Common IRS document requests in 401(k) plan audits

The IRS has recently increased its audits of employer 401(k) plans. Rather than wait for an audit, plan administrators should proactively consider potential issues and take any necessary corrective measures. The following is a brief rundown of what the IRS will request at the outset of an audit, as well as a non-comprehensive list of issues commonly scrutinized by the IRS during a 401(k) plan audit.

Initial IDR

The IRS’s initial Information Document Request (“IDR”) typically requests all necessary plan documents. These include all foundational and organizational documents, as well as the plan’s favorable determination letter or advisory letter, if applicable. This first IDR will request all interim amendments, and the Board of Director’s Minutes or other appropriate documentation indicating these amendments were timely adopted. The IRS will also request various other documents related to the plan, such as:

• The summary plan description,
• Summaries of all material modifications,
• Annual reports,
• A copy of the income tax return of the plan sponsor,
• Evidence of a current Fidelity Bond for all people handling trust assets, and
• A copy of the safe harbor notice given to eligible employees, if applicable.

A failure to produce these documents can have a negative impact on the result of the audit.

The second IDR

The IRS’s initial IDR is frequently accompanied by a second IDR, which focuses on more substantive issues.

ADP and ACP nondiscrimination tests

For instance, the second IDR will ask whether the plan passes the ADP and ACP nondiscrimination tests. These tests ensure that the contributions made by non-highly compensated employees are proportional to the contributions made by highly compensated employees (managers and owners). Because failing either of these tests can result in disqualification of the entire 401(k) plan, plan administrators should familiarize themselves with these tests and conduct a thorough review to ensure the plan passes both.

If the plan administrator determines that the plan fails one or both of these tests, corrective action can still be made within 12 months, such as making qualified nonelective contributions for the non-highly compensated employees. Alternatively, this problem can be avoided altogether by establishing or converting to a safe harbor 401(k) plan.