IRS Checklist – An Easy Way to Perform a Compliance Self-Checkup
As a plan sponsor, you bear a fiduciary responsibility to make certain that your qualified plan complies with all current employee benefits laws and regulations and that it operates under the plan’s current provisions. Do you know if your plan is current? If not, it’s time for an annual self-checkup.
Help from the IRS
The IRS wants to rectify possible 401(k) plan compliance lapses ahead of time. As an aid, it has published a checklist of common plan administration oversights, some of which are more flagrant than others.
One note of caution: while the checklist sums up major compliance issues, it’s not meant to be used as an exhaustive guide. It provides general definitions, as well as examples and methods for correcting possible errors in a plan. Because each plan is different, you should consult with your benefits specialist, or visit the IRS website for more information.
The IRS 401(k) Plan Checklist consists of a series of yes and no questions. Below is a sample of some (but not all) of the issues addressed in the checklist. If you responded “no” to any of these questions, then it’s time to take action.
- Have You Updated Your Plan Document Within the Last Few Years to Reflect Current Law?
If not, it is likely that it doesn’t include recent legislative or regulatory changes. Each year, the IRS issues a publication containing a cumulative list of plan qualification requirements. New requirements are listed by Internal Revenue Code (IRC) section. For example, your plan must comply with the Supreme Court decision in U.S. v. Windsor regarding same-sex marriage.
- Are Your Plan’s Operations Based on the Terms of Your Plan Document?
Unsure? Then you should conduct an independent review of your plan document provisions compared with its operation. It is especially important that if you’ve made amendments to your plan recently, to be certain that you’re operating the plan according to those amendments.
If you find any inconsistencies during your review, you should use a reasonable correction method that places affected participants in the position they would be in, if there were no deficiencies in the operations of the plan. Also, you should remember that the plan sponsor generally is responsible for ensuring that the plan operates according to its terms, even when employing third-party administrators or ERISA attorneys.
- Is Your Plan’s Compensation Definition for All Deferrals and Allocations Used Correctly?
Many plans contain more than one definition of compensation, depending on the purpose of the plan. For example, some definitions of compensation will include items such as fringe benefits and bonuses. Be sure to review your plan’s definitions to ensure that you’re applying the correct definition in your plan document. Another item to remember is, for 2015, the IRS has capped the total compensation permitted for contribution purposes at $265,000.
- Have You Identified All Eligible Employees and Given Them the Opportunity to Make an Elective Deferral?
Depending on the terms of your plan document, not all of your employees will be immediately eligible to participate in the plan. Some plans will defer eligibility based on age, service and hours worked. Be sure to provide your plan recordkeeper with a regularly updated W-2 employee roster in order to reduce the chances that you’ve forgotten anyone.
- Have You Deposited Employee Elective Deferrals on a Timely Basis?
You must deposit deferrals to the trust as soon as you can segregate them from employer assets. The Department of Labor (DOL) requires that the employer deposit all employee deferrals as soon as reasonably possible, but no later than the 15th business day of the following month. Operationally, if you are able to make the deposits within one to three business days of the payroll date, you a required to do so. The DOL clearly states that the 15-business-day-rule is only guidance and cannot be relied on if you are able to make deposits sooner. For plans with fewer than 100 participants, the DOL mandates a seven-business-day safe harbor rule. Failure to make timely deposits can be deemed a prohibited transaction, which can result in possible plan disqualification by the IRS.
- Do Participant Loans Satisfy Your Plan Document’s Requirements?
One problem the IRS sometimes comes across is that plans have made loans to participants, even though the plan document doesn’t provide for such loans being made. You must follow your plan’s loan provisions in order to avoid this being a prohibited transaction. Loans cannot exceed (1) the greater of $10,000 or half of the participant’s account balance, or (2) $50,000, whichever is lower. Amounts which exceed these limits are taxable to the participant in the period in which they occur. As with the other items above, failure to comply with the DOL regulations can result in a prohibited transaction.
- Did You Make Hardship Distributions Properly?
A “hardship” is defined under regulations as an “immediate and heavy financial need” that cannot be met by other resources. According to the IRS, you make this eligibility determination based on “all relevant facts and circumstances.” The IRS also identifies several expense categories and circumstances that automatically satisfy the test. This includes medical expenses, costs related to the purchase of a principal residence, or repairing damage to that home, family funeral expenses, postsecondary education tuition, room and board expenses for the next 12 months, and payments necessary to prevent eviction because of a mortgage foreclosure.
A financial need may be immediate and heavy even if it was reasonably foreseeable or voluntarily incurred by the employee. A hardship distribution may not exceed the amount of the employee’s need; however, the amount may include amounts necessary to pay any taxes or penalties resulting from the distribution. If you made hardship distributions without a plan provision, you must amend your plan document retroactively.
Avoiding and Correcting Errors
Responses of “no” to any of the questions above can have serious negative consequences for the plan. In order to avoid potential penalties, be sure to routinely review your plan document, at least annually. You can utilize a calendar to mark when to complete amendments. Keeping your plan up to date and making sure it is operating according to its terms will help you avoid prohibited transactions and possible disqualification by the IRS. If you find operational errors in your plan, use the IRS’s corrective program proactively to avoid disqualification or substantial penalties imposed by the IRS.
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