The Internal Revenue Service has recently announced that it will continue to commit substantial resources toward the audit of 403(b) plans.
Most educational institutions which sponsor these annuity plans view their responsibility as beginning and ending with collecting salary reduction contributions and forwarding them to their tax-sheltered annuity provider. This "hands off" approach works just fine - until the IRS takes a look at the plans and uncovers compliance problems. The IRS has clearly stated that the employer sponsoring a 403(b) plan is ultimately responsible for any failure to follow the rules and is, therefore, ultimately liable for any taxes or penalties for non-compliance.
The IRS issued audit guidelines to its agents in 1995 and has since been actively auditing 403(b) plans. The guidelines are helpful to employers, as well, because they provide a roadmap of the IRS' focus in its examinations, giving employers a "heads-up" - the ability to be especially careful of their operations and documentation in the IRS-targeted areas. While plan examinations are part of the IRS agenda on an ongoing basis, the fact that Section 403(b) plans are now the subject of increased audit attention means that schools must be even more vigilant than usual in their plan operation and administration.
Depending upon the types of problems the IRS discovers during audit, the resulting dollar exposure may include any or all of the following: (i) tax liability for the employee and employer, (ii) interest and/or penalties, and (iii) excise taxes. This exposure can be minimized or eliminated, however, by taking advantage of one of the IRS programs designed to assist employers in correcting plan problems without putting the plan at risk of losing its favorable tax qualified status.
Educational institutions may find it cost-effective to take advantage of the IRS Employer Compliance Resolution System, which permits a plan sponsor to correct plan violations without the tax/interest/penalty liability that would normally be incurred if the IRS found the problem under audit. While some corrections under the program involve disclosure to and an associated filing fee with the IRS, there is no-fee, no-disclosure self-correction for many common problems, so long as they are discovered and corrected by the employer within two years after the error occurred. As a result, many plan sponsors are taking a proactive approach to 403(b) compliance by conducting self-audits in an effort to uncover and cure problems before their plans become the subject of IRS review.
It is critical, if the employer chooses to self-correct, that the procedures outlined under the IRS compliance system be carefully followed so that the correction will be considered to have been appropriate and complete should the IRS later examine the plan. Therefore, employers should seek qualified legal counsel to assist them in developing the criteria for self-audit, identifying the method of correction for each specific problem that is identified during the audit, and determining the type and degree of documentation necessary to evidence that each correction was completed in an appropriate and timely manner.
For more detailed information concerning the IRS audit or correction program or to obtain guidance and assistance with respect to the structure and implementation of the self-audit process, please contact Donna Shopulski at (410) 332-8744 or Barry Berman at (410) 332-8809.
Saul Ewing's Educational Institutions Practice Group concentrates on the unique issues faced by the education community and represents a wide variety of educational institutions, both public and private. For more information about how the group can assist your organization, contact any of the following persons: Marshall B. Paul or Stephen J. Sfekas in Baltimore, (410) 332-8600; Frederick D. Strober in Philadelphia, (215) 972-1985; or William W. Warren, Jr. in Harrisburg (717) 238-7698.