Preparing for a retirement plan audit — especially for an Employee Stock Ownership Plan (ESOP) — can be a daunting task for any business. Ensuring compliance, accuracy, and readiness can not only prevent potential issues but also enhance the overall health of your ESOP.
In this blog post, we'll explore three critical considerations as you prepare for your ESOP audit — helping you navigate the process with confidence and efficiency. Whether you're new to the ESOP landscape or looking to refine your audit preparation, these insights will provide you with a solid foundation for success.
Consideration #1: The Timing of Conducting Your ESOP Plan Audit
Retirement plan financial statements (including ESOPs) must be filed alongside the annual Form 5500 to the U.S. Department of Labor (DOL) seven months after the end of the month the plan year ends, with an option to extend the deadline for two and a half months. Our advisors know many ESOP audits are extended past the seven-month deadline.
Why are retirement ESOP audits usually extended past the DOL deadline?
This is mainly due to:
- The time it takes for the completion of the independent third-party appraisal
- Various compliance tests that must be completed
- Mistakes that are made, and
- The allocation of company stock to participants that must be completed prior to the audit.
ESOP plan audits require strict coordination between the company and its various third parties — including the valuation firm, 5500 preparer, plan recordkeeper, and CPA firm — to ensure timely completion of the audit that meets the needs of all parties involved.
Consideration #2: Future Financial Projections and Budgeting During the Valuation Process
ESOP plans are generally comprised of mostly private company shares of stock, which a third-party appraiser must evaluate. The valuations contain detailed projected financial data, which must be evaluated and compared to actual results by an auditor.
Be prepared to answer questions related to your financial projections. CPA firms cannot rely solely on the valuation firm’s work and must test their inputs and estimates.
Why are financial projections discussed during the ESOP plan audit process?
It is crucial that the plan sponsor understands and can explain any variations from these projections — as bad projections could potentially lead to a bad third-party valuation report which could cause significant delays in the filing and/or audit process.
Consideration #3: Eligible Compensation
ESOP plan documents generally allocate shares of the company’s stock to its employees based on eligible compensation. What comprises eligible compensation is defined in the ESOP plan document and will generally differ from employees’ gross compensation due to wages such as commissions, bonuses, or auto-reimbursements (depending on the plan document).
The improper use of eligible compensation could lead to an allocation issue, which would mean all participants in the plan were allocated the incorrect amount of employer stock for that period.
Eligible compensation is very important but is generally not a difficult figure to determine. Plan sponsors and the ESOP trustees are ultimately responsible for ensuring that employer stock is allocated in accordance with the plan document.
What are the roles and responsibilities of the ESOP trustee during an audit?
The ESOP trustee has crucial responsibilities during an audit to ensure compliance and protect the interests of plan participants.
- Fiduciary. Primarily, the trustee acts as a fiduciary, ensuring all actions during the audit align with the best interests of the ESOP participants. These responsibilities include reviewing and providing necessary documents and records to auditors, such as financial statements, plan documents, and transaction records. Additionally, the trustee oversees the valuation of the retirement ESOP shares, ensuring that the valuation methods used are accurate, fair, and compliant with legal and regulatory standards.
- Regulation adherence. The trustee also ensures the ESOP adheres to all relevant laws and regulations, including ERISA requirements and IRS guidelines. They facilitate clear communication between auditors, company management, and ESOP participants, addressing concerns or questions that arise during the audit. If issues or discrepancies are found, the trustee identifies and implements corrective actions to maintain compliance.
- Risk management. They also assess and manage risks associated with the ESOP and report audit findings to participants and management, ensuring everyone is informed of the results and any necessary follow-up actions.
How can my business avoid compensation mistakes?
On an annual basis, company management should ensure that the eligible compensation their plan recordkeeper is using to allocate stock follows what is stated in the Plan document. Errors identified during audits related to eligible compensation issues can be costly and time-consuming to correct.
FAQs When Preparing for an ESOP Plan Audit
Is an ESOP audit required for business retirement plans?
Yes. ESOPs are qualified retirement plans that are subject to the Employee Retirement Income Securities Act of 1974 (ERISA). Therefore, ESOPs are subject to retirement plan audit guidelines, which must legally be followed.
What are the penalties for non-compliance in an ESOP audit?
Non-compliance in an ESOP audit can result in several serious penalties and consequences. The IRS and Department of Labor (DOL) may impose substantial fines and penalties, including excise taxes, correction fees, and penalties for late filings or inaccurate reporting.
Additionally, failure to comply with ESOP requirements can lead to the disqualification of the ESOP plan, resulting in the loss of tax-exempt status and significant tax liabilities for both the company and the participants. Trustees and other fiduciaries found in breach of their duties may face personal liability, including the responsibility for restoring any losses to the plan or profits made through improper use of plan assets.
Non-compliance can also lead to lawsuits from plan participants, the DOL, or other parties, resulting in costly litigation, settlements, and damage to the company's reputation. Companies found non-compliant may face increased scrutiny from regulatory bodies, leading to more frequent and thorough audits and additional compliance requirements.
What is the timeline for completing the full checklist for an ESOP audit?
The timeline and scope for completing an ESOP audit typically spans 5 to 9 months, depending on the complexity of the plan and the readiness of the company's records.
- Planning and preparation phase. Usually lasting 1-2 months, this phase involves initial meetings between the company and the audit team to discuss the audit's scope and objectives, gather necessary documents and records, and prepare a detailed audit plan.
- Fieldwork phase. This is followed by the fieldwork phase, which takes 2-4 months and includes an on-site or remote review of financial records, plan documents, and other relevant information, interviews with key personnel, and verification of transactions and compliance with regulatory requirements.
- Analysis and reporting phase. Following the fieldwork, the analysis and reporting phase spans 1-2 months, during which auditors analyze the collected data and prepare their findings, draft the audit report, and discuss preliminary findings with company management.
- Finalization phase. The finalization phase, lasting about 1 month, involves addressing any outstanding issues or additional information requests from the auditors, finalizing the audit report, and presenting it to the company's management and the ESOP trustee. Implementing any recommended corrective actions and ensuring ongoing compliance concludes the process.
ESOP Plan Audit Services from Kreischer Miller
While there are many other factors to consider when preparing for an ESOP plan audit, this is a good place to start prior to beginning the audit process.
Kreischer Miller has extensive expertise in ESOP accounting, along with the tax and regulatory intricacies of ESOP plans, including leveraged plans, share allocation, and the valuation process.
Reach out to a member of our ESOP team for support with your ESOP plan maintenance.