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Mid-Year adoption of 401(k)-- IRC 402(g) issues


Guest cgodfrey
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If SIMPLE IRA invalidated, amounts contributed should be shown in box 1 of Form W-2, enter $0, in box 13. Employees sd, but not required, to remove "excess." If nondeductible contributions are not reflected on Form W-2 then the 10 percent penalty may apply.

Apparently, the 6 percent penalty does not apply to a SIMPLE IRA (even if excess not removed timely); when removed after the due date, however, the includible amount may be taxed again when distributed. SIMPLE contributions (unlike SEP contributions) do not increase the amount under IRC 408(d)(5).

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  • 1 year later...
Guest DFerrare

If all of the SIMPLE IRA contributions are returned during the year, can the full 402(g) amount be deferred in the 401(k) plan?

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It is not clear whether the excess can be disregarded for purposes of the $12,000 limit. I think they can be disregarded if "corrected." Whether an actual distribution is made or can be effectuated by an employer may be problematical. It is unclear whether inclusion on Form W-2 is tantamount to a distribution (I think it would be; because the employer does not have any control over the funds in the account). The IRS seems a bit clueless on how IRA-based plans actually work; they assume (and have for some time) that the employer actually can implement or effectuate a distribution. Notice, too, that the IRS has never issued any guidance regarding distribution of excess SIMPLE-IRA contributions.

Whether they are disregarded for ADP testing, see below.

Aside: in a recent EPSRS submission, the IRS waived the 10 percent penalty for assets retained in a SIMPLE (not distributed) upon a qualification failure (employer had 2 plans). The practitioner's argument was that the employer had no control, rights, and so on. It seemed to work.

Treasury Regulation 1.408(g)-1(e)

(1) PLAN QUALIFICATION --

(e) TREATMENT OF EXCESS DEFERRALS --

(i) Effect of excess deferrals. For plan years beginning before January 1, 1988, a plan, annuity contract, simplified employee pension, or trust does not fail to meet the requirements of section 401(a), section 403(b), section 408(k), or section 501©(18), respectively, merely because excess deferrals are made with respect to the plan, contract, pension, or trust. For plan years beginning after December 31, 1987, see section 401(a)(30) and section 1.401(a)- 30 for the effect of excess deferrals on the qualification of a plan or trust under section 401(a). For purposes of determining whether a plan or trust complies in operation with section 401(a)(30), excess deferrals that are distributed under paragraph (e)(2) or (3) of this section are disregarded. Similar rules apply to annuity contracts under section 403(b), simplified employee pensions under section 408(k), and plans or trusts under section 501©(18).

(ii) TREATMENT OF EXCESS DEFERRALS AS EMPLOYER CONTRIBUTIONS.

For other purposes of the Code, including sections 401(a)(4), 401(k)(3), 404, 409, 411, 412, and 416, excess deferrals must be treated as employer contributions even if they are distributed in accordance with paragraph (e)(2) or (3) of this section. However, excess deferrals of a nonhighly compensated employee are not taken into account under section 401(k)(3) (the actual deferral percentage test) to the extent the excess deferrals are prohibited under section 401(a)(30). Excess deferrals are also treated as employer contributions for purposes of section 415 unless distributed under paragraph (e)(2) or (3) of this section. [Note: IRC 408 not mentioned in this paragraph}

(iii) Definition of excess deferrals. The term "excess deferrals" means the excess of an individual's elective deferrals for any taxable year, as defined in section 1.402(g)-1(b), over the applicable limit under section 402(g)(1) for the taxable year.

(2) CORRECTION OF EXCESS DEFERRALS AFTER THE TAXABLE YEAR.

A plan may provide that if any amount is included in the gross income of an individual under paragraph (a) of this section for a taxable year:

(i) Not later than the first April 15 (or such earlier date specified in the plan) following the close of the individual's taxable year, the individual may notify each plan under which deferrals were made of the amount of the excess deferrals received by that plan. A plan may provide that an individual is deemed to have notified the plan of excess deferrals to the extent the individual has excess deferrals for the taxable year calculated by taking into account only elective deferrals under the plan and other plans of the same employer. A plan may instead provide that the employer may notify the plan on behalf of the individual under these circumstances.

(ii) Not later than the first April 15 following the close of the taxable year, the plan may distribute to the individual the amount designated under paragraph (e)(2)(i) of this section (and any income allocable to that amount).

(3) CORRECTION OF EXCESS DEFERRALS DURING TAXABLE YEAR --

(i) A plan may provide that an individual who has excess deferrals for a taxable year may receive a corrective distribution of excess deferrals during the same year. This corrective distribution may be made only if all of the following conditions are satisfied:

(A) The individual designates the distribution as an excess deferral. A plan may provide that an individual is deemed to have designated the distribution to the extent the individual has excess deferrals for the taxable year calculated by taking into account only elective deferrals under the plan and other plans of the same employer. A plan may instead provide that the employer may make the designation on behalf of the individual under these circumstances.

(B) The correcting distribution is made after the date on which the plan received the excess deferral. 

© The plan designates the distribution as a distribution of excess deferrals.

(ii) The provisions of this paragraph (e)(3) are illustrated by the following example:

EXAMPLE. S is a 62 year old individual who participates in Employer Y's qualified cash or deferred arrangement. In January 1991, S withdraws $5,000 from Y's cash or deferred arrangement. From February through September, S defers $900 per month. On October 1, S leaves Employer Y and becomes employed by Employer Z (unrelated to Y). During the remainder of 1991, S defers $1,800 under Z's qualified cash or deferred arrangement. In January 1992, S realizes that S has deferred a total of $9,000 in 1991, and therefore has a $525 excess deferral ($9,000 minus $8,475, the applicable limit for 1991). An additional $525 must be distributed to S before April 15, 1992, to correct the excess deferral. The $5,000 withdrawal did not correct the excess deferral because it occurred before the excess deferral was made.

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  • 3 weeks later...
Guest jim williams

What if the Simple IRA plan consisted only of employer contributions of 3% of comp for the first half of the year but has not yet been funded? There are no salary deferral contribuitons. Can the employer fund the Simple IRA employer contribution and then establish a traditional 401(k) for the remaining of the year?

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You can have one, but not both, of the plans for the year. Can not mix and match during any calandar year period (exclusive plan rule). No overlapping plan years. Short QP plan years must end before the CY begins.

The Simple plan provisions appear to have already been violated; the 3 percent contribution is a matching contribution. How can there have been a match when no elective contributions have been made. IMO, the plan has been funded. The Simple-IRA already contains excess contributions (i.e., contributions not received under a qualified salary reduction arrangement, see IRC 408(p)(2)).

But, "yes," they can adopt a 401(k). See above posts for treatment of excess SIMPLE IRA contributions.

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