If your company has a retirement plan, you should be concerned about IRS retirement plan audits. Retirement plans are not audited as part of an ordinary business or employment tax audit. Instead, the IRS has specially trained revenue agents in every district just for retirement plan audits. This type of audit may derive from a prior business audit or from a review of annual IRS tax reporting Form 5500, which is required for most retirement plans.
Hiring firms with tax qualified retirement plans may have special problems with retirement plan audits where they classify workers as ICs.
1. Tax Qualified Retirement Plans
A tax qualified retirement plan is a retirement plan that covers business owners and employees and that satisfies the requirements of the federal Employee Retirement Income Security Act, or ERISA. That law is enforced by the U.S. Department of Labor, the IRS and the Pension Benefit Guarantee Corporation.
Contributions to a tax qualified retirement plan are tax deductible by the business, as are contributions by participating employees. In addition, income from retirement plan investments is tax free until it is withdrawn by the plan participants.
2. Anti-Discrimination Rules
You must satisfy complex ERISA rules to obtain these tax benefits. The most important are anti-discrimination requirements providing that the principal owners of a business cannot provide benefits only to themselves, corporate officers or highly paid employees. If there are other employees, many, but not all, must be included in the plan as well. In general, employees don’t have to be covered the moment they’re hired—but if they’re employed long enough and are old enough, you have to bring them into the plan.
ERISA has even more complex rules concerning which workers must be counted under the anti-discrimination rules and how many need to be covered. The anti-discrimination rules are satisfied, for example, if 70% of employees are covered. There are other ways to satisfy the rules that may require that fewer employees be included in the plan.
3. Losing Tax Qualified Status
If the IRS determines that workers you classify as ICs are really employees for ERISA purposes, it’s possible that not enough employees will be covered to satisfy the anti-discrimination rules. This can mean that your pension plan will lose its tax qualified status. In this event, all previous tax deductions for benefits or contributions to the plan can be thrown out. Your business can lose the deductions, and the benefit recipients will have to pay taxes on the benefits.
EXAMPLE: Acme Sandblasting Corporation has a tax-qualified retirement plan. Acme has 100 employees and another 100 workers classified as ICs. Seventy of the 100 employees are covered by the pension plan, apparently satisfying the anti-discrimination rules because 70% of workers Acme classifies as employees are covered. However, the IRS determines that the 100 ICs should be classified as employees for ERISA purposes. Acme really has 200 employees and 140 had to be covered. As a result, Acme’s retirement plan loses its tax qualified status.
The IRS uses the common law right of control test to determine if workers are employees or ICs for ERISA purposes. If a worker qualifies as an employee for federal payroll tax purposes, he or she is an employee for ERISA purposes as well.
See an Expert – Get Help
This is an extraordinarily complex area of the law, beyond the competence of most attorneys, let alone lay people. You should discuss this issue with your retirement plan administrator or seek advice from a retirement plan consultant or an attorney or CPA specializing in this field.