In our last issue, we discussed how to prepare for that dreaded storm in the distance: an IRS audit. In this issue, we will look at what to do when the storm rolls in and there is no escaping it. We will examine the five steps an employer should take once contacted by the IRS. We will also identify the common issues associated with an audit and how to correct these issues. Finally, we will conclude by discussing the benefits of self-audits and how GuideStone can help.
When an employer is notified by the IRS that they are the subject of an audit, there are five essential steps the employer should take immediately.
There are some common issues that do come up during an IRS audit. Understanding these frequent errors will help employers better prepare for an audit. These issues are discovered during audits because they are tricky and, therefore, commonly missed by employers. It can be helpful for an employer to look for these common issues long before being contacted by the IRS.
One of the most common errors is worker classification. Workers improperly classified as independent contractors impact all of the plans, including the self-employed plan. This can possibly be devastating to an employer. Reclassification of workers most often occurs through IRS employment tax examinations.
Another frequent issue the IRS encounters during an audit is an error within the actual plan document. This usually manifests itself as a result of employers failing to follow the written plan. This is a very common error that can be easily avoided. It is key for the employer to know the plan and follow the plan as written. One of the single most common errors is the payroll/HR system not matching the document requirements. Another way employers fail at following the written plan document is when there are other documents that dictate contributions, which are contrary to the written plan document. This could be in the form of a resolution adopted by a board of trustees. Additionally, the written document might have been amended and no longer matches the operations of the company. Finally, the employer might just have a misunderstanding of provisions in the written document.
Additional errors found by the IRS may involve nondiscrimination — usually exhibited by issues with universal availability. Employers must not improperly exclude employees. If the employer does make this error, it is very costly to remedy. The employer must make contributions, as well as earnings, to cure the failure.
Contribution errors are another common issue identified by the IRS. One of these errors may include incorrectly defining the term “compensation.” It is very important that employers pay attention to the compensation definition in the plan document. Other contribution errors include exceeding various limitations: elective deferrals and 415(c), for example. Employers also commonly make errors regarding the 5-year post-severance contribution.
Other common errors found relate to improper plan loans, hardship distributions and failure to follow transfers and distribution restrictions.
As you can see, there are many obstacles out there that can sink your ship (or at least cause a leak) inside the storm of an IRS audit. Hopefully knowing some of these issues ahead of time will help employers diligently prevent these errors.
Once again, the key to surviving the storm of an audit is prevention and preparation; however, if an employer is already in the midst of the storm, they must make the necessary corrections.
The IRS classifies the failures as either a contract failure involving an individual participant or a plan failure impacting the whole plan. Depending on the severity, the IRS will put the employer into either the Self-Correction Program (SCP) or the Compliance Audit Program (CAP).
As you may have guessed, the SCP is for less significant violations. Ideally, if failures are found, the IRS will put the employer into the SCP and give a specific criteria and timeframe for the employer to complete self-corrections. If the employer finds itself in the unenviable position of being placed into the CAP, it helps if the IRS auditor is your advocate. As strange as that sounds, the auditor can advocate to those making the decisions on your behalf. In addition, your attorney may be able to negotiate for lower sanctions, and an IRS auditor who is also an advocate can certainly help in this regard.
The bottom line is once an employer has reached this point, it is vital for them to complete all tasks requested by the IRS. While enduring this part of the storm, it may seem like it will never end. Rest assured, if the employer does what is asked, this storm will eventually pass (as all storms do).
The importance of an employer focusing on prevention and preparation cannot be overstated. There are some key self-auditing steps an employer should take to prepare for the storm of an IRS audit. The time and money spent in following these steps is nominal in comparison to what it takes to later reconcile errors found by the IRS.
The first step is to take the written plan and make sure it is consistent with other company documents. These documents may include employee handbooks, company webpages, procedural manuals, plan summaries, etc. Other self-audit steps include identifying operational practice & procedures; running test checks of eligibility, contributions and loans; protecting institutional knowledge and staying alert in changing payroll systems. Periodically taking these steps will help save the company from the impending storm.
At GuideStone, we want you to know you do not have to weather the storm completely on your own. GuideStone will help you along the way. GuideStone can help in the prevention of and preparation for the storm by providing information and assisting with mock-auditing tests for the employer. GuideStone will also assist once the storm hits by gathering and organizing the information needed by the IRS. So, while storms are inevitable, proper preparation will always minimize the damage, if any, the storms can inflict.
This information should not be considered tax or legal advice. GuideStone stands ready to assist your organization as you work with your legal and tax advisors by providing resource information that you and your advisor may find beneficial.
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