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Thanks for the advice/warnings, at this time I am researching on what can be done if anything. Nothing would be done without a lawyer.

Usually, I would not add anything to the responses of the wise folks on this thread but I have to commend the OP for questioning the response they received from "AI". While AI may give one a starting point, AI responses can be flat out wrong so, in my view, AI responses should always be viewed extremely critically. I fully agree with @Peter Gulia and @austin3515. I would like to add a couple of thoughts. OP notes that their initial query is in response to IRS Notice CP1348. The IRS's purview does not cover the entire universe of whether plan amounts can be used to pay penalties. So what occurs in an IRS Notice regarding prohibited transactions may not be the end of the story. Their purview only covers whether there is a prohibited transaction under 4975 and the consequences under the tax code. @austin3515 and, ultimately, @Peter Gulia look at the entire universe in bringing up the views of the DOL under ERISA. Also note that the concept of "plan assets" is an ERISA concept monitored by the DOL. In my experience, under ERISA, civil penalties assessed against fiduciaries, plan sponsors, or other parties for some sort of legal violations or prohibited transaction cannot be paid using plan assets. Plan assets must be used exclusively to provide benefits to participants and beneficiaries and to defray "reasonable administrative expenses." I have not researched this recently but my understanding is the DOL maintains that paying penalties from plan assets is not a reasonable expense and is strictly prohibited. DOL has stated that penalties under ERISA 502(i) must be paid by the party in interest involved in the transaction not the plan, and using plan assets to pay penalties is likely a breach of fiduciary duty. Also, regarding restoration or disgorgement as @Peter Gulia brings up, I have colleagues who distinguish between restoration/disgorgement, which are remedial in nature, as opposed to penalties, which are punitive in nature. They seem to imply that plan assets could be used for restoration or disgorgement but I must be thick-headed because I don't see it. How can you use plan assets to restore something to the plan? disgorge from plan? There may be circumstances that I am just not thinking of but it seems like a zero sum game.

Where did he make the deposits? What type of an account? Any other employees? Based on your prior answers, I don't see any reasonable path forward. When you run into stuff like that, do you really want to get involved with a potential client with such a low business acumen? I means seriously, how could he think they would be deductible?

HR standpoint - not HRA

Plan sponsor wanted a plan that provided a 1% match to HCEs and a higher match to NHCEs. The match is calculated each pay period with the plan sponsor setting the match in with their payroll service provider at the beginning of the year. This provision is obviously problematic as employees might move from HCE back to NHCE and vice versa and from an HRA standpoint is not very employee-friendly. I should add they have many well paid employees who however over and under the HCE threshold each year and are not owners. So for 2025 we see a couple HCEs who received more match than they should have. The match is discretionary but rigid and so the notice goes out. Seems we would transfer the excess match along with earnings from the participant's account to the plan's unallocated cash account. So there would e no distribution to the participant nor 1099-R. Thank you, Tom

Agree but wanted to check anyway. Thank you for the reference.

Agree but the CPA is a friend of mine and would like to help out, if I can and with an attorney involved. They know my requirements if they want me involved.

No nothing, zilch, nada was prepared as far as the documents go. No 5500 was filed (yes, required), no actuarial certifications were done (no actuary was involved). They just made the deposits and took the deductions.

I would think twice (thrice) before taking this assignment. The facts presented do not bode well for a good consultant/client relationship.

W-2 Comp has different meanings depending on whether you are looking at this from a qualified plan perspective or from a payroll perspective. If looking at it for payroll purposes, what is included as wages for purposes of reporting on a Form W-2 is determined under § 3401 (income tax withholding), i.e., wages, tips and other compensation reported in Box 1, which do not include Section 125 deductions. Because Section 125 plans allow employees to pay for certain benefits—such as health insurance premiums—with pre-tax dollars, these amounts are subtracted from their gross pay before their taxable wages are calculated. Since these deductions are taken out pre-tax, they are not subject to federal income tax, Social Security tax or Medicare tax (§§ 3101-3128). Note that some employers report Section 125 contributions in Box 14. However for qualified plan purposes the definition of W-2 Wages is defined under § 415. Under § 415, elective deferrals—including pre-tax contributions to a § 125 plan—are included as compensation. Though these amounts are excluded from taxable wages reported in Box 1 of Form W-2, they are specifically required to be added back when calculating compensation for § 415 purposes. When a qualified plan uses a "W-2 wages" for its definition of compensation, it must explicitly include § 125 deferrals to satisfy § 415 requirements. If the plan uses the "415 Safe Harbor" definition directly, these amounts are already included by definition. The reasoning behind this is because § 415 provides the limits for the total annual additions to a participant's account in a defined contribution plan, and including § 125 deferrals ensures that employees are not penalized for participating in pre-tax benefit programs (it is view as a more accurate reflection of total compensation for qualified plan limit testing).

Was a plan document ever prepared? If so, maybe they have a signed copy in their drawer? Did they create a trust? Where have the contributions been deposited? Generally you shouldn't be able to create a trust without a plan document. Are 5500's required? What is value of the assets? Any other plan participants? We need more information to give you better ideas. I agree with C.B. that if he never opened a trust, it would be difficult to justify that he has a qualified plan. However, if he has a trust and a plan doc, then you could go back and prepare 5 years of valuations and 5500's under DFVC.

Moreover, with unfreeze you can change the benefit formula to target precisely what your client wants to accomplish.

No, you can't self-correct the initial failure to adopt a written plan. See Rev. Proc. 2021-30 4.01(b) and Notice 2023-43 A-2(1).

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During 2020, did a proposal and never heard from the prospect and thought went away somewhere else. Just got an email from the CPA stating that, the prospect has been making contributions and taking deductions with no actuary and paperwork. No 5500 forms were filed but that is the easy part. They are now asking me to fix this. Is this something that can be self-corrected starting with 2020 plan year? Any thoughts/comments appreciated.

Interest AND mortality. See Bri's response. There is no such thing as an annuity with 12 monthly payments made all at once. There is an annuity with annual installments, or an annuity with monthly installments.

I'm an auditor myself. A lot of the replies have addressed some great points. I recommend also ensuring that you have prior years' information available. If the plan has never been audited, the auditor will generally need to go back a couple of years. Each auditor is different so how many years they go back will vary. Also, if you have any issues during the year being audited or in prior years, make sure you have the correction information handy. The auditor will most likely ask for that information. We're actually co-hosting a webinar February 24th called "Pitfalls of a 401(k) Audit: What You Need to Know". We will be talking about audit readiness, some of the more common issues we note during the audit, and other topics. The link is here and it's free: https://register.gotowebinar.com/register/6794741519587475289. I think it'll answer some of your questions. You'll have an opportunity to ask questions during the session. I hope it helps.

I suppose it depends on whether or not the DB contribution is mandatory or not. If their MRC is 0 then they could skip DB funding and do the 25% DC.

I say nothing about how, or even whether, some concept of a predecessor employer might affect a situation of a kind Old Reliable describes. Rather, I note only: Congress did not enact a definition of predecessor employer for Internal Revenue Code § 414A(c)(4)(A). The Treasury department has not yet interpreted what “predecessor employer” means for I.R.C. § 414A(c)(4)(A). I’m aware of other law that sets or interprets a concept of predecessor employer for other purposes or conditions. I don’t say anything about how those other uses might affect or influence any interpretation of I.R.C. § 414A(c)(4)(A). A plan’s sponsor or administrator might get its lawyer’s (or other IRS-recognized practitioner’s) advice and consider the range of possible and plausible interpretations.

The Labor department’s Voluntary Fiduciary Correction Program, at its § 7.6(b), suggests, indirectly, an opportunity to correct a fiduciary’s breach in paying, or allowing to be paid, from plan assets an expense that was not a proper plan-administration expense. While there are some further conditions and details, the correction is mostly about restoration or disgorgement, whichever is the greater recovery for the plan. https://www.govinfo.gov/content/pkg/FR-2025-01-15/pdf/2025-00327.pdf A VFCP no-action letter affords some relief from some ERISA title I civil investigation and civil penalties. I don’t know what might obtain tax law relief. This is not advice to anyone.

From ERISApedia. I assume it is cool to post this, lots of people post the EOB. Anyway, great textbook, I rely on it heavily! In short it is not as clear as I had thought. Mandatory automatic enrollment (MAE) does not apply to a plan year if, as of the beginning of the plan year, "the employer maintaining such plan (and any predecessor employer) has been in existence for less than 3 years." [Code §414A(d)(4)(A); Prop. Treas. Reg. §1.414A-1(d)(4)(i)] The proposed regulations do not define predecessor employer. The Section 415 regulations [Treas. Reg. §1.415(f)-1(c)(2)], which look to whether the new employer substantially continues the business of the old employer, might be a good starting point for making a good faith interpretation of the statute. Under those regulations, a predecessor employer is defined in one of two ways, depending on whether the company being evaluated continued the plan of the earlier company. In particular, the regulation provides that, if the current employer continued the prior plan: [A] former employer is a predecessor employer with respect to a participant in a plan maintained by an employer if the employer maintains a plan under which the participant had accrued a benefit while performing services for the former employer (for example, the employer assumed sponsorship of the former employer's plan, or the employer's plan received a transfer of benefits from the former employer's plan), but only if that benefit is provided under the plan maintained by the employer. On the other hand, if the current employer did not continue the prior plan (i.e., the benefits in the current employer’s plan were all accrued while the employees worked for the current employer): With respect to an employer of a participant, a former entity that antedates the employer is a predecessor employer with respect to the participant if, under the facts and circumstances, the employer constitutes a continuation of all or a portion of the trade or business of the former entity. Example 14.4.27 Fresh Foods swings open its doors on October 1, 2025, ready to serve the community, and promptly establishes a calendar year 401(k) plan. As a brand-new business, Fresh Foods gets to enjoy the "new kid on the block" exemption from MAE. This reprieve lasts until the plan year starting January 1, 2029. For now, the team can focus on stocking shelves and slicing compliance red tape. Example 14.4.28 Now imagine a twist: Fresh Foods, while newly incorporated, buys out Ed’s Good Groceries, which has been serving the same location since 2015. Fresh Foods also keeps many of Ed’s long-time employees. This changes the game. Since Fresh Foods continued Ed’s operations, Ed’s is likely a predecessor employer, and Fresh Foods can’t claim the new business exemption. The MAE rules kick in right away, applying from the moment the 401(k) plan is established.

I just don't see any basis for any sort of predecessor issues. My understanding has always been the only way that could happen is if the buyer maintains the plan of the seller, or some sort of spin-off. Are you saying that a straight asset sale, where the new buyer just so happens to hire some or all of the existing employees might somehow be considered not a new employer?

Under the Treasury’s proposed interpretation, an Internal Revenue Code § 414A(c)(4)(A) new-business exception is available “if, as of the beginning of the plan year, the employer maintaining the plan (aggregated with any predecessor employer) has been in existence for less than 3 years.” Proposed Treas. Reg. § 1.414A–1 A(d)(4)(i) (emphasis added). The Treasury’s notice of proposed rulemaking states: “Comments specifically are requested on whether guidance is needed to define the term ‘predecessor employer’ as used in section 414A(c)(4)(A) of the Code[.]” Internal Revenue Code § 414A(c)(4)(A) does not state or refer to a definition of predecessor employer. https://www.govinfo.gov/content/pkg/USCODE-2023-title26/html/USCODE-2023-title26-subtitleA-chap1-subchapD-partI-subpartB-sec414A.htm The proposed rule includes some interpretations about plan mergers. The proposed rule includes some interpretations about business mergers, and about other transactions that result in a different § 414(b)-(c)-(m) employer. But § 414A is not in any of § 414(b)-(c)-(m)’s lists of Internal Revenue Code provisions for which a § 414(b)-(c)-(m) definition of the employer applies. The Treasury proposes that a final rule (if published and effective) applies “to plan years that begin more than 6 months after” notice of the final rule is published. “For earlier plan years, a plan [is] treated as having complied with section 414A if the plan complies with a reasonable, good faith interpretation of [Internal Revenue Code] section 414A.” Observe too that a final rule the Treasury might make would be an interpretive rule, not a legislative rule Congress directed. A Federal court might be persuaded by, but does not defer to, the Treasury’s interpretation. At least for 2026, a plan’s sponsor or administrator might get its lawyer’s advice and consider the range of possible and plausible interpretations. More than one interpretation could be a substantial-authority interpretation. And even if one seeks the higher more-likely-than-not standard, more than one interpretation might meet that standard. This is not advice to anyone.