Figure Out if Your 401(K) Plan is in Compliance Before the IRS Does

In recent weeks, the IRS has sent Compliance Questionnaires to roughly 1,200 randomly selected 401(k) plans that filed a Form 5500 for the 2007 plan year. The IRS is asking for information about plan operations for the 2008 plan year (unless stated otherwise), including: (1) plan demographics; (2) participation issues; (3) employer and employee contributions; (4) top heavy and nondiscrimination rules; and (5) various other questions regarding the administration of the plan. The IRS will use the information it obtains from the Questionnaire responses to identify areas in which additional guidance or education is needed. More importantly, it will also allow the IRS to focus its enforcement efforts in areas where it finds wide-spread non-compliance.

Employers have 90 days to complete and return the form, though an extension may be possible. While completing the compliance check is voluntary, the IRS has stated that failure to complete the Questionnaire could result in enforcement action, including an audit of the plan. That said, the IRS has stated that the compliance check is not an audit, investigation or review of the plan sponsor’s books and records.

The Questionnaire is long, detailed and complicated. Employers that receive the questionnaire should discuss their responses with the plan’s ERISA counsel, third-party administrator, plan committee, or other service providers. We suggest this because if an operational error is discovered in the course of preparing the response, the employer will have an opportunity to make correction voluntarily.

Obviously, most 401(k) plan sponsors did not receive the Compliance Questionnaire, but that doesn’t mean they should ignore it. The Questionnaire provides sponsors a roadmap to review their plan operations and do an internal compliance check based on the items the IRS is asking about. Items of special importance:

  • does the plan pass discrimination testing (for non safe-harbor plans)?
  • does the plan properly include/exclude employees in compliance with Internal Revenue Code minimum coverage rules?
  • are employee deferrals being deposited timely? (Failure to do so is a prohibited transaction, which subjects the plan sponsor to excise taxes and a requirement to add interest to the amount deposited.)
  • are you properly administering plan loans pursuant to Code §72(p)?
  • are participant notices properly being prepared and distributed?

If you uncover errors through this internal review process—using the Compliance Questionnaire as a guide—most of them can be corrected either through self-correction or by submitting an application under the IRS Voluntary Corrections Program (VCP). Determining whether an error is eligible for self-correction or should be submitted under VCP requires experience and judgment, so if you do uncover errors, we urge you to consult with your plan advisers or counsel. If you would like a copy of the Questionnaire, please contact Heather Abrigo at Heather.Abrigo@faegredrinker.com.

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