Employee stock ownership plans (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.
For companies preparing for an upcoming ESOP plan audit, it is important to consider the following three items.
- Timing: Retirement plan financial statements (including ESOPs), with an attached audit opinion, must be filed alongside the annual Form 5500 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.
In my experience, many ESOP audits are extended past the seven-month deadline. This is mainly due to the time it takes for the completion of the independent third-party appraisal, various compliance test that must be completed, and allocation of company stock to participants that must be completed prior to the audit.
ESOP 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. - Future Financial Projections and Budgeting: ESOP plans are generally mostly comprised of private company shares of stock, which must be valued by a third-party appraiser. 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. 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. - 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 to ensure that employer stock is allocated in accordance with the plan document. 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.
While there are many other factors to consider when preparing for an ESOP plan audit, the summary points noted above are a good place to start prior to beginning the audit process. Please contact Kreischer Miller’s ESOP Industry Group for more information or specific guidance on ESOP audits.
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