Does Your Employee Benefit Plan Audit Offer Protection From The Department of Labor?
By David A. Price, CPA
Employees participating in employee benefit plans are protected by the Employee Retirement Income Security Act of 1974 (“ERISA”). Plan Administrators and others charged with governance responsibility for benefit plans are responsible for ERISA and Internal Revenue Code compliance. If your auditor is not addressing each of the following areas, you could be at risk for an onerous and costly Department of Labor or Internal Revenue investigation. The time to address these issues is before they do.
The most basic compliance is being aware of when an audit of an employee benefit plan’s financial statements is required. Generally, an audit by an independent accounting firm is required when a plan reaches “large plan” status and must file Schedule H with the Form 5500. The general rule is that a “large plan” is an employee benefit plan with 100 or more participants at the beginning of a plan year and a “small plan” is an employee benefit plan with 100 or less participants at the beginning of a plan year. However, if an employee benefit plan has between 80 – 120 participants at the beginning of a plan year, the plan can elect to file the same category as the previous plan year (small plan vs. large plan). As a result, the initial year a plan is considered a “large plan” does not occur until the plan reaches at least 120 participants. Once an employee benefit plan is established as a “large plan”, they must continue to file as such until they have less than 80 participants at the beginning of a plan year.
Full or Limited Scope Audit
Once it has been established that an audit of the employee benefit plan’s financial statements is required, it can be determined whether the plan has the option of engaging an independent accounting firm to perform a limited-scope audit, as permitted by DOL Regulation 29 CFR 2520.103-8. If an employee benefit plan has all of its plan assets held by a bank, trust company or other similar institution that undergoes periodic examinations by federal and/or state regulatory agencies than the Plan Administrator has the option of electing a limited-scope audit. The financial institution must certify on the completeness and accuracy of the investment activity. Under a limited-scope audit, the independent accounting firm is not required to perform any auditing procedures relating to the investments. However, all employee benefit plans that are required to file a Form 11K with the Securities Exchange Commission must have a full-scope audit conducted.
Key definitions and concepts are key
Key definitions and concepts must be thoroughly and well defined within the employee benefit plan’s Plan Document. Important concepts that must be established are the definitions and plan requirements for compensation, eligibility, employer matching contribution formulas, employer matching contribution eligibility, contribution period for employer matching contributions, vesting schedules, highly compensated employees, types of distributions allowed, and the Actual Contribution Percentage/Actual Deferral Percentage testing method.
Compensation and contribution limits
Important compensation and contribution limits for the calendar year 2010 and 2009 are as follows:
Annual Testing Musts!
Employee benefit plans commonly provide for elective contributions and the Actual Deferral Percentage and Actual Contribution Percentage tests must be performed on an annual basis. These tests are designed to identify plan discrimination issues. These tests are commonly performed by third parties, such as the plan’s trustee or a third party administrator. These tests are designed to compare the amount of employee and employer contributions compared to the employee’s salary. If the plan fails the test, a corrective distribution must be made to the highly compensated employees during the first 2 ½ months following the plan year. If this distribution is made after the 2 ½ months, than the employer may be subject to certain taxes. It is critical that proper year end payroll information, which agrees with the participants’ Gross Wages as reported on their W-2s, is forwarded to the third party to ensure an accurate calculation.
The Plan Document should also adequately describe the definition of a highly compensated employee, compensation to be used during the testing and employees who qualify for testing. There are certain employees who are subject to permissive disaggregation and are not required to be included in the Actual Deferral Percentage and Actual Contribution Percentage tests. This is commonly dependent on age and length of service. Permissive Disaggregation requirements should be defined in the Plan Document. Common errors that occur in performing the Actual Deferral Percentage and Actual Contribution Percentage tests include using improper compensation, not properly identifying highly compensated and non-highly compensated employees, and incorrect calculations being performed. Employers must assess each annual calculation and ensure that this is being performed by a competent and experienced party.
Employers must also be aware of the concept of a partial plan termination. An employee benefit plan is considered to be partially terminated if they undergo a participant reduction of approximately 20% as a result of an action, or a series of related actions, that could extend over multiple plan years. A plan can undergo a 20% reduction, but may not be considered a partial plan termination if this is a result of a series of unrelated actions. Common examples of a partial plan termination include the close of a business location or a product line. The determination of whether a plan has entered partial plan termination status requires judgment and should ultimately be decided by management after consultation with an attorney. A partial plan termination results in all participants becoming fully vested in their benefits.
The purpose of any employee benefit plan audit is to ensure compliance with all of the above to avoid any issues with the Department of Labor or the Internal Revenue Service. Scrimping on an employee benefit plan audit often proves to be a very costly plan.