How to Fix Those Mistakes Before Uncle Sam Finds Them
By Randy Cook
Qualified retirement plans are wonderful business tools for attracting and retaining employees, maximizing tax savings, and planning for retirement. For many businesses, the company-sponsored retirement plan is one of the most valuable assets associated with the business. As such, the prospect of an audit by the IRS or the U.S. DOL can strike fear into the heart of any employer who sponsors such a plan.
When IRS or DOL auditors discover that a retirement program is operating out of compliance, 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. As a result, audits by the IRS and DOL are often unpleasant wakeup calls for employers who have placed retirement plan issues on the backburner. To make matters worse, the number of retirement plan audits initiated by the IRS and DOL in recent years has significantly increased.
While an employer cannot prevent an audit by the IRS or DOL, the employer can take steps to be better prepared for the eventual audit. This preparation can reduce the cost (and fear) associated with a plan audit. One way to prepare is to utilize the services of the professionals who assist you with your retirement program and perform a “self-audit” of your plan. A self-audit can identify potential plan operation failures and ensure continued compliance with 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 Reports/Forms. Employers should verify that the annual IRS Form 5500 is being filed and 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 issues through the IRS and DOL voluntary correction programs.
The IRS correction program is known as 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, documentation of 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.” Again, 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 SCP and 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 serious plan failure is discovered during an IRS audit, the plan sponsor will likely find itself in the IRS Closing Agreement Program (“CAP”). Under CAP, a penalty is negotiated between the IRS and the plan sponsor. The maximum amount of the penalty is the amount that the IRS could recover if the plan was disqualified, all assets were distributed, and all prior deductions disallowed. During CAP the IRS will look at mitigating factors such as the plan sponsor’s ignorance of the failures and its good faith attempts to operate the plan properly. Although plan disqualification is not the norm, severe monetary sanctions are often imposed.
Given the serious consequences of violating retirement plan rules, most employers establish a retirement plan committee to monitor plan issues. Retirement plan committees are often comprised of individuals in ownership, management, or human resource positions. In addition to monitoring plan administration issues, these committees also typically review the performance of plan investments in order to insure compliance with fiduciary duties imposed by ERISA. Most retirement plan committees meet quarterly and include their professional advisors to the plan, such as ERISA attorneys, investment advisors, and third-party administrators.
Although IRS and DOL 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 the issues immediately and take advantage of the voluntary compliance programs. Professional assistance from retirement plan advisors is available for all of these techniques.