There are few things that
will give a person that sinking feeling in the pit of their stomach
like opening the mailbox and seeing an envelope with the words
"Internal Revenue Service" (or Department of Labor) in the return
address. It is similar to seeing that police car as you drive down the
highway; you might not even be speeding, but you immediately slow down
and wonder how you will look in stripes.
The IRS and DOL both have jurisdiction over qualified retirement
plans, and between the two agencies, they generally audit more than
20,000 plans each year. And, if recent speeches and articles are any
indication, both agencies will be visiting even more plan sponsors in
the months ahead.
While no article is likely to take away that initial panic, there
are certain steps you can take to make sure the reality of a visit
from your friendly neighborhood auditor is not nearly as bad as the
anticipation. In fact, with the right preparation, an IRS or DOL audit
of your retirement plan can be a non-event.
What Are They Looking for, Anyway?
When facing an audit, it is common to wonder what the Feds are
hoping to find. The answer depends on which Feds are doing the
Department of Labor
Among other things, the DOL is charged with the enforcement of
ERISA, which includes all of the rules requiring plan fiduciaries to
act prudently and in the best interest of participants and
beneficiaries. It is no coincidence, then, that in conducting audits,
the DOL's primary focus is to ensure that participants and
beneficiaries are receiving all the benefits to which they are
entitled and that fiduciaries are not jeopardizing the plan's ability
to provide those benefits. Specific areas of review might include
verifying the plan has an investment policy statement (and that it is
being followed) and confirming that employee salary deferrals and loan
payments are deposited on a timely basis.
Internal Revenue Service
Believe it or not, the division of the IRS that is responsible for
qualified retirement plans is one of the few divisions not charged
with raising revenue. That means they do not set out to find reasons
to penalize plan sponsors. Quite the contrary. Their goal is to
preserve the tax benefits associated with retirement plans by making
sure sponsors are operating their plans in accordance with
regulations, plan documents, etc. Essentially, the IRS understands
that retirement plans represent significant tax benefits to sponsors
and participants, and they want to be sure that those claiming the tax
benefits are playing by the rules.
It is a common misconception that if the government comes knocking,
there was a complaint, evidence of wrong-doing or something else that
must have initiated the visit. While both IRS and DOL take participant
complaints very seriously and sometimes do initiate investigations
because of them, many plan audits are semi-random in nature.
The selection process is not quite as random as putting a bunch of
Forms 5500 in a spinning barrel and pulling out the winning entries;
rather, the agencies identify certain issues or characteristics and
then query the Form 5500 database to find plans that fit those
criteria. Then, they randomly sample that population to determine
which plans they will audit.
As an example, several years ago, the IRS was concerned about plan
investments in real estate, so they were able to narrow their focus to
the affected plans by reviewing Form 5500 data.
The DOL has an ongoing, national enforcement project related to the
timely deposit of employee contributions. One way they may target
plans is to review Form 5500 to determine if receivables related to
salary deferrals are disproportionately high based on the total
employee contributions for the year.
What Should You Do When You Receive an Audit
This next statement might win the obvious award, but if you are the
proud recipient of an audit notice, do not ignore it. The notices
generally include a proposed schedule for the audit as well as a
laundry list of document requests and the contact information for the
examiner. Auditors are generally pretty reasonable people who
understand scheduling challenges. If you have a conflict or do not
believe you can gather all of the requested information in time, they
are usually willing to reschedule within reason as long as they have
However, before you contact the auditor, your first call should be
to the provider who assists you with plan compliance matters such as
your TPA. If you have worked with that service provider for a few
years, they probably have much of the information the auditor
requests. Given the volume of documents involved, the TPA will likely
need some time to compile all of the information, and they will
welcome as much advance notice as you can provide.
At that point, it is also useful to work with your providers to
conduct a pre-audit. This process involves reviewing plan records and
operations for the years the auditor will be examining. Retirement
plans are complex beasts, and despite best efforts, mistakes do
happen. To the extent you are able to identify mistakes and take
corrective action before the audit begins, the more likely you are to
minimize any penalties that might otherwise be assessed. Certain types
of mistakes can be completely self-corrected even when a plan is under
What Should You Do on the Big Day?
It is common for auditors to want to stop by your place of business
as part of their examination. Sometimes, they simply want to confirm
that there aren't hundreds of employees working on your factory floor
despite the fact that your Form 5500 says you only have 20
participants. Other times, they will conduct a significant portion of
their document review over several days in your office. Either way, it
is advisable to coordinate the length of the visit in advance.
One of the most important things you can do to expedite the review
process is to have all of the requested documents neatly organized.
Often times, the document request lists items in the same or similar
order that the auditor will review them. Consider using sticky notes,
labels or tabs to arrange everything in that same order to facilitate
a more streamlined review. In short, make it easy for the auditor to
find the requested information quickly so that he or she can move on
to the next item on the list.
While the rule of thumb is not to provide extraneous information
that has not been requested, it is important to be cooperative and
helpful. For example, if the auditor asks to see information about a
specific participant, try to identify the exact page rather than
handing the auditor a 300-page report and wishing him or her good
While it is certainly advisable to extend some common courtesy,
keep in mind that an auditor is still an auditor with an obligation to
take action if he or she identifies errors. As a result, it is a good
idea to exercise discretion in determining the internal personnel that
work with the auditor. An accounting clerk who is not familiar with
rules related to 401(k) plans may not think it is a big deal to
mention a payroll error that caused several late deferral deposits,
but an auditor will certainly think it is.
Be Confident…but Respectful
The IRS and DOL agents that audit plans have varying degrees of
experience and knowledge. Not every agent is going to be well-versed
in the myriad rules and regulations that govern retirement plans.
There are instances in which an auditor may challenge something that
is perfectly legitimate.
Consider this example. There was an agent reviewing a 401(k) plan
that used the so-called otherwise excludable rule to disregard certain
short-service employees from its nondiscrimination testing. The
auditor was not familiar with that rule and challenged the test
results even though they were correct. In that circumstance, it was
necessary to confidently point the agent to the Code section that
authorized the testing method; however, it was equally necessary to do
it in a helpful, non-confrontational manner rather than disparaging
his or her lack of knowledge of that rule.
Be Willing to Ask for Help
Anyone who does not have experience working with an auditor should
think twice about representing him or herself. Not only is it prudent
to seek counsel from plan service providers before the audit, it is
wise to seek their assistance throughout the audit.
What Can You Do before You Get an Audit
As the saying goes, an ounce of prevention is worth a pound of
cure, and that is especially true with retirement plan maintenance.
Conducting self-audits at regular intervals can highlight oversights
or procedures that may need to be updated and allows you to address
your findings without the pressure of an upcoming audit.
The IRS and DOL publish information about their enforcement
initiatives on their websites:
The websites also include a wealth of information about steps you
can take to identify and correct mistakes before the government comes
knocking. Resources include plan compliance checklists that focus on
the most common compliance errors. Both agencies also maintain
in-depth voluntary correction programs.
The IRS has recently highlighted the importance of internal
controls and has started reviewing them as part of their examination
process. In a nutshell, internal controls are processes and procedures
put in place to make sure errors do not occur in the first place.
If there is a checklist showing that during that last payroll
conversion, someone matched codes on the payroll system to the plan
document's definition of compensation, there is a higher likelihood
that the correct compensation was used to calculate that matching
contribution. With that solid internal control identified, there is
less of a need to spend time reviewing each compensation record on a
Audits are never fun. They require time and resources and no matter
how diligent your compliance efforts, leave you sitting on pins and
needles. However, retirement plan audits do not have to cause weeping
and gnashing of teeth.
With some professional advice from your service providers and some
organization, cooperation and courtesy in dealing with the agent, the
audit can be like a routine teeth cleaning rather than a root canal.
This newsletter is intended to provide general
information on matters of interest in the area of qualified retirement
plans and is distributed with the understanding that the publisher and
distributor are not rendering legal, tax or other professional advice.
Readers should not act or rely on any information in this newsletter
without first seeking the advice of an independent tax advisor such as
an attorney or CPA.