Internal Revenue Service Increases Enforcement Activity in 2006 (April 12, 2006)

Enforcing employee benefit plans’ compliance with the tax rules ranks high on the list of priorities for the Internal Revenue Service (the “Service”) this year.  After a prolonged focus on plan sponsor education and self-correction, the Service announced that it is renewing its focus on enforcement in 2006 and unveiled the new Employee Plans Compliance Unit (the “EPCU”) to increase the Service’s enforcement presence. 

 This alert describes how the Service’s increased enforcement activity may impact your organization and describes areas of noncompliance that currently occupy the Service’s attention.

 The Shape of Increased Enforcement

 In short, a renewed focus on enforcement means more audits of employee plans by the Service.  According to Steven Miller, the director of the Service’s TE/GE division, the number of audits conducted annually by the Service dropped sharply since the 90’s.  In 1999, for example, the Service conducted approximately 19,000 audits compared with 5,000 audits in 2005.  The Service intends to conduct more audits in 2006 than it did in 2005, but will use historical data and analysis to be more selective about the audits it initiates.

 EPCU plays an important role in the Service’s goal of conducting more targeted and efficient audits of employee plans.  EPCU uses a “soft contact” or preliminary fact-finding approach to employee plans compliance by calling, writing or even faxing plan administrators about areas of potential non-compliance.  This contact is intended to afford an administrator the opportunity to clarify any issues that may appear problematic to the Service.  You are not under audit if you receive a letter or phone call from EPCU, but the Service may initiate an audit if you fail to respond to EPCU correspondence.

Areas of Noncompliance that Concern the Service

Already EPCU has contacted more than 1,200 administrators about issues such as underfunded pension plans, follow-up on voluntary compliance agreements, Forms 5330 related to prohibited transactions, and Forms 5500 that reveal potential fraud.  The Service also includes on its enforcement agenda plan sponsors who have engaged in one of its listed abusive transactions, such as accelerated deductions under 401(k) plans and S-Corp ESOP abuses, and who did not come forward as part of its Abusive Transaction Settlement Initiative that ended in January. 

In addition, the Service envisions expanding its enforcement arm to areas that to date have not received much attention.  For example, the Service expressed an interest in exploring participation in 403(b) plans and how well prototype and other mass-marketed plans remain in compliance with tax laws after adoption.  In the area of executive compensation, the Service anticipates its focus will be on complex fringe benefits (e.g., aircraft usage, leasing arrangements and travel), severance packages (particularly those representing disguised parachute payments or charitable contributions), and nonqualified deferred compensation.

What Should You Do?

With the Service’s increased focus on enforcement, you should assess your comfort level with your plan’s compliance with applicable laws.  If you have concerns about your plan, you should contact your employee benefits attorney.  You should also contact your employee benefits attorney if you receive a letter, fax or phone call from EPCU.  A failure to respond to EPCU completely and carefully can result in an audit by the Service.

If you have any questions regarding this alert or other Employee Benefits Law related issues, please contact one of our Employee Benefits attorneys.

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