What You Need to Know: The New IRS Audit Initiative forRetirement Plans

The Internal Revenue Service recently announced that it will beconducting detailed audits on “large” qualified retirement plans,which will include defined contribution plans, defined benefitplans and collectively bargained plans of both types.

If you are a benefits advisor, and your client has a largequalified retirement plan, you need to be able to talk to yourclient about the new audit program.

The IRS informally defines “large” plans as plans that have atleast $50 million in assets and cover 2,500 or more active, retiredand separated participants.

The reason for the new focus on auditing large plans is simple:IRS and other governmental statistics reveal that 60% of all planparticipants and 70% of all plan assets are in these “large” plans.By concentrating auditing efforts on the big plans, the IRS hopesto maximize its results.

One new aspect of this audit is that the IRS audit team will belarger and more specialized.

The typical IRS Employee Plans Team Audit Program team will have6 to 8 agents, including a benefits attorney, a benefitsspecialist, a computer audit specialist, an actuary and otherspecialists as needed. (Example: an employment tax specialist.) Thetypical EPTA exam budget for a large plan is expected to use 200 to300 IRS staff days. This staffing budget will help the EPTA teamdrill down to a very detailed technical level.

Plan sponsors of targeted plans can take 2 courses ofaction.

The “head in the sand” approach is to blithely ignore new IRSauditing program. The problem with this approach is that the IRSimposes severe monetary sanctions on plan sponsors when itsauditors discover disqualifying defects.

The better, proactive approach is to hire experienced technicalexperts to perform a private operational compliance review. Thetechnical experts should know what the IRS auditors will ask andwhat operational problems might crop up. A proper operationalcompliance review can help a plan sponsor identify and correct planoperational violations on its own.

Private auditors occasionally do operational reviews after theIRS has notified the plan sponsor of its intent to audit the plan,but ideally, the sponsor should schedule the review before itreceives any hint of an IRS audit. A sponsor that identifiesviolations before an IRS audit either can correct the problemsitself or correct the problems with the blessings of the IRSthrough the IRS “Voluntary Compliance Program.”

An operational compliance review also can reduce the risk ofprivate civil litigation brought by plan participants and theirattorneys. These lawsuits are becoming more frequent and moreexpensive. The press has reported that some plan sponsors have paidmillions of dollars to settle plan-related class-actionlawsuits.

Plan sponsors also should recognize the intrinsic value ofoffering a well-run plan. A well-run plan can contribute to goodemployee morale and cut employee turnover rates. In some cases, awell-done review can help a sponsor improve plan administration andbenefits without significantly increasing the sponsor's costs.

The IRS initiative to audit large plans puts all plan sponsorsand their advisors on notice that, going forward, the IRS will beexpecting them to do regular, independent reviews. Even plansponsors of smaller retirement plans are not immune. It is likelythat the IRS EPTA teams will eventually shift their focus tosmaller plans. At that point, the EPTA teams will have a bettergrasp of what issues should be examined more closely.

Insurance companies in the retirement services market must beprepared to work with clients that either face IRS audits or aretaking steps to assess their own operations. Insurers can play avital role by providing both technical and administrativesupport.

If, for example, a plan sponsor is conducting an independentreview, the insurance company that provides plan administrativeservices should discuss its role in the audit with the plan sponsoras early as possible, in order to continue to maintain goodsrelations. The insurer also should consider whether to list suchservices in the administrative services contract.

Chris Lipski is the human resources risk management leader inthe human capital practice at Ernst & Young L.L.P., NewYork.

Reproduced from National Underwriter Edition, April 19, 2004.Copyright 2004 by The National Underwriter Company in the serialpublication. All rights reserved.Copyright in this article as anindependent work may be held by the author.