If you are a company that has over 100 employees, you are required to file a Form 5500 every year. As part of the requirements, you must include an audit. Also, the IRS or U.S. Department of Labor might require an audit if there have been complaints, or an irregularity was brought to their attention.
Sometimes, you might be chosen for a random audit. Audits are expensive, and they are a regular part of doing business. You might be wondering if you can deduct the 401(k) audit cost from your taxes.
Average 401(k) Audit Fees
The purpose of a 5500 audit is to make sure the Form 5500 is an accurate representation of the value of the assets that are included in the plan. The average cost of an audit depends on the case and the type of plan under management. The average cost of a 5500 audit is between $7,500 and $9,500 for a small business. An audit can take anywhere from six weeks to six months, depending on the complexity.
If you must have an audit performed, you might have several options when it comes to these fees. In some cases, you can pay expenses for managing the plan out of the plan assets, but in other cases, they can be deducted from your taxes. The rules for when each of these scenarios applies are not straightforward and can be confusing.
Deducting 401(k) Audit Fees
There are certain rules for what can be paid out of the 401(k) plan and what cannot. Audits are considered a necessary management expense to maintain compliance of the plan.
Another example of an expense that the plan can pay is if you must amend or reinstate the plan because of a change in the law. The plan can pay for these expenses, but there are some reasons why you might not want to choose this route.
If the expense is not directly related to the compliance of the plan and is optional, the fees generally cannot be deducted from the plan. One example of this is fees for running projections and “what if” scenarios to help you decide whether to include a Safe Harbor provision. In this case, the company will benefit from the expense and not the employees.
The test to decide whether the fees can be deducted from the plan or not is to ask who will benefit from the expense. If the employees will benefit, you can usually take the expense out of the plan. If the company will benefit, this is usually not allowed.
Taking Expenses as a Deduction
If you can take an expense for managing the plan from the plan assets, the most common way is to spread the cost over the number of participants. However, if the cost is for a participant loan, the individual who took out the loan will bear the expense.
Contributions to the plan and payments of plan expenses are tax-deductible, which means that it might make more sense to have the company pay the fee directly and take the deduction for it. One reason why you might want to do this is if the fees would create an excessive burden on the plan participants as opposed to the burden it would cause the company.
In some cases, certain expenses might not be clearly deductible from the plan, especially if both the company and the participants benefit. For this reason, it is a good idea to ask your tax professional or the IRS to see if an expense can be deducted from plan assets or whether you must pay it and deduct it from your taxes.
Adam Luehrs is a writer during the day and a voracious reader at night. He focuses mostly on finance writing and has a passion for real estate, credit card deals, and investing.