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IRS Audits and DOL Investigations of Plans and TPAs

Practice Management

Federal scrutiny is a possibility that virtually all plans face — a fact of life that TPAs need to recognize and prepare for. An April 23 ASPPA webinar addressed such investigations.

In “IRS Audits and DOL Investigations of Plans and TPAs.” Fred Reish, a partner at Drinker Biddle & Reath, offered his take and insights on such investigations, the risks they pose and how one may prepare for them — and maybe even lessen their likelihood.

The IRS and DOL look at many of the same things, Reish said. “In my experience, most of the issues that arise are in two categories,” said Reish. Either they are employer-driven — that is, the result of an employer doing something wrong — or the result of a TPA having made a mistake.

An audit or investigation poses a variety of risks. They can spell liability for the plan and/or the plan; they also can pose a “significant” risk to a TPA’s reputation, Reish said. And that, he added, can hit a TPA’s bottom line — undergoing an audit and/or investigation can result in a TPA not getting as many clients as it did before.

IRS Audits

So what is the IRS interested in? Reish identified 10 issues about which the IRS Employee Plans examiners are especially concerned.

  1. Plan Termination or Partial Termination. IRS interest can arise when there is a large drop in the number of plan participants, either when comparing multiple years or from the beginning to the end of a single year.
  2. Acquisitions. Acquiring employers’ exclusions of matching contributions for employees of the newly acquired company may elicit federal attention; they also might use incorrect compensation amounts when computing the matching contribution for business units of the newly acquired company. Attention also may arise from the use of incorrect matching contributions due to inaccurate participation dates for employees of newly acquired companies. “Some employers may point the finger” when an acquisition results in federal investigations, Reish warned, adding that “TPAs can get caught up in a bad situation.”
  3. Deferral Percentage Tests. Incorrectly performing ADP/ACP percentage calculations can result in audits and investigations, Reish said. In addition, there are two related hazards concerning newly acquired employees: not offering them an option to make elective deferrals and not considering them for testing purposes.
  4. Compensation. Red flags include multiple payrolls with different compensation coding and a difference in how the plan document defines compensation and the compensation that is reported.
  5. Plan documents. Failing to adop amendments in a timely manner can lead to automatic disqualification, Reish noted, adding that such issues are resolved through closing agreements. In addition, when a merger takes place and plans are merged into other plans, problems arise if plan documents have not been amended to comply with all applicable laws before the time the plans were merged.
  6. Vesting. Issues may exist when the accounts of participants age 65 and over are not 100% vested and there are forfeitures. In addition, problems arise if plans use incorrect vesting schedules or incorrectly determine participants’ service.
  7. Distributions and loans. “This is one of the hot issues” that come up in audits, Reish remarked. This is because problems can arise under the following circumstances. (1)There are large distributions on income statements relative to plan assets or to a prior or subsequent plan year. There may not be anything inherently wrong with that, said Reish, but still it can draw the IRS’s attention. (2) Plans may fail to suspend the salary deferrals of participants who receive hardship distributions from their accounts as required by Treas. Reg. §1.401(k)-1(d)(2)(iv)(b). (3) Plan participants who receive premature distributions or defaulting on plan loans fail to report the distributions and/or pay the 10% excise tax on their individual tax returns. (4) A return indicates that the plan terminated a long time ago, but distributions did not take place. This can be a flag for an abandoned plan, Reish said, noting that the DOL is especially concerned about this. (5) The employer uses automated systems for participants to secure plan loans, in-service distributions or hardship distributions. Significant compliance issues occur if required documentation or spousal consents are not secured and maintained, Reish warned. (6)Distributions are understated due to a plan’s failure to properly value employer real property or employer securities in a closely held corporation. This, Reish said, is a common problem, and no changes to such valuations can be a trigger for IRS attention.
  8. Assets. Problems arise if a large percentage of assets are classified as other assets on the balance sheet, are in just one investment or are invested in employer real property or securities. They also can develop of there are large administrative expenses. “There must be clarity in the agreement,” said Reish. “Problems erupt if there is a lack of clarity over who is responsible.”
  9. Limits. Plans may exceed Section 415 limits when participants are participating in more than one plan. Employees also may exceed the Section 402(g) limit when participants are participating in more than one plan that offers elective deferrals.
  10. Payroll-related issues. Large corporations with decentralized payroll systems may have problems administering the plan if there are no internal controls to ensure that plan provisions are properly applied. Issues also may arise if plan data used to prepare the Form 5500 does not match the actual records, such as payroll data.

The IRS Compliance Program

Reish discussed the strategies the IRS follows in enforcing compliance. IRS Tax-Exempt and Government Entities (TE/GE) employees submit suggestions regarding the issues that should be examined; once they are approved, those issues are considered to be a priority. In this way the TE/GE ensures that it is focused on the highest priorities.

In fiscal year 2018, Reish said, the IRS compliance program paid special attention to plans that failed to:

  • make required distributions under Section 401(a)(9);
  • correctly allocate contributions and/or forfeitures because compensation was defined incorrectly, or matching contributions were not made per plan terms;
  • withhold the proper amount of elective deferrals per plan terms; and
  • properly value all assets at fair market value and/or failed to properly reflect all plan assets in the name of the trust.

This year, Reish said, the IRS examiners are especially interested in:

  • determining whether smaller plans with trusts holding large assets have taken deductions on Form 1120 that exceed the limits set by Section 404; and
  • assessing terminated plans with cash balance features that may have exceeded Section 415 limitations or that may have generated a reversion subject to excise taxes. “In particular, the IRS is finding Section 415 violations,” Reish said.

Reish also discussed IRS Employee Plans’ “Learn, Educate, Self-Correct and Enforce” (LESE) projects, which are random selections of approximately 50 returns with similar characteristics that may reveal problems. He said that in examining Form 5500s filed by plans with 10 participants or less that made participant loans of more than $100,000, the most common issues were prohibited transactions, failure to amend a plan to reflect current law, and inadequate fidelity bonding. “The more you can do to minimize these problems or address them early, the better,” said Reish. He added that a service agreement should spell out not only what will be done, but also what the service provider will not do. He also observed that participant loans are “one of the tough areas where we’ve seen a lot of problems over the years.”


There are three main areas of IRS interest about which self-correction is especially important, Reish said:

  1. The definition of compensation. Reish said this “continues to be a huge problem.”
  2. Participant loans. Reish warned that problems in this area, such as loans being made despite the lack of plan provisions allowing them, “can fall at the feet of the TPA.”
  3. Compliance with plan document provisions. Reish said that problems arise when people either don’t know that they have to follow the plan, or think they have to follow the law but not the plan terms.

DOL Investigations

Reish told attendees that DOL investigations are driven by participant complaints, curious or suspicious numbers reported on a Form 5500, referrals from other federal agencies, and prohibited transactions. Regarding the latter, he said that it is “not a bad idea” to include an asterisk on a Form 5500 that denotes an explanation and notation if the prohibited transaction has already been corrected. Doing so, he said, could help a plan to avoid a DOL investigation.

Reish also cited the DOL’s Plan Investment Conflicts (PIC) Project, which investigates the receipt of improper or undisclosed compensation, as well as arrangements that involve indirect compensation, that are undisclosed or fall outside of market standards. And a DOL investigation concerning late deposit of deferrals “has been going on forever,” Reish said.
Missing participants are a special concern of DOL investigators, Reish noted. He reminded attendees that there is a fiduciary duty to do a “diligent search” to find them and suggested using an outside locator service for assistance in finding them if need be.

Action Steps

Reish suggested some actions that can be taken to head off, prepare and respond to IRS and DOL investigations.

  • Make sure that service agreements are worded in such a way that it is clear which mistakes are made by the employer and which are made by the TPA.
  • From a legal perspective, when you find an error, always try to self-correct. “Self-correction is always the right recommendation” to make to a plan sponsor, said Reish, adding that a service provider also should make sure that its records reflect that it suggested that the plan sponsor self-correct.
  • Keep in mind that if the DOL asks you to provide information, “this isn’t about you. This is about your plan sponsor.” He added that among the steps one should take is to make sure all disclosures are up to date.
  • If DOL officials come for an interview, it may seem like there is going to be a conversation, but it should be prepared for as if it were a trial or a deposition.
  • Educate plan sponsors about the DOL’s interest in finding missing participants. “I don’t think any of them know any of this,” he said.

Available on Demand

Information about on-demand ASPPA webcasts, including Reish’s “IRS Audits and DOL Investigations of Plans and TPAs” webcast, is available here.