IRS audits are always a strong possibility when it comes to qualified plans such as solo 401k plans; therefore, it is important to understand both how to prepare and what causes an IRS audit.
In our experience IRS audits usually occur because the employer or the participant did something wrong.
Here are some of the issues the IRS Employee Plans examiners generally check out:
- Plan Termination: IRS interest can arise when a solo 41k plan is terminated in a final Form 5500-EZ is not filed.
- IRS Approved Solo 401k Plan Provider: The IRS will confirm the solo 401k plan document provider is an IRS approved plan document provider by requesting a copy of the plan IRS Determination Letter. An IRS determination letter expresses to the plan sponsor the Service’s opinion regarding the qualified status—the compliance—of the plan’s document. It is not an opinion or affirmation of the plan’s compliance in operation.
- Plan Documents: Plan sponsors mistakenly think the adoption of a 401k plan is a one-time event. Failing to adopt amendments in a timely manner can lead to automatic plan disqualification.
- Distributions and 401k Participant Loans. These are issues that come up the most in audits of both full-time employer and solo 401k plans. This is not surprising because specific rules apply to both type of transactions. (1) Plan participants who receive premature distributions or defaulting on plan loans fail to report the distributions and/or pay the 10% excise tax on their individual tax returns. (2) The participant take a distribution without meeting a triggering event, or the required documentation is not completed. (3) Both in-plan conversions and distributions of in-kind assets such as real estate are not properly valued or the value is understated.
- 401k Contribution Limits. Plans may exceed Section 415 limits when participants are participating in more than one 401k plan. Employees also may exceed the Section 402(g) limit when participants are participating in more than one plan that offers elective deferrals.
- Titling of Plan Assets: Failure to properly reflect all solo 401k plan assets in the name of the trust.
Preparing and Responding to IRS Investigations
- When asked to provide information, make sure to provide it in connection with your solo 401k plan and self-employed business not your personal accounts or assets. You should also consult with your solo 401k plan provider to make sure all disclosures are up to date.
- If the IRS asks for supporting documents, make sure to provide all the documents listed on the IRS examination notice.
- If IRS requires an interview, prepared for as if it were a trial or a deposition.