audit nightmare

[K2retire]

I am the TPA for an audit level plan that is making me question everything I thought I knew. And it seems to be a real comedy of errors.

The plan sponsor's payroll company cut off employee deferrals when employees reached the compensation limit, even if they weren't up to the 402(g) limit yet. When an employee challenged this, we instructed them to restart the deferrals and that they would need to make a corrective contribution. The client figured a QNEC on their own and deposited it before the end of the year.

The auditor is now requiring them to correct all prior years when this happened, before they will release the audit. They instructed that the 5500 be filed with a statement explaining why there was no audit attached. The client has since received a letter giving them 45 days to produce the audit.

The client contacted an attorney for advice before filing the incomplete 5500. Although he says he has 30 years experience as an ERISA attorney and was a CPA who handled plan audits before that, he says he has never heard of allowing deferrals after the compensation limit has been reached. Question 1: Am I crazy, or is the attorney?

He also advised that because of the QNEC deposit before the end of the year, the client has interpreted their plan provisions to be that the stopping of deferrals was wrong. To correct all the prior years requires a VCP filing. However, because the only people who are potentially due corrections are HCEs, he expects the government to deny the proposed correction.

Back to the CPA, who wants to show receivables for all the prior years on the Schedule H. She also wants to show a negative receivable for the years that might not be deposited, if the attorney is correct. Question 2: Am I crazy, or is the accountant?

Question 3: Is this likely to be the new level of "attention to detail" that is common from accountants as a result of DOL's recent communications about audit quality?

[Lou S.]

Q1 - attorney is crazy in my opinion

Q2 - depends, is a VCP scheduled? What would you put as a receivable if you are going to wait on IRA approval. Also I have no clue why on earth the CPA could not issue the audit and simply disclose the issue in their report. To me it sounds like they had zero basis for not getting the audit done on time. I'd look for a new auditing firm for next year.

Q3 - Yea benefit audit have gotten increasingly insane. First started happening after Enron and whatever law that was that also brought in blackout notices but the level of crazy seems to escalate a bit each year.

And attorney may be correct, IRS may disallow a QNEC that goes only to HCEs. I have no direct experience of that but it smells like something the IRS would not be too keen on as it is really a boon to HCEs.

[My 2 cents]

Not a defined contribution practitioner, but aren't the compensation limit and the 402(g) limit two separate things? The way I understand the compensation limit to work is that compensation above the 401(a)(17) limit cannot be taken into account under a plan. If the participant earns $400,000 per year and elects a salary reduction of 4% of compensation, they don't get to contribute $16,000 to the 401(k) plan even though that is fine under 402(g). They only can contribute 4% of the compensation limit. Suppose you were talking about a profit sharing plan. You cannot set the profit sharing contribution at 4% of compensation and contribute more than 4% of the limited earnings.

Given the fact that the 402(g) limit does not override the compensation limit, the position taken by the accountant does not sound right to me (but then, not only do I not work on defined compensation plans, but I am also not an accountant).

[Doghouse]

See p. 7 of Employee Plan News at https://www.irs.gov/pub/irs-tege/epn_2012_1.pdf

IRS has affirmed this position a number of times.

[Mike Preston]

Check the document language. It may limit comp from which deferrals are allowed to the comp limit. While there is no requirement to do so, it certainly may have been drafted that way.

[Doghouse]

And Employee Plan News does say "unless your plan terms provide otherwise".

[K2retire]

See p. 7 of Employee Plan News at https://www.irs.gov/pub/irs-tege/epn_2012_1.pdf

IRS has affirmed this position a number of times.

The example is an employee who elected a dollar amount per pay period. The attorney is saying that an employee who elects a percentage of pay must be stopped at the comp limit as suggested by My 2 Cents.

In this case, the document does not limit deferrals beyond the 402(g) limit.

[Doghouse]

As I said, there are other sources that affirm the position, but I can't imagine why the logic can't be extended. There is really no difference.

[Bill Presson]

See p. 7 of Employee Plan News at https://www.irs.gov/pub/irs-tege/epn_2012_1.pdf

IRS has affirmed this position a number of times.

The example is an employee who elected a dollar amount per pay period. The attorney is saying that an employee who elects a percentage of pay must be stopped at the comp limit as suggested by My 2 Cents.

In this case, the document does not limit deferrals beyond the 402(g) limit.

If the plan does not limit the compensation to the 401(a)(17) limit for contributions, then the plan should not have stopped until the participants reached the deferral 402(g) limit. So frustrating.

And I think the auditors are being silly as well.

[QDROphile]

The argument by the lawyer that the answer based on the specified dollar deferral does not dispose of the issue shows that the lawyer is not only not knowledgeable, the lawyer is a weak thinker. Criticism of the lawyer's ethics is a possibility, depending on the circumstances.

[EPCRSGuru]

My understanding is that the IRS takes the position that the compensation limit in Code section 401(a)(17) does not require that salary deferral contributions be stopped when a participant’s compensation hits the limit for the year. The clearest formal articulation of the basis for this position appears in the preamble to the final 415 regulations that were issued in 2007 [TD 9319]: "As noted above, the final regulations provide that a plan cannot take into account compensation in excess of the section 401(a)(17) limit. In addition, the final regulations provide that elective deferrals can only be made from compensation as defined in section 415©(3). However, in applying these two rules, a plan is not required to determine a participant's compensation on the basis of the earliest payments of compensation during a year."

The IRS illustrates how this applies on the following page: http://www.irs.gov/Retirement-Plans/401k-Plans-Deferrals-and-matching-when-compensation-exceeds-the-annual-limit

And in the following IRS newsletters from 2009 and 2012: http://www.irs.gov/pub/irs-tege/fall09.pdf (see the top of page 4) http://www.irs.gov/pub/irs-tege/epn_2012_1.pdf (See We’re Glad You Asked #2 on page 7)

Those IRS pieces acknowledge that a plan’s terms can provide otherwise – e.g., that “a plan can specifically require that salary deferrals cease once a participant’s compensation reaches the annual limit. If your plan specifies that salary deferrals be based on a participant’s first $260,000 of compensation, then you must stop allowing” deferrals once an individual’s year-to-date compensation reaches the 401(a)(17) limit (emphasis in original).