Auditing Employee Benefit Plans. Josie Hammond
subject to the ADP test and not the ACP test, as would be the case with other after-tax employee contributions.
These contribution types may have different names with a particular plan document. They may be referred to as discretionary, elective, nonelective, profit sharing, safe harbor, and so on. It is important that the auditor be able to distinguish the type of contribution, whether required or discretionary, and how each is to be accounted for under the plan.
403(b) plans
403(b) plans are employee savings plans similar to 401(k) plans. They are sponsored by churches, charitable organizations, and public schools. Employees are allowed to make voluntary pretax, voluntary after-tax or Roth contributions. Employers can make matching contributions or discretionary contributions. 403(b) plans have different eligibility standards and different allocation limit testing, and employee voluntary pretax and Roth contributions are not subject to the average deferral percentage test. Instead of an average deferral percentage test, employee pretax and Roth contributions are subject to universal availability.This means that nearly all employees must have the right to participate in the plan and they must be actively notified of that right. There are some exclusions from participation for students, persons hired to work fewer than 20 hours per week, and so on. There are no design-based exclusions for the employee contribution. There can be design-based exclusions for any employer contribution. Any employer contribution is subject to nondiscrimination testing, including the average contribution percentage test, just like employer contributions to a 401(k) plan.
Like qualified retirement plans, 403(b) plans are required to be documented in writing. The documentation, however, does not have to be a single document, but it must reflect all of the operating requirements of the plan. As a result of the changes in the plan’s operations created under the final IRS regulations effective in 2009, a 403(b) plan now functions a lot like a 401(k) plan, with a few notable differences. The main difference is in the discrimination testing, as described previously. Other key differences include
an additional catch-up contribution provision for long-service employees, separate from the age 50 catch provision provided for 401(k) and 403(b) plans;
the right to continue employer contributions to the plan for five years following severance of employment;
a limitation on allowable investments for most plans to insurance annuity contracts or shares in regulated investment companies;
the absence of a trust. 403(b) investments must be held by insurance companies or in a custodial account (which does not have the same protective features as a trust) and, as such, may be exempt from ERISA’s general requirement that plan assets be held in trust.
The 2009 Form 5500 was the first reporting period in which 403(b) plans needed to complete Schedule I or H and attach audited financial statements, if applicable. Many auditors found that plan sponsors did not have sufficient records to provide reasonable assurance that there were no material misstatements on beginning balances that may have affected the current year statement of changes. In such cases, the auditor was likely to be confronted with the need to modify his or her opinion for a scope limitation, a GAAP departure, or both. The Department of Labor issued Field Assistance Bulletin (FAB) No. 2009-2 and No. 2010-1, which permit certain 403(b) contracts to be excluded from Form 5500 reporting and outline other provisions with respect to what plans will require an audit, what steps should be taken to accumulate plan data, and so on. Where the plan administrator instructed the auditor to exclude certain plan assets from the scope of the audit, this could result in a scope limitation under generally accepted auditing standards (GAAS), as well as a departure from GAAP if the financials do not represent the entire plan entity. However, FAB No. 2009-2, as interpreted by FAB No. 2010-1, provides that a filing would not be subject to rejection by the DOL due to a modified opinion solely pertaining to the exclusion of the contracts meeting the definition in FAB No. 2009-2 from the financials or the scope of the audit. This exclusion and the associated modified opinion continues for the current Form 5500 filings for many 403(b) plans, as the records have not been located and the materiality of the excluded contracts cannot be determined. This is an area that will continue to develop as these plans go through successive annual audits. For further information regarding 403(b) plans, refer to the DOL’s website (https://www.dol.gov/agencies/ebsa/employers-and-advisers/plan-administration-and-compliance/retirement/reporting-and-coverage-for-403b-plans), as well as the AICPA Employee Benefit Plans Audit Quality Center website on 403(b) matters: www.aicpa.org/InterestAreas/EmployeeBenefitPlanAuditQuality/Resources/AccountingandAuditingResourceCenters/Pages/403(b)%20Plans.aspx.
457 plans
Like 403(b) plans, these arrangements involve employee pretax contributions. The funded version of these plans is available only to governmental agencies. These plans are not subject to ERISA. They are also not the subject of this course, as their reporting is controlled by GASB, not FASB. There is also an unfunded version of the 457 plan available to certain tax-exempt employers, but such plans are also exempt from the audit requirement and, thus, outside of the scope of this class.
Employee stock ownership plans
These are stock bonus plans that are required to be primarily invested in “qualifying employer securities.” There is no clear definition of “primarily,” but it was generally understood to be more than 50 percent of plan assets on average over the life of the plan.3 In contrast, there is guidance on the definition of a “qualifying employer security.” Subject to some special rules for securities acquired prior to 1979, a “qualifying employer security” is any publicly traded security of the sponsor or its parent; or, for a nontraded security, it is a common stock possessing both the best dividend rights and the best voting rights of any outstanding common stock or a preferred stock convertible into such common stock.4
ESOPs include a number of special features:
Leveraging—An ESOP is permitted to borrow money from a related party or guaranteed by a related party without creating a prohibited transaction, as long as the applicable ERISA rules are met.5
This leveraging does not trigger unrelated business income.6
The contribution made to an ESOP of a C corporation can exceed the normal deduction limits. The annual addition limit may be measured by the lesser of the employer contribution or the fair market value of the shares released.
There are many tax incentives, which impose restrictions on the ESOP’s allocation of benefits within the trust. These restrictions are required to be included in the plan terms.
ESOPs are not permitted to be integrated with Social Security.
ESOPs cannot be tested for nondiscrimination using the various “safe harbors” that may be available to more traditional plans.
ESOPs holding nontraded stock are required to have an annual appraisal of any stock acquired after December 31, 1986. For this purpose, with some exceptions, “nontraded stock” includes any shares not listed on a Securities Exchange registered under Section 6 of the Securities Exchange Act of 1934. This position was formally issued by the IRS in 2011 and is generally effective for plan years beginning on or after January 1, 2012. It means that shares that actively traded on the Over-the-Counter Bulletin Board (OTCBB) or through “pink slips” will still need an appraisal.7
The rules for operating an ESOP may vary between ESOPs of S Corporations and those sponsored by