, 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 admin-
istrative function.

#### III. Connectivity software

In the proposed regulations, the Trea-
sury 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 bridg-

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

ing 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 adminis-
trative function. The other commenter rec-
ommended 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 demonstrat-
ing 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 enter-
prise resource planning (ERP) software,
few companies actually engage in devel-
oping 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 re-
ceived, the Treasury Department and the
IRS believe that a special rule for connec-
tivity software is not needed. The final
regulations clarify that software is not de-
veloped by (or for the benefit of) the tax-
payer primarily for the taxpayer's internal
use if the software is not developed for
use in general and administrative func-
tions. Accordingly, any software that is
not developed to be used in a general and
administrative function will not be consid-
ered 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 cat-
egorized differently from other types of
software. Whether certain software is de-
veloped 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 soft-
ware that is developed to connect a tax-

payer's existing payroll software with fi-
nancial budgeting software to allow an
exchange of data between the two soft-
ware modules would be considered to be
developed for the taxpayer's internal use
because the connectivity software's func-
tion is to be used in human resources and
financial management functions. Accord-
ingly, 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 soft-
ware development. If a taxpayer originally
develops software primarily for internal
use but later makes improvements to the
software with the intent to hold the im-
proved 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 devel-
oped 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 improve-
ments will be considered separate from
the existing software and will be consid-
ered developed primarily for internal use.
After consideration of the comments de-
scribed below, these final regulations re-
tain these rules without modification.

A commenter explained that it is com-
mon for a taxpayer to initiate a software

development project with one purpose in
mind and to later discover that other pur-
poses should be considered and pursued.
Commenters also explained that it is com-
mon 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 al-
lows 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 improve-
ments, as of the tax return filing date for
the taxable year or the beginning of the
taxable year in which the software devel-
opment 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 determi-
nation 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 dif-
ficulty substantiating their intended use of
the software at the beginning of the devel-
opment 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 be-
ginning of the software development; al-
lowing any change in a taxpayer's intent
throughout the development to support
treatment as qualifying research of ex-
penses incurred prior to that change would
frustrate the purpose of the credit. Further-
more, allowing a taxpayer to redetermine
the overall project's credit eligibility
throughout the development which could
span multiple years would provide uncer-
tain and inconsistent treatment and im-
pose an undue burden on both taxpayers
and the IRS. Finally, the final regulations
continue to provide a special rule for im-
provements to software that can be sepa-
rately identified. This special rule would
apply, for example, when a taxpayer com-
pletes a software development and then

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

decides to improve that software by un-
dertaking 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 tax-
payer to interact with third parties or al-
lows third parties to initiate functions or
review data on the taxpayer's system
(third party subset). The proposed regula-
tions 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 func-
tion software may be eligible for the re-
search credit, provided all the other appli-
cable requirements are met.

The Treasury Department and the IRS
received several comments on dual func-
tion software rules. One commenter rec-
ommended changes to clarify that the dual
function software rules do not apply to
software developed to be commercially
sold, leased, licensed, or otherwise mar-
keted to third parties, even if such soft-
ware was also developed to enable a tax-
payer 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 soft-
ware was also developed to enable a tax-
payer 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 ap-
plied 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 un-
der the substantially all rule. Similarly, if
substantially all of the software is internal
use, then the software should be consid-
ered 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 subcom-
ponents 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 soft-
ware. 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 per-
cent. 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, tech-
nique, 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 sat-
isfies 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 ini-
tiate functions or review data on the tax-
payer'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 satis-
fied only if 80 percent or more of a tax-
payer's research activities, for the devel-
opment or improvement of a business
component, measured on a cost or other
consistently applied reasonable basis,
constitute elements of a process of exper-
imentation. In contrast to the general re-
quirement 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 in-
ternal use software from qualifying re-
search. Accordingly, the Treasury Depart-
ment 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 ap-
proach.

Another commenter requested that the
dual function rules be eliminated because
the provisions are confusing and unneces-
sary 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 re-
cordkeeping 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

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

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 pre-
sumption 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 "primar-
ily" 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" lan-
guage in the statute, these regulations spe-
cifically identify the types of software
functions that are considered to be primar-
ily for internal use. A definition that spe-
cifically identifies the types of software
functions that are considered to be primar-
ily for internal use provides a clearer ob-
jective 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 Trea-
sury Department and the IRS believe that
the dual function software rules in the
proposed regulations strike an appropriate
balance between the administrative bur-
dens and compliance concerns relating to
claiming the research credit for activities
relating to software. Thus, these final reg-
ulations 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 op-
portunity to begin maintaining the neces-
sary documentation to establish their en-
titlement to research credits under these
rules.

#### B. Safe Harbor

The proposed regulations provided tax-
payers 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 re-
lated 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 sub-
set's use.

Some commenters requested that the
safe harbor be removed from the regula-
tions. 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 com-
menter, given that a taxpayer must docu-
ment 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 propor-
tion of software that is not developed pri-
marily for internal use.

After careful consideration, the final
regulations do not adopt these comments.
However, the safe harbor has been modi-
fied to clarify that the safe harbor can be
applied to the dual function software or
the dual function subset after the applica-
tion of § 1.41-4(c)(6)(vi)(B) of the final
regulations. The safe harbor is not a re-
quirement but an option available for tax-
payers 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 func-
tion 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 re-

quirements under section 41(d)(1). The
safe harbor provides a benefit, not a det-
riment, to taxpayers, provided the dual
function software or dual function sub-
set's use by third parties is anticipated to
be at least 10 percent of the total use.
Taxpayers who consider it too burden-
some 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 com-
menter noted that determining the per-
centage of third party use based upon an
estimate made at the beginning of soft-
ware development imposes an undue ad-
ministrative 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 com-
menter noted that it has not been their
experience that taxpayers plot out the fu-
ture 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 com-
menter requested that, similar to the pro-
visions for improvements to existing soft-
ware, there should be a mechanism to
recharacterize software over time.

While the Treasury Department and
the IRS understand commenters' con-
cerns, the final regulations do not change
the requirement that the time of determi-
nation occur at the beginning of the soft-
ware development. As discussed herein,
the Treasury Department and the IRS con-
tinue to believe that the rule requiring that
a determination be made at the beginning
of the software development is most ac-
curate 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.

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

##### D. Objective reasonable method

In the proposed regulations, the Trea-
sury Department and the IRS invited com-
ments on the administrability of measur-
ing 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 reason-
able methods (such as processing time,
amount of data transfer, number of soft-
ware user interface screens, number of
third party initiated functions, and other
objective, reasonable methods) and
whether the regulations should include
specific reasonable methods and exam-
ples.

A commenter recommended that due
to the wide range of taxpayers that will be
subject to these regulations, the final reg-
ulations should not provide overly de-
tailed 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 ac-
ceptable. Another commenter recom-
mended the adoption of the phrase "within
each industry" to ensure that the applica-
tion 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 mea-
sure reasonably anticipated use due to the
variety of industries that are subject to the
final regulations. Therefore, the final reg-
ulations provide that any objective, rea-
sonable method within the taxpayer's in-
dustry may be used for purposes of the
safe harbor.

##### VI. Third party definition

The proposed regulations provided that
the term "third party" means any corpora-
tion, trade or business, or other person that
is not treated as a single taxpayer with the
taxpayer pursuant to section 41(f). A com-
menter raised concerns and requested that
the Treasury Department and the IRS re-
consider whether it is appropriate to apply
the controlled group standard under sec-
tion 41(f). The commenter contended that
this third party definition would poten-
tially deny a research credit to some soft-

ware for artificial reasons. The commenter
further noted that if the regulations do not
modify the third party definition, taxpay-
ers 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 sec-
tion 41(b)(2) relating to in-house research
expenditures and in § 1.41-6(a)(3)(ii) re-
lating to the definition of controlled group
for purposes of aggregating expenditures.

The proposed regulations also pro-
vided 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 con-
duct of the taxpayer's trade or business,
e.g., the taxpayer's own vendors. A com-
menter contended that excluding any per-
son that uses a taxpayer's software to sup-
port a general and administrative function
from the definition of third party creates
confusion and blurs a well-conceived, ob-
jective measurement. This commenter be-
lieves the term third party suggests a per-
son 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 ser-
vices to the taxpayer, is collateral and
secondary. Accordingly, the final regula-
tions do not adopt these comments re-
questing 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 re-
sult in a reduction in cost or improvement
in speed or other measurable improve-
ment, that is substantial and economically
significant, if the development is or would
have been successful; (2) software devel-
opment involves significant economic risk
in that the taxpayer commits substantial
resources to the development and there is
a substantial uncertainty, because of tech-
nical 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 inno-
vation and significant economic risk re-
quirements. The proposed regulations fur-
ther 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 uncer-
tainty in the definition of technical risk for
purposes of meeting the significant eco-
nomic risk test. Commenters noted that
both sections 174 and 41 have long in-
cluded 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 uncer-
tainties 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" be-
fore "uncertainty" in the significant eco-
nomic risk test for internal use software
indicates a higher threshold of uncertainty
than that required for business compo-
nents 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 re-
gard to the capability or method of achiev-
ing the intended result. However, the
Treasury Department and the IRS under-

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

stand that it is difficult to delineate the
types of technical uncertainties and at-
tempting to do so may lead to unnecessary
burdens on both taxpayers and the IRS.
Furthermore, the appropriate design un-
certainty of internal use software may be
inextricably linked to substantial uncer-
tainty 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 De-
partment and the IRS believe that internal
use software research activities that in-
volve only uncertainty related to appropri-
ate design, and not capability or method-
ology, 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 Depart-
ment and the IRS believe that whether the
amount of resources committed is sub-
stantial 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 com-
ments.

#### C. Application of High Threshold of Innovation Test

Another commenter requested deletion
of the statement, "[i]t is not always nec-
essary to have a revolutionary discovery
or creation of new technologies such as a
new programming language, operating
system, architecture, or algorithm to sat-
isfy the high threshold of innovation test."
The commenter is concerned that the sen-
tence 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 Trea-
sury 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 regula-
tions to clarify that the internal use soft-
ware rules under § 1.41-4(c)(6) do not
apply to (1) software developed for use in
an activity that constitutes qualified re-
search, (2) software developed for use in a
production process to which the require-
ments 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 gen-
eral and administrative functions that fa-
cilitate or support the conduct of the tax-
payer'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 il-
lustrating the application of the process of
experimentation requirement to software
under section 41(d)(1)(C).

One commenter noted that the exam-
ples appear to suggest a presumption that
activities related to developing web de-
sign 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 regula-
tions and these final regulations do not
establish a presumption against a particu-
lar type of software; rather these examples
focus on the facts and circumstances sur-
rounding activities to determine whether
they involve a process of experimentation.

Another commenter requested that the
final regulations include additional exam-
ples demonstrating fact patterns that do

not initially qualify as a process of exper-
imentation but where a change in facts
introduces technical uncertainty that re-
quires 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 tax-
payer's business, we do not think more
examples would provide the clarification
that the commenter is seeking. Accord-
ingly, the final regulations do not include
additional examples to address this com-
ment.

##### i. Example 6

Section 1.41-4(a)(8), Example 6, of
the proposed regulations analyzed whether
activities related to selecting a commer-
cial 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 "de-
velop," "evaluate," and "determine" sug-
gest 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 pro-
cess 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 in-
tended to show that the process of exper-
imentation requirement is not met regard-
less of the terms used. Accordingly, the
final regulations do not adopt this com-
ment.

##### ii. Example 7

Section 1.41-4(a)(8), Example 7, of
the proposed regulations analyzed whether
when developing software, activities relat-
ing 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 algo-
rithm is appropriate for its needs involved
conducting a process of experimentation.

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

Two commenters recommended re-
moving Example 7. One commenter be-
lieved that the example did not provide
any clarification. The other commenter
stated that the example shows a failure to
meet the technical uncertainty require-
ment under section 174, rather than a pro-
cess of experimentation. While the Trea-
sury Department and the IRS agree with
the commenter that activities under sec-
tion 174 must be for the purpose of dis-
covering information that would eliminate
uncertainties, Example 7 is intended to
demonstrate the process of experimenta-
tion requirement under section 41(d). The
example shows a taxpayer's failure to
meet the process of experimentation re-
quirement under section 41(d)(1) because
the use of a technique or design, such as a
round robin workload distribution algo-
rithm, does not qualify where the taxpayer
did not conduct a process of evaluating
alternatives intended to eliminate uncer-
tainty regarding the development of soft-
ware. 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 sys-
tematic testing and evaluation of several
different algorithms in the development of
load balancing software involved con-
ducting 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 Depart-
ment 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 environ-
ment can be a valuable indicator of cir-
cumstances that may result in the neces-
sary 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 thresh-
old of innovation test once the software is

determined to be internal use software.
Additionally, this commenter requested
that the final regulations provide an addi-
tional example addressing this process.
The Treasury Department and the IRS
note that the examples are added to illus-
trate only the application of a process of
experimentation to software research.
They are not meant to address the high
threshold of innovation test; those exam-
ples 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 pub-
lished guidance than these final regula-
tions. 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 ex-
perimentation.

Two commenters requested deletion of
the phrase "routine programming" in Ex-
ample 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 con-
figuration of an ERP system, and the ex-
ample does not address this technical un-
certainty. 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 sec-
tion 41(d)(1). Rather, this example dem-
onstrates 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 alterna-
tives in order to eliminate uncertainty re-
garding the development of the ERP soft-
ware. Accordingly, the Treasury Department
and the IRS believe further clarification of
these examples is unnecessary. Further-
more, 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 ex-
amples illustrating the provisions con-
tained 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 ini-
tiate 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 func-
tion. 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 dis-
agree with the commenter's characteriza-
tion of Example 3. The example demon-
strates that the software is intended to
serve marketing purposes and thus is de-
veloped to be used in general and admin-
istrative 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 al-
low its users to upload and modify photo-
graphs at no charge allows third parties to
initiate functions on the taxpayer's sys-
tem.

A commenter believed the example is
an important example that comes to the
correct conclusion, but the commenter be-
lieved it is not a particularly good fact
pattern to illustrate the third party interac-
tion exclusion. Specifically, the com-
menter requested changes to the conclu-
sion of the example to show that the
advertising software is developed for use

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

in a marketing function to an unrelated
third party.

The purpose of the example is to illus-
trate the third party definition and to dem-
onstrate whether the software is devel-
oped to allow third parties to initiate
functions or review data. The example is
not meant to address which, if any, gen-
eral and administrative function applies to
the software. Accordingly, the final regu-
lations do not adopt this comment. How-
ever, 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 retroac-
tively back to 2004 to give software de-
velopment equal treatment with all other
types of qualified research as defined un-
der TD 9104 (69 FR 22). After further
consideration, the effective date in the
proposed regulations is generally retained
with slight modifications. These final reg-
ulations are prospective and apply to tax-
able 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 advan-
tage to taxpayers whose prior taxable
years are not closed by the statute of lim-
itations. Furthermore, retroactively deter-
mining whether taxpayers engaged in re-
search activities does not further the
purpose of section 41 which is to encour-
age taxpayers to engage in qualifying re-
search activities within the United States
and would impose a significant adminis-
trative burden on the IRS.

Section 41(d)(4)(E) provides that, ex-
cept to the extent provided by regulations,
research with respect to computer soft-
ware that is developed by (or for the ben-
efit of) the taxpayer primarily for internal
use by the taxpayer is excluded from the
definition of qualified research under sec-
tion 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 busi-
ness practices, these final regulations

more narrowly define internal use soft-
ware than the rules that apply for prior
periods. These final regulations are not,
and should not be viewed as, an interpre-
tation of prior regulatory guidance. Soft-
ware 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 Fed-
eral Register (69 FR 43)) is withdrawn
effective for taxable years beginning on or
after January 20, 2015, the date the pro-
posed regulations were published in the
Federal Register (80 FR 2624). For tax-
able years ending before January 20,
2015, taxpayers may choose to follow ei-
ther all of the internal use software provi-
sions of § 1.41-4(c)(6) in the final regu-
lations 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 regula-
tions 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 adminis-
trative 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 un-
der §§ 1.41-3(d) and 1.41-9(c) provide
sufficient guidance for taxpayers to fol-
low. In computing the research credit,
qualified research expenses and gross re-
ceipts must be determined on a basis con-
sistent with the definition of qualified re-
search 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 re-
ceipts 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. Sec-
tion 1.41-3(d) also provides examples il-
lustrating the requirement. Current section
1.41-9(c) contains similar rules. Accord-
ingly, 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 deter-
mined that section 553(b) of the Admin-
istrative 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 com-
ments were received.

### Drafting Information

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

* * * * *

### Adoption of Amendments to the Regulations

Accordingly, 26 CFR part 1 is amended
as follows:

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

## 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 con-
tents for § 1.41-4(c)(6)(i) through (viii).

The revision and additions read as fol-
lows:

§ 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 in-
ternal 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 fol-
lows:

§ 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 manage-
ment 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 soft-
ware 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 devel-
opment 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 soft-
ware offered by various vendors, purchases a com-
mercial software package of object-oriented func-
tions from vendor Z that X can use in its web
application (for example, a shopping cart). X evalu-
ates 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 soft-
ware.

(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 applica-
tion software being developed by X did not involve
conducting a process of evaluating alternatives in
order to eliminate uncertainty regarding the devel-
opment 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 respon-
sive to user online requests, X wants to develop
software to balance the incoming processing re-
quests 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 dis-
tribution 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 experimen-
tation.

Example 8. (i) Facts. X must develop load bal-
ancing software across a server cluster supporting
multiple web applications. X's web applications
have high concurrency demands because of a dy-
namic, highly volatile environment. X is uncertain of
the appropriate design of the load balancing algo-

rithm, given that the existing evolutionary algo-
rithms 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 func-
tions.

(ii) Conclusion. X's activities to develop soft-
ware are activities to develop a separate business
component under section 41(d)(2)(A). X's activities
involving the design, evaluation, and systematic test-
ing 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 un-
certainties related to the development of a business
component, identified alternatives intended to elim-
inate those uncertainties, and evaluated one or more
alternatives to achieve a result where the appropriate
design was uncertain at the beginning of X's re-
search activities.

Example 9. (i) Facts. X, a multinational manu-
facturer, wants to install an enterprise resource plan-
ning (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 re-
quirements 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 tem-
plates, reports, and other standard programs and
choosing among these alternatives in configuring the
system to match its business process and reengineer-
ing its business process to match the available alter-
natives 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 uncer-
tainty 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 exper-
imentation.

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 be-
cause 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 soft-
ware 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. How-
ever, when the shrinking-back rule is applied, a

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

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 el-
ements of a process of experimentation because X
identified uncertainties related to the development of
a business component, identified alternatives in-
tended to eliminate those uncertainties, and evalu-
ated alternatives to achieve a result where the appro-
priate 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 sec-
tion 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 thresh-
old 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 in-
ternal use by the taxpayer for use in an
activity that constitutes qualified research
(other than the development of the inter-
nal use software itself);

(B) Software developed by (or for the
benefit of) the taxpayer primarily for in-
ternal use by the taxpayer for use in a
production process to which the require-
ments 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 soft-
ware is an integral part, that is used di-
rectly by the taxpayer in providing ser-
vices in its trade or business. In these
cases, eligibility for the research credit is
to be determined by examining the com-
bined hardware-software product as a sin-
gle 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 primar-
ily 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 tax-
payer develops primarily for a related par-
ty's internal use will be considered inter-
nal 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 func-
tions. General and administrative func-
tions are:

(1) Financial management. Financial
management functions are functions that
involve the financial management of the
taxpayer and the supporting recordkeep-
ing. Financial management functions in-
clude, but are not limited to, functions
such as accounts payable, accounts receiv-
able, inventory management, budgeting,
cash management, cost accounting, dis-
bursements, economic analysis and fore-
casting, financial reporting, finance, fixed
asset accounting, general ledger book-
keeping, internal audit, management ac-
counting, risk management, strategic busi-
ness 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, train-
ing, 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 ser-
vices, government compliance services,
printing and publication services, and se-
curity services (for example, video sur-
veillance 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 commer-
cially 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 de-
pends on the intent of the taxpayer and the
facts and circumstances at the beginning
of the software development. For exam-
ple, software will not be considered inter-
nal 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 pri-
marily 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 mar-
keted 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 con-
sidered separate from the existing soft-
ware and will not be considered devel-
oped primarily for internal use.
Alternatively, if a taxpayer originally de-
velops software to be sold, leased, li-
censed, 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 soft-
ware 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 inter-
nal use.

(vi) Software developed for both inter-
nal use and to enable interaction with
third parties (dual function software)-
(A) Presumption of development primar-
ily for internal use. Unless paragraph

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

(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 func-
tion software) is presumed to be devel-
oped primarily for a taxpayer's internal
use.

(B) Identification of a subset of ele-
ments of software that only enables inter-
action 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 ini-
tiate 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 re-
lated to software developed for both inter-
nal 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 soft-
ware (dual function subset), a taxpayer
may include 25 percent of the qualified
research expenditures of such dual func-
tion software or dual function subset in
computing the amount of the taxpayer's
credit. This paragraph (c)(6)(vi)(C) ap-
plies only if the taxpayer's research activ-
ities related to the development or im-
provement of the dual function software
or dual function subset constitute qualified
research under section 41(d), without re-
gard to section 41(d)(4)(E), and the dual
function software or dual function sub-
set's use by third parties or by the tax-
payer to interact with third parties is rea-
sonably anticipated to constitute at least
10 percent of the dual function software or
the dual function subset's use. An objec-
tive, reasonable method within the taxpay-
er'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 in-

clude, 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 tax-
payer and the facts and circumstances at
the beginning of the software develop-
ment.

(E) Third party. For purposes of para-
graphs (c)(6)(iv), (v), and (vi) of this sec-
tion, the term third party means any cor-
poration, trade or business, or other
person that is not treated as a single tax-
payer with the taxpayer pursuant to sec-
tion 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 gen-
eral 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 tax-
payer 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 pur-
pose without modifications that would sat-
isfy 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 substan-
tial and economically significant, if the
development is or would have been suc-
cessful. 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 soft-
ware development involves significant
economic risk if the taxpayer commits
substantial resources to the development
and if there is substantial uncertainty, be-
cause 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 busi-
ness 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 al-
low 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 taxpay-
er's activities.

(D) Application of high threshold of
innovation test. The high threshold of in-
novation 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 develop-
ment 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 tech-
nology in new ways could be evidence of
a high threshold of innovation if it re-
solves substantial uncertainty as defined
in paragraph (c)(6)(vii)(C) of this section.

(viii) Illustrations. The following ex-
amples 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 addi-
tion, X developed software that interfaces directly
with the hardware to initiate and terminate a call,
along with other functions. X designed and devel-
oped the hardware and software together.

(ii) Conclusion. The telecommunications soft-
ware 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. Ac-
cordingly, 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 man-
agement-(i) Facts. X, a manufacturer, self-insures
its liabilities for employee health benefits. X devel-
ops 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

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

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. Ac-
cordingly, the software is internal use software be-
cause it is developed for use in a general and admin-
istrative function.

Example 3. Internal use software; human re-
sources 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 begin-
ning of the development, X does not intend to de-
velop 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 admin-
istrative function because employee access software
is a human resources management function under
paragraph (c)(6)(iii)(B)(2) of this section. Accord-
ingly, 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 ser-
vices-(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. Accord-
ingly, 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, under-
takes a software development project aimed at inte-
grating the majority of the functional areas of its
major software systems (Existing Software) into a
single enterprise resource management system sup-
porting centralized financial systems, human re-
sources, 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 finan-
cial, human resources, inventory, and sales systems
to the New Software. At the beginning of the devel-
opment, X does not intend to develop the software
for commercial sale, lease, license, or to be other-
wise 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 para-
graph (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 inter-
act electronically with its vendors to improve X's
inventory management. X develops the software to
enable X to interact with vendors and to allow ven-
dors to initiate functions or review data on the tax-
payer'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 ad-
ministrative 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 devel-
opment, 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 ini-
tiate functions or review data on the taxpayer's sys-
tem 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 func-
tions 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 para-
graph (c)(6)(iii)(A) of this section. The users and the
advertisers are third parties for purposes of para-
graph (c)(6)(iv) of this section. Furthermore, both
the software for uploading and modifying photo-
graphs 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 en-
abling X to interact with third parties or to allow
third parties to initiate functions on X's system.

Example 9. Not internal use software; commer-
cially 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 automa-
tion, 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 par-
ties 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 mainte-
nance 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 develop-
ment 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 improve-
ments to the software, and sells the improved soft-
ware to third parties.

(ii) Conclusion. Support services, which include
facility services, are general and administrative func-
tions 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. How-
ever, the improvements to the software are not de-
veloped primarily for internal use because the im-
proved 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; identifica-
tion of a third party subset-(i) Facts. X develops
software for use in general and administrative func-
tions 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 soft-
ware, 50% of which is allocable to the third party
subset.

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

(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 para-
graph (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 allo-
cable expenditures are qualified research expendi-
tures 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 para-
graph (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 develop-
ment 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 para-
graph (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 func-
tion 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 com-
puting the amount of X's credit pursuant to para-
graph (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 antic-
ipated to constitute 5% of the dual function soft-
ware'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 an-
ticipates that the dual function software's use by
third parties will be less than 10% of the dual func-
tion 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 sec-
tion 41(d)(4)(E), and the allocable expenditures are
qualified research expenditures under section 41(b).

Example 14. Dual function software; identifica-
tion 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 (Sub-
set B) allows third parties to review data and pro-
vides X with data used in its general and adminis-
trative 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 allo-
cable 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 antici-
pated 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 re-
search activities related to the development or im-
provement 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 expen-
ditures 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 re-
search under section 41(d), without regard to section
41(d)(4)(E), and the allocable expenditures are qual-
ified research expenditures under section 41(b), X
may include $6,250 (25% x $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 track-
ing a variety of human resource (HR) functions,
including employee reviews, salary information, lo-
cation within the hierarchy and physical location of
employees, 401(k) plans, and insurance coverage
information. X determined that improved HR effi-
ciency could be achieved by redesigning its disparate
software applications into one employee-centric sys-
tem, and worked to develop that system. X also
determined that commercially available database
management systems did not meet all of the require-
ments 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 capabili-
ties. The improvements, if successful, would provide
a reduction in cost and improvement in speed that is
substantial and economically significant. For exam-
ple, having one employee-centric system would re-
move 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 nec-
essary so that X could recover its resources in a
reasonable period. Specifically, X was uncertain re-
garding the capability of developing, within a rea-
sonable 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 soft-
ware because it is developed for use in a general and
administrative function. However, the software sat-
isfies 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 pro-
vide a reduction in cost or improvement in speed that

is substantial and economically significant. In addi-
tion, X's development activities involved significant
economic risk in that X committed substantial re-
sources to the development and there was substantial
uncertainty, because of technical risk, that the re-
sources would be recovered within a reasonable
period. Finally, at the time X undertook the de-
velopment 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 pro-
gramming language, and to move the new applica-
tion off the mainframe to a client/server environ-
ment. Both the object-oriented language and client/
server technologies were new to X. This project was
undertaken to develop a more maintainable applica-
tion, 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 signifi-
cant. X also determined that commercially available
systems did not meet the requirements of the pro-
posed system. X was certain that it would be able to
overcome any technological uncertainties and imple-
ment the improvements within a reasonable period.
However, X was unsure of the appropriate method-
ology 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 soft-
ware because it is developed for use in a general and

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

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 sub-
stantial 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 com-
puters. 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 employees' 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 ap-
plication available with such a capability. In addi-
tion, at the time X undertook the software develop-
ment project, X was uncertain regarding the
capability of developing a server application that
could schedule and distribute the jobs across thou-
sands 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 soft-
ware 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 soft-
ware because it is developed for use in a general and
administrative function. However, the software sat-
isfies 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 signifi-
cant. In addition, X's development activities in-
volved 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 eco-
nomically significant. At the time X undertook this
project, there was no commercial application avail-
able 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 de-
velopment 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 soft-
ware 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 para-
graph (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 end-
ing on or after December 31, 2003. Para-
graph (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 consis-
tent with all of paragraph (c)(6) of this
section or all of paragraph (c)(6) of this
section as contained in the Internal Reve-
nue 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 ei-
ther 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).

(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)

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

## Part III. Administrative, Procedural, and Miscellaneous

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

Notice 2016-59

### 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 de-
scribed in paragraph (A)(5)(a) of Appen-
dix 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 Ex-
tension 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 Accountabil-
ity Appropriations Act, 2007, Pub. L. No.
110-28.

Section 7528 provides that the Secre-
tary of the Treasury or delegate (the "Sec-
retary") shall establish a program requir-
ing the payment of user fees for requests
to the Internal Revenue Service (the “Ser-
vice") for letter rulings, opinion letters,
determination letters, and other similar re-
quests. The fees charged under the pro-
gram are to: (1) vary according to catego-
ries 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 deter-
mines to be appropriate, but the average

fee applicable to each category or subcat-
egory 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 guid-
ance for administering the user fee re-
quirements 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 Asso-
ciate Chief Counsel (International), the
Associate Chief Counsel (Passthroughs
and Special Industries), the Associate
Chief Counsel (Procedure and Adminis-
tration), 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 enti-
ties 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, para-
graph (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 re-
duced 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 tax-
payers who are parties engaged together
in the same transaction affecting all re-
questing taxpayers. The Service will in-
clude 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 ac-
tual costs in preparing letter rulings. Ac-
cordingly, pending publication of Rev.
Proc. 2017-1, taxpayers may rely on this
notice for purposes of requesting a re-
duced 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 rul-
ings. The user fee provided in paragraph
(A)(5)(a) of Appendix A of this revenue
procedure applies to a taxpayer or taxpay-
ers 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 Cor-
poration, 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 rul-
ings 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 rul-
ings 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 let-
ter 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 informa-
tion and underlying documents are sub-
stantially identical, and must specifically
identify the extent to which the letter rul-
ing 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

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

office at or before the pre-submission con-
ference that the taxpayer(s) intend to re-
quest reduced user fees pursuant to this
paragraph. At the pre-submission confer-
ence, 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 identi-
cal letter rulings is applicable to taxpayers
requesting closing agreements as described
in section 2.02 of this revenue procedure,
assuming they meet the requirements de-
scribed above for letter rulings.

.02 The text in the "CATEGORY" col-
umn of paragraph (A)(5)(a) of Appendix
A of Rev. Proc. 2016-1 is modified to
read as follows:

(5) User fee for substantially identi-
cal letter ruling requests, identical
changes in method of accounting, or
plans from issuing authorities under
§ 25(c)(2)(B). If the requirements of sec-
tion 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 en-
tity, or for parties engaged together in
the same transaction affecting all re-
questing taxpayers, for each addi-
tional letter ruling request after the
$28,300 fee or reduced fee, as appli-
cable, has been paid for the first letter
ruling request. These requests may in-
clude, 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 enti-
tled to the user fee under paragraph
(A)(5)(a) of this appendix, that re-
ceives 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 dis-
qualified 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 For-
eign Insurance Excise Tax Waiver Agree-
ment 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 As-
sociate Chief Counsel (Corporate), the
Associate Chief Counsel (Financial Insti-
tutions and Products), the Associate Chief
Counsel (Income Tax and Accounting),
the Associate Chief Counsel (Interna-
tional), 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).

## Extension of Replacement Period for Livestock Sold on Account of Drought Notice 2016-60

SECTION 1. PURPOSE

This notice provides guidance regard-
ing 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 Invol-
untary Conversion of Livestock. Section
1033(a) generally provides for nonrecog-
nition of gain when property is involun-
tarily converted and replaced with prop-
erty 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 in-
voluntary conversion under § 1033(e)(1)

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

and is solely on account of drought, flood,
or other weather-related conditions that
result in the area being designated as eli-
gible for assistance by the federal govern-
ment, § 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 replace-
ment period on a regional basis for such
additional time as the Secretary deter-
mines 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 ef-
fective for any taxable year with respect to
which the due date (without regard to ex-
tensions) 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 replace-
ment 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 replace-
ment 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 appli-
cable region. For this purpose, the first
drought-free year for the applicable re-
gion 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 re-
placement period determined under
§ 1033(e)(2)(A); and (3) does not in-
clude any weekly period for which ex-
ceptional, extreme, or severe drought is
reported for any location in the applica-
ble region. The applicable region is the
county that experienced the drought
conditions on account of which the live-
stock was sold or exchanged and all
counties that are contiguous to that
county.

A taxpayer may determine whether ex-
ceptional, extreme, or severe drought is
reported for any location in the applicable
region by reference to U.S. Drought Mon-

itor 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 se-
vere drought was reported during the
preceding 12 months. Taxpayers may
use this list instead of U.S. Drought
Monitor maps to determine whether ex-
ceptional, 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 excep-
tional, 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. Accord-
ingly, for a taxpayer who qualified for a
four-year replacement period for live-
stock 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 in-
cludes August 31, 2016), the replace-
ment 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 tax-
able 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 & Account-
ing). 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, Cal-
houn, Chambers, Cherokee, Clay, Cleburne,
Colbert, Coosa, Cullman, DeKalb, Elmore,
Etowah, Fayette, Franklin, Jackson, Jeffer-
son, Lamar, Lauderdale, Lawrence, Lee,
Limestone, Macon, Madison, Marion, Mar-
shall, Morgan, Pickens, Randolph, Russell,
Saint Clair, Shelby, Talladega, Tallapoosa,
Tuscaloosa, and Walker.

## Arizona

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

## Arkansas

Counties of Arkansas, Ashley, Bradley,
Calhoun, Chicot, Clark, Cleveland, Colum-
bia, Dallas, Desha, Drew, Faulkner, Gar-
land, Grant, Hempstead, Hot Spring, How-
ard, 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, Sacra-
mento, 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, Tuol-
umne, Ventura, Yolo, and Yuba.

Colorado

County of Baca.

Connecticut

Counties of Hartford, Litchfield,
Tolland, and Windham.

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

### Florida

Counties of Broward, Collier, Escam-
bia, 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, Daw-
son, DeKalb, Douglas, Effingham, El-
bert, Emanuel, Fannin, Fayette, Floyd,
Forsyth, Franklin, Fulton, Gilmer, Gor-
don, Greene, Gwinnett, Habersham,
Hall, Haralson, Harris, Hart, Heard,
Henry, Houston, Jackson, Jasper, Jen-
kins, Lamar, Laurens, Lincoln, Lump-
kin, 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, Good-
ing, Idaho, Jefferson, Jerome, Kootenai,
Latah, Lemhi, Lewis, Lincoln, Mini-
doka, Nez Perce, Owyhee, Payette, Sho-
shone, Twin Falls, Valley, and Wash-
ington.

## Kansas

Counties of Barber, Comanche, and
Morton.

Louisiana

Parishes of Acadia, Allen, Ascension,
Assumption, Avoyelles, Beauregard, Bi-
enville, Bossier, Caddo, Calcasieu,
Caldwell, Catahoula, Claiborne, Concor-

dia, De Soto, East Baton Rouge, East Car-
roll, East Feliciana, Evangeline, Franklin,
Grant, Iberia, Iberville, Jackson, Jefferson
Davis, Jefferson, La Salle, Lafayette, Lin-
coln, 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, Wash-
ington, Webster, West Baton Rouge, West
Carroll, West Feliciana, and Winn.

## Maine

Counties of Androscoggin, Cumber-
land, Kennebec, Knox, Lincoln, Sagada-
hoc, and York.

## Massachusetts

Counties of Barnstable, Bristol, Essex,
Franklin, Hampden, Hampshire, Middle-
sex, 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, Bo-
livar, Calhoun, Carroll, Chickasaw, Choc-
taw, Claiborne, Clay, Coahoma, Copiah,
Covington, Forrest, Franklin, Grenada,
Hinds, Holmes, Humphreys, Issaquena,
Itawamba, Jasper, Jefferson, Jefferson Da-
vis, Jones, Kemper, Lafayette, Lamar,
Lauderdale, Lawrence, Leake, Lee, Le-
flore, Lincoln, Lowndes, Madison, Mar-
ion, Monroe, Montgomery, Neshoba,
Newton, Noxubee, Oktibbeha, Panola,
Pearl River, Pike, Pontotoc, Prentiss,
Quitman, Rankin, Scott, Sharkey, Simp-
son, Smith, Stone, Sunflower, Talla-
hatchie, 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, Min-
eral, Nye, Pershing, Storey, Washoe, and
White Pine.

New Hampshire

Counties of Belknap, Cheshire, Hills-
borough, Merrimack, Rockingham, and
Strafford.

New Mexico

Counties of Lea, Roosevelt, and Union.

New York

Counties of Allegany, Broome, Cattarau-
gus, Cayuga, Chautauqua, Chemung, Cort-
land, Erie, Genesee, Jefferson, Lewis, Liv-
ingston, Monroe, Niagara, Onondaga,
Ontario, Orleans Oswego, Schuyler, Sen-
eca, Steuben, Suffolk, Tioga, Tompkins,
Wayne, Wyoming, and Yates.

### North Carolina

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

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

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, Rich-
land, 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, Mar-
shall, McCurtain, Murray, Muskogee,
Pontotoc, Pushmataha, Roger Mills, Ste-
phens, Texas, Tillman, Wagoner, Woods,
and Woodward.

## Oregon

Counties of Baker, Benton, Clackamas,
Clatsop, Columbia, Coos, Crook, Curry,
Deschutes, Douglas, Gilliam, Grant, Har-
ney, Hood River, Jackson, Jefferson, Jo-
sephine, Klamath, Lake, Lane, Lincoln,
Linn, Malheur, Marion, Morrow, Mult-
nomah, Polk, Sherman, Tillamook, Uma-
tilla, Union, Wallowa, Wasco, Washing-
ton, Wheeler, and Yamhill.

## Pennsylvania

Counties of Bradford, Cameron,
Centre, Clearfield, Clinton, Elk, Erie,
Lycoming, McKean, Potter, Susque-
hanna, 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, Fa-
jardo, Guayama, Guaynabo, Gurabo, Hu-
macao, Juncos, Las Piedras, Loiza,
Luquillo, Manati, Maunabo, Morovis, Na-
guabo, 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, Ander-
son, Bamberg, Barnwell, Berkeley, Cal-
houn, Cherokee, Chester, Chesterfield, Clar-
endon, Colleton, Darlington, Dorchester,
Edgefield, Fairfield, Florence, Greenville,
Greenwood, Hampton, Jasper, Kershaw,
Lancaster, Lee, Lexington, McCormick,
Oconee, Orangeburg, Pickens, Richland,
Saluda, Spartanburg, Sumter, Union, Wil-
liamsburg, 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, Law-
rence, Lincoln, Loudon, Marion, Mar-
shall, Maury, McMinn, Meigs, Monroe,
Moore, Polk, Rhea, Roane, Sequatchie,
Van Buren, and Warren.

## Texas

Counties of Anderson, Angelina, Ar-
cher, Atascosa, Bandera, Bastrop,
Baylor, Bell, Bexar, Blanco, Bosque,
Bowie, Brazos, Brown, Burleson, Bur-
net, Caldwell, Callahan, Camp, Cass,
Castro, Cherokee, Childress, Clay,
Cochran, Coke, Coleman, Collin, Co-
mal, Comanche, Concho, Cooke, Cory-
ell, Cottle, Crosby, Dallas, Deaf Smith,
Delta, Denton, DeWitt, Dickens, Dim-
mit, Eastland, Ellis, Erath, Falls, Fannin,
Fayette, Fisher, Floyd, Foard, Franklin,
Freestone, Frio, Garza, Gillespie, Gon-
zales, Grayson, Gregg, Grimes, Guada-
lupe, Hale, Hamilton, Hardeman,
Harrison, Haskell, Hays, Hemphill,
Henderson, Hill, Hockley, Hood, Hop-

kins, Houston, Hunt, Jack, Jasper, John-
son, Jones, Karnes, Kaufman, Kendall,
Kent, Kerr, Kimble, King, Kinney, Kle-
berg, Knox, La Salle, Lamar, Lampasas,
Lavaca, Lee, Leon, Limestone, Lip-
scomb, Live Oak, Llano, Lubbock,
Madison, Marion, Mason, Maverick,
McCulloch, McLennan, McMullen,
Medina, Menard, Milam, Mills, Mitch-
ell, Montague, Montgomery, Morris,
Motley, Nacogdoches, Navarro, New-
ton, Nolan, Nueces, Palo Pinto, Panola,
Parker, Polk, Rains, Red River, Robert-
son, Rockwall, Runnels, Rusk, Sabine,
San Augustine, San Jacinto, San Patri-
cio, San Saba, Schleicher, Scurry,
Shackelford, Shelby, Smith, Somervell,
Stephens, Sterling, Stonewall, Sutton,
Tarrant, Taylor, Terrell, Terry, Throck-
morton, Titus, Tom Green, Travis, Trin-
ity, Tyler, Upshur, Uvalde, Val Verde,
Van Zandt, Walker, Washington, Webb,
Wheeler, Wichita, Wilbarger, William-
son, Wilson, Wise, Wood, Yoakum,
Young, and Zavala.

## Utah

Counties of Beaver, Box Elder, Car-
bon, 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, Gar-
field, Grant, Grays Harbor, Island, Jeffer-
son, King, Kitsap, Kittitas, Klickitat,
Lewis, Lincoln, Mason, Okanogan, Pa-
cific, Pend Oreille, Pierce, San Juan, Sk-
agit, Skamania, Snohomish, Spokane, Ste-
vens, Thurston, Wahkiakum, Walla
Walla, Whatcom, Whitman, and Yakima.

## Wyoming

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

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

(Also Part I, Sections 2010, 2044, 2056, 2519, 2652;
20.2010-2; 20.2044-1, 20.2056(b)-7, 25.2519-1,
26.2652-1.)

## Rev. Proc. 2016-49

### SECTION 1. PURPOSE

The 2010 amendment of § 2010(c) of
the Internal Revenue Code (Code) allow-
ing an executor of an estate to make an
election under § 2010(c)(5)(A) (a porta-
bility 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 tax-
able 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 un-
used applicable exclusion amount (de-
ceased 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, 2001-1 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 surviv-
ing spouse of a decedent whose estate
received no benefit from the unnecessary
QTIP election. With the availability of
portability elections, however, the proce-
dure to void and nullify QTIP elections in
Rev. Proc. 2001-38 may bring into ques-
tion 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 pro-
cedures 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, ex-
cept as limited by § 2056(b), the value of
a taxable estate is determined by deduct-
ing 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 de-
duction for an interest passing to the sur-
viving spouse that is a "terminable inter-
est." 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 termina-
tion, 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 per-
son other than the surviving spouse. Un-
der § 2056(b)(7)(B)(i), QTIP is property
that passes from the decedent, in which
the surviving spouse has a qualifying in-
come 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 irre-
vocable.

(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 Re-
turn) 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 con-
sequences for the surviving spouse. Sec-

tion 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). Simi-
larly, under § 2519(a) and (b), any dispo-
sition of all or part of a qualifying income
interest for life in any property with re-
spect 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 ex-
ample 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 appli-
cable 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 pro-
vided a second example where the dece-
dent'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 elec-
tion 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

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

(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 Introduc-
tion of Portability Elections.

(1) In 2010, Congress amended
§ 2010(c) of the Code, and made conform-
ing 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 Re-
authorization, 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 subse-
quent 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 com-
puted were equal to the applicable exclu-
sion 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 ex-
clusion 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 infla-
tion.

(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 applica-
ble 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. Ex-
cluded 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 sat-
isfy to allow the decedent's surviving
spouse to apply the decedent's DSUE
amount to the surviving spouse's trans-
fers. In particular, the executor of the es-
tate 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 (includ-
ing 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 com-
plete and properly prepared estate tax re-
turn, unless the executor satisfies the re-
quirement in § 20.2010-2(a)(3)(i) to not
be considered to make the portability elec-
tion.

(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 ef-
fect 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 Regu-
lations provide that a portability election
made by the executor of a decedent's es-
tate applies as of the date of the dece-
dent's death and, therefore, the DSUE
amount of a decedent survived by a
spouse generally is included in determin-
ing 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 liabil-
ity.

(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 ap-
plicable credit amount and producing a
greater DSUE amount than would exist if
no QTIP election was made for the prop-
erty. An increased DSUE amount avail-
able 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 Trea-
sury Department and the IRS have deter-
mined 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 sat-
isfied:

(1) The estate's federal estate tax lia-
bility was zero, regardless of the QTIP
election, based on values as finally deter-
mined 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 there-
under; and

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

(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 re-
quired 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 there-
under, even if the decedent's DSUE
amount was zero based on values as fi-
nally 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 sec-
tion 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). Accord-
ingly, 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 Elec-
tion. 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 sur-
viving 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 informa-
tion 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 Re-
turn) 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 sec-
tion 3.01 of this revenue procedure. No-
tice 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, in-
cluding 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 appli-
cable exclusion amount in effect for the
year of the predeceased spouse's death.
The explanation should state that the por-
tability election was not made in the pre-
deceased 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 con-
sidered to have made a portability election

because of a late filing of that return,
evidence may consist of the account tran-
script 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 informa-
tion regarding this revenue procedure con-
tact Ms. Kim on (202) 317-6859 (not a
toll-free number).

# Section 2010 .- Unified Credit Against Estate Tax

26 C.F.R. 20.2010-2: Portability provisions ap-
plicable to estate of a decedent survived by a spouse.
This guidance provides procedures to disregard and
treat as null and void for transfer tax purposes a
qualified terminable interest property (QTIP) elec-
tion 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 es-
tates 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.
See Rev. Proc. 2016-49, page 462.

# Section 2044 .- Certain Property For Which Marital Deduction Was Previously Allowed

26 C.F.R. 20.2044-1: Certain property for which
marital deduction was previously allowed.

This guidance provides procedures to disregard
and treat as null and void for transfer tax purposes a
qualified terminable interest property (QTIP) elec-
tion in situations where the QTIP election was not

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

necessary to reduce the estate tax liability to zero.
This guidance provides that such procedures are
unavailable where QTIP elections are made in es-
tates 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.
See Rev. Proc. 2016-49, page 462.

## Section 2056 .- Bequests, Etc., To Surviving Spouse

26 C.F.R. 20.2056(b)-7: Election with respect to
life estate for surviving spouse.

This guidance provides procedures to disregard
and treat as null and void for transfer tax purposes a
qualified terminable interest property (QTIP) elec-
tion 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 es-

tates 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.
See Rev. Proc. 2016-49, page 462.

## Section 2519 .- Dispositions of Certain Life Estates

26 C.F.R. 25.2519-1: Dispositions of certain life
estates.

This guidance provides procedures to disregard
and treat as null and void for transfer tax purposes a
qualified terminable interest property (QTIP) elec-
tion 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 es-
tates 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.
See Rev. Proc. 2016-49, page 462.

## Section 2652 .- Other Definitions

26 C.F.R. 26.2652-1: Transferor defined; other
definitions.

This guidance provides procedures to disregard
and treat as null and void for transfer tax purposes a
qualified terminable interest property (QTIP) elec-
tion 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 es-
tates 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.
See Rev. Proc. 2016-49, page 462.

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

<!-- PageHeader="Rev. Proc. 2016-51" -->
<!-- PageHeader="TABLE OF CONTENTS" -->

### PART I. INTRODUCTION TO EMPLOYEE PLANS COMPLIANCE RESOLUTION SYSTEM

SECTION 1. PURPOSE AND OVERVIEW

.01 Purpose

469

.02 General principles underlying EPCRS

469

.03 Overview

469

SECTION 2. EFFECT OF THIS REVENUE PROCEDURE ON PROGRAMS

.01 Effect on programs

469

.02 Modifications relating to changes in the determination letter program

469

.03 Modifications relating to user fees

470

.04 Description of modifications

470

.05 Future enhancements

471

PART II. PROGRAM EFFECT AND ELIGIBILITY

SECTION 3. EFFECT OF EPCRS; RELIANCE

.01 Effect of EPCRS on retirement plans

472

.02 Compliance statement

472

.03 Excise and other taxes

472

.04 Reliance

472

SECTION 4. PROGRAM ELIGIBILITY

.01 EPCRS Programs

472

.02 Effect of examination

472

.03 SCP eligibility requirements relating to plan documents

472

.04 Established practices and procedures

473

.05 Correction by plan amendment

473

.06 Availability of correction for Employer Eligibility Failure

473

.07 Availability of correction for a terminated plan

473

.08 Availability of correction for an Orphan Plan

473

.09 Availability of correction for § 457(b) plans

473

.10 Egregious failures

474

.11 Diversion or misuse of plan assets

474

.12 Abusive tax avoidance transactions

474

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

SECTION 5. DEFINITIONS

.01 Definitions for Qualified Plans

474

.02 Definitions for 403(b) Plans

476

.03 Definitions for Orphan Plans

477

.04 Earnings

477

.05 IRA

477

.06 SEP

477

.07 SIMPLE IRA Plan

477

.08 Under Examination

477

SECTION 6. CORRECTION PRINCIPLES AND RULES OF GENERAL APPLICABILITY

.01 Correction principles; rules of general applicability

478

.02 Correction principles.

478

.03 Correction of an Employer Eligibility Failure

481

.04 Correction of a failure to obtain spousal consent

481

.05 Determination letter application not permitted

482

.06 Special rules relating to Excess Amounts

482

.07 Rules relating to reporting plan loan failures

483

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

.08 Correction under statute or regulations

484

.09 Matters subject to excise or other taxes

484

.10 Correction for 403(b) Plans.

485

.11 Correction for SEPs and SIMPLE IRA Plans

485

.12 Confidentiality and disclosure

486

.13 No effect on other law

486

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

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

.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

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

### PART I. INTRODUCTION TO EMPLOYEE PLANS COMPLIANCE RESOLUTION SYSTEM

#### SECTION 1. PURPOSE AND OVERVIEW

.01 Purpose. This revenue procedure
updates the comprehensive system of cor-
rection programs for sponsors of retire-
ment 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 Compli-
ance Resolution System ("EPCRS"), per-
mits Plan Sponsors to correct these fail-
ures and thereby continue to provide their
employees with retirement benefits on a
tax-favored basis. The components of EP-
CRS are the Self-Correction Program
("SCP"), the Voluntary Correction Pro-
gram ("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 appli-
cable plan document requirements of
the Code.

· Sponsors and other administrators
should make voluntary and timely cor-
rection of any plan failures, whether
involving discrimination in favor of
highly compensated employees, plan
operations, the terms of the plan doc-
ument, or adoption of a plan by an
ineligible employer. Timely and effi-
cient correction protects participating
employees by providing them with
their expected retirement benefits, in-
cluding favorable tax treatment.

· Voluntary compliance is promoted by
establishing limited fees for voluntary
corrections approved by the Internal
Revenue Service ("IRS"), thereby re-
ducing employers' uncertainty regard-

ing their potential tax liability and par-
ticipants' potential tax liability.

· Fees and sanctions should be gradu-
ated 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 cor-
rective actions to maintain the tax-
favored status of their plans.

.03 Overview. EPCRS includes the fol-
lowing basic elements:

· Self-correction (SCP). A Plan Sponsor
that has established compliance prac-
tices and procedures may, at any time
without paying any fee or sanction,
correct insignificant Operational Fail-
ures under a Qualified Plan, a 403(b)
Plan, a SEP, or a SIMPLE IRA Plan.
For a SEP or SIMPLE IRA Plan, how-
ever, SCP is available only if the SEP
or SIMPLE IRA Plan is established
and maintained on a document ap-
proved by the IRS. In the case of a
Qualified Plan or 403(b) Plan that sat-
isfies the requirements of sections 4.03
and 4.04, the Plan Sponsor generally
may correct even significant Opera-
tional Failures without payment of any
fee or sanction if the correction is
made within the time specified in sec-
tion 9.02.

· Voluntary correction with IRS ap-
proval (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 fail-
ure. Under VCP, there are special pro-
cedures 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 reason-
able 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 correc-
tion programs under EPCRS. This reve-
nue 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 en-
couraging the early correction of em-
ployee 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 cy-
cles for individually designed plans will
be eliminated, and the scope of the deter-
mination letter program for individually
designed plans will be limited to initial
plan qualification, qualification upon plan
termination, and certain other circum-
stances. For further information, see Rev.
Proc. 2016-37, 2016-29 I.R.B. 136.
EPCRS is being modified to take into ac-
count 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 pro-
gram, 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 negoti-
ated percentage of the Maximum Payment
Amount, but instead will be determined
based on the facts and circumstances, in-
cluding the relevant factors described in
section 14.02. The Maximum Payment

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

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 addi-
tional factors for Nonamender Failures
discovered while the plan is Under Exam-
ination, and section 14.04 significantly
modifies the sanction for Nonamender
Failures discovered during the determina-
tion 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 sub-
missions 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 sub-
missions (such as special user fees for
Group Submissions and rules relating to
establishing the number of plan partici-
pants). Beginning in 2017, all user fees
and rules relating to user fees for VCP
submissions will be published in the an-
nual EP revenue procedure that sets forth
user fees, including VCP user fees. Ac-
cordingly, most of section 12 has been
deleted. In addition, rules relating to cer-
tain amounts that are not user fees have
been moved from section 12 to other sec-
tions 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 in-
clude the following changes -

· Revising section 4.03 to address mod-
ifications 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 prac-

tices and procedures, as long as the
plan corrects excess annual additions
through the return of elective deferrals
to affected employees within 91/2
months after the end of the plan's lim-
itation year.

· Revising section 4.08 to include a sen-
tence 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, sec-
tion 4.10(3) provides that the IRS re-
serves 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, In-
terim Amendments, and Nonamender
Failures, and moving the definitions of
those terms from section 6.05 to sec-
tion 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 indi-
vidually designed plan need not be
current to be a Favorable Letter.

· Moving the concept that the Maxi-
mum Payment Amount includes the
tax that the IRS could collect for any
plan loan that did not meet the require-
ments 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 pro-
gram because the Social Security Ad-
ministration has announced that the
program is no longer available as a
method for locating lost plan partici-

pants who are owed additional retire-
ment benefits.

· Modifying section 6.05 to provide that
determination letter applications may
no longer be submitted with VCP sub-
missions and to clarify that the issu-
ance of a compliance statement with
regard to a VCP submission that in-
volves the correction of a Plan Docu-
ment 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 ex-
ample, depending on the nature of the
Overpayment failure (such as an Over-
payment failure resulting from a ben-
efit 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 em-
ployer or another person contribute the
amount of the Overpayment (with ap-
propriate interest) to the plan instead
of seeking recoupment from plan par-
ticipants and beneficiaries. Any cor-
rection method used must be consis-
tent 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 in-
volves 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 sub-
mitting a determination letter applica-
tion when correcting by plan amend-
ment under SCP.

· Modifying section 10.01 to reflect that
the user fees for EPCRS are now pub-
lished 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

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

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 Fail-
ures must be made by the date of sub-
mission 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 gov-
ernmental plans.

· Adding section 10.07(2)(b) to clarify
that a compliance statement issued
with regard to the correction of a No-
namender Failure is a determination
that the corrective amendment was
timely adopted, and not a determina-
tion 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 qual-
ification requirements.

· Revising renumbered section 10.09 to
reflect that a determination letter appli-
cation should not be requested as part
of an Anonymous Submission.

· Reorganizing renumbered section
10.10 with regard to Group Submis-
sions 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 docu-
ments 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 submis-
sion in order to reflect changes made
by Rev. Proc. 2016-37.

· Revising section 11.05 to delete pro-
cedures 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 ac-
knowledgement 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 determina-
tion letter application with a VCP sub-
mission 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 pre-
viously provided in Appendix D is
now Letter 5265.

· Modifying section 11.14(2)8 to delete
procedures for including a determina-
tion letter application with a VCP sub-
mission 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 sanc-
tions under Audit CAP (including
sanctions for Nonamender Failures
discovered Under Examination and

during the determination letter pro-
cess). For a description of the modifi-
cations, 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 correc-
tion method for certain Employee
Elective Deferral Failures associated
with missed elective deferrals for eli-
gible employees who are subject to an
automatic contribution feature in a
§ 401(k) plan or 403(b) Plan (includ-
ing employees who made affirmative
elections in lieu of automatic contribu-
tions but whose elections were not im-
plemented 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 cor-
rection methods for certain Employee
Elective Deferral Failures, one for fail-
ures 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 signifi-
cant failures. In incorporating this
change, the term "corrective contribu-
tions" was changed to "corrective al-
locations" 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 Trea-
sury (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. Accord-

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

ingly, 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 recoup-
ment 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 inter-
preting 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 rev-
enue 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 review-
ing 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 sec-
tion 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 require-
ments 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 Or-
ganization 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 re-
lief 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 eli-
gible 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 proce-
dures 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 pro-
vided, Audit CAP is available for Quali-
fied 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 ar-
rangements.

(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 Oper-
ational Failures can be corrected under
SCP; and, if correction of significant Op-
erational 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 relat-
ing to plan documents. (1) Requirements
for individually designed Qualified Plans.
The provisions of SCP relating to signif-
icant 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 sub-
ject 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 Quali-
fied 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 treat-
ing a 403(b) Plan as having a Favorable
Letter.)

(3) Requirements for SEPs and
SIMPLE IRAs. The provisions of SCP re-
lating to insignificant Operational Failures
(see section 8) are available for a SEP
only if the plan document consists of ei-
ther (i) a valid Model Form 5305-SEP,
Simplified Employee Pension-Individual
Retirement Accounts Contribution Agree-
ment, or 5305A-SEP, Salary Reduction
Simplified Employee Pension-Individual
Retirement Accounts Contribution Agree-
ment, adopted by an employer in accor-
dance with the instructions on the appli-
cable 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, Sav-
ings Incentive Match Plan for Employees
of Small Employers (SIMPLE)-for Use

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

with a Designated Financial Institution,
or 5304-SIMPLE, Savings Incentive
Match Plan for Employees of Small Em-
ployers (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 fa-
vorable opinion letter and that has been
amended in accordance with the proce-
dures set forth in Rev. Proc. 2002-10.

.04 Established practices and proce-
dures. 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 compli-
ance in form and operation with applica-
ble Code requirements. For example, the
plan administrator of a Qualified Plan that
may be top-heavy under § 416 may in-
clude in its plan operating manual a spe-
cific 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 evi-
dence 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 oc-
curred 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 suf-
ficient to prevent the occurrence of the
failure. A plan that provides for elective
deferrals and nonelective employer contri-
butions that are not matching contribu-
tions is not treated as failing to have es-
tablished practices and procedures to
prevent the occurrence of a § 415(c) vio-
lation 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
91/2 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 corpo-
rate 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 as-
sumed 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 Trans-
ferred Assets by the end of the first plan
year that begins after the corporate
merger, acquisition, or other similar trans-
action. (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 amend-
ment 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 Oper-
ational Failures by a plan amendment, in-
cluding correcting an Operational Failure
by a plan amendment to conform the
terms of the plan to the plan's prior oper-
ations, provided that the amendment com-
plies with the applicable Code require-
ments, 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 ac-
tion. 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 pro-
vided for under the plan, the plan may be
amended to provide for qualified nonelec-
tive contributions. As explained further in
sections 6.05 and 10.07(2), the issuance of
a compliance statement constitutes a de-
termination 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 oper-
ations 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 con-
tributions not already provided for under
the plan, the plan may be amended to
provide for qualified nonelective contribu-
tions. SCP is not otherwise available for a
Plan Sponsor to correct an Operational
Failure by a plan amendment.

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

.07 Availability of correction for a ter-
minated plan. Correction of Qualification
Failures and 403(b) Failures in a termi-
nated 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 termi-
nating Orphan Plan, the IRS may, in its
discretion, waive the user fee. In such a
case, the submission must include a re-
quest for a waiver of the user fee. See
section 11.03(13).

.09 Availability of correction for
§ 457(b) plans. The IRS will accept sub-
missions 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 spon-
sored by governmental entities described
in § 457(e)(1)(A). In the case of a § 457(b)
plan that is an unfunded deferred compen-
sation plan established for the benefit of
top hat employees of a tax-exempt entity
described in § 457(e)(1)(B), the IRS gen-
erally will not enter into an agreement to
address problems associated with such a
plan. However, the IRS may consider a

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

submission where, for example, the plan
was erroneously established to benefit the
entity's nonhighly compensated employ-
ees 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 No-
tice 2003-24, 2003-1 C.B. 853, with re-
spect to good faith bargaining and welfare
benefit funds); or (c) a defined contribu-
tion 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 re-
serves 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 avail-
able to correct failures relating to the di-
version or misuse of plan assets.

.12 Abusive tax avoidance transac-
tions. (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 Fail-
ure 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 Spon-
sor was, or may have been, a party to an

abusive tax avoidance transaction (as de-
fined in section 4.12(2)), then the matter
will be referred to the IRS Employee
Plans Tax Shelter Coordinator. Upon re-
ceiving 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 transac-
tion, and that the failures addressed in the
VCP submission are related to that trans-
action. 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 unre-
lated to the abusive tax avoidance trans-
action 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 compli-
ance statement be relied on for the pur-
pose 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 refer-
ral of the abusive tax avoidance transac-
tion matter for examination.

(c) Audit CAP and SCP (for plans Un-
der Examination). For plans Under Exam-
ination, if the IRS determines that the plan
or Plan Sponsor was, or may have been, a
party to an abusive tax avoidance transac-
tion, the matter may be referred to the IRS
Employee Plans Tax Shelter Coordinator.
With respect to plans Under Examination,
an abusive tax avoidance transaction in-
cludes 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 satisfac-
tory 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 abu-
sive transaction on the IRS web site enti-
tled "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 Fail-
ures; and (d) Employer Eligibility Failures.

(a) Plan Document Failure. (i) In gen-
eral. 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 Quali-
fication 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 amend-
ment 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 de-
scribed 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.

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

2002-29, 2002-1 C.B. 1176, as modified
by Rev. Proc. 2003-10, 2003-1 C.B. 259),
the amendment updating the mortality ta-
ble to reflect the guidance in Rev. Rul.
2001-62, 2001-2 C.B. 632, and the
amendment updating the definition of com-
pensation, for purposes of § 415(c)(3), to
include "deemed § 125 compensation" pur-
suant 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 require-
ments of the Code by reason of a change
in those requirements that is effective af-
ter 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 Febru-
ary 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 cor-
rects a disqualifying provision described
in § 1.401(b)-1(b) within the applicable
remedial amendment period. In general, a
disqualifying provision includes a provi-
sion 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 re-
quirement of the Code. A disqualifying
provision also includes any provision des-
ignated by the Commissioner as a disqual-
ifying provision under § 1.401(b)-1(b)(3).
See §§ 5 and 15 of Rev. Proc. 2016-37.
For an individually designed plan, a No-
namender Failure includes the failure to
timely amend for provisions that appear
on the Required Amendments List, as de-
scribed in Rev. Proc. 2016-37.

(b) Operational Failure. The term
"Operational Failure" means a Qualifica-
tion Failure (other than an Employer Eli-
gibility 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 retroac-
tively to reflect the plan's operations (for
example, pursuant to § 401(b)). In the
situation where a Plan Sponsor timely ad-
opted 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 Oper-
ational Failure or an Employer Eligibility
Failure. The correction of a Demographic
Failure generally requires a corrective
amendment to the plan adding more ben-
efits 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 ar-
rangement 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 Demo-
graphic Failure.

(3) Excess Amount; Excess Alloca-
tions; Overpayment. (a) Excess Amount.
The term "Excess Amount" means a
Qualification Failure due to a contribu-
tion, allocation, or similar credit that is
made on behalf of a participant or bene-
ficiary to a plan in excess of the maximum
amount permitted to be contributed, allo-
cated, or credited on behalf of the partic-
ipant or beneficiary under the terms of the
plan or that exceeds a limitation on con-
tributions or allocations provided in the
Code or regulations. Excess Amounts in-
clude: (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 em-
ployee 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 ex-
cess 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 con-
tribution, allocation, or other credit that is
made pursuant to a correction method pro-
vided under this revenue procedure for a
different Qualification Failure. Excess
Amounts are limited to contributions, al-
locations, or annual additions under a de-
fined contribution plan, after-tax em-
ployee 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 "Ex-
cess 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 "Overpay-
ment" 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 reg-
ulations. Overpayments include both pay-
ments 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 in-
clude a payment that is made pursuant to
a correction method provided under this
revenue procedure for a different Qualifi-
cation Failure. Overpayments must be
corrected in accordance with section
6.06(3) for defined benefit plans and sec-
tion 6.06(4) for defined contribution plans
and 403(b) Plans.

(4) Favorable Letter. With respect to a
particular Qualified Plan, the term "Favor-
able Letter" is defined in the following
manner.

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

(a) Favorable Letter for individually
designed plans. In the case of an individ-
ually designed plan, the term "Favorable
Letter" means a determination letter is-
sued with respect to the plan.

(b) Favorable Letter for master or pro-
totype plans and volume submitter plans.
In the case of a master or prototype plan,
the term "Favorable Letter" means a cur-
rent favorable opinion letter with respect
to the master or prototype plan (standard-
ized or nonstandardized) adopted by the
Plan Sponsor. In the case of a volume
submitter plan, the term "Favorable Let-
ter" 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 favor-
able opinion letter or advisory letter if the
letter considers the law changes incorpo-
rated 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 sub-
mitter plan, the plan is treated as having a
current favorable opinion letter or advi-
sory letter if the plan is terminated prior to
the expiration of the plan's current reme-
dial amendment cycle determined under
the provisions of Rev. Proc. 2016-37, and
the plan was amended to reflect the qual-
ification requirements that applied as of
the date of termination.

(5) Maximum Payment Amount. The
term "Maximum Payment Amount"
means a monetary amount that is approx-
imately 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 In-
come 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 proce-
dure.

(6) Plan Sponsor. The term "Plan
Sponsor" means the employer that estab-
lishes 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 con-
solidation of plan assets) under § 414(l)
from a plan sponsored by an employer
that was not a member of the same con-
trolled group as the Plan Sponsor imme-
diately prior to the corporate merger, ac-
quisition, 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 defi-
nitions under Rev. Proc. 2008-50 apply to
failures that occurred in taxable years be-
ginning 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 pro-
vided by § 403(b). There are four types of
403(b) Failures: (a) Plan Document Fail-
ures; (b) Operational Failures; (c) Demo-
graphic Failures; and (d) Employer Eligi-
bility Failures.

(a) Plan Document Failure. The term
"Plan Document Failure" means a plan
provision (or the absence of a plan provi-
sion) that, on its face, violates the require-
ments 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 ap-
plicable 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 Fail-
ure, or Employer Eligibility Failure.

(b) Operational Failure. The term
"Operational Failure" means a 403(b)
Failure (other than an Employer Eligibil-
ity 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 availabil-
ity of elective deferral contributions) and
401(m) (as applied to 403(b) Plans pursu-
ant to § 403(b)(12)(A)(i)) is an Opera-
tional 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 Em-
ployer Eligibility Failure. The correction
of a Demographic Failure generally re-
quires a corrective amendment to the plan
adding more benefits or increasing exist-
ing 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 organi-
zation described in § 501(c)(3) or a public
educational organization described in
§ 170(b)(1)(A)(ii). An Employer Eligibil-
ity Failure is not a Plan Document, Oper-
ational, or Demographic Failure.

(3) Excess Amount. The term "Excess
Amount" means a contribution or other
credit that is made on behalf of a partici-
pant 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

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

of the plan or that exceeds a limitation on
contributions provided in the Code or reg-
ulations. The term "Excess Amount" in-
cludes any amount in excess of the
amount permitted under the requirements
of § 402(g), 401(m), or 415. A contribu-
tion 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 consid-
ered to be a § 403(c) annuity contract (or,
if applicable, an amount to which § 61, 83,
or 402(b) applies). A contribution in ex-
cess of the limitation of § 415(c) that is
not maintained in a separate account in
accordance with the rules set forth in reg-
ulations under §§ 403(b) and 415 is an
Excess Amount. Thus, the correction prin-
ciples in section 6.06 apply.

(4) Overpayment. The term "Overpay-
ment" means a 403(b) Failure due to a
payment being made to a participant or
beneficiary that exceeds the amount pay-
able to the participant or beneficiary under
the terms of the plan or that exceeds a
limitation provided in the Code or regula-
tions. Overpayments include payments
made from the participant's or beneficia-
ry's 403(b) custodial account or annuity
contract under the plan that are not per-
mitted to be paid under the Code, the
regulations, or the terms of the plan. How-
ever, an Overpayment does not include a
payment that is made pursuant to a cor-
rection method provided under this reve-
nue procedure for a different 403(b) Fail-
ure. Overpayments must be corrected in
accordance with section 6.06(4).

(5) Favorable Letter. The term "Favor-
able 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 approx-
imately 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 re-
tirement plans (as defined in

§ 402(c)(8)(B)) and any interest or penal-
ties 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 “Eli-
gible 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. How-
ever, 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 Depart-
ment of Labor regulations governing the
termination of abandoned individual ac-
count 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 De-
partment of Labor to have accepted re-
sponsibility 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 bene-
ficiary 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" re-
fers to the adjustment of a principal
amount to reflect subsequent investment
gains and losses, unless otherwise pro-
vided 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") de-
scribed 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 examina-
tion (that is, an examination of a Form
5500 series or other Employee Plans ex-
amination); (b) a Plan Sponsor that is un-
der an Exempt Organizations examination
(that is, an examination of a Form 990
series or other Exempt Organizations ex-
amination); or (c) a plan that is under
investigation by the Criminal Investiga-
tion Division of the IRS.

(2) A plan that is under an Employee
Plans examination includes any plan for
which the Plan Sponsor, or a representa-
tive, has received verbal or written notifi-
cation from Employee Plans of an im-
pending 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 nondiscrim-
ination requirements of § 401(a)(4), the
minimum participation requirements of
§ 401(a)(26), the minimum coverage re-
quirements of § 410(b), or the require-
ments of § 403(b)(12)(A)(i), with any plan
that is Under Examination. In addition, a
plan is considered to be Under Examina-
tion with respect to a failure of a qualifi-
cation requirement (other than those de-
scribed 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 Examina-
tion with respect to the § 417 or 411

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

failure. For purposes of this revenue pro-
cedure, the term aggregation does not in-
clude consideration of benefits provided
by various plans for purposes of the aver-
age benefits test set forth in § 410(b)(2).

(3) An Employee Plans examination
also includes a case in which a Plan Spon-
sor has submitted any Form 5300 (Appli-
cation 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 Termi-
nating Plan) and the Employee Plans
agent notifies the Plan Sponsor, or a rep-
resentative, of possible failures, whether
or not the Plan Sponsor is officially noti-
fied of an "examination." This would in-
clude a case where, for example, a Plan
Sponsor has applied for a determination
letter on plan termination, and an Em-
ployee Plans agent notifies the Plan Spon-
sor that there are partial termination con-
cerns. In addition, if, during the review
process, the agent requests additional in-
formation 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 con-
sidered to be under an Employee Plans
examination for purposes of eligibility un-
der 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 autho-
rized 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 in-
cludes 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 im-
pending referral for an Exempt Organiza-
tions examination and also includes any

Plan Sponsor that has been under an Ex-
empt Organizations examination and is
now in Appeals or in litigation for issues
raised in an Exempt Organizations exam-
ination.

#### SECTION 6. CORRECTION PRINCIPLES AND RULES OF GENERAL APPLICABILITY

.01 Correction principles; rules of gen-
eral applicability. The general correction
principles in section 6.02 and rules of
general applicability in sections 6.03
through 6.13 apply for purposes of this
revenue procedure.

.02 Correction principles. Generally, a
failure is not corrected unless full correc-
tion is made with respect to all partici-
pants 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 asso-
ciated with that year will not be redeter-
mined because of the correction. Correc-
tion 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 correc-
tion method should restore the plan to the
position it would have been in had the
failure not occurred, including restoration
of current and former participants and
beneficiaries to the benefits and rights
they would have had if the failure had not
occurred.

(2) Reasonable and appropriate cor-
rection. The correction should be reason-
able and appropriate for the failure. De-
pending 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 cor-
rection method permitted under Appendix
A or Appendix B is deemed to be a rea-
sonable and appropriate method of cor-
recting 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 correc-

tion 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 appli-
cable facts and circumstances and the fol-
lowing 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 cor-
rection by distribution to participants or
beneficiaries or return of assets to the em-
ployer. For example, if an excess alloca-
tion (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 real-
located 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 pro-
vide 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 provi-
sions 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 nondis-
crimination requirements. Similarly, the
correction of a failure to satisfy the re-
quirements 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 nondiscrimina-
tion), solely by distributing excess
amounts to highly compensated employ-
ees would not be the typical means of
correcting such a failure.

(d) The correction method should not
violate another applicable specific re-
quirement of § 401(a) or 403(b) (for ex-
ample, § 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 Sub-

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

title 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 pro-
cedure.

(e) If a correction method is one that
another government agency has autho-
rized with respect to a violation of legal
requirements within its interpretive au-
thority and that correction relates to a vi-
olation 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 ter-
minate the plan and distribute plan assets
to participants and beneficiaries in accor-
dance with standards and procedures sub-
stantially 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 condi-
tions. First, the correction must comply
with standards and procedures substan-
tially similar to those set forth in 29 CFR
2578.1. Second, the qualified termination
administrator, based on plan records lo-
cated and updated in accordance with the
Department of Labor regulations, must
have reasonably determined whether, and
to what extent, the survivor annuity re-
quirements of §§ 401(a)(11) and 417 ap-
ply 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 rev-
enue 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 busi-
ness, 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 fail-
ure under this revenue procedure would
generally be taken into account as correc-
tion 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 de-
faulted 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. Gener-
ally, 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 Op-
erational Failures of that type for that plan
year. Similarly, Earnings adjustment
methods generally should be applied con-
sistently with respect to corrective contri-
butions or allocations for a particular type
of Operational Failure for a plan year. In
the case of a Group Submission, the con-
sistency requirement applies on a plan by
plan basis.

(4) Principles regarding corrective al-
locations and corrective distributions.
The following principles apply where an
appropriate correction method includes
the use of corrective allocations or correc-
tive distributions:

(a) Corrective allocations under a de-
fined contribution plan should be based
upon the terms of the plan and other ap-
plicable 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 correc-
tive allocation is being made) and should
be adjusted for Earnings and forfeitures
that would have been allocated to the par-
ticipant's account if the failure had not
occurred. However, a corrective alloca-
tion 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 Adjust-
ment Methods And Examples.

(b) A corrective allocation to a partic-
ipant's account because of a failure to
make a required allocation in a prior lim-
itation 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 ad-
dition for the limitation year to which the
corrective allocation relates. However, the
normal rules of § 404, regarding deduc-
tions, apply.

(c) Corrective allocations should come
only from employer nonelective contribu-
tions (including forfeitures if the plan per-
mits their use to reduce employer contri-
butions). For purpose of correcting a
failed ADP, actual contribution percent-
age (ACP), or multiple use test, any
amounts used to fund qualified nonelec-
tive 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 equiva-
lence (after considering the applicable re-
quirements 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 dis-
tribution 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 per-
son acting on behalf of the Plan Sponsor)
making a contribution to the plan equal to
the following amount (with interest up to

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

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 re-
spect to that failure. See also section
6.06(3) for correction of an Overpayment
(including a payment of benefits that ex-
ceeds the limitations imposed by § 436(d)
or 436(b), (c), or (e)).

(ii) A corrective distribution or a cor-
rective 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 cor-
rection, 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 restric-
tion pursuant to § 436(d), the Plan Spon-
sor must generally contribute to the plan
the amount of that corrective distribution
(but only half of the corrective distribu-
tion 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 re-
striction 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 dis-
tribution is made in a form that is not a
prohibited payment (for example, if the
correction is made by actuarially increas-
ing 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 con-
tribution under § 430 and is disregarded in

determining the amount added to a pre-
funding balance under § 430(f)(6). See
§ 1.436-1(f)(2) generally for rules relat-
ing to § 436 contributions.

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

(5) Special exceptions to full correc-
tion. In general, a failure must be fully
corrected. Although the mere fact that cor-
rection is inconvenient or burdensome is
not enough to relieve a Plan Sponsor of
the need to make full correction, full cor-
rection may not be required in certain
situations if it is unreasonable or not fea-
sible. Even in these situations, the correc-
tion method adopted must be one that
does not have significant adverse effects
on participants and beneficiaries or the
plan, and that does not discriminate sig-
nificantly in favor of highly compensated
employees. The exceptions described be-
low 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 ex-
ceed 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 in-
vestment results would have been, a rea-
sonable interest rate may be used. For this
purpose, the interest rate used by the De-
partment 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 partici-
pant or beneficiary is $75 or less, the Plan
Sponsor is not required to make the cor-
rective distribution if the reasonable direct

costs of processing and delivering the dis-
tribution to the participant or beneficiary
would exceed the amount of the distribu-
tion. This section 6.02(5)(b) does not ap-
ply 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 Over-
payment to a participant or beneficiary is
$100 or less, the Plan Sponsor is not re-
quired to seek the return of the Overpay-
ment 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) Rea-
sonable actions must be taken to find all
current and former participants and bene-
ficiaries to whom additional benefits are
due, but who have not been located after a
mailing to the last known address. In gen-
eral, such actions include, but are not lim-
ited 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 meth-
ods may be appropriate. A plan will not be
considered to have failed to correct a fail-
ure due to the inability to locate an indi-
vidual if reasonable actions to locate the
individual have been undertaken in accor-
dance with this paragraph; provided that,
if the individual is later located, the addi-
tional benefits are provided to the individ-
ual at that time.

(ii) The IRS Letter Forwarding Pro-
gram 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 ben-
eficiaries will have until the earlier of: a)

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

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 pe-
riod 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 sec-
tion 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, includ-
ing any investment gains, is not eligible for
favorable tax treatment accorded to distribu-
tions 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 Or-
phan Plan.

(6) Correction principle for loan fail-
ures. 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 cor-
rective payment. However, with respect to
the failure listed in section 6.07(3), the
employer should pay a portion of the cor-
rection payment on behalf of the partici-
pant 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 employ-
ees with respect to elective deferrals or
after-tax employee contributions. If a

Qualified Plan or 403(b) Plan has an Op-
erational Failure that consists of excluding
an employee that should have been eligi-
ble to make an elective deferral or an
after-tax employee contribution, the em-
ployer 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 con-
tributed to the plan accumulated with
earnings tax deferred in the future. This
correction principle applies solely to this
limited circumstance. It does not, for ex-
ample, 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 pro-
vided for correcting this failure do not
extend to other failures. Thus, the correc-
tion methods and the examples in Appen-
dix A, section .05, and Appendix B, sec-
tion 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 avail-
ability of correction by plan amendment,
see section 4.05.

(9) Reporting. Any corrective distribu-
tions from the plan should be properly
reported.

.03 Correction of an Employer Eligi-
bility Failure. (1) The permitted correc-
tion of an Employer Eligibility Failure is
the cessation of all contributions (includ-
ing elective deferrals and after-tax em-
ployee contributions). For VCP submis-
sions, 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 ex-
ample, for 403(b) Plans, an event de-
scribed 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 Fail-
ure (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 Eli-
gibility Failure, correction may include
treating contributions as not being ex-
cluded under § 403(b) (and thus the con-
tributions 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 qual-
ify as an eligible rollover distribution un-
der § 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 correc-
tion 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 Ap-
pendix A, section .07. The Plan Sponsor
must notify the affected participant and
spouse (to whom the participant was mar-
ried at the time of the distribution), so that
the spouse can provide spousal consent to
the distribution actually made or the par-
ticipant may repay the distribution and
receive a qualified joint and survivor an-
nuity.

(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

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

to consent, the spouse does not respond to
the notice, or the spouse cannot be lo-
cated), 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 be-
tween (i) the survivor annuity benefit de-
scribed in section 6.04(2)(b) or (ii) a
single-sum payment equal to the actuarial
present value of that survivor annuity ben-
efit (calculated using the applicable inter-
est rate and mortality table under
§ 417(e)(3)). Any such single-sum pay-
ment is treated in the same manner as a
distribution under § 402(c)(9) for pur-
poses 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 pay-
ment, the plan sponsor must contribute to
the plan the applicable amount under sec-
tion 6.02(4)(e)(ii)(A).

.05 Determination letter application
not permitted. (1) In general. A determi-
nation letter application may not be sub-
mitted with a VCP submission.

(a) Issuance of compliance statement
or closing agreement for Plan Document
Failures corrected through plan amend-
ment under VCP or Audit CAP. The issu-
ance 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 amend-
ment 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 un-

der Audit CAP, and the plan amendment
is accepted as a proper correction, then the
compliance statement under VCP or clos-
ing agreement issued under Audit CAP
constitutes a determination that the Oper-
ational Failure has been corrected, but is
not a determination that the terms of the
plan, including the corrective plan amend-
ment, satisfy the qualification require-
ments in form. See section 10.07(2)(c).

(2) Corrective amendments to pre-
approved plans. (a) Effect of corrective
amendment. Generally, under VCP or Au-
dit 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 Quali-
fication 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 sec-
tion 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 Spon-
sor to lose its reliance on the plan's opin-
ion 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 reme-
dial 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 distri-
butions from Qualified Plans or 403(b)
Plans (such as eligibility for tax-free roll-
over). Thus, for example, if such a distri-
bution was contributed to an IRA, the
contribution is not a valid rollover contri-
bution 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 de-
scribed in section 3 of Rev. Proc. 92-93,
1992-2 C.B. 505 (relating to the correc-
tive 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 dis-
tributed, 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 favor-
able tax treatment accorded to distribu-
tions from an eligible retirement plan un-
der § 402(c)(8)(B) (and, specifically, is
not eligible for rollover).

(2) Correction of Excess Allocations.
In general, an Excess Allocation is cor-
rected in accordance with the Reduction
of Account Balance Correction Method
set forth in this paragraph. Under this
method, the account balance of an em-
ployee who received an Excess Allocation
is reduced by the Excess Allocation (ad-
justed for Earnings). If the Excess Allo-
cation 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 improp-
erly 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 par-
ticipant or beneficiary (an unallocated ac-
count) established for the purpose of hold-
ing Excess Allocations, adjusted for

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

Earnings, to be used to reduce employer
contributions (other than elective defer-
rals) 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 contribu-
tions (adjusted for Earnings) must be dis-
tributed to the participant. For qualifica-
tion purposes, an Excess Allocation that is
corrected pursuant to this paragraph is dis-
regarded 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 attrib-
utable 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 Earn-
ings) 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 em-
ployee contributions that are matched, the
excess is apportioned first to after-tax em-
ployee contributions with the associated
matching employer contributions and then
to elective deferrals with the associated
matching employer contributions. Any
matching contribution or nonelective em-
ployer contribution (adjusted for Earn-
ings) which constitutes an Excess Alloca-
tion 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 (de-
fined benefit plans). An Overpayment
from a defined benefit plan is corrected in
accordance with rules similar to the Re-
turn of Overpayment and Adjustment of
Future Payments correction methods de-
scribed 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 appro-
priate interest) to the plan instead of seek-
ing recoupment from a plan participant or
beneficiary. Another example of an appro-
priate correction method includes a Plan
Sponsor adopting a retroactive amend-
ment to conform the plan document to the
plan's operations (subject to the require-
ments of section 4.05). Any other correc-
tion method used must satisfy the correc-
tion principles of section 6.02 and any
other applicable rules in this revenue pro-
cedure.

(4) Correction of Overpayment (de-
fined 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 Earn-
ings 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 ad-
justed for Earnings at the plan's earnings
rate is not repaid to the plan, the employer
or another person must contribute the dif-
ference to the plan. The preceding sen-
tence does not apply when the failure
arose solely because a payment was made
from the plan to a participant or benefi-
ciary 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 dis-
tribution)).

(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 unallo-
cated account, as described in section
6.06(2), to be used to reduce employer
contributions (other than elective defer-
rals) 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 Overpay-
ment 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 fa-
vorable tax treatment accorded to distri-
butions 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 appro-
priate correction method may include us-
ing rules similar to the correction method
in section 6.06(4)(a) but having the em-
ployer or another person contribute the
amount of the Overpayment (with appro-
priate interest) to the plan instead of seek-
ing recoupment from a plan participant or
beneficiary. Another example of an appro-
priate correction method includes a Plan
Sponsor adopting a retroactive amend-
ment to conform the plan document to the
plan's operations (subject to the require-
ments of section 4.05). Any other correc-
tion method used must satisfy the correc-
tion principles of section 6.02 and any
other applicable rules of this revenue pro-
cedure.

.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 dis-
tribution under § 72(p)(1) in connection
with a failure relating to a loan to a par-
ticipant made from a plan must be re-
ported 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

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

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 specifi-
cally requests such relief.

(2) Special rules for loans. (a) In gen-
eral. 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 require-
ments of § 72(p)(2) and are corrected
through VCP or Audit CAP. The correc-
tion 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 re-
serves 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 distribu-
tion 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 re-
payments made by correction under sec-
tions 6.07(2) and 6.07(3) do not result in
the affected participant having additional
basis in the plan for purposes of determin-
ing the tax treatment of subsequent distri-
butions from the plan to the affected par-
ticipant. The relief from reporting the
participant's loan as a deemed distribution
on Form 1099-R, as described in the pre-
ceding 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 requir-
ing that loans comply with § 72(p)(2)(A)
may be corrected by a corrective repay-
ment 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 accor-
dance with the amortization schedule for
the loan before correction, such prior re-
payments 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 re-
payment 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 repay-
ments 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 cor-
rective repayment is made). After the cor-
rective payment is made, the loan may be
reformed to amortize the remaining prin-
cipal 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 amor-
tization 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 origi-
nal 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 re-
quirements of § 72(p)(2). However, under
the Department of Labor's Voluntary Fi-
duciary 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 con-
tain 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 pay-
ment 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), mea-
sured from the original date of the loan, or
(iii) any combination of (i) or (ii).

.08 Correction under statute or regu-
lations. 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 gen-
eral rule, a Plan Document Failure that is
a disqualifying provision for which the re-
medial amendment period under § 401(b)
has not expired can be corrected under pro-
visions of the Code through retroactive re-
medial amendment.

.09 Matters subject to excise or other
taxes. (1) General rule. Except as pro-
vided in this revenue procedure, the cor-
rection programs are not available for
events for which the Code provides tax
consequences other than plan disqualifica-
tion (such as the imposition of an excise
tax or additional income tax). For exam-
ple, funding deficiencies (failures to make
the required contributions to a plan sub-
ject to § 412), prohibited transactions, and
failures to file the Form 5500 series can-
not be corrected under this revenue pro-
cedure.

(2) Section 4974. As part of VCP and
Audit CAP, if a failure involves the failure
to satisfy the minimum required distribu-
tion requirements of § 401(a)(9), in appro-
priate cases, the IRS will waive the excise
tax under § 4974 applicable to plan par-
ticipants 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 Spon-
sor, as part of the submission, must re-
quest the waiver and, in cases where the
participant subject to the excise tax is ei-
ther an owner-employee as defined in
§ 401(c)(3) or a 10% owner of a corpora-
tion, the Plan Sponsor must also provide
an explanation supporting the request. Un-
der 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 sup-

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

porting 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 ap-
prove 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 contribu-
tion 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) un-
der 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 insuffi-
cient 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 con-
tributions 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 ben-
eficiary ("recipient") removes the Over-
payment (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 re-
moves 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 con-
tribution) as a taxable distribution for the
year in which the Excess Amount (ad-
justed 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 elec-
tive 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 expla-
nation 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 correc-
tion 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 correc-
tion will include removing the amount
improperly distributed and rolled over
(adjusted for Earnings) from the recipi-
ent'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 un-
der VCP not in excess of the 10% addi-
tional income tax under § 72(t). The Plan
Sponsor, as part of the submission, must
request the relief and provide an explana-
tion 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 Fail-
ure, 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 main-
tain a separate account), or an exchange
made to a vendor which is not part of the
plan (and for which there is no informa-
tion sharing agreement). In addition, for
purposes of this revenue procedure, pend-
ing additional guidance, a 403(b) Plan

generally will be treated as having a Fa-
vorable 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 estab-
lished, if later), or (b) the employer has
failed to adopt a written 403(b) Plan
timely and corrects the failure in accor-
dance with section 6.10(3) below. In ad-
dition, for purposes of section 4.04 (re-
quiring that the Plan Sponsor or
administrator of the plan have established
practices and procedures reasonably de-
signed to promote and facilitate overall
compliance with applicable Code require-
ments in order to be eligible for SCP to be
available to correct Operational Failures),
the requirement to have established prac-
tices and procedures only applies for fail-
ures 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 ac-
cordance with the final regulations under
§ 403(b) and Notice 2009-3 may be cor-
rected 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 Announce-
ment 2009-89. However, the issuance of
a compliance statement or closing agree-
ment 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 Em-
ployer Eligibility Failure).

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

(2) Special correction for SEPs and
SIMPLE IRA Plans. In any case in which
correction under section 6.11(1) is not fea-
sible 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, discontin-
uance of contributions to a SARSEP or
SIMPLE IRA Plan, and retention of Ex-
cess 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 de-
ferral percentage test. If the failure in-
volves a violation of the deferral percent-
age 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 con-
tributions that are 100% vested to all eli-
gible nonhighly compensated employees
(to the extent permitted by § 415) neces-
sary 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 dis-
tribution of excess contributions, adjusted
for Earnings through the date of correc-
tion, 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 compen-
sated employees in the year of the failure,
(ii) current nonhighly compensated em-
ployees who were nonhighly compensated
employees in the year of the failure, or
(iii) employees (both current and former)
who were nonhighly compensated em-
ployees 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 undercontri-
butions 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 cor-
rection.

(b) Earnings adjustment methods. In-
sofar as SEP and SIMPLE IRA Plan as-
sets 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 in-
vestment results would have been, a rea-
sonable interest rate may be used.

(5) Treatment of Excess Amounts un-
der a SEP or a SIMPLE IRA Plan. (a)
Distribution of Excess Amounts. For pur-
poses of this section 6.11, an Excess
Amount is an amount contributed on be-
half of an employee that is in excess of an
employee's benefit under the plan, or an
elective deferral in excess of the limita-
tions of § 402(g) or 408(k)(6)(A)(iii). If an
Excess Amount is attributable to elective
deferrals, the Plan Sponsor may effect dis-
tribution of the Excess Amount, adjusted
for Earnings through the date of correc-
tion, to the affected participant. The
amount distributed to the affected partic-
ipant 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 partici-
pant receiving the distribution. In addi-
tion, the Plan Sponsor must inform af-
fected participants that the distribution of
an Excess Amount is not eligible for fa-
vorable tax treatment accorded to distri-
butions 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 de-
duction 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 sanc-
tion 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 Ex-
cess 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 subse-
quent 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 re-
quired to distribute the Excess Amount
and the sanction described in 6.11(5)(b)
does not apply.

.12 Confidentiality and disclosure. Be-
cause each correction program relates di-
rectly to the enforcement of Code require-
ments, the information received or
generated by the IRS under the program is
subject to the confidentiality requirements
of § 6103 and is not a written determina-
tion 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 Depart-
ment of Labor maintains a Voluntary Fi-
duciary 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 report-
ing requirements (Form 5500 series) un-
der 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 sec-
tion 8 (relating to insignificant Opera-
tional Failures) or, in the case of a Qual-
ified Plan or a 403(b) Plan, section 9
(relating to significant Operational Fail-
ures).

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

## 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 Fail-
ure is insignificant. This section 8 is avail-
able for correcting an insignificant Oper-
ational 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 consid-
ered in determining whether an Opera-
tional 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 contri-
butions involved in the failure; (3) the
number of years the failure occurred; (4)
the number of participants affected rela-
tive 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 rea-
sonable time after discovery of the failure;
and (7) the reason for the failure (for ex-
ample, data errors such as errors in the
transcription of data, the transposition of
numbers, or minor arithmetic errors). No
single factor is determinative. Addition-
ally, 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 Fail-
ure in a single year, or Operational Fail-
ures that occur in more than one year, the
Operational Failures are eligible for cor-
rection 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 deter-
mining if Operational Failures are insig-
nificant 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 relat-
ing to SCP (for example, the requirements
of section 4.04 relating to established
practices and procedures) have been sat-
isfied and that no Operational Failures oc-
curred other than the Operational Failures
identified below.

Example 1: In 1991, Employer X established
Plan A, a profit-sharing plan that satisfies the re-
quirements 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 limi-
tation year, the annual additions allocated to the
accounts of 3 of these employees exceeded the max-
imum limitations under § 415(c). Employer X con-
tributed $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 correc-
tion 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 limi-
tation year does not cause the failures to be signifi-
cant; 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 un-
der § 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 af-
fected 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 mone-
tary amount of the failure relative to the total em-
ployer contribution), the failure is significant. Ac-
cordingly, 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 compensa-
tion, 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 er-
rors in transcribing the compensation data with re-
spect to 6 of the plan's 40 participants, resulting in
excess allocations to those 6 participants' accounts.
Under these facts, the number of participants af-
fected by the failure relative to the number of par-
ticipants that could have been affected is insignifi-

cant, and the failure is due to minor data errors.
Thus, the failure occurring in 2005 is insignificant
and therefore eligible for correction under this sec-
tion 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 respon-
sibility for administering Plan B, in addition to other
administrative functions within Public School. Dur-
ing the 2005 plan year, a former employee should
have received an additional minimum required dis-
tribution of $278 under § 403(b)(10). Another par-
ticipant received an impermissible hardship with-
drawal 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 mul-
tiple failures occurred in a single plan year, the
failures are eligible for correction under this section
8 because in the aggregate the failures are insignif-
icant.

## 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 signifi-
cant) if the Operational Failure is cor-
rected and the correction is either com-
pleted 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 cor-
rection period. The last day of the correc-
tion period for an Operational Failure is
the last day of the second plan year fol-
lowing 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 ad-
ditional 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 sec-
tion 9.02. See section 6.02(5)(d)(ii) for a
limited extension of the correction period
set forth in this paragraph for Plan Spon-
sors taking action to locate lost partici-
pants.

(2) Extension of correction period for
Transferred Assets. In the case of an Op-
erational Failure that relates only to

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

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, ac-
quisition, or other similar employer trans-
action between the Plan Sponsor and the
sponsor of the transferor plan or the prior
sponsor of an assumed plan.

(3) Effect of examination. The correc-
tion 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 permit-
ting completion of correction after the end
of the correction period.)

.03 Substantial completion of correc-
tion. Correction of an Operational Failure
is substantially completed by the last day
of the correction period only if the re-
quirements 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, for-
mulating a correction method, and initiat-
ing correction in a manner that demon-
strates 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, cor-
rection is completed with respect to 65%
of all participants affected by the Opera-
tional Failure; and

(b) thereafter, the Plan Sponsor com-
pletes correction of the Operational Fail-
ure 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 relat-
ing 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 employ-
ees exceeded the § 402(g) limit and Employer Z
failed to make the required top-heavy minimum con-
tribution. In addition, during the review of the ad-
ministration 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 cor-
rected 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 ap-
plicable 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 de-
fined contribution plan sponsored by Employer C.
Following Employer A's review of Plan C, Em-
ployer A and Employer C agreed that Plan A would
accept a transfer of plan assets from Plan C attrib-
utable 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 Em-
ployer A that Plan C was tax qualified. Employers A
and C also agreed that such transfer would be in
accordance with § 414(1) and § 1.414(1)-1 and ad-
dressed 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 af-
fected 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 require-
ments of SCP. Under these facts, Employer A has,

within the correction period, corrected the Opera-
tional 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 require-
ments of this section 10 are satisfied with
respect to failures submitted in accor-
dance with the requirements of this sec-
tion 10 if the Plan Sponsor pays the user
fee required under section 6.08 of Rev.
Proc. 2016-8, or any subsequent guid-
ance that sets forth user fees for VCP
submissions, and implements the correc-
tive actions and satisfies any other condi-
tions in the compliance statement de-
scribed 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 ad-
dressed under VCP, and only those fail-
ures are covered by a VCP compliance
statement. The IRS will not make any
investigation or finding under VCP con-
cerning whether there are failures.

.03 Effect of VCP submission on exam-
ination. Because VCP does not arise out
of an examination, consideration under
VCP does not preclude or impede (under
§ 7605(b) or any administrative provi-
sions 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 ex-
amination. See section 5.08 for the defi-
nition of Under Examination.

.04 No concurrent examination activ-
ity. Except in unusual circumstances, a
plan that has been properly submitted un-
der 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 Sub-
mission is pending with respect to issues

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

not identified in the Group Submission at
the time such plan comes Under Exami-
nation. 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 exam-
inations 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 re-
quested 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 guid-
ance issued in the Internal Revenue Bul-
letin) while separately processing a VCP
submission for the same plan. Generally,
issuance of the determination letter in re-
sponse to an application made on a Form
5310 will be suspended pending the clo-
sure 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 fail-
ure 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 fail-
ures 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 re-
ceipt of a VCP submission, the IRS will
review whether the eligibility require-
ments 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 Ap-
plication for Voluntary Correction Pro-
gram (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 deter-
mines 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 oc-
curred, 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 cor-
rections and the plan's administrative pro-
cedures.

(4) Additional information required. If
additional information is required, an IRS
representative will generally contact the
Plan Sponsor or the Plan Sponsor's repre-
sentative and explain what is needed to
complete the submission. The Plan Spon-
sor will have 21 calendar days from the
date of this contact to provide the re-
quested 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 re-
quest 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 man-
ager).

(5) Additional failures discovered after
initial submission. (a) A Plan Sponsor that
discovers additional unrelated failures af-
ter 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 pro-
cessing 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 fail-
ures under consideration. However, the
IRS retains the discretion to determine
that a failure is outside the scope of the
voluntary request for consideration be-
cause the Plan Sponsor did not voluntarily
bring this failure forward. In this case, if
the additional failure is significant, all as-
pects of the plan may be examined and the
rules pertaining to Audit CAP will apply.

(6) Conference right. If the IRS ini-
tially 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 con-
tacted by the IRS representative and of-
fered a conference with the IRS. The con-
ference can be held either in person or by
telephone and must be held within 21 cal-
endar days of the date of contact. The Plan
Sponsor will have 21 calendar days after
the date of the conference to submit addi-
tional information in support of the sub-
mission. 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 re-
ferred 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

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

unsigned compliance statement. Within
30 calendar days of the date the compli-
ance statement is sent, the Plan Sponsor
must sign and return the compliance state-
ment 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 circum-
stances, the plan may be referred to Em-
ployee 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 cor-
rective 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 appropri-
ate 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 Spon-
sor has submitted a penalty of perjury
statement (see section 11.08(1)) with re-
spect to such subsequent modifications,
the Plan Sponsor will be required to sign
and return the compliance statement under
the general procedures described in sec-
tion 10.06(8)(a).

(9) Timing of correction. (a) In gen-
eral. The Plan Sponsor must implement
the specific corrections and administrative
changes set forth in the compliance state-
ment 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 correc-
tion period in writing and must be ap-
proved by the IRS.

(b) Interim Amendments and Non-
amender Failures. Correction of the fail-
ure to timely adopt Interim Amendments
or other required amendments, as de-
scribed 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 cor-
rective 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 leg-
islative 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 state-
ment. Once the compliance statement has
been issued (based on the information
provided), the Plan Sponsor cannot re-
quest a modification of the compliance
terms except by a new request for a com-
pliance statement, accompanied by an ad-
ditional user fee. However, if the re-
quested 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 modifica-
tion, a copy of the original compliance
statement and related VCP submission,
any other correspondence relating to the
issuance of the original compliance state-
ment, 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 com-
plied with the correction methods and that
any plan administrative procedures re-
quired 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 proce-
dures 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 ad-
ministrative procedures), and the time pe-
riod 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 require-
ments of the Code on account of the fail-
ures described in the compliance state-
ment if the conditions of the compliance
statement are satisfied. The reliance pro-
vided by a compliance statement is lim-
ited to the specific failures and years spec-
ified and does not provide reliance for any
other failure or year.

(2) Correction through plan amend-
ment. (a) Interim Amendment Failures.
With respect to a failure to amend a plan
timely for Interim Amendments, as de-
scribed in section 5.01(2)(a)(ii)(B) of this
revenue procedure, the issuance of a com-
pliance statement will result in the correc-
tive amendments being treated as if they
had been adopted timely for the purpose
of determining the availability of the re-
medial amendment period in Rev. Proc.
2007-44 and Rev. Proc. 2016-37. How-
ever, the issuance of such a compliance
statement does not constitute a determina-
tion as to whether the Interim Amend-
ment, 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 amend-
ments provided on the Required Amend-
ments List, as described in section
5.01(2)(a)(ii)(C)(the definition of Non-
amender Failure), the issuance of a com-
pliance statement will result in the correc-
tive amendments being treated as if they
had been timely adopted during the appli-
cable remedial amendment period. How-
ever, the issuance of such a compliance
statement does not constitute a determina-
tion as to whether the corrective plan
amendment as drafted complies with the
change in qualification requirement. The

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

compliance statement does not constitute
a determination as to whether the correc-
tive 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 Op-
erational Failure, then the compliance
statement issued under VCP constitutes a
determination that the Operational Failure
has been corrected, but is not a determi-
nation 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 un-
der § 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 amend-
ment period set forth in Announcement
2009-89 and Rev. Proc. 2013-22. How-
ever, the issuance of a compliance state-
ment 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) regula-
tions.

(3) Administrative procedures re-
quired. Where current procedures are in-
adequate for operating the plan in confor-
mance 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 adminis-
trative 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 ex-
cise tax or other penalty as provided under

section 6.09) are authorized to be signed
by managers within Employee Plans Rul-
ings and Agreements, under the Tax Ex-
empt 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 de-
fined 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 re-
spect to the same taxable year or years to
which the compliance statement relates.

.09 Special rules relating to Anony-
mous 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 identify-
ing the applicable plan, the Plan Sponsor,
or the Eligible Organization. The require-
ments 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 attor-
ney statement and the penalty of perjury
statement need not be included with the
initial submission). For purposes of pro-
cessing the submission, the State of the
Plan Sponsor must be identified in the
initial submission. All Anonymous Sub-
missions 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 submis-
sion is made by an individual who repre-
sents the Plan Sponsor, such individual
must satisfy the power of attorney require-
ments 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 representa-
tive will submit an executed copy of a
Form 2848, Power of Attorney and Dec-
laration of Representation, upon the dis-

closure of the identity of the Plan Sponsor
to the IRS. Once the IRS and the plan
representative reach agreement with re-
spect to the submission, the IRS will con-
tact the plan representative in writing in-
dicating 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 identi-
fying material (including the power of at-
torney statement and the penalty of per-
jury 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, un-
til each plan and Plan Sponsor is identified
to the IRS, a submission under this sub-
section 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 proto-
type plan, (b) a volume submitter practi-
tioner, as that term is defined in section
13.05 of Rev. Proc. 2015-36, (c) an insur-
ance company or other entity that has is-
sued annuity contracts or provides ser-
vices 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 er-
ror 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 Organi-
zation must notify the IRS that it is no
longer eligible to make a Group Submis-
sion. Under these circumstances the user
fee may be retained by the IRS.

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

(2) General rules. An Eligible Organi-
zation may submit a VCP request for a
Qualified Plan, a 403(b) Plan, a SEP, or a
SIMPLE IRA Plan under a Group Sub-
mission for Plan Document, Operational,
and Employer Eligibility Failures. If a
sponsor of a master or prototype plan sub-
mits 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 submis-
sion and a separate user fee must be sub-
mitted for each specimen plan. For this
purpose, in the case of either the master or
prototype plan or volume submitter spec-
imen plan, the number of plans is deter-
mined with reference to the number of
basic plan documents, not adoption agree-
ments.

(3) Special Group Submission proce-
dures. (a) In general, a Group Submission
is subject to the same procedures as any
VCP submission in accordance with sec-
tions 10 and 11, except that the Eligible
Organization is responsible for perform-
ing 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 pro-
vides the IRS with the information re-
quired in section 10.10(3)(c). The purpose
of the notice is to provide each Plan Spon-
sor with information relating to the Group
Submission request. The notice should ex-
plain 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 Spon-
sor responds within the 90-day period re-
questing that the Plan Sponsor's plan be
excluded from the Group Submission.

(c) When an Eligible Organization re-
ceives 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 ad-
ditional 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 iden-
tification 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 certifi-
cation 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 pro-
vided that the requirements of section
10.10(3)(b) have been satisfied. Appli-
cants are encouraged to submit the list on
a computer disk in Microsoft Word. Only
those plans for which correction is actu-
ally 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 El-
igible Organization filed the Group Sub-
mission with the IRS, the Plan Sponsor's
plan will be included in the Group Sub-
mission. However, with respect to such
plan, the Group Submission will not pre-
clude or impede an examination of the
plan with respect to any failures not iden-
tified in the Group Submission at the time
the plan comes Under Examination.

.11 Multiemployer and multiple em-
ployer plans. (1) In the case of a multiem-
ployer or multiple employer plan, the plan
administrator (rather than any contribut-
ing 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 multiem-
ployer or multiple employer plan has fail-

ures that apply to fewer than all of the
employers under the plan, the plan admin-
istrator may choose to have the user fee
(described in the annual revenue proce-
dure 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 submis-
sion 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 descrip-
tions. 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 in-
cluded in a single VCP submission.

(3) A schedule may be used only if its
printed content applies without modifica-
tion to the applicant's situation.

(4) Applicants may use the current ver-
sions 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

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

14568 series to improve usability, reflect
changes in law, or create additional sched-
ules by adding new forms to the Form
14568 series.

.03 Submission requirements. A VCP
submission must include the following in-
formation:

(1) Identification of failures. A com-
plete 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 proce-
dures applicable to the failures in effect at
the time the failures occurred.

(3) Proposed method of correction. A
detailed description of the method for cor-
recting the failures that the Plan Sponsor
has implemented or proposes to imple-
ment. Each step of the correction method
must be described in narrative form. The
description must include the specific in-
formation needed to support the proposed
correction method. This information in-
cludes, for example, the number of em-
ployees affected and the expected cost of
correction (both of which may be approx-
imated if the exact number cannot be de-
termined at the time of the request), the
years involved, and calculations or as-
sumptions the Plan Sponsor used to deter-
mine 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 contribu-
tions or distributions (indicating the com-
putation periods and the basis for deter-
mining Earnings or actuarial adjustments,
in accordance with section 6.02(4)).

(5) Computations. Specific calculations
for each affected employee or a represen-
tative 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 pro-
poses a correction method that involves
elective deferrals (whether matched or un-
matched) and matching contributions, the
Plan Sponsor must submit calculations il-

lustrating 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 cor-
rection and after the correction.

(6) Former employees or beneficiaries.
The method(s) that will be used to locate
and notify former employees and benefi-
ciaries, 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 proce-
dures. A description of the measures that
have been or will be implemented to en-
sure that the same failures will not recur.

(8) Request for excise tax relief
(§ 4972, 4973, 4974, or 4979) or addi-
tional 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 re-
quest.

(9) Loan failures and income tax re-
porting 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 in-
stead of the year in which the deemed
distribution occurred.

(10) Transferred Assets. If a submis-
sion includes a failure that relates to
Transferred Assets and the failure oc-
curred prior to the transfer, a description
of the transaction (including the dates of
the employer change and the plan trans-
fer).

(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 imple-
menting 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) regard-
ing elective deferrals, the Plan Sponsor
must, prior to making the VCP submis-
sion, contact the insurance company or
custodian with control over the plan's as-
sets to assure cooperation in effecting a
distribution of the excess deferrals ad-

justed 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 sub-
mission.

(12) Group Submissions. A Group
Submission must be signed by the Eligible
Organization or the Eligible Organiza-
tion's authorized representative and ac-
companied by a copy of the relevant por-
tions 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 sub-
mission must be accompanied by the fol-
lowing documents:

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

(2) Plan document. A copy of the en-
tire 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 ap-
plicable 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 reve-
nue procedure that sets forth user fees
(including VCP user fees), must be in-
cluded with the submission. The user fee
must be paid by check made payable to
the United States Treasury. Include a pho-
tocopy 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 Submis-
sions. 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

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

included in the submission and any addi-
tional amount is due at the time the com-
pliance 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 cor-
rection 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 re-
quirements 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 represen-
tative 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 Infor-
mation Authorization. (See Form 8821
and Instructions) See section 10.09 for
special rules relating to Anonymous Sub-
missions.

.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 Anon-
ymous Submission made pursuant to sec-
tion 10.09, and the submission is made by
an individual authorized to represent the
Plan Sponsor, the individual must submit
the following statement: "Under penal-
ties 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 Check-
list. The IRS will be able to respond more
quickly to a VCP submission if the sub-
mission is carefully prepared and com-
plete. The checklist provided on Form
8950 and the instructions to Forms 8950
and 8951 are designed to assist Plan Spon-
sors 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 con-
cerns an Orphan Plan and should include
information that establishes that the appli-
cant is an Eligible Party, as defined in
section 5.03(2).

.11 Acknowledgement letter. The IRS
will acknowledge receipt of a VCP sub-
mission (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 submis-
sion. 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 submis-
sions. Plan Sponsors and their representa-
tives should maintain copies of all corre-
spondence 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 as-
sembled 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 fail-
ures relate to Transferred Assets, in-
clude a description of the related em-
ployer transaction).

· An explanation of how and why the
failures occurred.

· Description of the method for correct-
ing failures, including Earnings meth-
odology (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 fail-
ures or corrections, then affirmatively
state that position when addressing
this issue.

· Description of the administrative pro-
cedures that have been or will be im-
plemented 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 re-
quested on Form 8951, and the sup-
porting rationale for such relief.

5\. If the VCP submission includes ei-
ther 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 deter-
mination 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.

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

## SECTION 12. VCP USER FEES

.01 User fees. (1) In general. The gen-
eral 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 (ex-
cept 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 cor-
rected in accordance with SCP or VCP)
upon an Employee Plans or Exempt Or-
ganizations 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 partic-
ipant 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 examina-
tion 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. Depend-
ing 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 admin-
istrative procedures are inadequate for op-
erating the plan in conformance with the
applicable requirements of the Code, the
closing agreement may be conditioned
upon the implementation of stated proce-
dures.

.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 sanc-
tion 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 agree-
ment between the IRS and the Plan Spon-
sor that is binding with respect to the tax
matters identified in the agreement for the
periods specified.

.06 Other procedural rules. The proce-
dural 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 rel-
evant factors described in section 14.02.
Sanctions will not be excessive and will
bear a reasonable relationship to the na-
ture, 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 sanc-
tion for Nonamender Failures discovered
during the determination letter application
process.

.02 Factors considered. Factors in-
clude:

(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 oc-
curred;

(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 compen-
sated 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 Em-
ployer Eligibility Failure;

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

(i) the reason for the failure (for exam-
ple, data errors such as errors in transcrip-
tion 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 Spon-
sor 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 Spon-
sor 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 Spon-
sor had reasonably determined that a pro-
vision 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 addi-
tional factor taken into account with re-
spect to a participant loan that did not

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

comply with the requirements of
§ 72(p)(2) is the extent to which the fail-
ure 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 in-
action).

.03 Transferred Assets. If the examina-
tion involves a plan with Transferred As-
sets 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 Trans-
ferred Assets were maintained as a sepa-
rate plan.

.04 Sanction for Nonamender Failures
discovered during the determination letter
application process. (1) Except as pro-
vided in section 14.04(2) and (3), if the
only failure identified by the IRS during
the determination letter application pro-
cess 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 ad-
opted after the end of the plan's last re-
medial 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 ad-
opted 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 ad-
opted 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 ad-
opted at any time before the end of the
plan's second six-year remedial amend-
ment 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 gener-
ally will not be less than the VCP user fee
applicable to the plan.

(b) If a Nonamender Failure is egre-
gious, the sanction will be determined under
section 14.01. Whether a Nonamender Fail-
ure 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 fail-
ure to timely adopt an amendment (upon
which a favorable determination letter
was conditioned) within the applicable re-
medial amendment period, the sanction is
$750 regardless of the number of plan par-
ticipants, provided the required amendment
is adopted within three months of the expi-
ration 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 proce-
dure. 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 de-
livered 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 sub-
mitted 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 con-
tained 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 spon-
sor, and a person is not required to re-
spond to, a collection of information un-
less 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 informa-
tion is required to enable the Commis-
sioner, Tax Exempt and Government En-
tities Division of the IRS to consider the
issuance of various types of closing agree-
ments 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 ben-

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

efits of the eligible employees is retained.
The likely respondents are individuals,
state or local governments, businesses or
other for-profit institutions, nonprofit in-
stitutions, and small businesses or organi-
zations.

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

The estimated annual burden per re-
spondent/recordkeeper varies from .5 to
45.5 hours, depending on individual cir-
cumstances, with an estimated average of
25.28 hours. The estimated number of re-
spondents or recordkeepers is 5,375.

The estimated frequency of responses
is occasional.

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

### DRAFTING INFORMATION

The principal authors of this revenue
procedure are Kathleen Herrmann and Pa-
mela R. Kinard of the Office of the Asso-
ciate Chief Counsel (Tax Exempt and
Government Entities). For further infor-
mation regarding this revenue procedure,
please contact the Employee Plans' tax-
payer 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 Qual-
ified Plans. In each case, the method de-
scribed corrects the Operational Failure
identified in the headings below. Correc-
tive allocations and distributions should
reflect Earnings and actuarial adjustments
in accordance with section 6.02(4) of this
revenue procedure. The correction meth-
ods in this appendix are acceptable to cor-
rect Qualification Failures under VCP,
and to correct Qualification Failures under
SCP that occurred notwithstanding that
the plan has established practices and pro-
cedures 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 har-
bors. 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, depend-
ing 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 contribu-
tion feature, the plan may use the correc-
tion 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 meth-
ods permitted. As provided in section
6.02(2), there may be more than one rea-
sonable and appropriate correction of a
failure. Any correction method used that
is not described in Appendix A or Appen-
dix 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 require-
ment 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 em-
ployees 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 Ap-
pendix A, and the Plan Sponsor would
need to satisfy the general correction prin-

ciples 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 contribu-
tion 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 re-
quired benefit must be accrued in the man-
ner 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 begin-
ning on or before December 31, 2001, the
multiple use test of § 401(m)(9). The per-
mitted correction method is to make
QNECs (as defined in § 1.401(k)-6) on
behalf of the nonhighly compensated em-
ployees to the extent necessary to raise the
actual deferral percentage or actual con-
tribution percentage of the nonhighly
compensated employees to the percentage
needed to pass the test or tests. For pur-
poses 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 contribu-
tions must be made on behalf of all eligi-
ble nonhighly compensated employees (to
the extent permitted under § 415) and
must be the same percentage of compen-
sation. 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, em-
ployees who would have received a
matching contribution had they made
elective deferrals must be counted as eli-
gible 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 cover-
ing 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 eligi-
ble 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.

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

.04 Failure to distribute elective defer-
rals in excess of the § 402(g) limit (in
contravention of § 401(a)(30)). The per-
mitted 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 distribu-
tion in gross income applies whether or
not any portion of the excess deferral is
attributable to a designated Roth contribu-
tion (see § 402A(d)(3)). In accordance
with § 1.402(g)-1(e)(1)(ii), a distribution
to a highly compensated employee is in-
cluded 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: em-
ployer provided contributions or benefits.
For plans with employer provided contri-
butions or benefits (which are neither
elective deferrals under a qualified cash or
deferred arrangement under § 401(k) nor
matching or after-tax employee contribu-
tions 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 con-
tribution plan or to provide benefit accru-
als 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 correc-
tive contribution for an improperly ex-
cluded employee is described in the fol-
lowing paragraphs of this section .05(2).
(See Examples 3 through 12 of Appen-
dix B.)

(b) If the employee was not provided
the opportunity to elect and make elective
deferrals (other than designated Roth con-
tributions) 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 em-
ployee'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 em-
ployee'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 defer-
ral 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 ex-
cludable employees and the other cover-
ing 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 com-
ponent plans is not permitted in order to
reduce the applicable ADP, the corre-
sponding missed deferral, and the required
QNEC. The QNEC required for the em-
ployee 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 em-
ployee.

(c) If the employee should have been
eligible for but did not receive an alloca-
tion 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 nonelec-
tive contribution on behalf of the affected
employee. The corrective employer non-
elective contribution is equal to the
matching contribution the employee
would have received had the employee
made a deferral equal to the missed defer-
ral determined under section .05(2)(b).
The corrective employer nonelective con-
tribution 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 con-
tributions) 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 pro-

vides a matching contribution rate that is
at least as favorable as 100% of the elec-
tive deferral made by the employee. If the
employee was not provided the opportu-
nity 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 esti-
mate of the missed deferral replaces the
estimate based on the ADP test in a tradi-
tional § 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 re-
quired 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 con-
tributions to satisfy the safe harbor re-
quirements of § 401(k)(12). The QNEC
required to replace the employee's missed
deferral opportunity and the correspond-
ing 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 fail-
ure), 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 subse-
quent 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

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

with this section .05(2)(d)(ii) replaces the
estimate based on the ADP test in a tradi-
tional § 401(k) plan. The required correc-
tive 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 defer-
ral, 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), which-
ever applies under the plan. The employer
contribution for the missed deferral op-
portunity must be a QNEC. The corrective
employer contribution consisting of the
QNEC required to replace the employee's
missed deferral opportunity and the corre-
sponding matching or nonelective contri-
bution 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 un-
der § 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 compensa-
tion 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 regu-
lations, at 74 FR 23134).

(e) If the employee should have been
eligible to elect and make after-tax em-
ployee contributions (other than desig-
nated 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 op-
portunity for making after-tax employee
contributions is equal to 40% of the em-
ployee's "missed after-tax contributions."

The employee's missed after-tax contribu-
tions are equal to the actual contribution
percentage (ACP) for the employee's
group (either highly compensated or non-
highly compensated) times the employ-
ee's compensation, but with the resulting
amount not to exceed applicable plan lim-
its. 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 sepa-
rately the portion of the ACP that is at-
tributable to after-tax employee contribu-
tions for the employee's group (either
highly compensated or nonhighly com-
pensated), 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 ex-
cluded 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 em-
ployer nonelective contribution on behalf
of the affected employee. The corrective
employer nonelective contribution is
equal to the matching contribution the em-
ployee would have received had the em-
ployee made an after-tax employee con-
tribution 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 af-
fected employee.

(g) The methods for correcting the fail-
ures 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 meth-
ods described in section .05(2)(b) through
(f) cannot be used until after correction of
the ADP or ACP test failures. For pur-
poses 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 eligi-
ble employees who were provided with

the opportunity to make elective deferrals
or after-tax employee contributions and
receive an allocation of employer match-
ing 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 em-
ployees 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 elec-
tive deferrals as designated Roth contribu-
tions, the correction is the same as de-
scribed under section .05(2). Thus, for
example, the corrective employer contri-
bution required to replace the missed de-
ferral 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 cor-
rective contributions made by the em-
ployer may be treated as designated
Roth contributions (and may not be in-
cluded in an employee's gross income)
and thus may not be contributed or allo-
cated to a Roth account (as described in
§ 402A(b)(2)). The corrective employer
contribution must be allocated to an ac-
count 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) Correc-
tion 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 em-
ployer 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 em-
ployee 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 contribu-
tions. For this purpose, the missed deferral
attributable to catch-up contributions is
one half of the applicable catch-up contri-
bution limit for the year in which the
employee was improperly excluded. Thus,

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

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 con-
tribution limit for a § 401(k) plan. The
eligible employee's missed deferral op-
portunity is $1,250 (that is, 50% of the
missed deferral attributable to catch-up
contributions of $2,500). The QNEC re-
quired to replace the missed deferral op-
portunity for the year of exclusion is ad-
justed 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 provi-
sion, could not make additional elective
deferrals on account of the plan or statu-
tory 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 mak-
ing catch-up contributions under this sec-
tion .05(4), the Plan Sponsor should as-
certain 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 match-
ing 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 contribu-
tion is equal to the additional matching
contribution the employee would have re-
ceived had the employee made a deferral
equal to the missed deferral determined
under paragraph (a) of this section .05(4).
The corrective employer nonelective con-
tribution 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 cor-
rection of the ACP test failure. For pur-
poses 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 em-
ployee contributions and receive an allo-
cation of employer matching contribu-
tions, 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 elec-
tive 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 defer-
ral." The missed deferral is determined by
multiplying the employee's elected defer-
ral percentage by the employee's compen-
sation. 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 defer-
ral 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 ad-
justed for Earnings to the date the correc-
tive QNEC is made on behalf of the af-
fected employee.

(b) Missed opportunity for after-tax
employee contributions. For eligible em-
ployees who filed elections to make after-
tax employee contributions under the Plan
which the Plan Sponsor failed to imple-
ment 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 percent-
age 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 match-
ing 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 match-
ing contribution had either the missed de-
ferral 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 cor-
rective employer nonelective contribution
or QNEC is equal to the matching contri-
bution the employee would have received
had the employee made a deferral equal to
the missed deferral determined under this
paragraph. The corrective employer non-
elective contribution or QNEC must be
adjusted for Earnings to the date the cor-
rective 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 fail-
ures. 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 de-
scribed 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 Spon-
sor's failure to implement employee elec-
tions and received allocations of employer
matching contributions, in accordance
with the terms of the plan, and may dis-
regard 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 spe-
cific rules in this section .05(6), the cor-
rection 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.

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

(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 sub-
ject 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 compen-
sation.

(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 har-
bor correction method is available for cer-
tain Employee Elective Deferral Failures
(as defined in section .05(10) of this ap-
pendix associated with missed elective de-
ferrals for eligible employees who are
subject to an automatic contribution fea-
ture in a § 401(k) plan or 403(b) Plan
(including employees who made affirma-
tive elections in lieu of automatic contri-
butions but whose elections were not im-
plemented correctly). If the failure to
implement an automatic contribution fea-
ture for an affected eligible employee or
the failure to implement an affirmative
election of an eligible employee who is
otherwise subject to an automatic contri-
bution feature does not extend beyond the
end of the 91/2-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 compen-
sation made on or after the last day of the
91/2-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 af-
ter 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 Earn-
ings) 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 signif-
icant operational failures (described in
section 9.02).

(b) Calculation of Earnings for certain
failures to implement automatic contribu-
tion features. This correction method pro-
vides 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 cor-
rected in accordance with the procedures
in this section .05(8). If an affected eligi-
ble employee has not affirmatively desig-
nated an investment alternative, missed
Earnings may be calculated based on the
plan's default investment alternative, pro-
vided 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 re-
quired corrective contributions relating to
any matching contributions. The Plan
Sponsor may also use the Earnings adjust-
ment 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 follow-
ing information:

(i) General information relating to the
failure, such as the percentage of eligible
compensation that should have been de-
ferred 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 contri-
butions will begin shortly).

(iii) A statement that corrective alloca-
tions relating to missed matching contri-
butions have been made (or that corrective
allocations will be made). Information re-
lating to the date and the amount of cor-
rective allocations need not be provided.

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

(v) The name of the plan and plan
contact information (including name,
street address, e-mail address, and tele-
phone 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 ex-
ceed 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 de-
ferrals if the following conditions are sat-
isfied:

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

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

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 Earn-
ings, which may be calculated as de-
scribed in section .05(8)(b) of this appen-
dix) 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 har-
bor correction method described in sec-
tion .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 re-
quired in sections .05(2)(b) and .05(5)(a)
of this appendix. In order to use this safe
harbor correction method, the Plan Spon-
sor must satisfy the following conditions:

(i) Correct deferrals begin no later than
the earlier of the first payment of compen-
sation 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 af-
ter 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 de-
scribed 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 require-
ments under SCP for significant opera-
tional failures (described in section 9.02
of this revenue procedure), including ad-
justments for Earnings, which may be cal-
culated 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 de-
ferred 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 contri-
butions will begin shortly).

(iii) A statement that corrective alloca-
tions have been made (or that corrective
allocations will be made). Information re-
lating to the date and the amount of cor-
rective allocations need not be provided.

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

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

(10) Employee Elective Deferral Fail-
ure. 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 affirma-
tive 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 af-
firmative election because the employee
was improperly excluded from the plan.
Automatic contribution features include

automatic enrollment and automatic esca-
lation features (including automatic esca-
lation features that were affirmatively
elected).

.06 Failure to timely pay the minimum
distribution required under § 401(a)(9).
In a defined contribution plan, the permit-
ted 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 re-
quired to be distributed for each year in
which the initial failure occurred should
be determined by dividing the adjusted
account balance on the applicable valu-
ation date by the applicable distribution
period. For this purpose, adjusted ac-
count 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 dis-
tributions for prior years. In a defined
benefit plan, the permitted correction
method is to distribute the required mini-
mum distributions, plus an interest pay-
ment based on the plan's actuarial equiv-
alence factors in effect on the date that the
distribution should have been made. See
section 6.02(4)(d) of this revenue pro-
cedure. 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 contrib-
ute to the plan the applicable amount un-
der 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 con-
sent 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 ac-
tuarially reduced to take into account dis-
tributions already received by the partici-
pant. However, the portion of the qualified
joint and survivor annuity payable to the
spouse upon the death of the participant

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

may not be actuarially reduced to take into
account prior distributions to the partici-
pant. Thus, for example, if, in accordance
with the automatic qualified joint and sur-
vivor annuity option under a plan, a mar-
ried participant who retired would have
received a qualified joint and survivor an-
nuity 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 partici-
pant's accrued benefit under the plan, then
the $600 monthly annuity payable during
the participant's lifetime may be actuari-
ally reduced to take the single-sum distri-
bution 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 sur-
vivor annuity benefit (calculated using the
applicable interest rate and mortality table
under § 417(e)(3)). For example, assum-
ing 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 (calcu-
lated 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 pur-
poses 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) contrib-
utes 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 de-
ferrals and after-tax employee contribu-
tions) 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 reason-
able error in estimating compensation) is
to place the excess annual additions into
an unallocated account, similar to the sus-
pense 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 ac-
count, 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 de-
ferrals or after-tax employee contributions
(even if the excess did not result from a
reasonable error in determining compen-
sation, the amount of elective deferrals or
after-tax employee contributions that
could be made with respect to an individ-
ual under the § 415 limits) is to distribute
the elective deferrals or after-tax em-
ployee contributions using a method sim-
ilar 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 ad-
ditions 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 pe-
riods. 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 lon-
ger maintaining the plan, or similar rea-
sons and (b) the plan is an Orphan Plan, as
defined in section 5.03, the permitted cor-
rection is to terminate the plan and dis-
tribute plan assets to participants and ben-
eficiaries (in accordance with title IV of
ERISA, if applicable). This correction
must satisfy four conditions. First, the cor-
rection 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 de-
fined 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 re-
quirements of §§ 401(a)(11) and 417 ap-
ply 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 Depart-
ment of Labor regulations, subject to in-
come, 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, notwithstand-
ing correction under this revenue proce-
dure, 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 fur-
nished to the Plan Sponsor, participants,
or beneficiaries need not indicate that the
procedures followed or notices furnished
actually comply with, or are required un-
der, Department of Labor regulations.

(2) 403(b) Failures for orphan con-
tracts or other assets. (a) Former employ-
ees or beneficiaries. In any case in which

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

a 403(b) Failure results from the Plan
Sponsor having ceased involvement with
respect to specific assets (including an in-
surance annuity contract) held under a de-
fined contribution plan on behalf of a par-
ticipant who is a former employee or on
behalf of a beneficiary, a permitted cor-
rection 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 La-
bor 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 ven-
dor to which contributions are being made
under the plan in order to become a con-
tract 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 Oper-
ational Failures under Qualified Plans.
This appendix also sets forth Earnings ad-
justment 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 ad-
justments in accordance with section
6.02(4) of this revenue procedure. The
correction methods in this appendix are
acceptable to correct Qualification Fail-
ures under VCP, and to correct Qualifica-
tion Failures under SCP that occurred not-
withstanding that the plan has established
practices and procedures reasonably de-
signed 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 simi-
larly be used to correct the failure.

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

(1) the plan year and the § 415 limita-
tion 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 Oper-
ational Failures and the eligibility and
other requirements for SCP, VCP, or Au-
dit CAP, whichever applies, are satisfied;
and

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

.03 Designated Roth contributions.
The examples in this Appendix B gener-
ally do not identify whether the plan of-
fers designated Roth contributions. The
results in the examples, including correc-
tive 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 cor-
rection method for a failure to satisfy the
actual deferral percentage ("ADP"), actual
contribution percentage ("ACP"), or, for
plan years beginning on or before Decem-
ber 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 cor-
rected 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 deter-
mined and assigned to highly compen-
sated employees as provided in paragraph
(1)(b)(ii) below. That excess contribution
amount (adjusted for Earnings) is either
distributed to the highly compensated em-
ployees or forfeited from the highly com-
pensated employees' accounts as provided
in paragraph (1)(b)(iii) below. That same
dollar amount (that is, the excess contri-
bution 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 com-
ponent plans is not permitted. This correc-
tion method may also be used to correct a
failure to satisfy the multiple use test for
plan years beginning on or before Decem-
ber 31, 2001.

(ii) Determination of the Excess Con-
tribution 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 begin-
ning 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 correc-
tions that complied with §§ 401(k)(8) and
401(m)(6), and, for plan years beginning
on or before December 31, 2001, the mul-
tiple use test.

(iii) Distributions and Forfeitures of
the Excess Contribution Amount. (A) The
portion of the excess contribution amount
assigned to a particular highly compen-
sated 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

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

year of the failure, is forfeited. If the
amount is forfeited, it is used in accor-
dance 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 proce-
dure. 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 (ad-
justed for Earnings) are forfeited in accor-
dance 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 em-
ployee and that payment is a forfeitable
match described in either paragraph
(1)(b)(iii)(A) or (B), then it is an Over-
payment defined in section 5.01(3)(c) of
this revenue procedure that must be cor-
rected (see sections 2.04 and 2.05 below).

(iv) Contribution and Allocation of
Equivalent Amount. (A) The Plan Spon-
sor makes a contribution to the plan that
is equal to the aggregate amounts dis-
tributed and forfeited under paragraph
(1)(b)(iii)(A) (that is, the excess contri-
bution 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 para-
graph (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 peri-
ods prior to the effective date of those
regulations, Notice 98-1, 1998-1 C.B.
327. The contribution made under para-
graph (1)(b)(iv)(A) is allocated to the ac-
count 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 compen-

sated employees for that year and who
also are nonhighly compensated employ-
ees for the year of correction. Alterna-
tively, the contribution is allocated to ac-
count 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 employ-
ees must receive a uniform allocation (as a
percentage of compensation) of the con-
tribution. (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 un-
der 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) ap-
plies 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 pe-
riods 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 com-
pensated 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 contribu-
tions 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 Em-
ployee Q). The corrective contribution is allocated to
the account balances of eligible nonhighly compen-
sated 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 contribu-
tions equal to 50% of the sum of an employee's
elective deferrals and after-tax employee contribu-
tions that do not exceed 10% of the employee's
compensation. The plan provides that matching con-
tributions are subject to the plan's 20% per year of
service vesting schedule and that matching contribu-
tions are forfeited and used to reduce employer con-
tributions if associated elective deferrals or after-tax
employee contributions are distributed to correct an
ADP or ACP test failure. For 2005, nonhighly com-
pensated employees made after-tax employee contri-
butions 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 con-
tribution 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 Ex-
ample 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 asso-
ciated 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 contri-
butions are $2,937.50 and $1,468.75, respectively.
Thus, $1,718.75 is forfeited from Employee P's ac-
count 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 Em-

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

ployee P is $250 and for Employee Q is $220. The
total amount of the forfeitures of $3,657.50 (Em-
ployee 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 Em-
ployees in a § 401(k) or (m) Plan. (a)
Correction Method. (i) Appendix A Cor-
rection 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 mak-
ing elective deferrals (other than desig-
nated Roth contributions) and after-tax
employee contributions to a plan that pro-
vides benefits that are subject to the re-
quirements 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 elec-
tive deferrals and the corrective contribu-
tions for employees who were improperly
excluded from electing and making elec-
tive deferrals to a safe harbor § 401(k)
plan for one or more full plan years. (See
Examples 8, 9, and 10.) Appendix A, sec-
tion .05(3) sets forth the correction
method for the exclusion of an eligible
employee from electing and making elec-
tive 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 cor-
rection 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 fail-
ure 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) be-
low, 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 Ap-
pendix 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 de-
scribed 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 de-
ferrals 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 con-
junction 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 em-
ployee who was improperly excluded
from electing and making elective defer-
rals (including designated Roth contribu-
tions) or after-tax employee contributions
for a portion of a plan year or from re-
ceiving 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 Spon-
sor 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 require-
ments 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 ex-
amples 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 con-
tributions) 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 employ-
ee's missed deferral is determined by mul-
tiplying 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 im-
properly excluded. In a safe harbor
§ 401(k) plan, the employee's missed de-
ferral is determined by multiplying 3%
(or, if greater, whatever percentage of the
participant's compensation which, if con-
tributed as an elective deferral, would
have been matched at a rate of 100% or
more) by the employee's plan compensa-
tion for the portion of the year during
which the employee was improperly ex-
cluded. The missed deferral for the por-
tion 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 para-
graph) and any elective deferrals actually
made by the employee for that year would
exceed (ii) the maximum elective defer-
rals permitted under the plan for the em-
ployee for that plan year (including the
§ 402(g) limit). The corrective contribu-
tion is adjusted for Earnings. For purposes
of correcting other failures under this rev-
enue procedure (including determination
of any required matching contribution) af-
ter correction has occurred under this sec-
tion 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 ex-
cluded. (See Examples 4 and 5.)

(2) The appropriate corrective contri-
bution 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 ad-
justed 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

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

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 di-
vided by 12. The missed deferral for the
portion of the plan year during which the
eligible employee was improperly ex-
cluded 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 elec-
tive deferrals actually made by the em-
ployee for that year would exceed (ii) the
maximum elective deferrals permitted un-
der 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 correc-
tion 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 em-
ployees to elect and make after-tax em-
ployee 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 compen-
sated), determined prior to correction under
this section 2.02(1)(a)(ii)(C), by the em-
ployee's plan compensation for the por-
tion of the year during which the em-
ployee was improperly excluded. If the
ACP consists of both matching and after-
tax employee contributions, then, for pur-
poses of the preceding sentence, in lieu of
basing the missed after-tax employee con-
tributions on the ACP for the employee's
group (either highly compensated or non-
highly compensated), the Plan Sponsor is
permitted to determine separately the por-
tions of the ACP that are attributable to
matching contributions and after-tax em-
ployee 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 ad-
justed for Earnings. The requirements re-
lating to the passage of the ACP test before
this correction method can be used, as de-
scribed in Appendix A, section .05(2)(g),
still apply.

(2) The appropriate corrective contri-
bution 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 con-
tributions 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 com-
pensation for the portion of the year dur-
ing 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 contrib-
uted 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 em-
ployee was excluded from making after-
tax employee contributions divided by 12.
The missed after-tax employee contribu-
tion 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 maxi-
mum after-tax employee contributions
permitted under the plan for the employee
for the plan year. The requirements relat-
ing to the passage of the ACP test before
this correction method can be used, as de-
scribed in Appendix A, section .05(5)(d),
still apply.

(D) Matching Contribution Failures.
(1) The appropriate corrective contribu-
tion for the failure to make matching con-
tributions 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 (deter-
mined 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 contri-
butions 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 contri-
bution 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 elec-
tive deferrals (including designated Roth
contributions) or, where applicable, after-
tax employee contributions for a portion of
the plan year is equal to the matching con-
tribution 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 match-
able contributions permitted under the
plan for the plan year. The corrective con-
tribution is adjusted for Earnings. The re-
quirements relating to the passage of the
ACP test before this correction method

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

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 compen-
sation for the portion of the year during
which the employee was improperly ex-
cluded, a pro rata portion of the employ-
ee'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 Spon-
sor is not required to make a corrective
contribution with respect to elective defer-
rals (including designated Roth contribu-

tions) or after-tax employee contributions,
as provided in sections 2.02(1)(a)(ii)(B)
and (C), but is required to make a correc-
tive 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 contribu-
tions 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.)

Example 3:

Employer B maintains a § 401(k) plan. The plan
provides for matching contributions for eligible em-
ployees 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 desig-
nated 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 Jan-
uary 1, 2006.

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

(b) Examples.

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, sec-
tion .05(2), to correct the failure to include Em-
ployee V in the plan for the full plan year begin-
ning January 1, 2006. Employer B calculates the
corrective QNEC to be made on behalf of Em-
ployee 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 multi-
plying that percentage by Employee V's compensa-
tion 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 contri-
bution 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 pro-
vided in section .05(3) of Appendix A).

Matching contributions: Employee V should
have been eligible for, but did not receive, an allo-
cation 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 con-
tribution 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 contri-
bution is adjusted for Earnings. Under the terms of
the plan, if Employee V had made an elective defer-
ral 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 Em-
ployee V's compensation ($30,000) or $900. Ac-
cordingly, 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 op-
portunity to, elect and make after-tax employee con-
tributions in 2006. Employer B must make a QNEC
to the plan equal to the missed opportunity for mak-
ing after-tax employee contributions for Employee
V, which is 40% of Employee V's missed after-tax
employee contribution. The QNEC is adjusted for

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

Earnings. The missed after-tax employee contribu-
tion 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 com-
pensation for 2006. Accordingly, the missed after-
tax employee contribution for Employee V, on ac-
count of the employee's improper exclusion from the
plan is $189 (0.63% x $30,000). The missed oppor-
tunity to make after-tax employee contributions to
the plan is $76 (40% x $189). Thus, the required
corrective contribution for the failure to provide Em-
ployee 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 op-
portunity ($1,200), the missed opportunity for
after-tax employee contributions ($76), and re-
lated 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 eli-
gible employee's plan compensation during the pay-
roll 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 eli-
gibility requirements and should have entered the
plan on January 1, 2006, was not offered the oppor-
tunity 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 De-
cember 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 Septem-
ber 1, 2006 through December 31, 2006 ($10,000).
After being allowed to participate in the plan, Em-
ployee X made $250 of after-tax employee contri-
butions for the 2006 plan year. The ADP for non-
highly 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 em-
ployee contributions for nonhighly compensated em-
ployees for 2006 was 0.5%.

Correction:

In accordance with section 2.02(1)(a)(ii), Em-
ployer 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 con-
tributions, 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 contribu-
tion on behalf of Employee X that satisfies the require-
ments 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 por-
tion of the year in which Employee X was not
provided the opportunity to make elective deferrals
and after-tax employee contributions. Thus, for ad-
ministrative convenience, in lieu of using actual plan
compensation of $26,000 for the period Employee X
was excluded, Employee X's annual plan compen-
sation 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 con-
tribution 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 compensa-
tion 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 Em-
ployee 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 re-
duced because no plan limit is exceeded when this
amount is added to the matching contribution al-
ready contributed for the 2006 plan year. Accord-
ingly, the required corrective employer contribution
is $480. The required corrective employer contribu-
tion 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 Jan-
uary 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 contri-
bution 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 contribu-
tions ($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 contribu-
tions 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 ac-
count 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 com-
pensated employees multiplied by $24,000 (8/12ths
of the employee's 2006 plan compensation of
$36,000). The missed after-tax employee contribu-
tion amount, based on this calculation, is $120. How-
ever, the sum of this amount ($120) and the previ-
ously made after-tax employee contribution ($950)
is $1,070. Because the plan limit for after-tax em-
ployee contributions is $1,000, the missed after-tax
employee contribution needs to be reduced by $70,
to ensure that the total after-tax employee contribu-
tions 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. Em-
ployee Y, who should have been provided the op-
portunity 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

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

Y's compensation from January 1 through June 30,
2006 was $130,000. The ADP for highly compen-
sated 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 ap-
plicable § 402(g) limit. Accordingly, the missed de-
ferral 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 ad-
justed 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 eli-
gible employee's plan compensation during the pay-
roll 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 re-
quirements 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 employ-
ee'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 partici-
pate 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 compen-
sated employees for 2006 was 1.8%. The portion of
the ACP attributable to after-tax employee contribu-
tions 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 em-
ployee contributions that the employee had the op-
portunity 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 elec-
tive deferrals or after-tax employee contributions.
The employer only needs to make a corrective em-
ployer 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 contribu-
tion 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 de-
ferrals during the period of exclusion, that is, Janu-
ary 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 non-
highly 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 Em-
ployee Z was not given the opportunity to make
elective deferrals or after-tax employee contribu-
tions. Accordingly, the missed matching contribu-
tion for the period of exclusion is obtained by mul-
tiplying 2% by Employee Z's compensation of
$10,000 (3/12ths of the employee's 2006 plan com-
pensation of $40,000). Based on this calculation, the
missed matching contribution is $200. However, when
this amount is added to the matching contribution al-
ready 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 non-
highly compensated employee who met the eligibil-
ity 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 defer-
ral 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 re-
quirements of § 401(k)(12), the corrective contribu-
tion 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 com-
pensation. (See Appendix A, section .05(2)(d).)
Therefore, in this case, Employee M's missed defer-
ral is equal to 4% multiplied by $20,000, or $800.
The QNEC for Employee M's missed deferral op-
portunity 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 re-
quired corrective contribution for Employee M's
missed matching contribution is $800. Since the
matching contribution is required to satisfy the re-
quirements of § 401(k)(12), the corrective contribu-
tion 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 compen-
sation.

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

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 defer-
ral 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 nonelec-
tive 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 Em-
ployee M is $900 (that is, $300 for the missed
deferral opportunity, plus $600 for the missed non-
elective 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 de-
fined 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 elec-
tive 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 con-
tributions 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 attribut-
able 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 corre-
sponding matching contribution is $1,500 (that is,
60% of $2,500). Thus, the required corrective con-
tribution 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 em-
ployees 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 pro-

cessed, 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 de-
scribed 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 Em-
ployee 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 sec-
tion .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 Em-
ployee 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 oppor-
tunity 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 alloca-
tion 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 em-
ployer nonelective contribution is adjusted for Earn-
ings. Under the terms of the plan, if Employee T had
made an elective deferral of $3,000 or 10% of com-
pensation ($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 op-
portunity ($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 Meth-
ods. (i) Appendix A Correction Method. Ap-
pendix A, section .05, sets forth the correc-
tion method for correcting the failure to
make a contribution on behalf of the em-
ployees improperly excluded from a defined
contribution plan or to provide benefit ac-
cruals for the employees improperly ex-
cluded from a defined benefit plan. In the

case of a defined contribution plan, the cor-
rection 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 mean-
ing of § 1.401(k)-6).

(ii) Additional Requirements for Ap-
pendix 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 Ap-
pendix A correction method, an allocation
amount is determined for each excluded
employee on the same basis as the alloca-
tion amounts were determined for the
other employees under the plan's alloca-
tion formula (for example, the same ratio
of allocation to compensation), taking into
account all of the employee's relevant fac-
tors (for example, compensation) under
that formula for that year. The Plan Spon-
sor makes a corrective contribution on
behalf of the excluded employee that is
equal to the allocation amount for the ex-
cluded employee. The corrective contribu-
tion is adjusted for Earnings. If, as a result of
excluding an employee, an amount was im-
properly allocated to the account balance of
an eligible employee who shared in the orig-
inal allocation of the nonelective contribu-
tion, no reduction is made to the account
balance of the employee who shared in the
original allocation on account of the im-
proper 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 em-
ployee for a plan year from a profit-sharing
or stock bonus plan that provides for non-
elective contributions may be corrected us-
ing the reallocation correction method set
forth in this section 2.02(2)(a)(iii). Un-
der the reallocation correction method,
the account balance of the excluded em-
ployee is increased as provided in para-
graph (2)(a)(iii)(B) below, the account
balances of other employees are reduced
as provided in paragraph (2)(a)(iii)(C) be-
low, and the increases and reductions are
reconciled, as necessary, as provided in
paragraph (2)(a)(iii)(D) below. (See Ex-
amples 16 and 17.)

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

(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 allo-
cation 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 ad-
justed 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) ap-
plies if most of the employees with ac-
count 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 allo-
cation of the contribution through the date
of correction, no adjustment for Earnings
is required to the amount determined un-
der 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 ad-
ministrative 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 orig-
inal 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 cor-
rection.

(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 re-
ductions under section 2.02(2)(a)(iii)(C),
the Plan Sponsor makes a corrective con-
tribution 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 in-
creases under section 2.02(2)(a)(iii)(B),
then the amount by which each employ-
ee's account balance is reduced under sec-
tion 2.02(2)(a)(iii)(C) is decreased on a
pro rata basis.

(E) Reductions Among Multiple Invest-
ment Funds. If an employee's account bal-
ance is reduced and the employee's ac-
count balance is invested in more than one
investment fund, then the reduction may
be made from the investment funds se-
lected in any reasonable manner.

(F) Limitations on Use of Reallocation
Correction Method. If any employee would
be permitted to retain any distribution pur-
suant 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 con-
tributions. 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 eligi-
ble 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 compen-
sation. Most of the employees who received alloca-
tions 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 allo-
cation, the allocation made on behalf of each em-
ployee 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 cor-
rective 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 employ-
ees, adjusted for Earnings. The excluded employees
receive an allocation equal to 10% of compensation
(adjusted for Earnings) even though, had the ex-
cluded 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 inclu-
sion of the excluded employees in the allocation of
that contribution would have resulted in each eligible
employee, including each excluded employee, re-
ceiving 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 Earn-
ings. Employer D determines the adjustment for
Earnings using the rate of return of each eligible
employee's excess allocation (using reasonable, con-
sistent assumptions). Accordingly, for an employee
who shared in the original allocation and directed the
investment of the allocation into more than one in-
vestment fund or who subsequently transferred a
portion of a fund that had been credited with a
portion of the 2006 allocation to another fund, rea-
sonable, consistent assumptions are followed to de-
termine 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 conve-

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

nience, 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 bal-
ances of the excluded employees is increased ex-
ceeds the aggregate amount (adjusted for Earnings)
by which the other employees' account balances are
reduced. Accordingly, Employer D makes a contri-
bution 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 contribu-
tion plan to apply the proper vesting per-
centage 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 para-
graph. The Plan Sponsor makes a corrective
contribution on behalf of the employee
whose account balance was improperly for-
feited in an amount equal to the improper
forfeiture. The corrective contribution is ad-
justed for Earnings. If, as a result of the
improper forfeiture, an amount was im-
properly 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 reallo-
cated among the account balances of the
other eligible employees in the plan, a
failure to apply the proper vesting per-
centage 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 cor-
rection method set forth in this paragraph. A
corrective reallocation is made in accor-
dance with the reallocation correction
method set forth in section 2.02(2)(a)(iii),
subject to the limitations set forth in sec-
tion 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 im-
proper forfeiture is reduced by the amount

of the improper forfeiture that was allo-
cated to that employee's account. The
Earnings adjustments for the account bal-
ances that are being reduced are deter-
mined in accordance with sections
2.02(2)(a)(iii)(C)(2) and (3) and the re-
ductions 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 aggre-
gate 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 in-
creases, then the amount by which each
employee's account balance is reduced is
decreased on a pro rata basis. (See Exam-
ple 17.)

##### (2) Examples.

Example 16:

Employer E maintains a profit-sharing plan that
provides for nonelective contributions. The plan pro-
vides for self-directed investments among four in-
vestment funds and daily valuation of account bal-
ances. The plan provides that forfeitures of account
balances are reallocated among the account balances
of other eligible employees on the basis of compen-
sation. During the 2006 plan year, Employee R ter-
minated 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 dis-
tribution 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, Em-
ployer E makes a contribution on behalf of Em-
ployee 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, Em-
ployee 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 (ad-
justed for Earnings). Because most of the employees
whose account balances are being reduced are non-
highly 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 Em-
ployee R is increased exceeds the aggregate amount
(adjusted for Earnings) by which the other employ-
ees' account balances are reduced. Accordingly, Em-
ployer 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 Relat-
ing to a § 415(b) Excess. (a) Correction
Methods. (i) Return of Overpayment Cor-
rection 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 re-
turned 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 differ-
ence to the plan. In addition, in accor-
dance 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 cor-
rection method, in the case of plan bene-
fits 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 para-
graph (1)(a)(ii). Future payments to the
recipient are reduced so that they do not

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

exceed the § 415(b) maximum limit and
an additional reduction is made to recoup
the Overpayment (over a period not lon-
ger than the remaining payment period) so
that the actuarial present value of the ad-
ditional reduction is equal to the Overpay-
ment plus interest at the interest rate used
by the plan to determine actuarial equiv-
alence. (See Examples 18 and 19.)

(B) Joint and Survivor Annuity Pay-
ments. If the employee is receiving pay-
ments 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 cor-
rected under this adjustment of future pay-
ment 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 un-
der § 415(d) after benefit payments have com-
menced. 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 re-
ceived by Employee S for 2006 included an Over-
payment of $10,000 (because the § 415(b)(1)(A)
limit for 2006 was $175,000). This error was discov-
ered at the beginning of 2007.

Correction:

Employer F uses the adjustment of future pay-
ments 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 Over-

payment. Accordingly, Employee S's future benefit
payments from the plan are reduced to $175,000 and
further reduced by $1,000 annually for life, begin-
ning 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 pay-
ments correction method to correct the § 415(b)
failure, by recouping the entire excess payment made
in 2006 from Employee S's remaining benefit pay-
ments 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 cor-
rection 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 dis-
tributions 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 cor-
rection 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 dis-
tributions 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 re-
turned 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) Ap-
pendix 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 em-
ployee (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 employ-
ee's annual addition that exceeds the lim-
its under § 415(c) ("§ 415(c) excess") for
the limitation year, and (C) who has ter-
minated 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) ex-
cess is deemed to consist solely of the
matching and nonelective contributions. If
the employee's § 415(c) excess (adjusted
for Earnings) has previously been for-
feited, 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 ac-
count, as described in section 6.06(2) of
this revenue procedure, to be used to re-
duce employer nonelective contributions
in succeeding year(s) (or if the amount
would have been allocated to other em-
ployees who were in the plan for the year
of the failure if the failure had not oc-
curred, 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 Ap-

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

pendix A correction method, this correc-
tion 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 contri-
butions and matching contributions may
be corrected using the return of Overpay-

ment correction method set forth in sec-
tion 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 contribu-
tions. The plan provides that the nonelective contri-
butions vest under a 5-year cliff vesting schedule.
The plan provides that when an employee terminates
employment, the employee's nonvested account bal-
ance is forfeited five years after a distribution of the
employee's vested account balance and that forfei-
tures 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, accord-
ingly, a § 415(c)(1)(B) limit of $15,000. Employee T
made elective deferrals and after-tax employee con-
tributions. For the 1998 limitation year, Employee U
had § 415 compensation of $40,000, and, accord-
ingly, 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 re-
ceived his entire vested account balance (which con-
sisted 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 ac-
count balance) consisting of $500 (adjusted for Earn-
ings) of after-tax employee contributions and $2,500
(adjusted for Earnings) of elective deferrals is made
to Employee T. Employer G uses the forfeiture cor-
rection 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 contri-
butions. Accordingly, Employee U's nonvested ac-
count balance is reduced by $300 (adjusted for
Earnings) which is placed in an unallocated ac-
count, as described in section 6.06(2) of this rev-
enue procedure, to be used to reduce employer
contributions in succeeding year(s). After correc-
tion, 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 defer-
rals that do not exceed 8% of the employee's plan
compensation for the plan year. For the 1998 limi-
tation 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, con-
sisting 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 re-
maining $1,500 excess is apportioned equally be-
tween 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 con-
tributions. 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) (relat-
ing to a § 415(c) excess), may be cor-
rected 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 Over-
payment 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) Reduc-
tion of Account Balance Correction
Method. The allocation of contributions or
forfeitures under a defined contribution

plan for a plan year on the basis of com-
pensation 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 sec-
tion 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 contri-
bution 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 unal-
located account, as described in section 6.06(2) of
this revenue procedure, to be used to reduce em-
ployer contributions in succeeding year(s).

.07 Correction by Amendment. (1) Sec-
tion 401(a)(17) Failures. (a) Contribution
Correction Method. In addition to the re-
duction of account balance correction
method under section 6.06(2) of this rev-

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

enue procedure, a Plan Sponsor may cor-
rect 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 be-
half of each of the other employees (ex-
cluding 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 compensa-
tion 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 de-
nominator 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 ad-
justed 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 em-
ployee), 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 con-
tribution 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% mul-
tiplied 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 Fail-
ure of making hardship distributions to
employees under a plan that does not pro-
vide for hardship distributions may be
corrected using the plan amendment cor-
rection method set forth in this paragraph.
The plan is amended retroactively to pro-
vide for the hardship distributions that
were made available. This paragraph does
not apply unless (i) the amendment satis-
fies § 401(a), and (ii) the plan as amended

would have satisfied the qualification re-
quirements of § 401(a) (including the re-
quirements applicable to hardship distri-
butions under § 401(k), if applicable) had
the amendment been adopted when hard-
ship distributions were first made avail-
able. (See Example 26.) The Plan Amend-
ment 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 § 1.401(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 Janu-
ary 1, 2005, to provide a hardship distribution option
that satisfies the rules applicable to hardship distri-
butions 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 distribu-
tions under § 401(k)) if the amendment had been
adopted in 2005.

(3) Early Inclusion of Otherwise Eligi-
ble Employee Failure. (a) Plan Amend-
ment 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 com-
pleted the plan's minimum age or service
requirements but became a participant in
the plan on a date earlier than the appli-
cable 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 op-
erations. 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 con-
tributions based upon an employee's salary reduc-
tion contributions. In 2007, it is discovered that all
four employees who were hired by Employer L in
2006 were permitted to make salary reduction con-
tributions to the plan effective with the first weekly
paycheck after they were employed. Three of the
four employees are nonhighly compensated. Em-
ployer 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 ap-
propriate correction method for an Oper-

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

ational Failure in a defined contribution
plan includes a corrective contribution or
allocation that increases one or more em-
ployees' 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 adjust-
ments for corrective contributions or allo-
cations made under the correction meth-
ods 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 require-
ment 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 alloca-
tions 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 fail-
ure (determined under section 3.01(2)).
The Earnings amount is allocated in ac-
cordance 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 ad-
ministrative convenience set forth in this
section 3 is treated as a precise determi-
nation of Earnings. Thus, if the probable
difference between an approximate deter-
mination of Earnings and a determination
of Earnings under this section 3 is insig-
nificant and the administrative cost of a
precise determination would significantly
exceed the probable difference, reason-
able estimates may be used in calculating
the appropriate Earnings.

(d) This section 3 does not apply to
corrective distributions or corrective re-

ductions in account balances. Thus, for
example, while this section 3 applies in
increasing the account balance of an im-
properly excluded employee to correct the
exclusion of the employee under the real-
location 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 sec-
tion 2.02(2)(a)(iii)(C) for rules that apply
to the Earnings adjustments for such reduc-
tions.) In addition, this section 3 does not
apply in determining Earnings adjustments
under the one-to-one correction method de-
scribed 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 em-
ployee's account balance, the beginning
of the period of the failure is the date as of
which the account balance was improp-
erly reduced. See section 6.02(4)(f) of this
revenue procedure.

(b) Rules for Beginning Date for Ex-
clusion of Eligible Employees from Plan.
(i) General Rule. In the case of an exclu-
sion of an eligible employee from a plan
contribution, the beginning of the period
of the failure is the date on which contri-
butions of the same type (for example,
elective deferrals, matching contributions,
or discretionary nonelective employer
contributions) were made for other em-
ployees for the year of the failure. In the
case of an exclusion of an eligible em-
ployee from an allocation of a forfeiture,
the beginning of the period of the failure
is the date on which forfeitures were allo-
cated 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 ex-
cluded from making periodic elective de-
ferrals or after-tax employee contribu-
tions, 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 Earn-
ings 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 Earn-
ings rate generally is based on the invest-
ment 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 in-
vestment 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 pe-
riod of the failure. For administrative con-
venience, if most of the employees for
whom the corrective contribution or allo-
cation 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 contribu-
tion 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 with-
out regard to any special investment pro-
visions that vary according to the size of
the fund. Further, the Earnings rate appli-
cable to the corrective contribution or al-
location for a portion of a valuation period
may be a pro rata portion of the Earnings
rate for the entire valuation period, unless

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

the application of this rule would result in
either a significant understatement or
overstatement of the actual Earnings dur-
ing that portion of the valuation period.

(4) Allocation Methods. (a) In General.
For purposes of this section 3, the Earn-
ings 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 un-
der the plan in accordance with the plan's
method for allocating Earnings as if the fail-
ure had not occurred. (See, Example 28.)

(c) Specific Employee Allocation
Method. Under the specific employee al-
location 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 Earn-
ings for the valuation period during which
the corrective contribution or allocation is
made, the corrective contribution or allo-
cation (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 allo-
cation is made may be allocated as if that
employee's account balance had been in-
creased as of the last day of the prior
valuation period by the corrective contri-

bution or allocation, including only that
portion of the Earnings amount attribut-
able to Earnings through the last day of
the prior valuation period. The employ-
ee's account balance is then further in-
creased as of the last day of the valuation
period during which the corrective contri-
bution or allocation is made by that por-
tion of the Earnings amount attributable to
Earnings after the last day of the prior
valuation period. (See Example 29.)

(d) Bifurcated Allocation Method. Un-
der the bifurcated allocation method, the
entire Earnings amount for the valuation
periods ending before the date the correc-
tive contribution or allocation is made is
allocated solely to the account balance of
the employee on whose behalf the correc-
tive contribution or allocation is made.
The Earnings amount for the valuation
period during which the corrective contri-
bution or allocation is made is allocated in
accordance with the plan's method for
allocating other Earnings for that valua-
tion 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 pe-
riod 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 correc-
tive 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 correc-
tive contribution or allocation is made
("second partial valuation period") is al-

located 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 cur-
rent year but without regard to contributions re-
ceived during the current year (the "prior year ac-
count balance"). Plan contributions for 1997 were
made on March 31, 1998. On April 20, 2000, Em-
ployer L determines that an operational failure oc-
curred for 1997 because Employee X was improp-
erly excluded from the plan. Employer L decides to
correct the failure by using the Appendix A correc-
tion method for the exclusion of an eligible em-
ployee 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 Contri-
bution:

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 deter-
mine 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, Em-
ployer 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 Decem-
ber 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 ac-

count 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 contri-

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

bution (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 in-
creased 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 allo-
cation of Earnings for 1998 is increased, as of De-

cember 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 correc-
tive contribution ($5,750(.10)), to determine the ac-
count balances as of December 31, 1999. However,
each account balance other than Employee X's ac-
count balance has already shared in the 1999 Earn-
ings, 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 ac-
count 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 in-
creased 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 Em-
ployee X's account balance) will share in the 2000
portion of the earnings amount based on the esti-
mated 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 Contri-
bution:

The earnings amount on the corrective contribu-
tion is the same as in Example 28, but the earnings
amount is allocated using the specific employee al-

location 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 in-

creased by $7,084. Alternatively, Employee X's ac-
count 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 in-
creased 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 × 15%

2$5,750($5,000 + $750) × 10%

3$6,325 ($5,000 + $750 + $575) × 12%

#### Example 30:

The facts are the same as in Example 28.

Earnings Adjustment on the Corrective Contri-
bution:

The earnings amount on the corrective contribu-
tion 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 val-
uation 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

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

$6,325 ($5,000(1.15)(1.10)); and the December 31,
1999 account balances of employees (including Em-

ployee 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 × 15%
2$5,750 ($5,000 + $750) × 10%
3$6,325 ($5,000 + $750 + $575) × 12%

4 After 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 Contri-
bution:

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 (includ-
ing 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 × 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.

26 CFR 601.105: Examination of returns and claims
for refund, credit, or abatement; determination of
correct tax liability. (Also Part I, § 42; 1.42-14.)

### Rev. Proc. 2016-52

#### SECTION 1. PURPOSE

This revenue procedure publishes the
amounts of unused housing credit carry-
overs 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 proce-
dure for requesting an allocation of un-
used 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 Reve-
nue Bulletin the amount of unused hous-
ing credit carryovers allocated to qualified

states for a calendar year from a national
pool of unused credit authority (the Na-
tional Pool). This revenue procedure pub-
lishes 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:

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

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

Qualified State

Amount Allocated

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 Of-
fice of Associate Chief Counsel (Pass-
throughs and Special Industries). For fur-
ther information regarding this revenue
procedure, contact Mr. Holmes at (202)
317-4137 (not a toll-free number).

# Section 42 .- Low-Income Housing Credit

26 CFR 1.42-14. Allocation rules for post-1989
State housing credit ceiling amounts. Guidance is
provided to state housing credit agencies of qualified
states that request an allocation of unused housing
credit carryover under section 42(h)(3)(D) of the
Internal Revenue Code. See Rev. Proc. 2016-52

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

# 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 pub-
lished 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 ap-
plied 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 confu-
sion. It is not used where a position in a
prior ruling is being changed.

Distinguished describes a situation
where a ruling mentions a previously pub-
lished 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 pub-
lished ruling that is not considered deter-
minative with respect to future transac-
tions. This term is most commonly used in
a ruling that lists previously published rul-
ings 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 pe-
riod of time in separate rulings. If the new
ruling does more than restate the sub-

stance 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 rul-
ings 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 ma-
terial published in the Bulletin.

A-Individual.

Acq .- Acquiescence.

B-Individual.

BE-Beneficiary.

F.R .- Federal Register.

FUTA-Federal Unemployment Tax Act.

FX-Foreign corporation.

G.C.M .- Chief Counsel's Memorandum.

GE-Grantee.

TFE-Transferee.

TFR-Transferor.

CI-City.

GR-Grantor.

IC-Insurance Company.

TP-Taxpayer.

Ct.D .- Court Decision.

I.R.B .- Internal Revenue Bulletin.

TR-Trust.

CY-County.

LE-Lessee.

TT-Trustee.

D-Decedent.

LP-Limited Partner.

U.S.C .- United States Code.

DC-Dummy Corporation.

X-Corporation.

DE-Donee.

Del. Order-Delegation Order.

Nonacq .- Nonacquiescence.

O Organization.

DR-Donor.

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.

BK-Bank.

B.T.A .- Board of Tax Appeals.

T.C .- Tax Court.

C-Individual.

T.D .- Treasury Decision.

C.B .- Cumulative Bulletin.

CFR-Code of Federal Regulations.

GP-General Partner.

T.I.R .- Technical Information Release.

COOP-Cooperative.

LR-Lessor.

M-Minor.

Y-Corporation.

Z-Corporation.

DISC-Domestic International Sales Corporation.

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.

T-Target Corporation.

<!-- PageFooter="Bulletin No. 2016-42" -->

<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

## Numerical Finding List1

Bulletin 2016-27 through 2016-42

### Action on Decision:

2016-01, 2016-16 I.R.B. 580
2016-02, 2016-31 I.R.B. 193
2016-03, 2016-40 I.R.B. 424

### Announcements:

2016-21, 2016-27 I.R.B. 8
2016-23, 2016-27 I.R.B. 10
2016-24, 2016-30 I.R.B. 170
2016-25, 2016-31 I.R.B. 205
2016-26, 2016-38 I.R.B. 389
2016-27, 2016-33 I.R.B. 238
2016-28, 2016-34 I.R.B. 272
2016-29, 2016-34 I.R.B. 272
2016-30, 2016-37 I.R.B. 355
2016-31, 2016-38 I.R.B. 392
2016-32, 2016-40 I.R.B. 434
2016-33, 2016-39 I.R.B. 422
2016-34, 2016-39 I.R.B. 422
2016-35, 2016-39 I.R.B. 423
2016-36, 2016-39 I.R.B. 423
2016-37, 2016-39 I.R.B. 423

### Notices:

2016-40, 2016-27 I.R.B. 4
2016-41, 2016-27 I.R.B. 5

2016-42, 2016-29 I.R.B. 67

2016-43, 2016-29 I.R.B. 132
2016-44, 2016-29 I.R.B. 132
2016-45, 2016-29 I.R.B. 135
2016-46, 2016-31 I.R.B. 202
2016-47, 2016-35 I.R.B. 276
2016-48, 2016-33 I.R.B. 235
2016-49, 2016-34 I.R.B. 265
2016-50, 2016-38 I.R.B. 384
2016-51, 2016-37 I.R.B. 344
2016-52, 2016-40 I.R.B. 425
2016-53, 2016-39 I.R.B. 421
2016-54, 2016-40 I.R.B. 429
2016-55, 2016-40 I.R.B. 432
2016-57, 2016-40 I.R.B. 432
2016-58, 2016-41 I.R.B. 438
2016-59, 2016-42 I.R.B. 457
2016-60, 2016-42 I.R.B. 458

### Proposed Regulations:

REG-163113-02, 2016-36 I.R.B. 329
REG-147196-07, 2016-29 I.R.B. 32
REG-123854-12, 2016-28 I.R.B. 15
REG-131418-14, 2016-33 I.R.B. 248
REG-102516-15, 2016-32 I.R.B. 231
REG-109086-15, 2016-30 I.R.B. 171
REG-134016-15, 2016-31 I.R.B. 205

Proposed Regulations :- Continued

REG-101689-16, 2016-30

I.R.B. 170

REG-103058-16, 2016-33

I.R.B. 238

REG-105005-16, 2016-38

I.R.B. 380

REG-108792-16, 2016-36

I.R.B. 320

## Revenue Procedures:

2016-37, 2016-29 I.R.B. 136
2016-39, 2016-30 I.R.B. 164
2016-40, 2016-32 I.R.B. 228
2016-41, 2016-30 I.R.B. 165
2016-42, 2016-34 I.R.B. 269
2016-43, 2016-36 I.R.B. 316
2016-44, 2016-36 I.R.B. 316
2016-45, 2016-37 I.R.B. 344
2016-46, 2016-37 I.R.B. 345
2016-47, 2016-37 I.R.B. 346
2016-48, 2016-37 I.R.B. 348
2016-49, 2016-42 I.R.B. 462
2016-51, 2016-42 I.R.B. 465
2016-52, 2016-42 I.R.B. 520

## Revenue Rulings:

2016-17, 2016-27 I.R.B. 1
2016-18, 2016-31 I.R.B. 194
2016-19, 2016-35 I.R.B. 273
2016-20, 2016-36 I.R.B. 279
2016-23, 2016-39 I.R.B. 382
2016-24, 2016-39 I.R.B. 395
2016-25, 2016-41 I.R.B. 435

## Treasury Decisions:

9773, 2016-29 I.R.B. 56
9774, 2016-30 I.R.B. 151
9775, 2016-30 I.R.B. 159
9776, 2016-32 I.R.B. 222
9777, 2016-36 I.R.B. 282
9778, 2016-31 I.R.B. 196
9779, 2016-33 I.R.B. 233
9781, 2016-35 I.R.B. 274
9782, 2016-36 I.R.B. 301
9783, 2016-39 I.R.B. 396
9784, 2016-39 I.R.B. 402
9785, 2016-38 I.R.B. 375
9786, 2016-42 I.R.B. 442

1A 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.

<!-- PageFooter="October 17, 2016" -->

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageBreak -->

## Finding List of Current Actions on Previously Published Items1

## Revenue Procedures :- Continued

2016-3

Bulletin 2016-27 through 2016-42

Modified by Rev. Proc. 2016-45, 2016-37 I.R.B. 228

Notices:

2016-29

Modified by

2009-89

Rev. Proc. 2016-39, 2016-30 I.R.B. 164

Modified by

Notice 2016-51, 2016-37 I.R.B. 344

Treasury Decisions:

2012-54

2013-17

Obsoleted by

Obsoleted by

Notice 2016-51, 2016-37 I.R.B. 344

T.D. 9785 2016-38 I.R.B. 375

2013-1

2014-12

Modified by

Modified by

Notice 2016-41, 2016-27 I.R.B. 5

T.D. 9776 2016-32 I.R.B. 222

2013-1
Superseded by
Notice 2016-41, 2016-27 I.R.B. 5

2013-67
Modified by
Notice 2016-51, 2016-37 I.R.B. 344

2015-63
Superseded by
Notice 2016-58, 2016-41 I.R.B. 438

### Revenue Procedures:

2003-16
Modified by
Rev. Proc. 2016-47, 2016-37 I.R.B. 346

2007-44
Clarified by
Rev. Proc. 2016-37, 2016-29 I.R.B. 136

2007-44
Modified by
Rev. Proc. 2016-37, 2016-29 I.R.B. 136

2007-44
Superseded by
Rev. Proc. 2016-37, 2016-29 I.R.B. 136

2009-33
Modified by
Rev. Proc. 2016-48, 2016-37 I.R.B. 348

2015-36
Modified by
Rev. Proc. 2016-37, 2016-29 I.R.B. 136

2016-3
Modified by
Rev. Proc. 2016-40, 2016-32 I.R.B. 228

"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.

<!-- PageFooter="Bulletin No. 2016-42" -->
<!-- PageFooter="October 17, 2016" -->
<!-- PageBreak -->

# Internal Revenue Service Washington, DC 20224

Official Business
Penalty for Private Use, $300

# 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.