By James G. Isaac, Susan Peters Schaefer & Karen A. Simonsen
McDermott Will & Emery, LLP
, Chicago, IL
The Internal Revenue Service (IRS) recently published an updated list of common plan mistakes found during IRS Employee Plans Team Audits (EPTA) and an internal controls questionnaire used by EPTA auditors. Although the EPTA Program focuses on retirement plans with at least 2,500 participants, the published materials give all plan administrators valuable insights into the IRS's audit process and what the IRS believes plan sponsors can do to avoid common errors in plan administration. Plan sponsors can utilize these tools to assess their plans' current compliance and to correct any mistakes identified.
Compliance Trends and Tips
This IRS resource provides an extensive description of the mistakes most frequently found by the EPTA auditors. The website also offers tips on how to avoid these errors.
Common Errors. One of the most common problems identified by EPTA team members is the plan sponsor's failure to adopt timely amendments to comply with changes in the law. The failure to adopt timely amendments could result in significant penalties (possibly even plan disqualification) if uncovered during an audit. To avoid such failures, the IRS suggests plan sponsors conduct an annual review of the plan document.
Other common errors found in all plan types include failures to:
• Follow the plan document's terms on plan eligibility, eligible compensation, vesting, and contribution and benefit limitations
• Make required minimum distributions for participants over age 70 1/2
• Properly process and report distributions
• Maintain adequate plan records and internal controls
In addition, the IRS has found that 401(k) plans often fail to correct nondiscrimination testing (ADP/ACP) failures, do not correctly apply matching contribution formulas and fail to follow the plan's automatic enrollment procedures. Common defined benefit pension plan mistakes include using inaccurate data in benefit calculations, failing to follow the suspension of benefits rules and commencing benefit payments at the wrong time.
Suggested Procedures to Minimize Errors.
EPTA auditors also suggest ways to avoid making these common mistakes. For example, to avoid mistakes related to eligible compensation, the IRS suggests using a straightforward definition of eligible compensation and using the same definition for multiple purposes within the plan and across plans. A 401(k) plan's failure to follow automatic enrollment procedures can best be avoided by properly documenting and communicating automatic increases in salary deferrals and ensuring that the plan document contains language addressing participant rehires in the context of automatic arrangements. To address suspension of benefits issues, defined benefit plan sponsors should ensure that the plan document includes a suspension of benefits provision and should work with the plan's administrator to confirm that the suspension of benefits notice is accurate and being provided when necessary.
Internal Controls Questionnaire and Document List
This resource provides sample questions used to check a plan administrator's procedures and internal controls. The questionnaire contains four sets of questions each directed at various points of plan compliance: human resources, payroll, plan administration and operational failures.
• Regarding human resources, EPTA auditors inquire about (i) the coordination of employees' hiring and termination with the actual delivery of benefits; (ii) how transferred, rehired and leased employees are handled; and (iii) how plan practices and procedures are communicated to new benefits or human resources personnel when turnover occurs.
• Regarding payroll, EPTA examiners focus on the controls in place for the accurate transmission of employee payroll data to the plan recordkeeper. The IRS also reviews whether certain pay is run through nonstandard payroll (such as bonuses and executive pay), how payroll errors are corrected, how the correction is communicated to the plan administrator and whether record of the correction is maintained.
• Regarding plan administration, EPTA examiners review how responsibilities are allocated and how communications and data are maintained between the plan sponsor and the plan's recordkeeper or other service providers. Examiners will consider items such as who is responsible for determining that timely amendments are executed for the plan. In addition, EPTA auditors review how the custodian of trust assets maintains trust data, communicates that data to the plan's trustee and deals with errors. They also review how certain reportable transactions and events are identified and disclosed.
• Regarding operational plan failures, EPTA examiners will ask a series of procedural questions. For example, examiners will want to know what procedures are in place to identify operational failures, how identified failures have been corrected and what new procedures have been implemented so that failures do not occur again. The IRS will be particularly interested in a plan sponsor's answers to these questions when determining whether sanctions are appropriate and, if so, the severity of these sanctions.
Finally, the IRS provides a guide with a comprehensive list of documents that need to be made available during an EPTA audit. Guides specific to both defined contribution and defined benefit plans are available, as well as a combined guide for both plan types. Depending on the specific issues under review, an auditor may require that the plan sponsor make available such diverse materials as documentation confirming the correction of a plan's past operational failures, the amount and date of distributions to individual participants (including bank records documenting distributions), and the amounts and types of plan expenses and other disbursements.
Next Steps for Plan Sponsors
The EPTA materials not only alert plan sponsors of what to expect in an IRS audit but also are valuable resources to check plan compliance and internal control procedures. These are important tools that plan administrators may use to conduct self-audits of plan compliance. Plan sponsors should conduct periodic self-audits, as frequently as annually. These self-audits can permit the plan to self-correct errors currently, without requiring IRS approval, and prepare for eventual IRS audits. The questionnaire specifically asks about the self-audit procedures in place, and the IRS may consider evidence of self-audit procedures in negotiating any penalties for errors found in a formal audit.
For more information, in the Tax Management Portfolios, see Wagner and Bianchi, 375 T.M., ECPRS — Plan Correction and Disqualification, and in Tax Practice Series, see ¶5510, Qualified Retirement Plans — Overview.