Are You Playing Audit Roulette with Your 401(k) Plan?
The prospect of an audit by the Internal Revenue Service (IRS) or the U.S. Department of Labor (DOL) strikes fear into the heart of most employers who sponsor qualified retirement plans. When an auditor finds violations of the Employee Retirement Income Security Act (ERISA), the consequences can be severe. The employer may lose past deductions, face monetary sanctions, or even suffer the ultimate penalty – plan disqualification. Plan fiduciaries may be held personally liable for civil or criminal penalties if breaches of fiduciary duty are found. An audit may be an unpleasant wakeup call to an employer who has placed retirement plan issues on the backburner. To make matters worse, the number of retirement plan auditors operating in Oregon has more than doubled, resulting in an increase in the number and frequency of plan audits.
While an employer cannot prevent an audit by the IRS or DOL, he or she can be prepared for their knock upon the door. Preparation can reduce the cost (and fear) associated with a plan audit. One way to be prepared is to utilize the services of the professionals who assist you with your retirement plan to perform a “self-audit” of your plan. A self-audit can identify potential plan failures and ensure continued compliance with the applicable rules and regulations. In order to be effective, the self-audit should cover a variety of areas:
- Plan Documentation. Employers should verify that their plan document has been amended for the most recent tax law changes. The Summary Plan Description (SPD) should also be updated for plan changes and distributed to participants. IRS Form 5500s, summary annual reports, and financial statements should be retained for at least three years.
- Plan Operations. Employers should verify that the plan is being operated according to its terms and applicable regulations. They should also sample eligibility calculations, vesting calculations, distribution procedures, loan procedures, and plan contributions to test for compliance.
- Plan Compliance Testing. Employers should ensure all applicable annual testing is being performed with respect to the plan. Employers should consult with their ERISA attorneys if they are unsure what tests are required or who is performing such tests.
- Annual Forms. Employers should verify that the annual IRS Form 5500 is filed and that all applicable 1099R forms are completed.
By reviewing these items with the assistance of ERISA counsel, an employer can identify potential issues and develop methods to increase efficiency and maintain compliance. If issues are identified, the employer should explore opportunities to correct those violations through the voluntary IRS correction program.
The IRS correction program is the Employee Plans Compliance Resolution System (EPCRS). Once a failure is identified, an employer can use one of the compliance programs under EPCRS to correct that failure. For some failures, the Self-Correction Program (SCP) may be utilized to correct the violations pursuant to correction methods and principles set forth by the IRS. The ERISA attorney working with the employer can assist in determining the appropriate course of correction. As part of the SCP, an employer is expected to establish procedures for ongoing compliance. The SCP does not require the employer to seek IRS approval of the correction. While the SCP is not a guarantee against the issue being raised in an audit, self-correction of plan failures may significantly reduce or even eliminate sanctions for noncompliance.
For more serious failures, the Voluntary Correction Program (VCP) under EPCRS may be utilized to seek correction with IRS approval. The VCP requires that a submission be made to the IRS along with payment of a compliance fee. ERISA counsel can prepare the requisite submission materials. Approval of the correction by the IRS ensures employers that sanctions will not be applied for the compliance failure in a subsequent audit. Both the SCP and the VCP require that specific procedures be followed and that the correction be clearly documented. Voluntary correction of plan qualification defects is almost always less costly than correction (and payment of sanctions) as part of an IRS or DOL audit.
If a failure is discovered as part of an IRS audit, the penalty applied will be a negotiated amount based upon the maximum penalty the IRS could assess. Because most failures are technically items that could lead to plan disqualification, the maximum penalty is likely to be quite large. Although plan disqualification is not the norm, severe monetary sanctions could be imposed.
Given the serious consequences of retirement plan compliance issues, it may also be advisable to establish a pension committee to monitor plan issues. A pension committee may be comprised of individuals in ownership, management, or human resource positions. Pension committees also frequently include professional advisors to the plan, such as ERISA attorneys or third-party administrators. Once formed, a pension committee may meet on an ongoing basis to ensure continued compliance. They may also address plan issues as they arise in an effective and efficient manner.
Although audits cannot be entirely avoided, the cost, work, and worry associated with IRS and DOL scrutiny can be diminished by the techniques described above. The key is to establish procedures to ensure compliance on a prospective basis. Continued review is critical to ensuring those procedures remain effective. When issues do arise, employers should address those issues immediately and utilize the applicable compliance program. Professional assistance from retirement plan advisors is available for all of these techniques. For further information please feel free to contact our office.