The IRS continues its series of focused, limited scope audits. Audit initiatives include looking at:
- Nonqualified deferred compensation plans. IRS is considering operational and plan document compliance, including compliance with IRC Section 409A. Their examinations will focus on elections to defer the receipt of compensation, plan distributions and funding restrictions.
- Defaulted participant loans. There is a concern that loans are not being repaid in a timely manner and that some loans are not be getting taxed as “deemed distributions” when a loan goes into default. Generally, a loan goes into default no later than the end of the calendar quarter which follows the quarter in which a payment was missed. On default, the entire loan is taxed as deemed distribution, not just the payments in arrears.
- For 401(k) plans, ADP/ACP tests that have not been run correctly or situations in which failed test corrections are not made timely.
- Plans with Roth provisions. There is a concern about deferral and distribution errors due to the complexities of administering Roth provisions.
- Small employers with multiple plans! IRS has a concern that there could be a greater risk of error in administering multiple plans. For example, if a company sponsors an ESOP and a 401(k) plan with different definitions of compensation, are there errors in the compensation data provided to third party administrators?
The Department of Labor continues its focus on ESOP examinations. As stated on its website, “The Employee Stock Ownership Plan (ESOP) project is designed to identify and correct violations of ERISA in connection with ESOPs… Due to their unique nature, ESOPs can have distinct violations, as well as violations that can be found in any employee benefit plan. One of the most common violations found is the incorrect valuation of employer securities. This can occur when purchasing, selling, distributing or otherwise valuing stock. Other issues include failure to provide participants with specific benefits required or allowed under ESOPs, such as voting rights, ability to diversify their account balances at certain times, and the right to sell their shares of stock when received. EBSA (Employee Benefits Security Administration) will also review the refinancing of ESOP loans…”
Recent DOL investigations include a special emphasis on review of stock transactions to determine that no more than fair value is paid for employer stock on a transaction date. Trustees can expect to get questions on their process for selecting and monitoring an appraiser, and the process by which they review and critique a draft valuation report. It is critical for trustees to retain documentation of their vendor selection process (including all vendors who provide services to the ESOP) as well as documentation that the draft valuation report was carefully read and reviewed before it was accepted. Keeping a list of questions asked and answered can be helpful, along with keeping a copy of the draft report with notes and checks in the margins.
Overheard at the April National Center for Employee Ownership (NCEO) Conference in Atlanta:
Buy one, get one free. If your ESOP is audited by DOL, the agency may look at your health plans at the same time in regard to Affordable Care Act compliance.
In the Cincinnati region, ESOPs are frequently examined after the first Form 5500 is filed.
Best estimates are that 20-25% of DOL examinations are triggered by participant complaints. Word to the wise – take participant questions seriously and provide answers promptly.