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Common errors in 401K Audits [Part 1]

Published by Summit Marketing Team on May 4, 2020 6:00:00 AM

The 401(k) Audit CPA Success Show: Episode 7


This is part one of a two part series on the types of errors that happen during 401k audits.

In this episode, Jamie Nau sits down with Kim Moore, the Summit CPA audit director, to talk about compensation and contribution errors. Even if you don’t need an audit, this episode will help you to be aware of anything you need to know if you provide a 401k plan for your employees.

Jamie Nau: Welcome everybody, to today's podcast. We're going to talk through a very important issue that I think everybody will be interested in. We're going to talk about the type of errors that happened during 401(k) audits, and what you can keep an eye out for. So this is actually a two-part podcast. So we're going to do part one today, which will be just about the compensation and contribution area. Next time we'll do another podcast on all the other errors that come up during an audit. So again, I'm joined by our Director of Auditing here, Kim. So, Kim, welcome to the podcast and I am excited talk about this.

Kim Moore: Thank you. Yeah, great to be here Jamie, glad to talk about this very important topic, as you mentioned.

Jamie Nau: Yeah, I think everybody that goes into an audit and of course, they expect the best. But I think oftentimes the question is, what can go wrong, and what will go wrong? And so I think this is a really important topic. And hopefully we'll have people listening and understanding the audit process a little better through this through this topic, right?

Kim Moore: Right, and we'll talk a little bit about things even if you don't need an audit. Things that you can be looking out for if you're administering your plan, because all these apply in general, whether you need an audit or you only have a few people in your plan, it all still applies.

Jamie Nau: So let’s get started, again, we're talking about just compensation or contribution type errors right now. So I'll let you get started.

Kim Moore: Sure, let's start with compensation. As you are withholding deferrals from the people that want to participate in the plan that are your employees, the place that you often have to start at is compensation, because usually employees will direct you to withhold a certain percentage of their compensation: something like 3 percent or 5 percent. So obviously 5 percent of a number is a calculation, but the beginning compensation number matters. And, you know, we get a lot of people there like, why do you even need to talk about that? They get paid a certain amount, how can that be a problem? But it actually can often be a problem because there are different components that make up what a person will get paid, or what you could define as compensation. So you have to consider things like is the person hourly? So they are going to be paid by the hour, or maybe they’re salaried, which then they will get paid the same amount every pay period, or maybe they get paid once a month versus maybe other people get paid every two weeks or every week. So all of that factors into compensation. You also have to consider things like bonuses, and commissions. Legally, that's compensation to the individual, and certainly from a tax standpoint, that would be considered compensation, but it depends on the plan. It isn't always considered compensation for the plan. Quite often we see this as an area of confusion, and sometimes it's just an administrative error that the person setting up the payroll coding doesn't consider whether a bonus should be considered as compensation for the 401(k) plan. They'll usually think about it from a tax standpoint, but they don't really stop and think, wait a minute, how should this be handled for our 401(k) plan? So when you get to things like that, first thing I would say is go check your plan document. What do the plan documents say, because most adoption agreements, or full plan documents, whichever option you have, will specify the definition of compensation and it will allow you to exclude certain things. So quite often we see bonuses plans will ignore this in their plan documents, or there'll be nothing checked, which means that bonuses are included in compensation unless you specifically exclude them. Or you may have already thought about this and said, nope, we always want to exclude bonuses, and we do not want to have to defer on bonuses. We want the employees be able to keep the whole amount of their bonus. Or you may have an option that you say, we're going to let the employees choose. So they can make a special election. So they may say, I want 5 percent of my pay withheld on my regular paycheck, but whenever I get a bonus I'm going to come to you and say, no, don't withhold anything. Or maybe on a bonus, I want you to withhold 50 percent, so you may allow your employees to do a special election for bonus payments. Same thing could happen for commissions, but we see it most often with bonus payments. So I would say, first of all, if you're a plan sponsor, and you're working in payroll you want to check on this. Go talk to your payroll staff. Find out what kinds of compensation you have, what types of specific coding you do in your payroll system, because that's another area that can crop up. Maybe your intention was to follow your plan document, but it wasn't handled appropriately in terms of the payroll coding, because that's going to dictate what happens on an individual paycheck. So go talk to your payroll staff, find out things like holiday pay, bereavement pay. You may give a special holiday check of twenty five dollars or something. Find out what different kinds of pay you have. Ask how is it supposed to be handled per your adoption agreement, and then what is the coding set up in your payroll system supposed to be because all of those things need to match. Then if you do have options, so you're allowing your participants, or your employees to choose on a bonus, say a bonus, separate bonus run, then work with your payroll staff so that they understand that. The other thing we like to see is that they're taking direction on optional decisions, only via documentation. It shouldn't be that the payroll processor runs into an employee in the hall and they say, oh, by the way, I just saw him get bonus, but I don’t want to get that whole bonus. Don't take out any 401(k). Then the payroll person goes back, writes on a sticky note, changes payroll coding, and then throws the sticky note away, and then later on somebody comes back, whether that's an auditor, or a regulator, or could be the employee themselves and says, hey, you know, I never told you not to withhold, or I told you, you know, leave the withholding, what happened here? Those decisions should only be based off of documentation that you have that you can keep either with the payroll run, or in better cases with the employee file so there is documentation.

Jamie Nau: So I know you do a lot of 401(k) plans. So of those three that you mentioned either withhold, don't withhold or it's optional, which is the most common that you've seen?

Kim Moore: The most common that we see, and people don't even think about this, and so when you kind of look at the adoption agreement, you'll see a whole bunch of lines and it'll say bonus commission and it'll have all these other different payment types which people can check to either omit, or make them optional, and they just ignore the whole thing. So when we come in and we say hey, you know, we've had the individual, you know, Susie and she had a bonus and she's participating in 5 percent, but we didn't see any withholding on the bonus. Oh well, Susie just told us not to, and so we thought that was okay. Now you know that is not technically correct. If you do not allow exceptions, then don't allow exceptions. If you want to allow that to occur, then you need to change plan document. So the most important thing is that you understand what your plan document says, and you follow the plan document. If you don't want it to work the way your plan document says, then you need to change plan document, or you need to change your process. Everything needs to be aligned so that you're following what the plan document says, that's the most important thing.

Jamie Nau: I think it's really important for people listening to this podcasts that might not quite have a 401(k) plan, but they're thinking about implementing one. So I think this is the type of stuff you should think about when implementing your 401(k) plan. Make sure that you think through how you want to handle these type of compensation. So I think that an important part. So the follow up question, I asked this on each of these, because I think one of the things that I remember back in my 401(k) days is anytime you hear the word error, you're like, oh, no, what am I going to do? What's the penalty? So I wanted to make sure that's understood here. So let's say that I'm 401(k) provider, and I am supposed to be withholding on bonuses, and I decide not to for two employees. What would my penalty be?

Kim Moore: Yeah, it's situational, but technically if you have not withheld and you were supposed to. then you need to go back and do a either a voluntary correction or just correct it on your own. But we would suggest voluntary correction. There are Department of Labor and IRS voluntary correction programs that you can follow and we'll be talking about those in another podcast. But follow the instructions. The first thing I would do if you figure out that this has happened, or any problems like this,  is to go to your third party administrator, or your service provider, whoever you work with that holds the funds and does the administration for your plan, and explain to them what happened. Go into the specifics and say, I've just want to let you know, it was just an error, it was not intentional. These errors, and the both the Department of Labor and IRS, they understand things happen. So that's why they've set up the volunteer correction program. So talk to them, find out what the specifics are for your situation, what you need to do, and then go down the voluntary correction amount. But more than likely, you are going to have to fund as a company whatever you would have withheld, or at least a portion of what you would have withheld for that bonus payment, or other missed compensation. Then you also have to consider that you may have a company match on that, or some other type of employer contribution, you will also have to fund that. You've missed that probably as well. So you're going to have to go back and figure out what are those totals you're going to have to fund that. The provider will have to put that into their respective participant accounts, and then there's a process you go through, depending on what the error is, which volunteer correction program you go through, there's different procedures relative to that. So that's the best thing to do. Talk to them, tell them that you heard about programs, you'd like to go that route. We find that is usually the easiest and the least expensive way also. So that's what I would recommend. One other thing which is going to lead us into our next topic is that if you do find out that you missed something, and that there should have been something withheld, or an employer match, or something like that, and you missed it, the other thing that's going to happen is that those are probably going to be late contributions. Which leads us to that topic. So why don't I just move into that?

Jamie Nau: Yeah, why don't you just  jump into that.

Kim Moore: So this is, I will tell you we see this on quite a number of audits, and talking to other colleagues at other audit firms that are doing these types of audits. It is one of the most common errors that you see in these type of plan audits. I will also tell you, for the Department of Labor, it's a big hot button issue with them and they are really cracking down as they're doing audits and investigations, as they're reviewing forms 5500 submissions, because this is something that will get reported on the 5500 form that you file annually. Also that form becomes public knowledge also, so keep all of that in the back of your mind. You know, if you think about your plan, you're running payroll on a periodic basis, whatever your payroll schedule is for your company, you probably have withholdings on each of those payrolls. You submit those funds to your provider, and then they invest those funds as the participant has directed that they invest them. Whether that's one fund or twenty funds, however, they've split it, and you think, well, that I've done that. I've withheld amounts, I've turned them all over. I've funded whatever the employer contributions is, and we also have to think about loan repayments as part of this because that factors into it as well. But I've done all that. It's all accurate. I've funded it. I don't know why they're talking about like contributions? Why would that be an issue? Well, the reason it's an issue is the Department of Labor has issued guidelines that say that those funds need to be deposited as soon as administratively feasible. Which is a bunch of wording to most people don't mean anything. Like, well can't you just tell me 5 days, 10 days, 50 days, give me a number and I can work with that. They won't do that because they understand that again, it's situational, every company has a different payroll schedule. They may run one payroll. They may run 20 payrolls and they're on different timing, and so it would take them a lot longer to separate out all the different components of payroll, because if you think about running a payroll, you've got the original compensation amount. You got to go through all the calculations, figure all that out, then you're going to have all of your withholdings. So you've got federal tax, state tax, local tax, you know, all the insurance type things, anything else the employee may ask you to withhold. You've got garnishments, and then you can have 401(k) withholdings, loan repayments. So there's a whole lot that goes into any payroll run department. The Department of Labor understands that, and they don't want to issue a guideline that's not going to work for somebody because they're working with all different sized companies, all different perplexities. So instead, they give us this guideline that says, administratively feasible. But what that really means is that as you're running your payroll, you got to remember it's on a regular basis. How long does it take you once you've actually calculated the compensation amount for each individual, you've calculated those withdrawals or withhold amounts? How long does all of that take, and then how long does it take for you to separate out the totals? Because you're going to separate out totals out of the payroll and be sending them out to the federal government,  and sending them out to various state governments, et cetera, and then you're going to have amounts that you're going to send you 401(k) provider. How long does that take? If on a regular basis that's one day, that's your timeframe. You should be doing every payroll, submitting within 1 day. If that's 5 days on a regular basis, then that's your timeframe. What's really important here is that you sit down with your payroll staff and figure out all of what I just talked about. How long does it take to do all those various components on a regular basis? Not when you're under a crunch time. Just on a regular basis, given your workload, how long does that take? It's not as important if it’s 1 day versus 5 days versus 10 days. It's more important to be consistent. So if you say given our workload, given the staff that we have, given what we expect them to complete, given all their other tasks that they have to do, our timing is 5 days, that's fine. The DOL is not generally going to come in and say, nope, shouldn't be 5 days, should be 3 days. But what they will do is schedule out your timing, and if they were to do an investigation, or just an audit of you as a company for your 401(k) plan, they would take three years’ worth of payrolls. They would schedule them out. They would see how long did it take from the pay date. So the date that the employee would have been paid. So that's the date they would have received the funds had it not been withheld, to the date it went into their account at the plan. So how long was that? And then they are going to schedule it out for three years, and they're going to look at the timeliness, and if they say, yep, you know, generally it was 5 days, but here's 1 they did it in 1 day, that shows me they could have done it in a day. So every other thing over 1 day is late. Now, what we see, either one option that we sell a lot is, people don't understand this. They think they can do it whenever they get around to it. So as I'm just running my payroll and it’s 5 o’clock and it’s time for me to go home, the next thing I'm supposed to do is fund the 401(K), I'll do it the next day. So now that's taking a day longer, or it goes over a weekend. So there's a couple more days. You know, they don't understand, or maybe they think I can fund whenever I want. So they'll fund two or three paydays together, because I just got to the point that, okay, enough is built up maybe in my GL account of those withholdings I need to remit, so now I'm going to remit. That's a problem. You know, that's not understanding the guidelines, that's not following the rules. Then in those cases, at least two of those payments, if not all of them, would be deemed late. So, number one, if you don't understand these rules, stop and understand your payroll. You need to fund them payday by payday. So we see that a lot, people don't understand that they're funding them just as they get around to it, or as they feel like doing it, they think that's okay, it's not. You don't want to do that. The other thing that we see is that they may understand the rules, and they have set up a time frame, and if you schedule out all the payments for a year, you'll see them pretty consistently: 5 days, 5 days, maybe 4 days here, 5 days, 5 days, and then maybe the person that does payroll will be on vacation and their backup comes in. You see it go one of two directions. It may take them longer because they don't do it on a regular basis. They want to make sure its correct. So maybe they take 10 days to do it. Now, that's outside the timeframe. The opposite thing we tend to see though, is that the person filling in, they know timing's important so they're really on the ball, and want to make sure they do this ahead of anything else. So we see the timing for that is one. So now you have a problem because you've shown you can do it in a day, even though on a regular basis it’s the 5 days. So the bottom line with all of this is to sit down with your payroll staff. Figure out what tasks they do as a part of payroll. What's a reasonable date? And I tell our people, set it reasonably. Don't say, well, it's probably 5 days, but I could do it in 3. I'm going to make it 3. No. Make it 5 and be consistent. Do it in the 5 days on a regular basis. You know, that's not to say if it's 5 all the time and you miss one, and it's 6 days that it’s going to be that big of a deal, but just try to make them as consistent as possible.

Jamie Nau: Yeah, this is interesting because I haven't done a 401(k) audit in probably 10 years, but I remember this being the number one issue when I used to do 401(k) audits back in the day. I think like you said, the biggest thing was the amount of people we had to sit into a conference room and just explain this rule. Like how many people do not understand that it's like you said, it's establishing when is a reasonable time frame to do it? And doing that consistently, because like you said, it's pretty easy to audit. It's pretty easy to pull out the payroll dates, it’s easy to pull out the dates the contributions happen, and say, well, look, now you consistently had 5 days, but there is a couple 12 days in here, what are we going to do about it? So it's a very easy thing to audit, and it's a very easy thing to make a mistakes on. Again, if I was timed on everything I did in my job it would be crazy with the amount of discrepancies there were and how often things happened and didn't happen. So that is one area you just have to have great controls around, you have to have great focus around. You really have to understand the role. So I think for people listening to this podcast, hopefully that is what they are getting out of it, is that this is a very complex role. Once you understand more, and I think Kim did a great job explaining it, but it's very important to follow it. 

Kim Moore: And to go to our earlier conversation about what happens if you do have late contributions. So let's say you did the 5 days, and then you had a couple that were the 12 days those were deemed late, again there's a specific voluntary correction program that in most cases that the folks will use. The Department of Labor has a really nice online tool for this calculation that you have to do. You have to go back and figure out from the date that it should have been deposited, to the date that it actually was, obviously it’s a number of days, the online calculator will then calculate what they're calling lost earnings. From the Department of Labor standpoint, those contributions should have been funded into the participant account, and then the market would move up or down just depending on whatever market, and then those folks would have gotten the funding or, you know, in today’s case, would have lost money out of their account. But they're assuming that is probably going to go up. Bottom line is you took away the opportunity for that participant to manage that money in their account because they can change contributions investment selections on a regular basis. So the participant could see the market moving, they might change around their investment selection to best take advantage of what's happening in the market, and you didn't allow them to do that because those funds weren't in there. They weren't invested. So they will make you calculate lost earnings. The company has to fund that, and then they have to pay the administration costs for your third party administrator to work through all that. And stop and think if you missed two paydays, that doesn't sound like a big deal, but you have to do it on a participant by participant basis. So what if you have two, three hundred participants? You're going to have to pay your administrator to calculate every one of those lost earnings for each participant for each payday. So the last earnings in today's world don't end up usually being a lot of money, but the administrative nightmare to fix this. It takes a lot of your payroll staff or your HR staff, whoever's managing the plan, it takes a lot of their time that they don't really have, and it will cost you money to get it fixed through the administration process. It's also a red flag to the DOL as well. So it's just something that is fairly easy to avoid if you have good controls, good processes. You check on it regularly. It’s fairly easy not to have a problem, but once you get into the problem, and now you've got to fix it, it's just a tremendous amount of work.

Jamie Nau: It's just important to be educated. I think that's the key. Again if I am listening to this podcast I'm sure anyone who is listening to a 401(k) podcast is probably educated and really understand it. I think it's so important that you're listening to this and getting that part of it. So I think you have a couple more items to talk through, but before we get to those, I want to throw our email address out there. So our email address is: audit@summitcpa.net.  We really want to make this podcast for the listeners, so if you have any questions, or you want to be a guest on the show it would be really awesome, so feel free to email us. A lot of times we tailor these topics based on those e-mails we're getting. So please, please e-mail us any questions you have. So I'll throw it back over to Kim for the last couple of errors you have on this list here.

Kim Moore: Sure, and yeah, please do let us know any topics that you'd really like us to cover because we want to make this as useful as possible. And will all of the audits that we do, I'm sure we can probably answer your question. We have probably seen something through our audits that you might have questions about. So the last couple of things I wanted to just throw out there, these are kind of small things, but things that we do see, it makes the whole process so much easier if you make sure you align your payroll schedule with whatever your service provider, whatever you've told them to expect. So if you've told them every two weeks on a Friday, make sure you stick to that. That will help make sure that you don't have problems.  Maybe loan repayments that get missed it can lead to late contributions, so make sure you stick to that schedule. Make sure you communicate the schedule on any changes you make. Let your service provider know. We also see sometimes people will run items outside of the payroll system. So somebody maybe needs a payday advance, or something, or there's an error in the running of the payroll, in some of the things that you're putting in, we see this a lot with hourly folks or again, those commission bonus payments. Maybe you calculated it wrong. You need to make a correction, you just say hey, it'll be easier to just cut a check. Not going to go through payroll, just cut a check and get him the money. That's okay if you want to do it that way just to hurry up and get out the funds, but stop and think when you do that, your payroll system is set up to calculate all the taxes, calculated garnishments, and also to calculate your own deductions and employer match. So by doing it outside the payroll system, you've just given yourself a lot of extra work. So we recommend people don't do that, or do it as infrequently as possible. We also recommend that people reconcile their contributions either as part of the 401(k) process, part of payroll process, or part of the bank reconciliation process. But on regular basis just go in and make sure that you're probably doing journal entries into your accounting system that whatever you're using for your company, so make sure that's matching up with the amounts that you're actually funding. Make sure nothing is showing up in your bank account reconciliation indicating that maybe there was an error, maybe one of those payments got rejected, or didn't get fully taken in by your service provider. If there's any kind of issues that show up in your bank account reconciliation that looks like their payroll related, pay particular attention to those because that could indicate there's a problem going on somewhere along line, it could it could impact 401(k) plan. Last thing I wanted to mention is that you're highly compensated folks will hit a maximum during the year. Every year the IRS updates their maximums that they allow for contributions, catch up contributions, etc. So make sure you look at those at the beginning of the year and you let your employees know, and also talk with those highly compensated folks. If they spread out their contributions throughout the year, that may allow them to maximize the employer match, or employer contribution, where if they don't do that, they're contributing more upfront than they may lose out on some employer match. So not that that's an error or a compliance issue, but just something to help out your employees. Just something we like to point out.

Jamie Nau: No, that's definitely important. I think that's the key, and we've talked about this several times, but you're running for 401(k) play as a benefit to your employees. So you want to make sure you're doing everything right to properly benefit your employees.

Kim Moore: Right. So I think that wraps up our conversation today on compensation and contribution issues.

Jamie Nau: I agree, I definitely learned quite a bit during this today. It's nice to have it outlined like this. I know oftentimes people's biggest concern is they don't want to get audited because they're afraid about theirs errors they have. So just having the them out there really kind of takes the sheet off the issues, and you really know what's going on. So I definitely appreciate all the time you took for this Kim. Next month we will talk though part two and we'll go into some additional steps. Thanks for listening.

 

Common Errors in 401K Audits [Part 1]


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