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IRS checklist offers a convenient compliance self-checkup

January 4, 2016 / 4 min read

The IRS wants to nip possible 401(k) plan compliance lapses in the bud. Is your plan in compliance? Not sure? Then it’s time for an annual self-checkup. Here's our summary of some of the key issues to help guide you.

As a plan sponsor, you have a fiduciary responsibility to ensure that your qualified plan complies with all current employee benefits laws and regulations and operates within the plan’s current provisions. Do you know if your plan is current? If not, it’s time for an annual self-checkup.

Help from the IRS

The IRS wants to nip possible 401(k) plan compliance lapses in the bud. To help do this, it has issued a checklist of common plan administration oversights, some more egregious than others.

Beware, though: While the checklist summarizes major compliance issues, it is not meant to be used as a comprehensive guide. It provides general definitions, examples and methods for correcting possible errors. Because each plan is different, consult your benefits specialist or visit the IRS website ( for more information.

Say yes

The IRS 401(k) Plan Checklist contains yes/no questions. Let’s take a look at some (not all) of the issues the checklist covers. If you respond “no” to any of these questions, it’s time to take action.

  1. Have you updated your plan document within the last few years to reflect current law?
    If not, chances are it does not reflect recent legislative or regulatory changes. Each year, the IRS releases a publication containing a cumulative list of plan qualification requirements. New requirements are listed by Internal Revenue Code (IRC) section. For example, your plan must comply with the Supreme Court decision in U.S. v. Windsor regarding same-sex marriage.
  2. Are your plan’s operations based on the terms of your plan document?
    If you are not sure, conduct an independent review of your plan document provisions compared with their operation. This is especially true if you have amended your plan recently to make sure you’re operating the plan according to those amendments. If you find inconsistencies, use a reasonable correction method that places affected participants in the position they would be in if there were no operational plan defects. And remember, the plan sponsor generally is responsible for ensuring that the plan operates according to its terms even when employing third-party administrators or ERISA attorneys.
  3. Is your plan’s compensation definition for all deferrals and allocations used correctly?
    Many plans have more than one definition of compensation, depending on the purpose. For example, some definitions of compensation include items such as fringe benefits and bonuses. Review your definitions to be sure that you are applying the correct definition found in your plan document. And remember, for 2015, the IRS has capped the total compensation permitted for contribution purposes at $265,000.
  4. Have you identified all eligible employees and given them the opportunity to make an elective deferral?
    Depending on your plan document’s terms, not all employees will be immediately eligible to participate. Some plans defer eligibility based on age, service and hours worked. Provide your plan recordkeeper with a regularly updated W-2 employee roster to minimize the chances you have overlooked anyone.
  5. Have you deposited employee elective deferrals on a timely basis?
    You must deposit deferrals to the trust as soon as you can segregate them from employer assets. The Department of Labor (DOL) requires the employer to deposit deferrals as soon as reasonably possible, but no later than the 15th business day of the following month. Operationally, if you can make the deposits within one to three business days of the payroll date, you must do so. The DOL clearly states that the 15-business-day-rule is only guidance and cannot be relied on if you can make deposits sooner. For plans with fewer than 100 participants, the DOL mandates a seven-business-day safe harbor rule. Failure to make timely deposits may be deemed a prohibited transaction, resulting in possible plan disqualification by the IRS.
  6. Do participant loans satisfy your plan document’s requirements?
    One problem the IRS sometimes encounters is that plans have made loans to participants, even though the plan document does not provide for such loans. You must follow your plan’s loan provisions to avoid a prohibited transaction. Loans cannot exceed 1) the greater of $10,000 or half of the participant’s account balance, or 2) $50,000, whichever is lower. Amounts exceeding those limits are taxable to the participant. Failure to comply with the DOL regulations may result in a prohibited transaction.
  7. Did you make hardship distributions properly?
    “Hardship” is defined as an “immediate and heavy financial need” that cannot be met by other resources. According to the IRS, you make this eligibility determination based on “all relevant facts and circumstances.” The IRS also identifies several expense categories and circumstances that automatically satisfy the test. This includes medical expenses, costs related to the purchase of a principal residence or repairing damage to that home, family funeral expenses, postsecondary education tuition, room and board expenses for the next 12 months, and payments necessary to prevent eviction because of a mortgage foreclosure.

A financial need may be immediate and heavy even if it was reasonably foreseeable or voluntarily incurred by the employee. A hardship distribution may not exceed the amount of the employee’s need; however, the amount may include amounts necessary to pay any taxes or penalties resulting from the distribution. If you made hardship distributions without a plan provision, you must amend your plan document retroactively.

Avoiding and fixing mistakes

Answering “no” to any of these questions can have serious consequences for the plan. To avoid problems for your plan, make it routine to review your plan document. Use a calendar to note when to complete amendments. Keeping your plan up to date and operating according to its terms will help you avoid prohibited transactions and possible disqualification. If you find operational errors in your plan, use the IRS’s corrective program before the IRS discovers the error to avoid substantial penalties.

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