Business and Legal Insights

The Internal Revenue Service (IRS) conducts hundreds of audits of 401(k) and other employee qualified retirement benefit plans each year.   Audits can result from participant complaints, inter-agency referrals, responses contained in the plan’s Form 5500 or from the random selection of the plan for audit.

There are many 401(k) plans that go decades without an audit.  Some plans are never audited by the IRS; but what happens when a 401(k) plan is selected for audit?

The process begins when the plan receives an initial audit letter (generally referred to the “IDR letter”) from the IRS.

The initial IDR letter asks for scores of documents.  The requested documents include those that should be readily accessible such as the 401(k) plan document, amendments, the Summary Plan Description, any Summary of Material Modifications, the most recent IRS Determination Letter and the plan sponsor’s relevant tax returns.  The IDR also requests documents and information that may take longer to access, such as payroll information and trust account statements.

The agent will use the documents and information provided to start the audit.  Frequently, the agent will prepare a second IDR letter to request additional documents/information.  The second IDR letter may include specific questions or concerns the agent has regarding the operation of the plan.

In a perfect world, the documents and information provided to the agent pursuant to the initial IDR letter are sufficient and the audit is concluded with a letter from the IRS stating that no changes are required.  At this point life returns to normal - or at least pre-audit status.

Unfortunately, the agent sometimes finds document or operational errors that require remedial steps, including the payment of penalties or fines.  The plan sponsor must correct these errors before the audit can be concluded.

Experience has shown that there are certain aspects of a 401(k) plan’s operation and documentation that are almost always examined during an audit.  Below, I briefly discuss some of the issues that we have seen in our representation of plans that have undergone or are undergoing an IRS audit.

We thought this information would be helpful for 401(k) plans in the day-to-day operation of the plan and in preparing for the audit that hopefully will never occur.

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