The Importance Of Good Internal Controls - IRS Tax Forms

August 8, 2013The Importance of Good InternalControlsMonika Templeman, Esq.Director, Employee Plans Examinations, IRSJanice GoreEP Exam Area Manager, Great Lakes

Retirement Plan Resources Retirement Plans Website – www.irs.gov/retirement Newsletters – from the Retirement Plans website,select “Newsletters” in the left-hand navigation bar,choose “subscribe” and then select “Retirement Newsfor Employers,” our newsletter for employerssponsoring retirement plans and “Employee PlansNews,” our newsletter for retirement plansprofessionals.2

Importance of Good InternalControls Can eliminate or reduce errors inplan operation Plan sponsor can quickly identifyerrors to correct via Self Correctionwith minimal cost3 Impacts Audit Closing AgreementProgram (Audit CAP) sanctionnegotiations

Importance of Good InternalControls4 Can keep the audit “focused” Can significantly reduce the time forconducting an examination Can shorten turnaround time on requestfor further information duringexamination Can promote clear communicationbetween IRS andemployer/representative

Good Internal Controls Affect anEmployee Plan Audit The EP agent will evaluate the effectiveness of theplan’s internal controls to determine to perform A focused audit (just look at 3-5 issues) or Expand the scope of the examination Good internal controls are a key factor in keeping anaudit “focused” The internal control interview helps the examinerdetermines whether the plan is Well run or Whether there are serious compliance risks that would giverise to expanding the scope of the audit5

Good Internal Controls Affect anEmployee Plan Audit The EP agent will make every effort to ensureyour internal control systems are runningsmoothly when the audit concludes NOTE! If a self correction action is more than65% complete, even if the error is significant,it can be self corrected during the audit6

Examples of Insufficient Internal ControlsDiscovered During EP Audits Third party reports frequently have inaccurate data Dates of hire and termination Employee age and service Compensation, etc. Decentralized payroll systems without internalcontrols Each subsidiary determines eligibility, HCE status, orwhat constitutes plan “compensation,” result in incorrectcoverage and allocations7 Data used for Form 5500 fails to conform to actualrecords (i.e., payroll data)

Good Internal Control Examples Segregation of Duties Established Systems 8Ex.: Payroll, Human ResourcesImportant to check that systems accuratelyverify the data and processes to ensure plancompliance Good IT System Knowledgeable & Responsible Personnel Form 5500 returns accurately filed &reconciled

Questionnaire – Current Location9

Coming Soon – New & ImprovedTool! Good News! We added new internalcontrol questions and repackaged the401(k) Questionnaire as the QSAT(Questionnaire Self Audit Tool) Scheduled to be released in 2013 The QSAT will help plan sponsors tofind, fix and avoid costly mistakes10

QSAT ToolHow to Use the QSAT(with Internal ControlQuestions) to avoidCommon Plan Errors11

Common Plan Errors Non-amender/Late amender Failure to follow the terms of the plan Definition of “Compensation” Matching contributions Omitting eligible employees Loan issues Nondiscrimination testing (ADP/ACP) IRC 402(g) limits Timely deposit of employee elective deferrals12 Hardship Distributions

Non-Amender/Late AmenderFailure to timely amend the plan for changes inthe lawDocuments to maintain: Original plan document All subsequent amendments or restatements All adoption agreements Any opinion letter or advisory letter issued bythe IRS Any determination letter issued by the IRS13 Board of Director’s resolutions and minutesrelated to the plan

QSAT - Internal Control Questions Who is responsible for making timelyamendments to the plan for changes inthe law? If there has been a merger oracquisition, and plans are merged, whoverifies that the language of the resultingplan is correct as intended?14

Non-Amender/Late AmenderInternal Control Tips Use a “tickler file” or similar system Annual review of plan document Does Summary Plan Descriptionmatch plan? Maintain contact with company whosold the plan15

Fixing Non-Amender/LateAmender ErrorsYou can fix the mistake under the EPCRS –Revenue Procedure 2013-12 Self Correction (SCP) - NO Voluntary Compliance program (VCP) - YES The Fix: Adopt amendment(s) for missed law changesOR16 Adopt a pre-approved plan from an M&Psponsor or volume submitter practitioner

Failure to Follow Plan TermsPlan definition vs. plan operation notconsistent Failing to communicate plan changesto those involved in planadministration Definition of “Compensation” for allpurposes Matching contributions17

QSAT - Internal Control Questions What is your plan’s definition ofcompensation? Are there multiple definitions included in theplan? Who determines the participantscompensation amount for plan purposes fromthe payroll records?18 Who verifies that participants’ compensationused for all plan purposes is according to thedefinitions in the plan document?

Failure to Follow Plan TermsInternal Control TipsAvoiding Definition of Compensation Errors Know plan document definition and allchanges Compare to operational procedures Know what third-party administrators agreedto provide (Are they relying on the employerfor all information?)19 If possible, simplify the plan’s definition ofcompensation and use the same definitionfor multiple purposes

Failure to Follow Plan TermsInternal Control TipsAvoiding Matching Contribution Errors Review plan document annually to verify the planterms are being followed and that the plan is Properly counting hours of serviceCorrectly identifying plan entry datesUsing correct “Compensation” definitionPayroll periods vs. plan terms Annual amounts and percentages Compare to operational procedures Timing of the match20

Fixing Failure to Follow the Terms ofthe Plan ErrorsEPCRS Revenue Procedure 2013-12 Fixing Definition of Compensation Errors Over contribution Elective deferrals Distribution of excess amount earnings Profit-sharing allocation Forfeit and reallocate w/ earnings or Place in unallocated account for future use Under contribution Corrective contribution w/ earnings21

Employee Eligibility22Excluding eligible employees / Includingineligible employees caused by: Misunderstanding plan’s “eligibility” and“entry dates” definitions Different requirements for differentcontributions Operating the same as the prior year –without reviewing the plan document forchanges Not considering part-time employees Not including employees who elect not tomake deferrals

QSAT - Internal Control Questions Who determines when an employee iseligible to participate in the plan? What steps does this person take todetermine if an employee is eligible toparticipate in the plan? What steps are taken to notify an employeethey are eligible to participate in the plan? How does the plan track the amount ofservice an employee has completed?23

QSAT - Internal Control Questions Who is responsible for maintaining personnelrecords? What actions are taken to make sure thepersonnel records are accurate? How is information from personnel recordsshared with the plan administrator? Who is responsible for sharing personnelinformation with the plan administrator andensuring this information is accurate?24

Employee EligibilityInternal Control TipsAvoiding the mistake Conduct annual self audit and compareoperation vs. plan terms Date of hireDate of birthHours of serviceEntry dateSalary deferral elections Review plan document25 Inspect payroll records Inspect W-2 forms

Fixing Employee Eligibility ErrorsFixing the mistake Qualified Non-Elective Contributions(QNEC) equal to Missed DeferralOpportunity 50% of employee’s missed deferral26

Loan Issues Loans in excess of the 50,000 maximum allowed Treatment of outstanding loan balances whenparticipant terminates employment and accountbalance is distributed Plans that limit number of loans to a participant andviolate the plan provisions by providing more than thelimit. Loan terms longer than 5 years – and loan found notto be for purchase of primary residence. Plans that allow loans – but the plan document doesnot allow loans (Can be corrected by retroactive amendment – SCP)27

QSAT - Internal Control Questions Who verifies the plan’s loan provisions? How does a participant request a loan fromthe plan? How are loan applications reviewed andapproved? Who reviews and approves requests forloans? Who determines a participants maximum loanamount?28 How is the loan delivered from the trust to theparticipant?

Loans: Internal Control TipsAvoiding the error Develop loan procedures and systemsto ensure Five year plan limits Reasonable interest rate Meet dollar limit of IRC 72(p) Repayments being made According to plan terms29 Repayments at least quarterly

Fixing Loan ErrorsFixing the error Self Correction (SCP) - NO Generally, participant cannot correct topreserve loan exemption Some exceptions exist under EPCRS See EPCRS Revenue Procedure 2013-1230

Nondiscrimination testing(ADP/ACP)401(k) testing and/or contribution errorsCauses include: Not properly identifying HighlyCompensated Employees Excluding those who elect not to defersalary from the test Not using the correct “compensation”definition31 Not using the testing method defined by theplan document (current or prior year)

QSAT - Internal Control Questions Who verifies that correct data was used to completethe annual testing? Who determines which participants are highlycompensated employees? Who verifies deferrals allocated to participants'accounts are correct? Who determines whether participants compensationfor deferral purposes are correct? How are matching and nonelective contributionamounts determined? Who ensures that each participant receives thecorrect matching and/or nonelective contribution?32

Nondiscrimination TestingInternal Control TipsAvoiding the mistake Establish/Amend plan to safe harbor plan Eliminate communication gaps Employer Plan administrator Verify the accuracy of: Classification of Employees (Highly and non-highlycompensated) Family aggregation33 Definition of compensation

Fixing Nondiscrimination TestingErrorsFixing the mistake Rerun tests if original data incorrect Two methods Qualified non-elective contributions One-to-One method Correction Within 12 months following plan year end – OK Otherwise, correct using EPCRS 2013-1234

IRC 402(g) LimitsFailure to limit elective deferrals to IRC402(g) limits This can be a costly error If not timely returned – will be taxed twice Plan document may have define limits belowthe maximum under 402(g) 35Note: IRS 402(g) limits for 2013 - 17,500

QSAT - Internal Control Questions Are procedures in place to ensure thatparticipants will not exceed the 402(g) limit? Are there checks and balances to alert theplan administrator if the limits of 402(g) (orplan limits) are exceeded so that correctiveaction can be taken timely?36

402(g) LimitInternal Control TipsAvoiding the mistake Sufficient payroll information Checks and balances Procedures to follow if contribution limits areexceeded During annual self audit compare Participant’s elective contributions §402(g) limit for the year Analyze employee records37 Age 50 catch-up

Fixing Excess Elective DeferralErrorsFixing the mistake Distribute excess deferral to employee Correct by April 15 following close of year Otherwise 10% additional tax (IRC 72(t)) If not timely, can use EPCRS to correct IRC 72(t) tax cannot be waived38

Timely Deposit of DeferralsFailure to timely deposit elective deferralscaused by: Misunderstandings about DOL rules regardingthe timing requirements For plans with less than 100 participants,there is a 7 business day safe harbor rule forcontributions39 If the plan contains specific language statingwhen the deposits will be made for exampleweekly with payroll, the terms of the planmust be followed