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SEP, Improper Deferrals, How to Clean Up situation?


Guest Gerry Hedgcock
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Guest Gerry Hedgcock

Mr. Lesser, I appreciate very much your reply to my question on improper deferrals. At this point we are trying to decide the best way to "clean up" the situation. The employer has been making a uniform contribution to all eligible employees. The improper salary deferrals are more properly characterized as voluntary employee IRA contributions which have been subject to FICA/Medicare but not income tax. Some of these voluntary EE IRA contributions are in excess of the annual $2,000 limit. The most logical solution and the most time consuming would be to amend the W-2's and personal tax returns of the employees for 1997 and 1998. Their ability to deduct the IRA contribution would then be dependent on their individual income levels and any excess contributions over the annual limit would be subject to the 6% excise tax and need to be refunded.

The most expedient method, if permissable, would be to distribute all of the employee IRA voluntary contributions in 1999 and subject the payment to ordinary income and the 10% penalty, if applicable, in 1999.

Question: Are both of the above methods available without disqualifying the SEP arrangement? Can you recommend a third party administrator for a 457 plan which would permit an independent broker to handle the investment side.

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1. Once the money goes into the IRA, it is controlled by the employee - you couldn't require payment of the entire (or any part) of the IRA, as it is the individual's IRA (whether the contribution is made through a SEP arrangement or the "voluntary" arrangement that you describe).

2. An alternative might be to try to recharacterize the arrangement as a SEP arrangement, with the higher limits. You could amend the FICA filings - although it may take a while for the employees to get their share back. This depends on whether you have an argument that the SEP requirements (such as contributions for all ees with service in 3 of the 5 years) is met.

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The answer depends upon the facts. The degree of faith one gets from the answer, therefore, stroingly related to the facts. Now, if they are "payroll deduction IRAs" and amounts were defered in excess of $2,000 then they are also subject tpo tax and become the employee's problem. However, it is unlikely that the trustee or custodian wd accept such large amounts. Therefore, (I'd wager) that they were contributed and designated as SEP contributions--and therein the problem lies. What did the employees sign if anything to have their wages "reduced" or "set-aside?" What other informationwas provided? E/ee don't just suffer a reduction in pay w/o knowing what it is. The saga continues...

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