IRS: A Keen Eye on 401(k) Plans
Retirement plans continue to top the list of IRS examination priorities. When the IRS Tax Exempt and Government Entities (TE/GE) Office issued its fiscal year 2018 work plan, a number of “recurring errors” were outlined and remain on the watch list. These “recurring errors” require continued focus from plan sponsors and service providers. Over the past years, the same issues were drivers behind the Employee Plan Examination unit’s random focused examinations of retirement plans under Learn, Educate, Self-correct, Enforce (LESE) Projects program. You can see the most current list of LESE projects and their findings here. The biggest offenders on the list continue to be:
- Document errors: late or missing amendments
- Not following the plan document provisions in operation of the plan
- Failing non-discrimination tests
- Missing the mark with plan limits
- Not depositing employee elective deferrals timely
We’ve prepared a set of questions you can use with plan sponsors to diagnose and treat possible plan ailments before they become a bigger problem and/or get identified during plan audit.
- Have you updated your plan document to comply with the changes in the tax code? Have you timely signed the amendments and retained them in your plan records?
Major changes in retirement plan law and tax regulations require modification of plan document language and procedures by specific deadlines spelled out by the IRS. Plan sponsors need to execute the modifications in a timely manner and keep copies of all plan documents for the life of the plan. At some point during an audit or in the course of plan merger/termination, the plan sponsor may be required to demonstrate compliance with current and prior law; a complete document file helps accomplish this task. Among the most recent major changes, frequently referred to by their acronyms, are GUST, which encompassed a set of acts which came into effect between 1994 and 2000, EGTRRA of 2001, and PPA of 2006.
In addition to plan restatements, plans periodically need to be amended to align with required changes to current law – these amendments are called interim amendments – or to add or remove optional plan provisions – these amendments are called discretionary amendments. In addition, plan sponsors may periodically execute corrective amendments; these amendments are generally employed to fix certain plan test failures, for example, relaxing plan profit-sharing allocation conditions to correct a failed coverage test. Each of the amendment types has a prescribed timeframe for implementation.
- Do you understand how your plan works? Are you managing the plan consistent with its terms?
Failure to follow the terms of the plan document is the most common mistake made by plan sponsors. In order to operate the plan accurately, understanding its provisions is essential. Of equal value is establishing proper administrative procedures. Does your client have clarity about the plan’s eligibility and entry requirements? What happens when an employee becomes eligible? Is your client aware of the loan procedures under the plan? Are these procedures followed properly for the owner and non-owner employees? Does your client know applicable plan limits? Are procedures properly documented to ensure continuity of care?
- Does your plan cover a sufficient number of employees? Have there been or do you anticipate changes in business ownership? Have there been or do you anticipate changes in your workforce?
Non-discrimination is a key trait of a qualified retirement plan and, therefore, is frequently a focus of IRS audit and enforcement efforts. In order to assure compliance with this tenet, the Internal Revenue Code contains a number of tests. For a plan to be non-discriminatory, a specified amount of benefits should be extended to a specific percentage of eligible non-owner employees. While carve-outs and certain exclusions are permissible, the plan has to comply with coverage and benefit amount requirements at all times to maintain its tax-preferred status.
Changes in employee census, such as new hires, terminations, rehires, additions of business associates, transactions (mergers, acquisitions, sales) should be communicated to the plan service providers (consultants, third-party administrators, recordkeepers, etc.) as quickly as possible to assess the impact of those events on the plan’s operation and take appropriate proactive action. Ownership of other businesses, either direct or indirect (such as through family attribution), may also have a significant impact on non-discrimination testing and should be properly disclosed for proper plan administration.
- Have all eligible participants been notified about their eligibility and informed about their rights under the plan?
It is not uncommon for employees working on a part-time basis or those electing not to make salary deferrals to be erroneously considered ineligible. The retirement plan document spells out who is considered an eligible employee based on the eligibility and participation standards specified by the Internal Revenue Code and ERISA. Determination of eligibility becomes more complex when leased, contracted or shared employees are involved, and therefore help of a properly trained retirement professional becomes crucial. All newly eligible participants should be notified and educated about their benefits, rights, and responsibilities under the plan. It is a good practice to establish a communication procedure to ensure consistency and completeness. Creating recurring calendar reminders may help with getting into a habit of timely enrollment.
- Have employee salary deferral contributions and loan repayments been deposited timely?
The employer is responsible for timely deposit of salary deferrals and loan repayments to the plan. The Department of Labor’s (DOL’s) rules require deferrals to be deposited into the plan trust on the earliest date that these amounts can be segregated from the employer’s general assets, but in no event later than the 15th day of the following month. The 15th day of the month is the latest deadline and is not considered a safe harbor. Employee contributions to a retirement plan with less than 100 participants are deemed timely as long as they are deposited within seven business days from the day they were withheld. Depositing salary deferral contributions on the date of the payroll tax transmission for that pay period has been frequently suggested as a recommended practice. Failure to timely deposit employee salary deferrals may lead to a prohibited transaction which requires restorative payments to participants and payment of excise tax to the IRS.
- Have you provided all eligible participants with the required annual notices and statements?
Qualified plans require that certain plan information be made available to plan participants and beneficiaries; examples of such documents include the following:
- Summary Plan Description (SPD) – A document distributed to participants to communicate their benefits, rights and responsibilities in plain language. SPD should be provided to all new participants and beneficiaries.
- Summary of Material Modifications (SMM) – Advises plan participants of amendments made to the plan. This should be distributed no later than 210 days after the end of the plan year in which the change was made.
- Summary Annual Report (SAR) – A narrative of the plan’s financial information as outlined on Form 5500; this report must be made available to defined contribution plan participants on an annual basis.
- Individual Benefit Statements – Provide information about the participant’s account balances and explain what portion of those benefits is vested, or owned, by plan the participant. They should be distributed at least quarterly for participant-directed accounts and at least annually for the trustee-directed accounts.
- Blackout Notice – Should be provided to all profit sharing plans with or without a 401(k) feature 30 days in advance of any plan activities that may restrict participants’ access to plan funds. Examples of such plan activities include change of investment options, transfer to a different investment platform or mergers/acquisitions.
Compliance with qualified retirement plan rules and regulations can be a daunting task; it’s no surprise that plan sponsors find it difficult at times to avoid inadvertent mistakes. The good news is that as long as the plan sponsor identifies the problems prior to an IRS audit, these mistakes may be rectified using self-correction and voluntary correction programs at a significantly reduced compliance fee.
For discussion purposes only and in no way represents legal or tax advice. For advice regarding your specific circumstances, the services of an appropriate legal or tax advisor should be sought.