In Part One of this two-part series, I described the methods IRS will be using to achieve compliance in qualified pension and 401(k) plans, as set out in its recently issued 2018 Work Plan. Here, I describe the specific issues identified in the Work Plan that will draw the interest of the IRS.
Initiatives Begun in 2017
Let’s get started with a few things recited in the Work Plan that were initiated in 2017 and that will carry over into the 2018 fiscal year.
- Hardship distribution substantiation directives. The IRS issued guidelines to its agents for examining whether a plan sponsor has properly substantiated whether a hardship distribution by 401(k) and 403(b) plans is on account of an immediate and heavy financial need. This is a problem that vexes many plan sponsors as some service providers who have responsibility for this function under their agreements with plan sponsors have failed to follow the requirements for substantiation.
- Maximum loan amount directive. The IRS issued a directive to its agents in the 2017 fiscal year addressing the maximum plan loan amount for participants with multiple loans. The problems in this compliance area relate to the determination of the maximum loan amount when participants take out two loans in the same 12-month period.
- Section 403(b) & 457 plans. The IRS continues to examine plans that fail to meet the universal availability requirements for salary deferrals, the limitations relating to age 50 and/or 15-year special catch-up contributions, improper hardship withdrawals.
IRS Examination & Compliance Check Priorities in 2018
The Worksheet describes two types of compliance activity: Examinations and Compliance Checks. Examinations are generally broad in scope and Compliance Checks make narrow inquiries into specific compliance issues.
- Mergers/consolidations. Plans that have transferred their assets or liabilities to another plan as the result of a merger or acquisition are a target will be the subject of examination activity.
- Discrimination testing. Various testing issues will be examined, including “gateway” testing failures, failed actual deferral percentage (ADP) and actual contribution percentage (ACP) tests, and failures to give proper notices to participants in safe harbor plans.
- Participation & coverage failures in operation. Failures to satisfy in operation the statutory requirements relating to minimum age and/or service. An example of this type of failure is allowing ineligible participants to participate.
- Distribution Failures. These failures include distributions subject to the minimum required distribution rules (under section 401(a)(9)), distributions not made consistent with the terms of the plan, and terms (either in timing or form), and distributions that are not made in the amount.
- Failures to properly value trust investments in small plans. Arriving at a proper value for plan assets is a concern for the IRS as it impacts several plan functions. These include the reporting of the appropriate taxable amount on distributions and determining the correct amount of minimum required distributions. The Work Plan mentions real estate investments as a type of asset that may have proper valuation issues.
- Erroneous allocations of contributions & earnings. Plans that made erroneous allocations of contributions and forfeitures due to the use of an incorrect definition of compensation or that failed to make all matching contributions consistent with plan terms.
- Failures to hold the proper amount of elective deferrals. The IRS appears to be concerned that plans are not withholding elective deferral contributions consistent with plan terms.
The IRS will continue to use Compliance Checks to determine whether a plan is adhering to recordkeeping and information reporting requirements. Compliance Checks are not a full plan examination, but rather represent an IRS inquiry into a specific aspect of plan operations. They do not become full-blown examinations unless during the course of the check facts develop provide a reason for a full examination.
Compliance Check topics listed in the Work Plan are these:
- Plans with partial terminations. Partial terminations result in full vesting of affected participants. A partial termination occurs when there is substantial diminution in the number of participants and there is a corporate event related to it (for example, the closing of a company division or a plant).
- Plans with non-participant loans. Non-participant loans likely draw the attention of the IRS because they potentially involve related parties and that is a prohibited transaction and excise tax implications.
- Section 403(b) plans. The IRS continues to up its game in what was once an ignored part of IRS’ jurisdiction over employee benefit plans. Plan sponsors can expect more attention in all the aspects of compliance related the Internal Revenue Code.
- Section 457(b) plans with excess deferrals. The IRS created the Employee Plans Compliance Unit (EPCU) Non-Governmental 457(b) Plans Excess Deferrals Project to verify that participant salary deferrals under these arrangements do not exceed the $17,500 limit.
Thoughts and Ideas for Plan Sponsors
What is remarkable about the Work Plan “lists” is how common the problems they identify have been over so many years. They are the choke points for plan operations and administration that get plan sponsors into trouble and with a little effort can be avoided. But used as a checklist, the Work Plan can be effective in avoiding or diminishing the worst consequences of an IRS “inquiry” into your plan’s affairs.
Perhaps a good way for plan sponsors to approach the Work Plan is to approach the items on it with the following three questions:
- Is the item a cause for concern?
- If there is a cause for concern, can we verify the plan is compliant?
- If the plan is not compliant, what is the best approach to fixing the problem?
An excellent resource for correcting problems is the IRS' own 401(k) Fix It Guide. The guide is quite complete (although it doesn’t offer solutions for every issue on the Work Plan) and even offers tips on how to avoid problems.
Chuck Humphrey is a consultant to Fiduciary Plan Governance and the principal of Law Offices of Charles G. Humphrey and the author of the Fiduciary Responsibility eSource available at erispedia.com. Mr. Humphrey can be reached at firstname.lastname@example.org or at 716-465-7505.