A March 25 ASPPA webcast took a close look at the mechanics of IRS and Pension Benefit Guaranty Corporation (PBGC) audits of pension plans, and how to prepare for them.
Clint Blankenship, President of McCloud & Associates, Inc. and Meredith Sesser of Sesser Law offered their insights on IRS and PBGC audits, as well as ways to prepare for and respond to them.
Why an IRS Audit?
How does an IRS audit arise in the first place? Sasser identified the top 10 issues identified in IRS examinations.
1. Minimum Funding. Sasser said that problems in this area are unique to defined benefit plans. “Especially in conditions today, a lot of companies are unable to meet their minimum,” she said. If they can’t, they are to file a Form 5330; however, she added, “many don’t, which leads to an exam.” Another issue that commonly arises is companies providing incorrect calculations regarding figuring out what minimum contributions are.
2. Inadequate or No Fidelity Bond. Many don’t have a copy of one, which they are supposed to submit, because they don’t have one, Sasser said.
3. Vesting or Benefit Accruals. Sasser noted that errors that have been cited with vesting and benefit accruals include the following erroneous cash-outs and forfeitures, use of the wrong vesting schedules, and errors when calculating a participant’s vesting percentage.
4. Prohibited Transactions. A common problem in this regard, Sasser said, is participants using plans as bank accounts in taking loans against their retirement accounts. Others include Code Section 72(p) violations due to the original excessive length and/or amount of the loan exceeding either what Section 72(p) allows or exceeding plan requirements. In addition, she said that problems arise from loans that are made:
- from plans that don’t provide for them;
- to disqualified persons under Code Section 4975; and
- to HCEs that violate one or more of the exemptions listed under Section 4975(d).
5. Participation/Coverage. Not taking all the employees into account is a common problem, Sasser said.
6. Discrimination of Contributions/Benefits. Problems in this area that are red flags, Sasser said, include plan provisions being misapplied, erroneous calculations and failing to cover enough people.
7. Deductions (Including Actuarial). Contributions not made in a timely fashion and excess contributions are common errors Sasser identified concerning deductions.
8. Non/Late Amender. It is “very common” for plans to not have all the documents necessary in this regard, Sasser said. She noted that it is easy to fix such an issue before an audit through the IRS Employee Plans Compliance Resolution System (EPCRS).
9. Required Distributions. “Minimum distributions are very important, said Sasser, adding that “in light of the rules, they are looked at even more.”
10. Joint and Survivor Annuity. Sasser identified spousal consent as the biggest problem with joint and survivor annuities.
How does the IRS choose a particular plan for an audit? Sasser said there can be several reasons; including:
- a disgruntled employee;
- a plan simply chosen randomly;
- a large drop in the number of participants in the plan;
- a large investment in real estate; and
- a high amount of administrative expenses, which can suggest a breach of fiduciary duty.
Sasser noted that it is possible to fix a problem that a report points out and add a caveat to it to that effect.
Preparing for an Audit
The more organized the materials given to an IRS examiner are, the faster it will go, Sasser said. She added that tact is important, noting that being nice and the easy to deal with also will help an audit to go faster.
Sasser also suggested having appropriate people available to answer questions, such as a trustee, representative with power of attorney, record keeper, actuary and employer personnel profession. And she said that one should be be prepared to:
- explain the plan’s terms, practices, procedures, and internal administrative processes and controls;
- explain operation of the plan;
- provide all applicable test results;
- identify plan errors resolved through self-corrections and the Voluntary Correction Program (VCP) and proof of corrections;
- identify unresolved errors and suggestions to correct them; and
- provide information about related employers/entities, including controlled groups, affiliated service groups and Qualified Separate Lines of Business (QSLOBs).
Avoiding an Audit
EPCRS is key to avoiding an IRS audit in the first place, Sasser indicated, pointing out that it offers a way to remedy mistakes and avoid the consequences of plan disqualification. She said that corrections should:
- be reasonable and appropriate;
- resemble one already provided for in the Internal Revenue Code; and
- entail consideration of all facts and circumstances.
PBGC Audits
There are a variety of things that can trigger a PBGC audit, Blankenship noted. Among them are:
- the PBGC receiving complaints from a participant or practitioner;
- plan issues identified during the standard termination process;
- deduction of processing fees from participants’ benefits;
- failure to obtain appropriate election forms;
- non-majority owners forgoing benefits;
- failure to include all benefit options in annuity contracts; and
- problems with rollover of missing participants’ benefits; and failure to calculate missing participants’ benefits under ERISA Section 4050.5.
One should not give the PBGC a reason to audit by lack of cooperation or lack of effort to complete the standard termination process, he added.
The PBGC’s focus, Blankenship said, is whether or not participants received correct distributions, assets have been reconciled, missing participant information has been verified and participant information has been confirmed.
PBGC examinations create stress, Blankenship. He observed that the Standard Termination Audit Document Request Checklist that the PBGC sends with an audit letter is six pages long and warned that clients “are going to be stressed. Be ready for that.”
Blankenship said that the date that appears on the audit letter the PBGC sends is to be considered the date on which the 30-day response time started. “Front load the process,” he said, remarking that doing so will be helpful since one does not know how long it will take to gather the information that the PBGC will want.
Blankenship suggested organizing one’s files before a PBGC audit letter even arrives. One can then organize files more if needed when the letter arrives, but being ready in advance will allow one to provide information to the PBGC quickly, he noted.
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