Sometimes the Service is explicit about its enforcement priorities. Other times officials drop hints in public speeches. And sometimes they just keep quiet in hopes plan sponsors will not let their guard down thinking they are out of the danger zone.
Bryan Cave LLC attorneys Chris Rylands and his colleague Lisa Van Fleet have been working on gauging the IRS’ enforcement and audit priorities. Their observations may assist in working with plan sponsor clients with retirement compliance planning--and not just for the sake of avoiding an audit.
What the IRS has been clear about is the kinds of problems it most frequently identifies in audits. This brief list (and these infractions are of course very fundamental) serves as a baseline checklist for plan administration quality control:
- Failure to make timely amendments to plan documents reflecting changes in the law
- Plan administration decisions that are inconsistent with plan terms
- Making contribution amounts, benefit calculations or testing exercises based on an incorrect definition of “compensation”
- Botching eligibility determinations, such as not allowing eligible employees to join the plan, or conversely enrolling ineligible employees
- Failing to make required minimum contributions in a top heavy plan
A perennial audit red flag is the reporting of a substantial proportion of plan assets listed under “other.” “If it’s a large number, the IRS is wondering, ‘what are you offering participants?’” Assuming it’s an illiquid investment, the IRS will want to know whether valuations are conducted annually, Rylands says.
In addition, the IRS when looking at 401(k) plans is particularly focused on the strength of internal controls. It is not an uncommon attitude among some small plan sponsors, he says, that “I have outsourced my 401(k) administration and I don’t have to monitor it.” Plan advisors, consultants, TPAs and recordkeepers should nip that kind of thinking in the bud. “They should encourage the sponsor to contact them if they see anything that doesn’t look right; it should be a cooperative relationship.” And of course sponsors need to understand they can never fully rid their own fiduciary responsibilities, no matter what kind of external fiduciaries are in the mix.
“The IRS understands that people make mistakes, but if you make mistakes and you have no controls, the IRS is going to come after you even harder,” Rylands warns.
He also says most IRS audits will zero in on three or four issues that tend to be prevalent trouble spots within the plan sponsor’s industry or demographic segment. For example, employers with a low-wage labor force are more likely to have issues with administration of plan loans, simply by virtue of the typically higher utilization of loans among such employers.
Or if the sponsor is in an industry characterized by high employee turnover rates, the IRS may be looking more closely at service and eligibility processing.
“If the sponsor has administrative issues that occur with frequency, odds are it’s going to be common for similar employers, and the IRS is going to know that and focus on those issues,” Rylands says.
