What is the 2 year rule for audit thresholds?
It is not possible to find the phrase “2 year rule” in the official Form 5500 instructions. In most 401(k) audit conversations, professionals use this term to describe the 80–120 participant rule. This concept highlights how the current filing category relies on the filing status from the previous year. Additionally, defined contribution plans use a specific counting method for their first return — looking at the end-of-year participant count — rather than the beginning-of-year count.
Is there a real 2 year audit threshold rule?
Not officially. The true test looks at whether the plan classifies as a "small plan" or a "large plan" for Form 5500 purposes. Employee benefit plans with 100 or more participants, in general, must submit audited financial statements with their annual filing. However, if the plan falls between 80 and 120 participants, you are permitted to stick with the same filing category you used last year. As the current status links back to the previous year, plan sponsors have casually named it the “2 year rule”.
What do people mean by it?
- “2 year rule” — The current filing category relies on the filing status from last year
- “First-year rule” — A defined contribution plan's very first Form 5500 return relies on the end-of-year participant count
For established defined contribution plans, participants with account balances at the beginning of the plan year are counted. But if you are filing the plan's first return, the Form 5500 instructions require you to use the end-of-year participant number instead.
When does the prior year matter?
The previous year only comes into play if the participant count lands between 80 and 120. Within this range, the plan administrator gets to choose to file in the same category as the previous year. In the case of filing as a small plan last year, it is possible to remain in that category this year as long as the count is 120 or below. If you filed as a large plan, you can stay large.
How should plan sponsors apply the rule?
- Count the plan participants exactly as the Form 5500 requires
- Determine if this is the plan’s very first return
- Check if the final participant count lands between 80 and 120
- Look up the filing category you used last year
- Verify if an audit is necessary for the current filing
Dimov Audit can help with audit thresholds
Unsure if the plan falls into the small or large category? Dimov Audit is here to assist. We review the participant numbers and previous filing status alongside your audit requirements well ahead of the Form 5500 deadline. Reach out to us for direct support with 401(k) audit planning, annual filings and employee benefit plan audits.
