Retirement plan compensation failures are one of the top ten most common errors submitted to the IRS’s Voluntary Compliance Program. In this podcast, Marcel Weiland discusses two scenarios of compensation failures in the area where we see it most often in our practice, bonus compensation.
Speaking of benefits, this is Marcel Weiland.
One of the most common errors the IRS sees in plan audits is the failure to include certain types of compensation when calculating employee 401(k) deferrals, and when making matching contributions. In this podcast, we’re going to discuss two scenarios of a compensation failure in the area where we see it most often, bonus compensation. We’re also going to talk about the range of expense involved in correcting the error before a plan audit has occurred, and after a plan audit has occurred.
Let’s start with some brief background on plan audits. An IRS plan audit can start by random selection, or it could be triggered by something amiss on a Form 5500. The IRS will start an audit by looking at a plan’s Form 5550 that is within the 3-year statute of limitations. That’s called an Open Tax Year. But here’s the tricky thing about the statute of limitations as it plays out in an IRS audit. When the IRS finds an issue in an open tax year, they will still follow that failure back to its inception.
So now let’s look at the tales from the crypt, bonus compensation errors: one where the error involved employee deferrals and another which involved matching contributions.
The scenario we’ve seen most often is where there was a failure to include bonus compensation when deducting employee salary deferrals. In one case, we worked with a client before an audit had started. We were able to have the employer make corrective contributions equal to 50% of the missed deferral opportunity plus earnings, as allowed by the IRS EPCRS revenue procedure. We filed for and obtained a compliance statement in the IRS Voluntary Correction Program. That’s typically referred as the VCP.
The client could then use that compliance statement as a shield against any future IRS audit challenge of the plan about that particular failure. In addition to the cost of the corrective contributions and earnings, the employer had to pay a few thousand dollars to have the VCP application prepared and pay a $3,000 VCP filing fee.
Now let’s discuss the tale of another error involving matching contributions.
The IRS determined in an audit that bonus compensation had not been included in matching contributions. They followed the yellow brick road of the bonus compensation failure back about 15 years and required corrective contributions on the missed bonus compensation and earnings. In this situation, in addition to the cost of the corrective contributions and earnings, the employer had to pay a substantial IRS audit penalty.
The two take-aways here are, one, that plan compensation failures are common and easy to make. That means plan sponsors need to be extremely careful to calculate contributions based on the plan’s specific definitions of compensation.
And two, that an annual plan review is helpful because it’s less costly to uncover plan errors before the IRS knocks on your door in an audit. That way, you can file an application for a compliance statement in the IRS Voluntary Correction Program and avoid expensive penalties.
If you need specific guidance on this topic, let’s start a conversation. This podcast is for general informational purposes only. It does not create an attorney-client relationship between Employee Benefits Law Group and the listener or reader and does not constitute legal advice for a specific situation.
IRS 401k Plan Checklist
The IRS’s Voluntary Correction Program, part of the Employee Plans Compliance Resolution System (EPCRS), is one of three methods for correcting qualified retirement plans errors. The IRS’s 401(k) Plan Checklist is a helpful tool for determining if your plan has fallen into the trap of the IRS’s Top Ten Failures Found In the Voluntary Correction Program. The checklist is largely based on rooting out those particular failures.