Common IRS document requests in 401(k) plan audits

The IRS has recently increased its audits of employer 401(k) plans. Rather than wait for an audit, plan administrators should proactively consider potential issues and take any necessary corrective measures. The following is a brief rundown of what the IRS will request at the outset of an audit, as well as a non-comprehensive list of issues commonly scrutinized by the IRS during a 401(k) plan audit.

Initial IDR

The IRS’s initial Information Document Request (“IDR”) typically requests all necessary plan documents. These include all foundational and organizational documents, as well as the plan’s favorable determination letter or advisory letter, if applicable. This first IDR will request all interim amendments, and the Board of Director’s Minutes or other appropriate documentation indicating these amendments were timely adopted. The IRS will also request various other documents related to the plan, such as:

  • The summary plan description,
  • Summaries of all material modifications,
  • Annual reports,
  • A copy of the income tax return of the plan sponsor,
  • Evidence of a current Fidelity Bond for all people handling trust assets, and
  • A copy of the safe harbor notice given to eligible employees, if applicable.

A failure to produce these documents can have a negative impact on the result of the audit.

The second IDR

The IRS’s initial IDR is frequently accompanied by a second IDR, which focuses on more substantive issues.

ADP and ACP nondiscrimination tests

For instance, the second IDR will ask whether the plan passes the ADP and ACP nondiscrimination tests. These tests ensure that the contributions made by non-highly compensated employees are proportional to the contributions made by highly compensated employees (managers and owners). Because failing either of these tests can result in disqualification of the entire 401(k) plan, plan administrators should familiarize themselves with these tests and conduct a thorough review to ensure the plan passes both.

If the plan administrator determines that the plan fails one or both of these tests, corrective action can still be made within 12 months, such as making qualified nonelective contributions for the non-highly compensated employees. Alternatively, this problem can be avoided altogether by establishing or converting to a safe harbor 401(k) plan.

Timely deposits

Another issue reviewed by the IRS looks at whether the participant’s deferrals were timely deposited into the plan trust. The latest date that deferrals can be deposited is the 15th business day of the month following each deferral. Failure to make timely deposits can cause both an operational mistake and a prohibited transaction.

Plan administrators can correct operational errors through the IRS’s Employee Plans Compliance Resolution System and prohibited transactions through the Department of Labor’s Voluntary Fiduciary Correction Program. While these corrective measures do exist, it still benefits plan administrators to discover any problems as early as possible and correct the plan’s procedures to ensure all future deposits are timely made.

Participant loans and section 72(p)

The IRS’s second IDR will also ask whether participant loans conform to the requirements of the plan and section 72(p).1 Plan administrators can do this preemptively by familiarizing themselves with section 72(p), as well as the plan’s loan policy and then reviewing all outstanding loans to discover any inconsistencies or delinquencies. If any problems are found during this review, the plan administrator can work with the employees who are late on repayment or whose loans are disqualified and set up a corrective repayment plan or modify the loan terms to fit within section 72(p) and the plan’s requirements.

Other issues

While these are some of the more common and recurring issues found in IDRs, the IRS may also inquire about other issues. Because of increased audit activity, plan administrators should be increasingly diligent and thorough to make sure the 401(k) plan is not disqualified due to a minor mistake or problem. The laws that govern 401(k) plans are dynamic and complex. If your 401(k) plan is selected for audit, it is highly advisable to obtain representation.

For more information on this topic, or to learn how Baker Tilly employee benefit plan specialists can help, contact our team.

1. All section references are to the Internal Revenue Code of 1986, as amended, and the Treasury Regulations thereunder.