Do-It-Yourself Compliance Audit
By Kristiana Rodriguez, CIP
Last month we supplied some summer reading for you. We offered a list of things you might have time to read and review between filing Form 5498, IRA Contribution Information, in May, and the deadline for removing excess contributions, in October. This month we’re covering how to review your files in a do-it-yourself compliance audit. No one wants to be caught unprepared by an IRS audit. Because the best defense is a good offense, here are some tips and tricks to review your own files so you can learn what areas may need your attention.
We’ll focus on the following four areas.
Opening documents
Withholding
Reporting
Recreating transactions
You’ll want to gather a random sample of IRA files to review. This may be digital files or physical files, depending on how you keep your documents. Consider reviewing 10 percent of your files. If that is too daunting, know that reviewing some is better than reviewing none.
Opening documents
Financial organizations are required to provide opening documents to their IRA clients and can be penalized by the IRS for failing to do so. When reviewing a file, you’ll want to confirm that your IRA application contains language stating the IRA owner received the required documents and that she signed the application. A representative from your organization must also sign the application to make it valid. Hopefully you can say “yes” to the following questions.
Do you have proof that all IRA owners were provided with a plan agreement, disclosure statement, and financial disclosure when they opened an IRA?
Were amendments timely sent when required?
If documents have been updated or amended, is your staff using the most current versions?
Withholding
Federal tax withholding is a common compliance issue: failing to follow the rules can lead to significant fines from the IRS.
The withholding rules state that a withholding election is valid until it is revoked. Our audit expert, Tammy Schultz, adds some insight into withholding compliance.
“Most organizations treat the withholding election as if it belongs to the transaction and not to the IRA or retirement plan. Let’s say, for example, that an IRA owner establishes scheduled payments and elects to waive withholding. Later in the year, the IRA owner requests a distribution that is not part of the scheduled payments. The IRA owner elects to withhold 10 percent, which changes the withholding election for all future payments to 10 percent. If the organization fails to apply the new withholding election to future distributions, the organization could be subject to IRS penalties, including being liable for the amount that should have been withheld but wasn’t.”
Common withholding errors include a financial organization
not retaining evidence that it provided IRA owners with a withholding notice at the time(s) required, based on the frequency of distributions,
not withholding according to the IRA owner’s election, and
failing to withhold at the default withholding rate, if a signed election to waive or withhold at another rate wasn’t made.
Reporting
Reporting IRA distributions and contributions is the closest contact that you’ll have with the IRS annually, which makes it an important area to focus on. Improper reporting not only leads to compliance errors, but it may lead to an IRS audit. Even if a financial organization contracts with a data processing firm, the financial organization ultimately is responsible for any incorrect reporting penalties.
If audited, your financial organization could be fined for
failing to timely file Form 5498 with the IRS;
failing to timely file Form 1099-R with the IRS and sending a copy to the client; and
failing to provide clients with an account statement, FMV statement, and RMD statement.
Here are some questions to keep in mind when reviewing reporting.
Are the correct distribution codes being used—especially during complex transactions, such as excess contribution removals? (A new code was added just this year, for qualified charitable distributions!)
Has the net income attributable (NIA) for an excess contribution removal or recharacterization been calculated correctly, or at all?
Are there notes in the file to explain why certain transactions were performed or corrected?
Recreating a Transaction
When reviewing a file, you will want to review the transactions that occurred, and the documentation of those transactions found in the file. Missing documentation could point to the need for further training or clarity in your processes. Ideally, you should be able to recreate every transaction through the documentation found in the file.
Examples of transaction documentation
Deposit documentation can include a deposit slip or form signed by the IRA owner, showing the date and amount of the deposit, the contribution type, the year for which the contribution is made, and deposit terms or rules, such as the certificate of deposit contract.
Withdrawal documentation should include a withdrawal statement or request (authorization from the IRA owner or beneficiary to take a distribution in the amount and for the reason given), and a withholding notice and election.
RMD documentation should include the calculation method, reporting information, and distribution timing.
Portability documentation could include any forms or correspondence relating to a transfer, rollover, recharacterization, or conversion.
Death claims should be accompanied by
a certified copy of the death certificate;
an executed withdrawal statement or other instructions from the estate representative or each beneficiary;
the distribution method (e.g., life expectancy payments or 10-year rule);
a certified copy of Letters of Testamentary or Letters of Administration (from the issuing County or Probate Court) if no beneficiary is designated (if applicable); and
an affidavit of a successor of the decedent (if applicable, when the value of the entire probate estate is a small amount and the estate will not be probated).
Divorce claims should be documented by retaining
a copy of the divorce decree (or the portion thereof) granting all or a portion of the IRA owner’s IRA to the ex-spouse, and
a withdrawal statement or request executed by the IRA owner in accordance with the terms of the divorce decree.
After you’ve reviewed your file sample, you’ll want to note any common errors. What is consistently done correctly and what areas need more attention. Perhaps your staff needs more training with supplying withholding notices, maybe your forms are out of date, or master files need to be stored properly. Whatever the problem is, now is a great time to identify it and find a solution.
Help is Available
Financial organizations may find it helpful to work with an IRA services provider, such as Ascensus. In addition to offering a variety of IRA training, including on-site and distance learning options, Ascensus offers a compliance review and operational assessment in which an experienced Ascensus ERISA consultant evaluates a financial organization’s IRA program on site. Based on the findings, Ascensus makes recommendations on updated procedures to help the financial organization bring their IRA program into compliance.
Visit Ascensus to learn more about IRA training and compliance services.
