This article originally ran on October 21, 2014.
By Linda Segal Blinn
A statistic for 403(b) sponsors to ponder: According to Daniel S. Gardner, Employee Plans Mid-Atlantic Area Compliance Coordinator at the Internal Revenue Service, while approximately 20% of for-profit plans have compliance issues discovered upon IRS audit, the rate of issues discovered upon audit rises to 80% when the IRS audits 403(b) plans.
Speaking at the annual meeting of the Association of School Business Officials (ASBO) in September, Gardner noted that the IRS is hiring more staff dedicated to auditing 403(b) and 457(b) plans. Employers looking to avoid common pitfalls may wish to focus on the top five issues that Gardner indicates that the IRS finds in audits.
1) Amounts Contributed in Excess of the IRS Annual Deferral Limit
Expect the IRS to continue to examine 403(b) plans for compliance with the annual deferral limit under Code Section 402(g) and the annual additions limit under Code Section 415(c).
When auditing 457(b) plans, the IRS has seen some 457 participation agreements that do not adhere to the regulatory requirements. The 457 regulations provide that the participation agreement to defer amounts to the 457(b) plan cannot be effective sooner than the first day of the month following the month in which the participation agreement was entered into. If a plan accepts amounts prior to the regulatory effective date of a participation agreement, this would be considered an operational defect. While there is no specific guidance to address correction, Gardner suggests that a potential correction mechanism may be to require the 457(b) plan to make a corrective distribution to the participant of the amount that was contributed prior to the IRS-permitted effective date of the participation agreement.
2) 403(b) Universal Availability Requirement
In order for employee pre-tax deferrals and Roth contributions to be nondiscriminatory, a 403(b) plan must generally extend eligibility to all employees, with limited exclusions permitted in the internal revenue code. A 403(b) plan must include a provision defining the employee eligible to defer into the plan.
However, according to Gardner, there may be a disconnect between the eligibility provision of the 403(b) plan document and operations of that plan, particularly if the 403(b) plan excludes employees who normally work less than 20 hours per week. To validate that the 403(b) plan document and operation align, the IRS auditor may request samples of employee data based on compensation paid and compare that sample against the hours of service performed. If the employer is not tracking hours of service, this “could be a stumbling block” in appropriately excluding employees who normally work less than 20 hours per week from deferring into the 403(b) plan.
3) Written 403(b) Plan
According to Gardner, the IRS continues to see 403(b) sponsors who have not timely adopted a plan document by Dec. 31, 2009. Gardner reminded attendees that the IRS’ Voluntary Correction Program (VCP) under the latest version of the Employee Plans Compliance Resolution system (contained in Revenue Procedure 2013-12) enables an employer to correct this defect. While this correction mechanism will also include the submission of a user fee to the IRS, the employer may want to proceed with a VCP filing because “it comes with the assurance that the plan will remain qualified.”
4) Hardship Withdrawals
In addition to requesting data about the hardship withdrawals made, an IRS auditor may also seek information documenting internal controls in place for hardship withdrawals under the 403(b) plan. For example, if a 403(b) plan document provides that there be a 6-month suspension of deferrals after the hardship withdrawal, an IRS agent may ask to see the employer’s procedures to implement such a suspension.
Loans continue to be a focal point when a plan is audited. The IRS is particularly focused on whether the maximum loan availability limits under Code Section 72(p) have been exceeded when there is more than one vendor under the retirement plan.
If the plan document permits loans, an employer’s plan procedures should also encompass loan procedures. According to Gardner, “If you have loans, have a loan policy.”
Linda Segal Blinn, J.D., is Vice President, Technical Services for Tax-Exempt Markets at Voya Financial™ (formerly ING U.S.). She is not a practicing attorney for Voya Financial.
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