As a business owner, offering an Employee Benefit Plan is important for providing financial security and well-being to your employees. It reflects your concern for the team, attracts and retains the best talent, and provides major tax benefits to the owners of the business.
These advantages come with a very serious responsibility to make sure that your EBP is well managed, in compliance with regulations, and transparent to participants. In this respect, the Employee Benefit Plans are under the scrutiny of both the Internal Revenue Service and the U.S. Department of Labor; both have strict rules to protect the interests of employees and to make sure that the contributions by employers are correctly applied.
Because of such regulatory complexity, many businesses rely on CPA firms to independently audit their EBPs. These audits are for legal purposes and assure that your plan’s financial statements are presented fairly and in conformity with federal standards.
The blog discusses the concept of what an employee benefit plan is, why they may need an audit, and how the audit process is performed.
What is an Employee Benefits Plan?
The Employee Benefit Plan is one form of compensation, other than direct salary or wages, paid by employers to their employees. These plans are fashioned to support the financial stability, health, and overall well-being of employees, hence reflecting the commitment an employer has toward the care of workers beyond providing only a paycheck.
The offering of an Employee Benefit Plan enables the business owner to develop a solid company culture while improving employee satisfaction and enhancing employee retention. With today’s tight job market, a properly structured benefits package can make all the difference in attracting and retaining the best employees.
The following are things usually included in an Employee Benefit Plan:
- Retirement plans (401(k), pension, etc.)
- Bonuses and incentive schemes
- Employee stock options
- Student loan repayment assistance
- Tuition reimbursement or professional development
- Commuter benefits
- Health Savings Accounts (HSAs) and Health Reimbursement Accounts
- Time off and flexibility
- Paid holidays
- Family and medical leave
- Flexible work policies include working remotely and flexible hours.
Why the Employee Benefits Plan (EBP) needs to be audited
An audit of an employee benefit plan is essential to maintain one’s plan in compliance with the regulations of the Internal Revenue Service regarding all contributions, distributions, and tax reporting.
From the IRS’s perspective, an audit is a check for compliance aimed at ensuring your plan is in conformity with all applicable tax laws, since EBPs are subjected to special tax treatment. Typically, employer contributions to certain retirement and welfare plans are tax-deductible, whereas employees may enjoy benefits like tax-deferred growth or tax-free contributions. However, usually, the availability of these benefits is contingent on a plan satisfying strict requirements promulgated by the IRS.
Here’s why the EBP audit for tax compliance is important:
Ensures precision in tax reporting
The IRS requires that all financial transactions within your EBP be reported correctly, including employer contributions, employee deferrals, and benefit distributions. An audit will confirm that these amounts are correct and consistent with your company’s tax filings.
Verifies Plan Qualification Status
The Internal Revenue Code grants a favourable tax status to qualified plans. An audit can help ensure your plan is meeting the IRS qualification standards, which include contribution limits and non-discrimination rules, so the plan does not lose its tax-advantaged status.
Early detection of errors or noncompliance
Mistakes such as excess contributions, late deposits, or incorrect information about participants could lead to some tax penalties and even the disqualification of a plan. Regular audits help to find and resolve issues before they escalate.
Supports Employer Tax Deductions
Employer contributions to selected benefit plans are generally deductible; however, the plan has to meet each of the IRS’s eligibility requirements. An audit ensures that the deductions taken are appropriate and adequately supported.
Builds Credibility with the IRS
Good faith and reasonable cause may be demonstrated by keeping accurate records and audit documentation that would reduce the likelihood of further examination or penalties from the IRS in governmental audits.
How does the employee benefit plan get audited?
An EBP audit is a detailed examination of your company’s financial records to ascertain that your benefit plan is reported accurately and in conformance with the IRS. For the business owner, it serves as confirmation that your compliance will protect the associated tax benefits of providing those benefits.
Planning and Risk Assessment
The auditor begins with a planning and risk assessment phase before testing any data. It involves evaluating the plan’s governing documents, prior filings, and internal control systems to find which areas are more likely to present cases of noncompliance or financial misstatements. Based on that, during this stage, the CPA identifies the parts of the plan that need deeper testing, such as those concerning contribution timing, participant eligibility, or tax-deferred contributions.
Testing Financial Transactions and Internal Controls
Once the areas of risk are determined, the auditor conducts transaction testing to confirm whether your plan’s financial records are presented correctly. The auditor will also test the operating effectiveness of your internal controls to ensure contributions are remitted on a timely basis, participant information is recorded correctly, and all financial transactions are properly recorded. This level of testing will help provide assurance that your plan is operating in conformance with IRS tax rules.
IRS Compliance Verification
A significant part of the audit is to ascertain whether the plan follows the main qualification standards prescribed by the IRS, which include limits on contributions, non-discrimination testing, and rules on participant eligibility. The auditor verifies that contributions and deferrals are transmitted in a timely manner and that all transactions within the plan are within and in conformance with the Internal Revenue Code. In addition, for the plan to maintain its tax-qualified status without additional and punitive costs, it needs to be maintained in these areas.
Issuing the Audit Report
After the audit, a CPA prepares an audit report summarizing the financial condition and areas of concern for the plan. This report provides assurance for both the employer and the IRS regarding the proper operation of the plan and the accuracy of financial statements. Any mistakes identified by the auditor or instances of noncompliance are mentioned in detail, together with ways to correct those errors.
Correcting and Maintaining Compliance
If the audit uncovers any issues, the business owner should take immediate action to fix them. The IRS does give the opportunity to correct certain mistakes under its Employee Plans Compliance Resolution System, known as EPCRS, to help employers maintain their plan’s qualified status and avoid disqualification or penalties. Quickly addressing any findings demonstrates good faith and a commitment to compliance.
Conclusion
For business owners, it is necessary that they understand what an employee benefit plan is in its entirety, and that the EBP be kept in compliance and well-managed for the protection of both your company and your employees. A properly audited plan ensures compliance with the IRS, protects your tax benefits, and reinforces financial transparency. Regular audits prevent expensive penalties but also exhibit accountability and reinforce trust among your employees.
By partnering with a seasoned CPA firm, you can ensure that your EBP will meet all IRS requirements and continue to provide long-term value for your business and your team.
