It is often too late to correct 401(k) plan document or operation errors once an audit letter is received without incurring significant penalties from the IRS. A new IRS pilot program provides advance notice of an audit to employers who sponsor 401(k) plans, and a 90-day window to correct any errors.

There are currently IRS programs in place to correct 401(k) errors but an employer must do so voluntarily before being audited. If an audit does uncover an error, the opportunity to self-correct or to file under an IRS correction program is lost and potential penalties increase exponentially. Typical plan errors include a failure to keep the plan document up to date, excluding eligible employees or improperly administering plan loans. Many employers play the “audit lottery,” particularly for minor plan errors.

The pilot program represents a “free pass” for employers that would otherwise be audited without an opportunity to correct. For errors that cannot be self-corrected, the employer can work with the IRS to correct and apply for a “closing letter” but subject to a flat fee otherwise applicable under the voluntary correction process.

An employer that receives a letter from the IRS granting the 90-day window should do everything possible to identify and correct any 401(k) plan errors and otherwise comply with the pilot program. It could mean a savings of tens of thousands of dollars in IRS penalties. Others should perform regular reviews and correct voluntarily under one of the established IRS programs. Employers who have not reviewed plan compliance should not assume advance notice of audit will be provided or that the pilot program will become permanent.