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EP Team Audit (EPTA) Program - EPTA Compliance Trends & Tips - Common Trends Across All Plan Types

Many Plan Trends are common to all Plan Types. This section incorporates those trends and tips on how to correct plan errors.

Failure to amend the plan document for tax law changes by the end of the period required by law

Top Failure Reported in Voluntary Correction Program

One of the most common issues found with regard to the plan document is that the sponsor has not timely adopted amendments to comply with the current law. As Congress passes new legislation, sponsors are given an allotted time to make and execute amendments. The failure to do so may cause problems in plan operation (is the plan following the law or the un-amended plan document) and may result in disqualification of the plan upon IRS audit.

The general deadline for timely adoption of amendments, including remedial, interim or discretionary amendments, can be complex for sponsors of qualified plans. Sponsors should review the annual cumulative lists maintained on Internal Revenue Service web page as well as Rev. Proc. 2007-44, as updated, to make sure their plans are amended on a timely basis. Currently, the most common law changes that employers have failed to amend their plans for are GUST, the good faith amendments for EGTRRA and the Final and Temporary regulations under section 401(a)(9).

Once a failure to amend issue is found on an EPTA audit, it can only be resolved through a closing agreement. In addition, EPTA audits have found that merger of plans into other plans continues to cause disqualification of both plans if the merged plans are not timely amended for applicable laws prior to the merger.

There are a number of ways to avoid a failure to amend the plan on a timely basis:

  • Maintain a calendar or tickler file of when amendments must be completed. In addition, an annual review of the plan document may identify the need to amend.

  • Ensure the plan document and Summary Plan Description (SPD) match. If the plan document has been amended, compare the new language against the old summary plan document and make appropriate changes.

  • Maintain contact with the attorney, actuary or company that services the plan. The amendment process is not a simple process. Certain plan documents must be individually amended for each change, while prototype documents may be amended by sponsors of the plans. Plan sponsors should maintain contact, on at least a yearly basis, with the company that services the plan. If the servicing company provides a set of amendments to the employer for adoption, care should be taken to ensure that the amendments are adopted timely. Plan Sponsors should keep signed and dated copies of plan documents and any amendments indefinitely.

More information on finding, fixing, and avoiding this error can be found in Issue #1 of the 401(k) Fix-It Guide.

Failure to follow the plan document’s definition of compensation for determining contributions

Second Highest Failure Reported in Voluntary Correction Program

Plans may be drafted to define compensation differently for contribution purposes and testing purposes. It is extremely important that the payroll department follow the plan’s definition of compensation for contribution purposes (i.e., employee pre and post tax deferrals, employer nonelective contributions and employer matching contributions). For 401(k), 457(b) and 403(b) plans, the media (paper forms, electronic screens) used to make the election should be clear on the types of compensation that are or are not eligible for the deferral/contribution. For example, certain types of compensation may be excluded such as bonuses, commissions, overtime, fringe benefits, or certain types of compensation should be included when the document states to include them. The failure can result in participants receiving allocations to their accounts that are either greater than or less than the amount they should have received. 

EPTA agents have found issues on executive pay and executives exceeding the Code Section 401(a)(17) limits, specifically: 

  • Equity compensation plans typically generate Form W-2 income on exercise of stock options or early sales of stock purchased through a section 423 stock purchase plan. A plan, which permits employees to make section 401(k) deferrals from such income, may not have any means to collect the deferred income and, therefore would be applying the deferral percentages incorrectly.

  • If the section 401(a)(17) compensation limitation is exceeded, the result could be excess employer contributions. 

EPTA audits have also found that large corporations with decentralized payroll systems may have problems administering the plan, if there are no internal controls to ensure the plan provisions are properly applied. For example, if each subsidiary determines what constitutes plan compensation, significant compliance issues may occur in allocations.

To determine if the plan is using the proper compensation for allocations and deferrals, the Plan Sponsor should review the plan document and perform an annual self audit. Many plans are operated based on a short summary of the plan document containing many of the definitions and operational requirements. But as the plan is amended, the compensation definition may change while the plan continues to operate as it had previously. 

It is important to review the plan section that deals with allocations and deferrals. Each plan document contains a section, in the basic plan document or in an attached adoption agreement, which provides how allocations and/or deferrals must be made. This plan or adoption agreement section will have language that says, for example, “Employees may defer up to 15% of their Compensation…” Plan sponsors must go to the plan section containing definitions and find the “Compensation” definition. Spot-check deferrals and allocations to see if the correct compensation is being used. Some of these definitions are very complicated with expense reimbursements, car allowances, bonuses, commissions, and overtime pay that is included or not included in the definition of compensation. Plan sponsors with a complicated definition of compensation should develop a worksheet to calculate the correct amounts.

There are a number of ways to avoid compensation mistakes: 

  • Perform annual reviews of the plan’s operations.

  • If the plan document is amended, check the definitions against the old plan document, noting any differences. 

  • If the plan document is amended, communicate those changes to everyone involved in the plan’s operations. 

  • Make sure the person in charge of determining compensation is properly trained to understand the plan document. 

  • Know what service providers (record keepers, administrators, payroll services) have agreed to provide. They may be relying on the Plan Sponsor for all information, such as compensation and deferral amounts, used in their own work. 

  • If possible, simplify the plan’s definition of compensation and use the same definition for multiple purposes. 

More information on finding, fixing, and avoiding this error can be found in Issues #2 & #3 of the 401(k) Fix-It Guide.

Failure to follow the plan document’s eligibility provisions

Third Highest Failure Reported in Voluntary Correction Program

Failure to follow the Plan's eligibility and participation provisions can result in costly compliance resolutions for plan sponsors. The biggest trend under this category involves the improper exclusion of employees that are determined, upon audit, to be eligible for the plan. Many factors contribute to this error, some of which include part-time employees that become eligible for the plan and including employees in the plan after a company merger. This error results in potential disqualification of the plan as employees who are otherwise eligible should be receiving contributions from the plan. Discrimination tests and funding issues could also become a problem when this error occurs.

Eligibility failures include the following common situations: 

  • Misclassification of independent contractors. 
    If plan documents fail to include language concerning the exclusion of independent contractors who are reclassified by a court or a governmental agency as employees, such former independent contractors would be covered by the plan and entitled to retroactive benefits.

  • Related Employer issues
    Employers who are members of a controlled group or an affiliated group under IRC sections 414(b), (c), (m), (n) or (o) (“Affiliate”) must pay careful attention to the plan language regarding the employees of the entire Affiliated group or unrelated entity. For example, standardized prototype plans automatically include all employees of all Affiliates.  Non-standardized prototype plans, volume submitter plans and individually designed plans can be drafted to exclude an Affiliated Employer’s employees as long as nondiscrimination tests are met. 

Confusion over the inclusion or exclusion of employees in a controlled group situation often occurs in connection with a merger or acquisition. Where otherwise eligible employees are excluded, the excluded employees don’t receive an allocation of contributions to which they are entitled. Where ineligible employees are included in the plan the employer has made additional contributions which it should not have made to the plan.

In EPTA audits, corporations with decentralized payroll systems have problems if there are no internal controls to ensure plan provisions are properly applied. For example, if each subsidiary determines eligibility for plan participation, significant compliance issues may occur as a result of different interpretations of who is and is not eligible.

  • Part-time vs. full-time employee eligibility issues

    • Part-time vs. full-time employee eligibility issues
      The definition of who is a full-time employee or a part-time employee is different for all employers. Therefore, it is important to understand how the IRS views the exclusion or treatment of part-time employees in a qualified plan by reviewing the language of the February 14, 2006 Quality Assurance Bulletin on Part-Time Employees and Issue #6 of the 401(k) Fix-It Guide

    • The use of hours versus elapsed time method of tracking time
      Plans may calculate service for purposes of eligibility and vesting by utilizing hours, an equivalency method based on hours or an elapsed time service crediting method based on periods of time. Many recordkeeping and payroll systems have limitations that cannot support all three methods of service tracking. It is important to confirm that the plan record keeper and the payroll provider comply with the plan terms on tracking service.  For example, Plan X requires: (1) 1000 actual hours for vesting service; and (2) vesting service is calculated on a plan year basis. The sponsor must track each employee's actual hours each year and report the hours to the record keeper on a timely basis. Some vendors will automatically set their vesting system to default to no hours, based on an employee's hire date. If that occurs, some employees would earn more vesting than permitted and other employees would earn less vesting than permitted. The correction could be very costly to a plan sponsor.

    • Rehire issues
      Employers should be careful to enroll rehired employees on a timely basis in accordance with the plan documents and the IRC. Failure to permit a rehire to join a plan on a timely basis may result in the employer having to make costly make-up contributions.

Plan Sponsors can avoid costly eligibility mistakes by reviewing plan documents and inspecting payroll records to extract the total number of employees, birth dates, hire dates, hours worked, termination dates, entry dates and other pertinent information.  Also, Plan Sponsors should inspect form(s) W-2 and State Unemployment Tax returns (compare the employees on these records with the payroll records) to see if employee counts are accurate. 

Failure to satisfy IRC Section 401(a)(9) minimum distributions

Sixth Highest Failure Reported in Voluntary Correction Program

Understanding the record keeper’s procedures for calculating required minimum distributions should eliminate potential distribution failures. It is important to provide age, date of termination and ownership data to the plan record keeper on a timely basis. 

The law requires that a participant receive a distribution when they attain a certain age.  This failure involves the plan not making distributions to participants where they have attained the age for required distributions under the law. The law requires that the participant pay an excise tax of 50% on the amount of the required distribution if it is not made timely. In addition, after a participant dies, the rules governing the timing of required distributions to their beneficiaries are not always followed. The Service will, in appropriate cases, waive the excise tax for a late distribution if the plan sponsor requests the waiver in appropriate situations. 

Failure to follow the in-service distribution provisions of the plan document

Fifth Highest Failure Reported in Voluntary Correction Program

Many plans permit participants to withdraw some or all of their plan assets before termination of employment or retirement. The IRC has strict rules on timing of distributions and retirement plans may have even stricter rules or not permit in-service distributions at all.

  • Impermissible in-service distributions

    The law provides that distributions to participants can be made only upon certain events or the attainment of a specific age. This failure occurs when a distribution is made to a participant where the law or plan terms do not permit a distribution. For example, defined benefit and money purchase plans may not provide for in-service distributions prior to age 62 or attainment of Normal Retirement Age. 

  • Failure to follow hardship rules

    The Plan Administrator must have controls in place to determine if a participant incurs a hardship under the terms of the plan, including suspension of salary deferrals if required by the plan. 

Administering in-service withdrawals may be complicated.  As with many mistakes, employers with a better understanding of their plan document make fewer mistakes. What follows are a few things plans sponsors can do to cut down on mistakes in this area: 

  • Review the language in the plan document to determine when and under what circumstances distributions can be made. 

  • When the plan document is amended, make certain the language regarding in service distributions is contained in the most recent plan document and summary plan description (or summary of material modifications). 

  • Establish hardship and in-service distribution procedures.  Work with service providers (if any) to determine if the procedures are sufficient to avoid mistakes. 

  • Only permit hardship distributions that meet the requirements of section 401(k) of the Code and the plan document. 

  • Look for signs that the hardship distribution program is being abused or badly managed.

    • Too many hardship requests by one group or division may be a sign of abuse.

    • Requests for hardship distributions from multiple employees look identical.  Each situation should have its own individual circumstances. 

    • Only the highly compensated employees have hardship distributions. This may be a sign that rank-and-file employees have not been properly notified of the availability of hardships. 

More information on finding, fixing, and avoiding this error can be found in Issue #10 of the 401(k) Fix-It Guide.

Failure to provide correct distribution forms, make timely distributions and prepare correct tax reporting of distributions

Many plan vendors use the same distribution forms for all of the plans they administer despite the fact that plans may have different distribution options and requirements.  Incorrect forms lead to incorrect distributions and incorrect tax reporting.

These failures include the following:

  • Spousal consent for applicable waivers

    Some plans require spousal consent for all distributions.  Administrators must confirm that spousal consents are, in fact, required. 

  • 20% income tax withholding requirement

  • Notices and timing of mandatory small cash-outs (IRA rollover and/or $1,000 cash-out) Many vendors are cashing out under $5,000 distribution without a participant's consent but failing to rollover the distribution to an IRA.

  • Loans

  • Complete loan forms appear to be missing from many electronic loan systems.  Participants must be provided all data in order for the loan to comply. 

  • Forms of distributions (installments, lump sum, annuity)

    If distribution forms do not offer the correct options that are provided under a plan, the participant is harmed and must be offered additional options.

Plan Sponsors should review distribution (in-service, termination and loans) forms provided by their service providers on a yearly basis to make sure they follow the plan terms. 

Failure to follow the plan’s vesting schedule

Plan sponsors that do not continually update their vendors on employees’ hours, or employment dates of termination will cause the plan to fail to follow the plan's vesting schedule. 

  • Improper forfeitures

    If participants are paid out less than their vested percentage, forfeitures are increased erroneously. 

  • Improper payouts

    If vesting is incorrect, corrections to the participant's distribution can be costly and time consuming because the plan sponsor must seek return of the improper payouts. 

In particular, EPTA audits have found: 

  • Issues may exist where the accounts of participants who have attained normal retirement age have forfeitures. If the participant has attained normal retirement age, the participant should be 100% vested and there should be no forfeitures.

  • Plans failed to properly calculate participants’ vesting percentages. 

  • Plans may be using incorrect vesting schedules. 

  • Plans may fail to properly determine participants’ service correctly. 

  • Failures occur when plan administrators incorrectly apply the vesting provisions written in the plan documents. 

  • 100% vesting may occur if there is a downsizing or a sale of a subsidiary or division for the participants who are impacted. 

Failure to retain records

To assist EPTA plan sponsors and administrators, a Taxpayer Documentation Guide has been developed. This guide, developed by EPTA agents and outside practitioners, provides a comprehensive listing of documents needed for a proper examination of issues identified for examination. This guide assists plan sponsors in determining the documents/information needed to be kept current and readily available or recoverable when requested for an audit.

-- Why retain records?

-- How long should records be retained?

-- What Records Should be Preserved for Access During an Audit?

Failure to maintain internal controls

  • Another tool to support EPTA plan sponsors and administrators is the Internal Controls Questionnaire. This questionnaire provides examples of questions asked by Employee Plans examiners in order to gain an understanding of the system procedures and internal controls.

    This product was developed with outside practitioner input in an effort to make plan sponsors and administrators understand the responsibilities and coordination needed to keep a qualified plan and trust in compliance with the tax laws. These documents are to be considered useful tools to assist you in keeping your plan in compliance with the law but the Service provides no guarantee, expressed or implied, as to the reliability or completeness of the furnished data.

Failure to follow the terms of a qualified domestic relations order (QDRO)

Failure to follow the terms of a QDRO may cause a plan sponsor to pay the benefit twice. Retirement Plan Participant Notices provides a greater explanation to the requirements of the law.

Failure to satisfy IRC Section 415

EPTA audits have determined that IRC Section 415 limits may be exceeded due to participation in multiple plans.

Page Last Reviewed or Updated: 17-Dec-2015