Navigating an Employee Stock Ownership Plan Audit


Dec. 20, 2016

By Peter J. Shuler and Lori L. Stuart, QPA

Employee stock ownership plans (ESOPs) frequently are audited by the U.S. Department of Labor (DOL), and the DOL has stated that such plans are a target enforcement area for the agency. For newly formed ESOPs, the DOL’s goal is to audit the plan within the first six years. These audits focus on the transaction and the valuation of the stock. Other triggers for a DOL audit are participant complaints, referrals from other agencies, and review of the Form 5500, “Annual Return/Report of Employee Benefit Plan,” filings. Plans that pay out unusually large distributions in a plan year also face increased chances for audit. The DOL appears to be reviewing ESOP loan documents and amortization schedules to ensure that the loan payments and share release computations follow the documents.

Though the IRS also audits ESOPs (focusing on prohibited transactions, such as a purchase or sale of stock between the company and the ESOP based on an outdated share price or inappropriate deductions by the company based on contributions or dividends that mostly related to C corporations), there typically are fewer IRS audits of ESOPs.

Taking Action

If your ESOP gets selected for an audit, do not panic. The DOL or IRS generally will provide a list of documents and data to have available during the audit process. As soon as you receive a letter or phone call indicating you’re under audit, your first step should be to notify your ESOP administrator, your ESOP counsel, and your trustee and forward to all the list of documents and data that you will need to have ready for the scheduled audit. The plan administrator together with counsel and the trustee will help you understand the audit process and how to get ready for having the agency’s representative on-site.

Responding to the initial list of items in a timely and complete manner is important to facilitating a smooth audit process. You are not required to provide any requested documents in advance of the visit, but you can voluntarily offer to provide these documents electronically in a bookmarked portable document format (PDF) or in a binder prior to the on-site visit. Providing information early is highly recommended since doing so gives the agency representative a chance to look over everything and can help minimize the time he or she spends on-site. Keep in mind, though, that agents may request other documents or data as the audit progresses.

Another important key in the audit process is to be nice. The DOL and IRS representatives are people doing their jobs. Being antagonistic or not being ready when the auditor arrives on-site will not help or shorten the audit process. And remember, the auditors also have full schedules, so trying to delay or move an audit date may not be possible.

Navigating the Audit

Many times, the auditor assigned to your case will not necessarily be an ESOP expert and might need an explanation of how allocations were determined or how the share release was computed. In such cases, auditors generally are willing to speak with third-party administrators, attorneys, or trustees to get the explanations they need. In fact, the DOL may include interviews with certain service providers as part of the audit process.

Once the on-site visit is completed, the next step is a response from the agency detailing any problems identified that require attention and the corrective actions to resolve the issues, or if no problems were identified, there will be a closing letter. Regardless of what it says, the letter should be sent to your third-party administrator and attorney for help determining which corrective actions are necessary and providing additional explanations or information that address the problems identified so that no further action is needed. It can take a year or more before a letter is issued, but it’s appropriate to follow up with the agency representative periodically if you’re concerned.

Nothing to Fear

An IRS or DOL audit should not be feared. Instead, it should be faced head on knowing that the ESOP’s team of service providers is ready to help navigate through the process so that you are prepared. An audit is not something to be faced alone.