Federal audits and investigations of retirement plans are on the rise. With proper preparation, you can get through the process with minimal problems. A well-prepared employer will help simplify the audit process, minimize paperwork, lower administrative costs and reduce risks connected with an audit.
Avoiding an audit
The best way to prepare for an audit is to conduct business in such a manner that there’s no reason to audit your plan. Participant complaints are one of the most common reasons for audits.
The United States Department of Labor (DOL) has created publications to help participants identify potential abuses by their company, such as Ten Warning Signs That Your 401(k) Contributions Are Being Misused.
Questionable information on Form 5500 can also trigger an audit. Or the DOL may suspect that the plan administrator isn’t remitting contributions timely and accurately. And if the company you hire to audit your plan gets audited by the DOL, this may prompt the DOL to audit your plan.
Remember, the IRS and DOL share information between the agencies, which can prompt interest by either department. DOL investigators complete a checklist as part of their audit process which contains questions aimed at identifying compliance issues that they can refer to the IRS for further investigation. DOL and IRS audits generally go back a minimum of three years and often go back further if any substantial errors are discovered, but generally no more than six years.
There are several actions you can practice to help avoid an audit. For example, have a simple plan document which uses fixed entry dates for entry into the plan, such as the first of the month, first of the quarter or annually. You can also have employer contributions vest immediately to simplify plan administration. Use any forfeiture balances according to your plan document’s definitions as soon as possible.
Amend the plan as soon as possible after changes in the law. Verify with your payroll department or vendor that the plan’s definition of compensation is being followed. Remit employee contributions as soon as possible after each payroll to avoid late deposit penalties.
Ensure that contributions or benefits don’t favor highly compensated employees only and that proper testing is completed to confirm that the plan isn’t top heavy.
Accurately calculate, make and then timely report distributions. Be sure that you have loan and hardship documentation (loan amortization schedules and documentation for eligible hardship reasons) on file.
Follow the terms of any qualified domestic relations orders. Obtain an adequate fidelity bond, which is defined as at least 10% of the plan’s value (not less than $1,000, and not required to be more than $500,000).
Document relationships or arrangements with service providers and understand your plan’s fees. Increasingly, the bulk of questions from the DOL are about fees, revenue sharing arrangements and investment compensation arrangements.
Finally, make sure to timely and accurately file all federal tax returns.
Completing your audit successfully
If the government selects your plan for an audit, it’ll send a letter with a request for various plan records and documents. If you have items that are off-site, discuss the issue with the auditor to request additional time to obtain the information.
To keep the audit running smoothly, label the documentation requested with the number from the government’s request list. It can be helpful to make a copy for your reference. Make sure you understand the plan documents and policies. Let the auditor know if you’re unclear on a request.
The agent in charge of the audit will set a date to perform an on-site audit with the employer or their power of attorney. During or after the audit, the agent will let you know if he or she needs additional records and if any items require a change or correction. If the agent finds no items requiring change or correction, he or she will issue a closing letter that closes the audit. The letter explains the agent’s conclusions and recommendations.
If the agent requests additional information, you must provide it and set up a follow-up meeting with the agent, at which time the parties discuss any tax changes or correction programs. In a worst-case scenario, the agent may propose the plan be revoked or issue a nonqualification letter.
Generally only a small percentage of behaviors that the IRS or DOL scrutinizes during audits involve intentional misconduct by plan sponsors. The majority of violations come from errors, omissions and oversight by plan sponsors.