CPA & Business Advisory Blog

Issues that the IRS focuses on when it audits a tax-qualified plan

The Internal Revenue Service (IRS) has been increasing its audit activity in the qualified plan area.  The IRS recently indicated that it had audited approximately 10,000 qualified plans in 2011 (an 18% increase from 2007, the last year for which data is available), as well as conducting 4,500 “compliance checks,” new program which includes a lower level of review than an audit.  Additionally, the IRS has created a new program (Employee Plans Team Audit) which targets plans that have in excess of 2,500 participants.

Why has the IRS increased its audit activity?

The IRS has increased its audit activity because it continues to find that plan sponsors are not in compliance with the law and the plan documents.  In 2010, the IRS reported that over 63% of the audits that it conducted in this area resulted in changes to the IRS filings, and penalties were assessed in most of those cases.  Although some plans are selected for audit on a random basis, many are selected because of special projects that the IRS undertakes or referrals from IRS audits of the plan sponsor as well as the Department of Labor; the IRS noted that 83% of plans which are audited due to referrals must make changes.

What is the IRS looking for?

The IRS has indicated that there are certain issues that it initially focuses on when it audits a qualified plan.  These issues can be summarized in the following manner.

All qualified plans:

  • Failures in the underlying legal documents—including failure to amend, contradictory summary plan descriptions and insufficient evidence of plan sponsor adoption of the plan
  • The plan in operation does not follow the plan document
  • The definition of compensation is not followed in the allocations
  • Incorrect eligibility—most often, eligible employees are erroneously excluded from the plan

401(k) plans:

  • Deferrals exceed the compensation limit
  • Matching contributions are incorrectly calculated
  • Failure to satisfy the average deferral test
  • Failure to transmit deferrals to the custodian in a timely manner
  • Hardship distributions are not in accordance with the terms of the plan—examples are insufficient documentation, incorrect distribution
  • Loans are not created and/or administered properly

What should a plan sponsor do?

It can be very expensive to correct plan mistakes after the IRS has determined that mistakes have occurred.  A plan sponsor should review plan documentation and procedures to make sure that the document is current and that the plan is being administered in accordance with the terms of the document.  All appropriate tests should be conducted and, if any issues appear, the ability to self-correct under the Employee Plans Compliance Resolution System should be considered.

We would be pleased to assist you with questions related to qualified and non-qualified retirement programs. 

Have questions about IRS audits of qualified plans? Post a comment below or contact our Compensation & Benefits Advisory Services Group at 440-449-6800.


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