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ESOP Audits and Voluntary Compliance Programs

An NCEO Issue Brief

by Jude Anne Carluccio and Steven R. Lifson

This is one of our archived publications; specialized publications that have been removed from our main publication list and are not being updated, but are are still available for purchase, although sometimes only in digital form.

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An employee stock ownership plan (ESOP), like other qualified retirement plans, must meet various legal requirements. It may be audited by the Internal Revenue Service (IRS) or the U.S. Department of Labor (DOL) to ensure its compliance with the law. Whether or not it is audited, there are voluntary corrective programs that allow the company to correct certain errors without disqualifying the plan.

The first part of this publication is the article "When the DOL or IRS Comes Knocking: Dealing with Audits." It describes what is involved in an audit, how to handle one, how to avoid problems, and what types of voluntary corrective programs are available both inside and outside the context of an audit. (This publication addresses governmental compliance audits, not the periodic audits of financial statements required of certain ESOPs and other benefit plans.)

The second part of this publication is the article "Voluntary Programs Available to Correct Defects in Qualified Plans." It provides a detailed discussion of the voluntary corrective programs; their requirements, applicability, and submission procedures; and their specific application to ESOPs.

Publication Details

Format: PDF, 36 pages
Dimensions: 8.5 x 11 inches
Edition: 1st (August 2010)
Status: Available for electronic delivery

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When the DOL or IRS Comes Knocking: Dealing with Audits
Voluntary Programs Available to Correct Defects in Qualified Plans


From "When the DOL or IRS Comes Knocking: Dealing with Audits"

With an IRS audit, the ESOP sponsor is generally required to provide a large inventory of ESOP-related data to insure that the ESOP's documentation is current, the ESOP's annual administrative tests were performed at the proper time, the proper employees benefited from the operation of the ESOP, and the ESOP was otherwise properly administered. Documents often required to be produced for the IRS include the company's income tax returns and payroll records, and a large inventory of historical ESOP records. The IRS often analyzes employee accounts to ensure eligible employees are included and receiving proper annual contributions, forfeiture income allocations, and that allocations comply with retirement plan rules such as the Code Section 415 maximum contribution limits that apply to each ESOP participant. For larger employers, the IRS will initially test a random sampling of participants instead of reviewing all plan participant data. The IRS may also attempt to confirm the following ESOP plan terms are being properly administered to the extent applicable to your ESOP: eligibility, plan loans, hardship, diversification and termination distributions, participant account rebalancing, pre-distribution account investment in ESOP plan assets other than company stock, S corporation prohibited company stock allocations under Code Section 409(p), the anti-cutback rules that prohibit reduction or elimination of accrued benefits, and compliance with the ESOP's vesting schedule.

From "Voluntary Programs Available to Correct Defects in Qualified Plans"

The Revenue Procedure offers the following example of an insignificant operational failure: In 1991, Employer X established Plan A, a profit-sharing plan that satisfies the requirements of Code Section 401(a) in form. In 2003, the benefits of 50 of the 250 participants in Plan A were limited by reason of application of Code Section 415(c). However, when the IRS examined Plan A in 2006, it discovered that, during the 2003 limitation year, the annual additions allocated to the accounts of three of those employees exceeded the maximum limitations under Code Section 415(c). Employer X contributed $3,500,000 to the plan for the plan year, and the amount of the excesses totaled $4,550. Under these facts, because the number of participants affected by the failure relative to the total number of participants who could have been affected by the failure, and the monetary amount of the failure relative to the total employer contribution to the plan for the 2003 plan year, are insignificant, the Section 415(c) failure in Plan A that occurred in 2003 would be eligible for correction under the self-correction program. Even if the violation had occurred in three consecutive years and involved three different people for each year, the IRS concluded that the operational failure would be considered insignificant.