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401(k) deferrals - double deduction or not


Guest 401kbee
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Guest 401kbee

ER had a hickup with payroll. Didn't deduct contributions. Would it be fair to double up next paycheck or rather make up the contribution in the form of a QNEC. Where does this stand with the EBSA? would they be the body guiding this?

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I'm assuming that this is a calendar year plan and the failure to deduct occurred in 2007. Send a memo to affected employees giving them the opportunity to increase one or more future payroll deductions to make up for the omissions.

If you're straddling plan years or there is a very short amount of time left in the plan year, this is a much more difficult case.

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Guest Truth

I would not recommend that outcome.

See Revenue Procedure 2006-27 - - Section 6, Part .02(7) states that "If a Qualified Plan has an Operational Failure that consists of excluding an employee that should have been eligible to make an elective contribution under a cash or deferred arrangement or an after-tax employee contribution, the employer should contribute to the plan on behalf of the excluded employee an amount that makes up for the value of the lost opportunity to the employee to have a portion of his or her compensation contributed to the plan accumulated with earnings tax free in the future." (http://www.irs.gov/pub/irs-irbs/irb06-22.pdf, Page 956).

While people are quick to suggest that outcome, I haven't seen anywhere in the guidance that permits anything other than an employer contribution here.

Similarly, the last EPCRS Revenue Procedure (2003-44) states that for a partial year failure of this type, "The employer makes a corrective contribution on behalf of the excluded employee that satisfies the vesting requirements and distribution limitations of [iRC Section] 401(k)(2)(B) and ©."

I could see how people could reasonably argue over whether to use the full amount that should have been deferred, or 1/2 that group's ADP rate, but I just don't understand how you could justify no corrective contribution at all.

On the correction method above, does the plan allow the participant to change their deferral election daily? If not, that might create another operational failure...

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Guest Truth

A payroll error which causes an employee who was supposed to defer into the plan to not be able to defer into the plan. Sounds like the payroll error caused this employee to be excluded from the plan, if only for one payroll.

What if the plan only has quarterly deferral election changes? You are causing another operational failure (or possibly two more) by allowing the participant to double up the next pay period and then going back to normal after that.

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Many corrections expressly permitted by EPCRS or if not expressly permitted within the spirit of EPCRS are technically operational diversions. The IRS is not looking to play gotcha with plans and employers.

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Guest Truth

I've read Rev Proc 2006-27 and Rev Proc 2003-44 cover to cover dozens of times. This isn't within the spirit of EPCRS. The "spirit" of the EPCRS is that employees are returned to the position they would have been in, had the error not occurred. Shorting an employees take home pay in future paychecks to make up for an employer error is not returning them to the position they would have been.

What if this was 6 payrolls instead of 1? What if it was 15? You'd probably be telling me it's the employee's responsibility to monitor their paycheck. I'd respond with the same quote from 2006-27, above.

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Truth, obviously one of the key facts is that it was just 1, not 6 or 15. Let's just agree to disagree. If you are ever faced with this situation (one payroll error), please let us all know what your client's reaction is when you tell him or her that he/she has to make QNEC contributions.

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Guest Truth

I have been faced with this error, and the employer didn't care at all when I advised a QNEC of 1/2 the nHCE's rate for one payroll. We're not talking about a lot of money here.

Using high numbers let's say he makes $50,000 and the nHCE ADP rate is 5%. That's $1923 per payroll (bi-weekly). 2.5% of that is $48. Gee, a $48 QNEC to remain in compliance. And that's with relatively high numbers, since few plans have nHCE rates of 5%.

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Guest Truth

And another thing, if you're advising something that is not in the EPCRS, I hope you're a lawyer, because if you're not it's an unauthorized practice of law. If you are a lawyer, it's just bad legal advice. It's one thing to read EPCRS, and then make recommendations based on examples given. It's another to recommend solutions not offered by EPCRS.

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"I've read Rev Proc 2006-27 and Rev Proc 2003-44 cover to cover dozens of times. This isn't within the spirit of EPCRS. The "spirit" of the EPCRS is that employees are returned to the position they would have been in, had the error not occurred. Shorting an employees take home pay in future paychecks to make up for an employer error is not returning them to the position they would have been."

I think that perhaps your many readings have been unnecessarily rigid in this regard. I don't know of anyone else who takes this interpretation. In fact, these employees were not really excluded from participation. And if they are "shorted" in their next paycheck, that places them in the same position they would have been otherwise, since their prior take home paycheck was LARGER than it should have been. I do believe that most of us would argue that this is precisely in the spirit and overriding principles of 2006-27.

There is actually specific support for this general idea, in a situation where employees are actually improperly denied the opportunity to defer. Take a look at Appendix B, Section 2, .02(F). Since this clearly and specifically allows for a result where the employer is NOT required to do the make-up contribution that you deem is required, in a situation where an employee is ACTUALLY excluded - then it would seem absurd to not allow a similar fix in a situation which is far less egregious.

But heck, if your employers don't mind paying the extra money, there's certainly nothing wrong with your approach. I just don't believe it is required.

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I do believe that most of us would argue that this is precisely in the spirit and overriding principles of 2006-27.

There is actually specific support for this general idea, in a situation where employees are actually improperly denied the opportunity to defer. Take a look at Appendix B, Section 2, .02(F). Since this clearly and specifically allows for a result where the employer is NOT required to do the make-up contribution that you deem is required, in a situation where an employee is ACTUALLY excluded - then it would seem absurd to not allow a similar fix in a situation which is far less egregious.

But heck, if your employers don't mind paying the extra money, there's certainly nothing wrong with your approach. I just don't believe it is required.

Yep, I'd sure argue that!

A one time missed deduction that's noticed immediately within the same plan year can, as Belgarath noted under App B, Sec 2, be fixed by simply taking the deduction in the next pay period. The two things I would look at are 1) did the EE miss out on any match which might need to be corrected after the extra deduction is taken and 2) is two times the EE's deduction % greater than the plan's allowed deferral %, in which case I'd be extra careful to document why the higher % was taken on that subsequent paycheck.

After the second payroll is run and the double deduction is taken, as long as any lost match is corrected, then the employee will be in the same position as he/she would have otherwise been after that same payroll.

Kurt Vonnegut: 'To be is to do'-Socrates 'To do is to be'-Jean-Paul Sartre 'Do be do be do'-Frank Sinatra

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Guest 401kbee

thank you all for you comments, It seems as if we are going to be creating a memo for participants regarding a double deduction. The plan is very flexible to allow for payroll period deferral changes, and the max deferral percentage is 70%. You did make a good point regarding the match. They do have a match, so must be careful on reporting the deductions separately so that participants receive their proper match. Now with regards to any gain or interest owed, would that be credited as a straight ER contribution subject to vesting or would that come in as a QMAC?

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Now with regards to any gain or interest owed, would that be credited as a straight ER contribution subject to vesting or would that come in as a QMAC?

If you're using a fixed rate of interest, it should be neglible amount for one pay period. We always just stuck ours in w/ regular ER contributions. I'm not aware that we ever did it as a QMAC.

Kurt Vonnegut: 'To be is to do'-Socrates 'To do is to be'-Jean-Paul Sartre 'Do be do be do'-Frank Sinatra

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Steelerfan, the plan asset reg. is not pertinent here because this is an issue of money not being withheld (as opposed to withheld money not being deposited).

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Steelerfan, the plan asset reg. is not pertinent here because this is an issue of money not being withheld (as opposed to withheld money not being deposited).

I'm not sure your thinking straight on this. The failure to withhold does not get you out of the plan asset reg because the amounts become plan assets as soon as they can be reasonably segregated from the general assets of the employer even if they forgot to withhold the money. As a matter of payroll, whether or not the amount is coded and "withheld" properly, the amount sits in the employers GL until it is tranmitted to the plan. The issue as you say "withheld money not being deposited" is really a fiction--the "withheld" money stays put until transmission to the trust (unless the ER is evil). The glitch of forgetting to withhold doesn't take away the obligation to pay the money (which is still sitting where it would normally be had it been "withheld") to the trust. This was one of the first cases I ever worked on.

Under your logic the failure to withhold deferrals would never raise a DOL concern? Not true. There are two issues under the plan asset regulations. One is the failure to withhold, which creates a "sole benefit" issue--i.e. holding on to $ the employer is no longer entitled to--the ER "benefits" from having use of the $. DOL would be very concerned about systematic failures to withhold as a breach of the terms of the plan, fiduciary duty and use of the assets not for the sole benefit of participants and beneficiaries and a prohibited transaction.

The regulation requires that employee contributions be transmitted to the plan and properly invested at the time that employee contributions can reasonably be segregated from the employer's general account, but in no event later than the 15th business day following the month in which the participant contributions are received by the employer.

If the employer screws up its payroll and forgets to withhold, the plan asset clock starts to tick. If you notice the problem any time after the amounts would normally have been transmitted to the trust, I would think the DOL compliance program would be on the agenda.

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the amounts become plan assets as soon as they can be reasonably segregated from the general assets of the employer even if they forgot to withhold the money.

Wow. I find that pretty extreme. How can they segregate the assets if they don't have them?! Remember, the money went to the participants (and some to tax withholding, I would guess); it's not like the employer is holding anything here.

Ed Snyder

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SF: What reg are you looking at? The plan asset regs apply to "amounts that a participant has withheld from his wages by the employer, for contributions to the plan". If the employer fails to withhold the contributions from the employee's wages there are no "plan assets" subject to the plan asset regs. The purpose of the plan asset reg was to prevent the employer from using employee contributions that were withheld from the employee's pay for its own benefit. Until the employee's contribution is withheld from the employee's pay by the employer it is not a plan asset.

I dont see what the PT issue is since the employer does not withhold any funds from the employee's pay but pays them to the employee the funds never become plan assets subject to ERISA or 4975.

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the amounts become plan assets as soon as they can be reasonably segregated from the general assets of the employer even if they forgot to withhold the money.

Wow. I find that pretty extreme. How can they segregate the assets if they don't have them?! Remember, the money went to the participants (and some to tax withholding, I would guess); it's not like the employer is holding anything here.

They are obligated to make the contribution under the terms of the plan. The amounts were wrongly paid to the participant, you're right, but the plan is entitled to the money and employer has the obligation to pay, so I guess I'm saying the employer has use of the money it must still pay to the plan, even though the participants has been "overpaid", as has been pointed out.

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The er doesnt have any "use of the money" because contributions are never withheld from the employee's wages. E.g., employee elects to defer 10% of weekly pay of $1000. If employer fails to withhold $100 employer pays employee $1000 less withholding and employer withholdws bupkis from the employee's pay.

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The er doesnt have any "use of the money" because contributions are never withheld from the employee's wages. E.g., employee elects to defer 10% of weekly pay of $1000. If employer fails to withhold $100 employer pays employee $1000 less withholding and employer withholdws bupkis from the employee's pay.

I understand. there's just something not right that I can't put my finger on. I think this raises a different problem than the plan asset reg--its' the exclusive benefit rule and plan's right to receive the contribution. The DOL has indicated that a prohibited extension of credit may occur if fiduciaries fail to take appropriate steps to collect delinquent contributions, including employee deferrals that are not timely paid over to the trust. [PTE 76-1, 41 Fed. Reg. 12740 (1976)]

Clearly, as a fiduciary, the employer had a duty to withhold contributions and remit to the trust. If ER fails to withhold $, the employees could certainly sue on behalf of the plan, even though they got the money in their pay.

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