IRS Audit Risk Areas for Nonprofit Retirement Plan Sponsors
During AAFCPAs’ recent Nonprofit Educational Seminar (April 2023), Employee Benefit Plan Practice leaders Davide Villani, CPA, CGMA and Shawn P. Huxley, CPA, MSA updated 400+ CFO and Executive Director attendees on the IRS’ 2023 strategic focus areas for small exempt organizations that sponsor retirement plans. AAFCPAs audits 180+ plans annually including 401(k) and 403(b) plans, putting us in a unique position to assist and advise with benefit plan oversight.
The full session was recorded and may be viewed as a webcast at your convenience. >>
Each year, the IRS publishes a list of focus areas to target and data mine. This year, they honed-in on the following key areas within small exempt organizations that sponsor retirement plans.
Are Investments Properly Administered?
The IRS would like to see that plan investments are properly administered. They will be looking into party-in-interest transactions in the plan trust and ensuring participant loans have not violated Internal Revenue Code (IRC) Section 72(p). Within those areas, their primary concern will be with fiduciary rules, or ensuring you are doing everything required for a retirement plan regardless of the plan or organization size.
The IRS will also be looking into participant loans. For instance, if an employee is terminated or goes on leave and no longer receives a paycheck from your organization, you should monitor whether they continue with loan repayment. If their loan goes into default, you will need to decide if that employee is ever going to repay the loan. This may result in a deemed distribution. The employee will likely then receive a form from the IRS and will be held responsible for taxes just as they would with standard fund distribution. That employee may also be held responsible for early distribution penalties depending on their age.
One-participant plans can be common within very small organizations. The IRS is looking to see if plan sponsors contributed to the retirement plan and if they are meeting all qualifications. If not, plan sponsors might face excise tax on excess contributions for failure to comply. Likewise, if you have a small but growing organization and new employees are now eligible for your plan, the IRS will need to ensure employees are not being excluded from it improperly.
Worker classification is another high-risk area for organizations, particularly nonprofits. Nonprofits disclose 1099s on Form 990 and list their top five independent contractors. If a worker is misclassified as an independent contractor versus an employee, there could be significant disadvantages to that worker and significant advantages to that organization. Specifically, organizations may enjoy a reduced tax burden by averting the worker’s FICA or other employer-side liabilities. Meanwhile, workers receiving a 1099 absorb that burden via self-employment tax. Independent contractors are usually ineligible for employee benefits, such as healthcare, retirement, and employer matching.
To determine proper worker classification, ask yourself:
- Does your organization control or have the right to control what the worker does and how the worker does the job?
- Does your organization direct or control the financial and business aspects of the worker’s job?
- Are the business aspects of the worker’s job controlled by you, the payer?
- How is the worker paid?
- How are expenses reimbursed?
- Who provides the tools and supplies related to the job being performed?
- Are written contracts in place or employee-type benefits available for the worker, such as a pension plan, an insurance plan, or vacation pay?
- Will the relationship continue or is it a one-time situation?
- Is the work being performed by that worker a key aspect of your organization?
Required Minimum Distributions
The IRS also plans to focus on Required Minimum Distributions, or RMDs, in large defined benefit plans, which must begin on April 1st following the calendar year an employee turns 70½. Organizations that fail to make those distributions could trigger plan disqualification and a 50 percent excise tax on amounts not distributed.
An Opportunity to Self-Correct
The IRS does provide options to fix or correct errors through its Voluntary Correction Program, or VCP. This program lets plan sponsors pay a fee at any time prior to examination to gain IRS approval to self-correct plan failures. Use of the VCP may limit exposure to fines, penalties, or excise tax, as well. But this program is only available to those who have not received a notification from the IRS or the Department of Labor regarding potential noncompliance.
The IRS and the DOL are looking to work with nonprofits to help resolve issues. If issues arise that you have not yet encountered in the past, please contact us. We too are here to help.
If you have questions, please contact Davide Villani, CPA, CGMA at firstname.lastname@example.org or 774.512.4012 or Shawn P. Huxley, CPA, MSA at email@example.com or 774.512.9075—or your AAFCPAs partner.