Is There A Target On That Plan’s Back?

June 2, 2021 | posted in: Accountants | by

The IRS Announces New Audit Focus on Solo 401(K) Plans

If you have clients whose businesses sponsor a solo 401(k) plan, it may be in the crosshairs of the Internal Revenue Service. The Service’s TE/GE (Tax Exempt and Government Entities) division has identified one-participant 401(k) plans as among its current audit initiatives for fiscal year 2021. In its web posting announcing the initiative, TE/GE states: “[t]he focus of this strategy is to review one-participant 401(k) plans to determine if there are operational or qualification failures, income and excise tax adjustments, or plan document violations.” Read more from the IRS here.
Some common pitfalls to be aware of may include:

  • Employees Eligible for Benefits: Solo 401(k) plans lose their solo status when the business sponsoring them acquires employees, and the employees work the necessary number of hours required for eligibility under the plan. This will trigger application of minimum coverage, nondiscrimination, and top heavy rules, as well as ERISA reporting and disclosure requirements.
  • Controlled Group/Affiliated Service Group: This issue is related to the first in that, if the business that sponsors the solo 401(k) plan is under common control with a business that has common law employees, the answer to the question “who is the employer” — and who has employees — will be both businesses under common control, not just the business that sponsors the solo 401(k). 
  • Form 5500 Filing Duties: Solo 401(k) plans are exempt from filing Form 5500-EZ so long as plan assets remain under $250,000. If plan assets exceed this threshold and a Form 5500-EZ is not filed, significant penalties could be assessed by IRS and by Department of Labor. 
  • Exceeding Contribution and Deduction Limits: The contribution and deduction limits that apply to group 401(k) plans also apply to a solo 401(k) plan. Employee salary deferrals cannot exceed the applicable dollar limit under Internal Revenue Code (“Code”) § 402(g) ($19,500 in 2021, plus $6,500 for those 50 and older). 
  • Plan Document Errors: Plan documents need to be updated periodically to comply with the law, meeting the adoption deadlines for preapproved plan remedial amendment cycles (the next one falls on July 31, 2022). Voluntary plan amendments also have to be properly documented and timely adopted. 
Now is the time to review your clients’ plan designs and operations to determine if any of these might be issues for them (and therefore for you!). It is prudent to take steps as soon as possible to correct any compliance failures so that if an IRS audit does occur, it is resolved without incident. Using the service of a third-party administrator like Frye Retirement Planning can significantly reduce or avoid these pitfalls completely, especially if your clients are new to retirement plan sponsorship, and/or set up their plans via their broker, or on their own.
As always, we can help you help your clients avoid these issues. Please do not hesitate to contact us with any questions you may have, or if you would like us to review your clients’ plans to check for compliance.