The IRS seems to like making lists of mistakes; one common IRS list is the annual list of the “Dirty Dozen” for the top 12 tax fraud items each year. When it comes to 401(k) Plans the IRS has also published a list that seems to align with items that seem to come up when professionals discuss the increase in Department of Labor 401(k) Audits. While 401(k) audits often can’t be prevented, the impact of one should be able to be reduced if 401(k) Plans address the most common mistakes that the IRS has identified in other plans:
1. The failure of plan sponsors to ensure their plan document has been updated in a timely manner to reflect recent changes in the law. The IRS recommends that plan sponsors review their plan documents annually and maintain regular contact with their plan providers.
2. The failure to follow plan terms. Plan sponsors are encouraged, by the IRS, are urged to communicate with plan participants and plan service providers about any changes to the plan on a “timely basis.” Summary of Material Modifications and updated Summary Plan Descriptions are required to be given to plan participants after any plan amendment is made. Part of the annual review should be used to ensure that the current operational aspects of a 401(k) plan follow the terms of the plan documents. If they don’t then corrective actions should be taken in regards to the operations or as an amendment to the plan documents (or sometimes both if necessary) so that the operations and the plan documents match.
3. The incorrect definition of the plan’s definition of compensation for salary deferrals and allocations. The suggested remedy is to ensure proper training for whoever is responsible for determining compensation and annually reviewing compensation definitions and that they are consistently followed.
4. The fourth mistake is the misapplication of employer matching contributions to eligible employees. Matching contributions are often viewed as “free money,” and it’s important to ensure that the right amounts are directed to the right people. The IRS urges plan sponsors to contact their payroll personnel to ensure they have “adequate and sufficient” records about employment and payroll.
5. The failure of 401(k) plans to satisfy nondiscrimination tests. The Profit Sharing Council of America (PSCA) reports that the percentage of companies that fail these tests increases every year. Plan sponsors who fail the tests, either for the Actual Deferred Percentage (ADP) or the Actual Contribution Percentage (ACP), should consider a Safe Harbor Plan or automatic enrollment, according to the IRS. Another helpful tactic is to work with the plan’s administrator, at the sponsoring company, to ensure all employees are classified correctly and to familiarize the plan sponsor and administrator with the plan’s terms.
Committing any of these common mistakes can cause headaches for plan sponsors and potentially more pain for plan participants. Reviewing this list with your financial advisor, TPA or other technical advisor can be a tremendous help. This past year, the U.S. Department of Labor (DOL) has been doing its utmost to spread the word that 401(k) audits are on the rise. The DOL is in the throes of hiring 1,000 new employees, including 670 investigators, as part of its increased focus on noncompliance issues. With the ever increasing regulation in the retirement plan arena no one can ever guarantee that a DOL audit won’t happen or that a DOL audit won’t result in any corrections, but improving your plan and its operations with the aid of lessons learned by others is always a good practice and should result in a more beneficial outcome should your plan get selected by the DOL for audit.
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