There are few things
that will give a person that sinking feeling in the pit of their
stomach like opening the mailbox and seeing an envelope with the
words "Internal Revenue Service" (or Department of Labor) in the
return address. It is similar to seeing that police car as you drive
down the highway; you might not even be speeding, but you
immediately slow down and wonder how you will look in stripes.
The IRS and DOL both have jurisdiction over qualified retirement
plans, and between the two agencies, they generally audit more than
20,000 plans each year. And, if recent speeches and articles are any
indication, both agencies will be visiting even more plan sponsors
in the months ahead.
While no article is likely to take away that initial panic, there
are certain steps you can take to make sure the reality of a visit
from your friendly neighborhood auditor is not nearly as bad as the
anticipation. In fact, with the right preparation, an IRS or DOL
audit of your retirement plan can be a non-event.
What Are They Looking for, Anyway?
When facing an audit, it is common to wonder what the Feds are
hoping to find. The answer depends on which Feds are doing the
Department of Labor
Among other things, the DOL is charged with the enforcement of
ERISA, which includes all of the rules requiring plan fiduciaries to
act prudently and in the best interest of participants and
beneficiaries. It is no coincidence, then, that in conducting
audits, the DOL's primary focus is to ensure that participants and
beneficiaries are receiving all the benefits to which they are
entitled and that fiduciaries are not jeopardizing the plan's
ability to provide those benefits. Specific areas of review might
include verifying the plan has an investment policy statement (and
that it is being followed) and confirming that employee salary
deferrals and loan payments are deposited on a timely basis.
Internal Revenue Service
Believe it or not, the division of the IRS that is responsible
for qualified retirement plans is one of the few divisions not
charged with raising revenue. That means they do not set out to find
reasons to penalize plan sponsors. Quite the contrary. Their goal is
to preserve the tax benefits associated with retirement plans by
making sure sponsors are operating their plans in accordance with
regulations, plan documents, etc. Essentially, the IRS understands
that retirement plans represent significant tax benefits to sponsors
and participants, and they want to be sure that those claiming the
tax benefits are playing by the rules.
It is a common misconception that if the government comes
knocking, there was a complaint, evidence of wrong-doing or
something else that must have initiated the visit. While both IRS
and DOL take participant complaints very seriously and sometimes do
initiate investigations because of them, many plan audits are
semi-random in nature.
The selection process is not quite as random as putting a bunch
of Forms 5500 in a spinning barrel and pulling out the winning
entries; rather, the agencies identify certain issues or
characteristics and then query the Form 5500 database to find plans
that fit those criteria. Then, they randomly sample that population
to determine which plans they will audit.
As an example, several years ago, the IRS was concerned about
plan investments in real estate, so they were able to narrow their
focus to the affected plans by reviewing Form 5500 data.
The DOL has an ongoing, national enforcement project related to
the timely deposit of employee contributions. One way they may
target plans is to review Form 5500 to determine if receivables
related to salary deferrals are disproportionately high based on the
total employee contributions for the year.
What Should You Do When You Receive an
This next statement might win the obvious award, but if you are
the proud recipient of an audit notice, do not ignore it. The
notices generally include a proposed schedule for the audit as well
as a laundry list of document requests and the contact information
for the examiner. Auditors are generally pretty reasonable people
who understand scheduling challenges. If you have a conflict or do
not believe you can gather all of the requested information in time,
they are usually willing to reschedule within reason as long as they
have some lead-time.
However, before you contact the auditor, your first call should
be to the provider who assists you with plan compliance matters such
as your TPA. If you have worked with that service provider for a few
years, they probably have much of the information the auditor
requests. Given the volume of documents involved, the TPA will
likely need some time to compile all of the information, and they
will welcome as much advance notice as you can provide.
At that point, it is also useful to work with your providers to
conduct a pre-audit. This process involves reviewing plan records
and operations for the years the auditor will be examining.
Retirement plans are complex beasts, and despite best efforts,
mistakes do happen. To the extent you are able to identify mistakes
and take corrective action before the audit begins, the more likely
you are to minimize any penalties that might otherwise be assessed.
Certain types of mistakes can be completely self-corrected even when
a plan is under examination.
What Should You Do on the Big Day?
It is common for auditors to want to stop by your place of
business as part of their examination. Sometimes, they simply want
to confirm that there aren't hundreds of employees working on your
factory floor despite the fact that your Form 5500 says you only
have 20 participants. Other times, they will conduct a significant
portion of their document review over several days in your office.
Either way, it is advisable to coordinate the length of the visit in
One of the most important things you can do to expedite the
review process is to have all of the requested documents neatly
organized. Often times, the document request lists items in the same
or similar order that the auditor will review them. Consider using
sticky notes, labels or tabs to arrange everything in that same
order to facilitate a more streamlined review. In short, make it
easy for the auditor to find the requested information quickly so
that he or she can move on to the next item on the list.
While the rule of thumb is not to provide extraneous information
that has not been requested, it is important to be cooperative and
helpful. For example, if the auditor asks to see information about a
specific participant, try to identify the exact page rather than
handing the auditor a 300-page report and wishing him or her good
While it is certainly advisable to extend some common courtesy,
keep in mind that an auditor is still an auditor with an obligation
to take action if he or she identifies errors. As a result, it is a
good idea to exercise discretion in determining the internal
personnel that work with the auditor. An accounting clerk who is not
familiar with rules related to 401(k) plans may not think it is a
big deal to mention a payroll error that caused several late
deferral deposits, but an auditor will certainly think it is.
Be Confident…but Respectful
The IRS and DOL agents that audit plans have varying degrees of
experience and knowledge. Not every agent is going to be well-versed
in the myriad rules and regulations that govern retirement plans.
There are instances in which an auditor may challenge something that
is perfectly legitimate.
Consider this example. There was an agent reviewing a 401(k) plan
that used the so-called otherwise excludable rule to disregard
certain short-service employees from its nondiscrimination testing.
The auditor was not familiar with that rule and challenged the test
results even though they were correct. In that circumstance, it was
necessary to confidently point the agent to the Code section that
authorized the testing method; however, it was equally necessary to
do it in a helpful, non-confrontational manner rather than
disparaging his or her lack of knowledge of that rule.
Be Willing to Ask for Help
Anyone who does not have experience working with an auditor
should think twice about representing him or herself. Not only is it
prudent to seek counsel from plan service providers before the
audit, it is wise to seek their assistance throughout the audit.
What Can You Do before You Get an Audit
As the saying goes, an ounce of prevention is worth a pound of
cure, and that is especially true with retirement plan maintenance.
Conducting self-audits at regular intervals can highlight oversights
or procedures that may need to be updated and allows you to address
your findings without the pressure of an upcoming audit.
The IRS and DOL publish information about their enforcement
initiatives on their websites:
The websites also include a wealth of information about steps you
can take to identify and correct mistakes before the government
comes knocking. Resources include plan compliance checklists that
focus on the most common compliance errors. Both agencies also
maintain in-depth voluntary correction programs.
The IRS has recently highlighted the importance of internal
controls and has started reviewing them as part of their examination
process. In a nutshell, internal controls are processes and
procedures put in place to make sure errors do not occur in the
If there is a checklist showing that during that last payroll
conversion, someone matched codes on the payroll system to the plan
document's definition of compensation, there is a higher likelihood
that the correct compensation was used to calculate that matching
contribution. With that solid internal control identified, there is
less of a need to spend time reviewing each compensation record on a
Audits are never fun. They require time and resources and no
matter how diligent your compliance efforts, leave you sitting on
pins and needles. However, retirement plan audits do not have to
cause weeping and gnashing of teeth.
With some professional advice from your service providers and
some organization, cooperation and courtesy in dealing with the
agent, the audit can be like a routine teeth cleaning rather than a