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Risk Assessment Program - Results of Examinations of Form 5500 401(k) Plans with sponsors from the Arts, Entertainment & Recreation Industry


In FY 2001, at the request of the Commissioner of the IRS, each of the business units of the IRS was directed to create a Risk Assessment of their entire Customer population. This assessment was to be designed to be able to provide compliance information on this population by breaking it into market segments. The format of the assessment and the creation of the market segments were basically left up to each business unit’s discretion. The goal of this program for Employee Plans Examination Division was to be able to identify the baseline compliance level of each new market segment, which had never been done before. Once this was done, we would be able to direct our resources toward the segments which we found to be noncompliant. The Program was designed to improve the voluntary compliance of all sponsors who maintain qualified retirement plans. 

This is a summary of the examinations completed in the market segment made up of 401(k) Plans sponsored by the Arts, Entertainment and Recreation Industry. As of April 2011 we had examined over 400 Form 5500 filings.

Project Results:

The results indicated that there was a high degree of Noncompliance within this segment. There are two key areas to discuss in this article, plan sponsor business code analysis and the issues found. Each Industry (i.e. Arts, Entertainment & Recreation) is made up of business codes based on the North American Industry Classification System (NAICS). The Arts, Entertainment & Recreation Industry is made up of nine business codes. Over 50% of this segment’s plan sponsor’s business codes are made up of just one business code (“Other Amusement & Recreation” which includes golf courses, ski facilities, marinas, fitness centers, bowling centers). Sponsors using the other eight codes have between 3% and 8% of this segment’s plan sponsor’s business codes each. We found substantial data in our examinations that plan sponsors who used the “Other Amusement & Recreation”, “Spectator Sports”, and “Agents & Managers for Artists, Athletes, Entertainers, & Other Public Figures” business codes had a high degree of Noncompliance.  Noncompliance was especially high with plan sponsors representing “Spectator Sports”.

The most common failure involves errors in the ADP/ACP testing and in the timely depositing of the 401k deferrals. The tests are detailed in Internal Revenue Code sections 401(k)(3) and 401(m)(3). Common errors in the tests are not properly identifying highly compensated employees, improperly including or excluding employees on the test and using the wrong compensation and/or contribution amounts.  Another area we found a number of problems with was not timely depositing the employee deferrals. 

The second most prevalent failure involves participation/coverage. Participation errors [see Internal Revenue Code section 410(a)] occur when a plan does not include an employee in the plan when the plan document states they should or brings an employee into the plan contrary to the plan document (i.e. plan states a employee enters the plan after six months of service but in operation employees participate immediately or visa versa). Coverage errors occur when the plan does not “cover” (meaning they are a participant) a certain amount of employees as required by Internal Revenue Code section 410(b).  

The third most common failure involves errors in allocating contributions to the plan participants. Allocation errors occur when the contribution is not allocating in the manner in which the plan document states it should. Common examples include using the wrong compensation definition, including or excluding certain employees and enforcing or failing to enforce requirements stated in the plan document that must be met for a participant to receive an allocation (i.e. last day employment, certain hours of service). 

Avoiding the Error:

ADP/ACP Testing/Deferrals:
The best way to avoid these problems is too make sure all the people responsible for running the tests are knowledgeable in the law covering such [Internal Revenue Code sections 401(k)/(m)]. This includes knowing what contribution amounts are used, what employee compensation to use, whether an employee is considered Highly Compensated or Non Highly Compensated and what yearly period to use in applying the testing.   

Those responsible for administering the amounts employees elect to contribute to the plan must make sure they are timely deposited. The Department of Labor regulations requires employee deferrals to be deposited as soon as they can be segregated.

Errors involving participation/coverage can be caused by a number of things. Poor recordkeeping and/or lack of knowledge regarding such are the two most common errors.  Participation is generally based on an employee’s date of hire, the amount of service completed from the date of hire, and possibly the age of the employee. If adequate records are not maintained properly, errors will occur. The best way to avoid participation problems is too make sure all the people responsible for administering plan participation know the correct and most current eligibility provisions in the plan document.

In order to make sure your plan does not have errors in coverage it is essential that whoever is responsible for administering such has an in depth knowledge of Internal Revenue Code section 410(b) as this contains the coverage requirements every plan must meet. As part of this they must also know exactly who is eligible for and in the plan and who is not.

Contribution Allocations:
401(k) plans can have multiple types of contributions being allocated to the plan.  In addition to tax deferred contributions, there could be employee after tax contributions, employer matching contributions, and employer discretionary contributions. The best way to avoid allocation problems is too make sure all the people responsible for the allocations know the correct and most current allocation formulas. They must know the correct and most current definition of compensation being used in the formulas and assure it is used in the calculations. Finally, they must also know whether or not the plan calls for forfeitures to be allocated to participants (in addition to amounts required by the plan formula), and if so what is the allocation formula.

Page Last Reviewed or Updated: 25-Sep-2014