Posted by Maria T. Hurd, CPA
Yes, the Audit Extends to Excluded 403(b) Employees: Testing Compliance with Universal Availability
It’s never a good sign when an employer sponsoring a 403(b) plan says: “You don’t need to see backup for employees who are excluded from the plan.” Ohh! But we do! Not often, but sometimes, clients try to “school” us on what documents we can request to complete a 403(b) financial statement audit. In these cases, they quickly learn that resistance is futile, because improper exclusion is the biggest risk area for 403(b) plan.
For details on the Universal Availability Rules, please refer to our recent blog – Universal Availability Rules.
Universal Availability violations often result in material adjustments to the financial statements due to size of the corrective contributions that must be funded by the employer when eligible employees are improperly excluded from participation. For that reason, auditors do need to see census and payroll data for all employees who have been excluded from plan participation, as well as annual notices of the opportunity to defer for those who are eligible but not contributing.
Unfortunately, we are not able to accommodate client requests to eliminate audit steps to verify proper compliance with one of the signature features of a 403(b) plan: Universal Availability. The audit cannot be completed until we can estimate the effect of the improperly excluded employees on the financial statements and whether value of Universal Availability violations result in a material deficiency.
Not surprisingly, our list of audit steps is remarkably similar to the published Internal Revenue Manual for IRS examiners 4.72.13 IRC 403(b) Plans | Internal Revenue Service (irs.gov).
To validate the relevance of our audit steps, I have listed below all the Universal Availability audit procedures we perform, which, by the way, are also included in examination guidelines in the Internal Revenue Manual:
- Review the plan document for the eligibility requirements for IRC 403(b) elective deferrals.
- Determine that the plan document only excludes employees listed in 26 CFR 1.403(b)-5(b)(4):
- Non-resident aliens with no U.S. source income
- Employees who normally work less than 20 hours per week (or a lower number of hours per week as the plan may require)
- Students performing certain services (as described in IRC 3121(b)(10)). According to Mayo Foundation for Medical Education and Research v. United States, 562 U.S. 44 (U.S. 2011), medical residents aren’t considered to be students under IRC 3121(b)(10)
- Employees whose maximum elective deferrals under the plan would be no greater than $200
- Employees eligible to participate and make elective deferrals under an eligible governmental 457 plan, a qualified CODA (i.e., an IRC 401(k) plan) or another IRC 403(b) plan of the employer
- If the plan has permitted any excludable employee to make elective deferrals, then no other employees may be excluded under that provision, (26 CFR 1.403(b)-5(b)(4)(i)).
- Verify that employees are provided meaningful information about the plan by reviewing resources such as:
- The plan sponsor’s employee benefits package/handbook
- Emails the plan sponsor made available about the plan operation
- The plan sponsor’s internet site
- The SPD, if available
- Required annual notices giving effective opportunity. (26 CFR 1.403(b)-5(b)(2)).
- Using payroll codes or other employment classification records determine whether employees of a specific job classification are improperly excluded from making elective deferrals.
- If the plan excludes employees who work less than 20 hours per week, or 1,000 hours per year, analyze and verify how the employer monitors hours worked. Verify that once eligible, the employer properly notifies the employee of eligibility and permits entry into the plan within a reasonable time frame but by the first day of the next plan year and all subsequent years. See Notice 2018-95 on transition relief from the “once-in-always-in” exclusion condition.
- Review excluded employees to determine if they were properly excluded from making elective deferrals. After the first day of the first taxable year that begins after December 31, 2009, the following employees can’t be excluded from participating in an IRC 403(b) plan:
- Employees who used a one-time election to participate in a governmental plan that isn’t an IRC 403(b) plan.
- Visiting professors for up to one year.
- Employees affiliated with a religious order who take a vow of poverty.
- Union employees who were excluded must be able to participate in the IRC 403(b) plan by January 1, 2009, or the earlier of the date on which the collective bargaining agreement terminates or July 26, 2010.
A governmental plan may have until January 1, 2011, before it must start including the employees listed above.
As evidenced by the thorough audit steps listed above, verification of the proper application of the Universal Availability rules is perhaps the most important audit step for a 403(b) plan. Improper exclusion is the top finding in audits performed by the IRS and by Independent Qualified Public Accountants (IQPAs) and it is a step we cannot eliminate upon request. Compliance with document production requests is a better choice than resisting them.