There has been much press coverage on how the Inflation Reduction Act provides billions in funding for IRS enforcement. Some stories say that the IRS will be hiring 87,000 new agents to audit taxpayers over the next 10 years. This is disputed but there is no doubt that there is $80 billion in funding to the IRS under the Act. Of this over $46 million is allocated to enforcement. However, enforcement means a number of things other than just hiring agents to audit, it can also include hiring customer service agents, IT personnel and upgrading technology. Secretary Treasury Yellen has stated that taxpayers making less than $400,000 a year should not see an increase in the rate of auditing activity.
This debate centers generally around individual taxpayers. However, since 2010 the IRS has seen its budget cut by 20%. The number of employees has decreased by 16,000 employees and its enforcement agents decreased by 30%. See, What The New $80 Billion for the IRS Really Means for Your Taxes. Therefore, the agency needs the funding. However, businesses and employers should be aware of the upcoming increase in enforcement and ensure they can withstand an audit. In particular benefits plans should perform self-audits to see if there are document or operational failures that might be self-corrected or corrected under EPCRS or the Voluntary Closing Agreement program. Likewise, there is significant reason to believe that there may be an enforcement initiative for nonqualified deferred compensation plans. These are addressed respectively below.
Over the past few years there has been a lot of legislation affecting plans due to the Covid-19 Pandemic. On top of that, pre-approved plans were required to be restated for changes in the law to a certain point. The way qualified plans work is that the IRS gives employers time after changes in the law are effective to adopt the written provisions into the plan document. However, the plan must be operated in accordance with the new provisions upon the effective date regardless if the plan has been amended or not. Therefore, there is ample opportunity for disconnects causing failures. Below is a list of some items that should be reviewed.
- Ensure plans have been timely restated. For example, preapproved defined contribution plans were required to be restated by July 31, 2022.
- Ensure plans are properly operated. For example, if the employer has adopted increased loan amounts for Covid-19 and/or distributions for Covid-19 hardships that the plan is properly operating these provisions with proper employee notices, etc.
- Ensure that any interim amendments required to be adopted are done so by their effective date. While the deadline for adopting amendments for many changes has been extended not all have been. See Notice 2022-23 Does Not Extend Deadline For Adopting Amendments to Plans for All CARES Act Provisions: Loan and In-Service Withdrawal Provisions Excluded.
- Ensure that elective deferrals are timely deposited.
- Ensure Forms 5500 are timely filed
- Ensure that Required Minimum Distributions (RMDs) are being properly distributed by the applicable age 70 1/2 or 72. Document if the plan suspended RMDs in 2020 due to Covid-19.
- Review the basic plan operation to ensure it is operating smoothly, participants are entering timely, getting employer contributions timely, etc.
These are but some of the issues that should be considered in a self-audit to ensure the plan is ready for an audit.
Nonqualified Deferred Compensation (NQDC) Plans.
Last year the IRS revised its Nonqualified Deferred Compensation Audit Technique Guide effective June 1, 2021. This document explains to auditing agents what issues they should be looking for when auditing nonqualified plans. The guidelines breakdown the issues to the following three.
- When are deferred amounts includible in employee’s gross income?
- When are deferred amounts deductible by the employer?
- When are deferred amounts considered for employment tax purposes?
The new guidelines have a more detailed emphasis on Code section 409A and how it significantly changed the rules governing NQDC Plans including the fact that plans must be in writing. The guidelines list of series of questions agents should ask to discover the possible plans of the employer. For example:
Does the employer have any plans, agreements, or arrangements for employees that supplement or replace lost or restricted qualified retirement benefits?;
Do employees have individual employment agreements?;
Do employees have any salary or bonus deferral agreements?;
Does the employer have any insurance policy or annuity plan designed to provide retirement or severance benefits for executives?;
Are there any board of director’s minutes or compensation committee resolutions involving executive compensation?; and
Is there any other written communication between the employer and employees that sets forth “benefits”, “perks”, “savings, “severance plans”, or “retirement arrangements”
Employers would be prudent to self-audit their records to identify all possible arrangements and confirm their compliance with Code section 409A and other principles of law such as the Constructive Receipt and Economic Benefit doctrines. Also as a result of the Pandemic many Executives may have renegotiated their employment arrangements or even taken severance. These arrangements should be confirmed to be compliant with Code section 409A, as well.
The fact that the IRS updated its Audit Technique Guide could be a signal that it plans more examination activity in this area.
The additional funding for enforcement to the IRS under the Inflation Reduction Act will no doubt lead to more examinations. The benefits area is ripe for increased enforcement activity. Employers should be proactive to ensure their plans and operations are in good shape not only because they might be audited by the IRS but because it is the prudent thing to do. A compliance failure may not only affect the tax effects of a plan but can also lead to a claim by a participant. Additionally, while the pandemic is not over, businesses have learned how to deal with it and it should no longer be an excuse for neglecting plans.
We are always available to help review plans for compliance.