During a phone forum, Monika Templeton, director of Employee Plans Examinations at the Internal Revenue Service (IRS) in Washington, said good internal controls allows plan sponsors to quickly identify errors to correct via the agency’s Self-Correction Program (SCP) with minimal cost. Good internal controls also impact Audit Closing Agreement Program (Audit CAP) sanction negotiations.
Templeton noted that having practices and procedures in place to promote or facilitate compliance is a prerequisite for entering into the SCP. Having a plan document alone does not imply established procedures. During examinations, agents often find no internal controls in place or internal controls that are inconsistently followed, she said.
Templeton explained that the Employee Plans (EP) agent will evaluate the effectiveness of the plan’s internal controls to determine whether to perform a focused audit—i.e., just look at three to five issues—or to expand the scope of the examination. Good internal controls are a key factor in keeping an audit “focused.”
The internal control interview helps the examiner determine whether the plan is well-run or there are serious compliance risks that would give rise to expanding the scope of the audit.
“The EP agent will make every effort to ensure your internal control systems are running smoothly when the audit concludes,” Templeton said. As a side note, she added that if a self-correction action is more than 65% complete, even if the error is significant, it can be self-corrected during the audit.
Janice Gore, EP area manager for the Great Lakes, shared some examples of insufficient internal controls found during EP audits:
- Third-party reports frequently have inaccurate data, such as dates of hire and termination, employee age and service and compensation;
- Decentralized payroll systems without internal controls—e.g., if each subsidiary determines eligibility, highly compensated employee (HCE) status, or what constitutes plan “compensation,” it can result in incorrect coverage and allocations; and
- Data used for Form 5500 fails to conform to actual records—i.e., payroll data.
Templeton said a yearly checkup needs to confirm there are good internal controls in place, and good communication needs to exist beween the company and its different locations or subsidiaries.
During the phone forum, it was announced that the IRS has repackaged the 401(k) questionnaire (see “29% Chose Deferral Higher than Default”) as the QSAT (Questionnaire Self-Audit Tool), scheduled to be released sometime this year. The QSAT will help plan sponsors find, fix and avoid costly mistakes. According to Gore, it asks questions an EP examiner will ask.
Gore and Templeton shared examples of commonly found errors, questions the QSAT will ask to help plan sponsors avoid or find those errors, and suggested tips for good internal controls.
For example, nondiscrimination testing errors can occur due to improperly identifying HCEs, excluding those who elect not to defer salary from the test, using an incorrect definition of “compensation” and not using the testing method defined by the plan document, for the current or prior year.
The QSAT asks the following internal control questions related to nondiscrimination testing:
- Who verifies that correct data was used to complete the annual testing?
- Who determines which participants are highly compensated employees?
- Who verifies that deferrals allocated to participants’ accounts are correct?
- Who determines whether participants’ compensation for deferral purposes is correct?
- How are matching and nonelective contribution amounts determined? and
- Who ensures that each participant receives the correct matching and/or nonelective contribution?
Internal control tips to help avoid nondiscrimination testing errors include: Establish/amend the plan to be a safe harbor plan; eliminate communication gaps between the employer and plan vendor; and verify the accuracy of employee classifications, family aggregation and definition of compensation.
Until the QSAT is released, the IRS has other tools plan sponsors may use at www.irs.gov/Retirement-Plans.