ineligible employee defers

[k man]

client discovered after the money had been deducted from paycheck and remitted to the plan. do you treat this like an excess deferral under 402(g) or is there some other way to return the money?

[david rigby]

Not sure if that is covered explicitly, but you can look at the IRS correction program here:

http://benefitslink.com/IRS/revproc2003-44.shtml

Is there another paycheck this year? If so, can you use a neagtive deduction to effectively reverse the incorrect deduction? (Ask your ERISA attorney if that is acceptable.)

[Guest ptpnthr]

An ineligible deferral should be corrected under EPCRS. Often, in such a case, you distribute the $ plus earnings and document what you did. But there are a lot of rules and you need to look at EPCRS in the link above or higher a benefits counsel/consultant who can help you with it.

[R. Butler]

We have treated like a 402(g) excess in the past.

[k man]

if you treat like 402(g) excess you then you forfeit earnings, correct? someone in the office wants to treat it as a mistake in fact. i dont think it is this but there is not much information on mistake in fact contributions.

[R. Butler]

We don't forfeit the earnings; we distribute the earnings just like with any 402(g) excess.

[k man]

what do you think about mistake in fact. erisa 403

[R. Butler]

I'd be hesitant to say inclusion of an ineligible employee is a mistake of fact. I use mistake of fact only for typo's and maybe math errors.

[TBob]

I agree that you should not try the mistake of fact route here. That term gets thrown around alot in the industry but my understanding is that the IRS gives it a very narrow definition.

If you correct this under EPCRS and distribute the ineligible deferrals with earnings, how do you tax report the distribution? Should it go on a 1099R? What Distribution Code? In the past we reported this on a 1099Misc. Is this correct?

[FundeK]

If the participant was allowed into the plan due to a payroll clerk miskeying in the date of hire, wouldn't that be considered a mistake in fact? It would be a typo as R. Butler indicated. The date of hire was in fact mistaken, thus allowing early entry.

[R. Butler]

If you correct this under EPCRS and distribute the ineligible deferrals with earnings, how do you tax report the distribution? Should it go on a 1099R? What Distribution Code? In the past we reported this on a 1099Misc. Is this correct?

I rarely do the 1099's, but I am fairly confident that we treat exactly like a 402(g) excess. We use the 1099-R & use code 8 (at least I think code 8).

If the participant was allowed into the plan due to a payroll clerk miskeying in the date of hire, wouldn't that be considered a mistake in fact? It would be a typo as R. Butler indicated. The date of hire was in fact mistaken, thus allowing early entry.

I would not treat deferrals by an ineligible participants as a mistake of fact, even if the payroll clerk entered an incorrect hire date.

[FundeK]

This probably isn't correct, but it is what we did at my previous employer.

We sent a check (for the contribution amount), addressed to the company, and instructed the to run it through their payroll system and withhold normal payroll taxes. WE did not issue a 1099. We forfeited the earnings. If there were no earnings, we sent a check to the company for whatever we were able to generate with the trades, and the company was responsible for making up the difference when they paid the funds back to the participant.

How far off the mark was that procedure?

[R. Butler]

How far off the mark was that procedure?

It may not be off the mark; we just don't handle it that way. Unfortunately, I have seen very little guidance on specific correction methods other than the plan amendment correction method found in all of the EPCRS Rev. Proc. Most plan sponsors don't want to amend & make the employee eligible, treating it like a 402(g) failure seems like a "reasonable & appropriate" correction method to me.

[Harwood]

IRS speakers state that it is not acceptable to distribute the ineligible deferrals directly to the participant and report such on a 1099-R. There is nothing in the Code or Regulations or published procedures to support this type of distribution. To do so might place the tax qualification of the plan at risk.

An early version of the CORBEL GUST document had a provision for distributing ineligible deferrals back to the employee from the Trust. That paragraph was removed from the final document - I assume because the IRS wouldn't allow it.

Some material is at www.mhco.com/Chronological_Updates/Distribution,%20Reporting-Ineligible%20Employee.htm

[mbozek]

I thought that a refund of excess contributions is available only for eligible participants. If an employee is ineligible then the contribution should be returned to the employer who will issue a payroll check to the employee for which federal and state income tax will be withheld since accepting contributions from an ineligible employee is a mistake of fact. Having the trustee refund the excess contributions does not satisfy state labor law requirements that the employer must pay the wages earned by the employee and may result in underwithholding of income tax.

[TBob]

If you send the ineligible contributions back to the employer, would that not be considered a "reversion of plan assets"?

[mbozek]

Contributions can't be plan assets if they are made by an ineligible person and if leaving them in the trust could disqualfiy the plan. Since the IRS doesnt allow distribution of the deferral via a 1099 the only way to correct the problem is to refund the amount to the employer.

[Mike Preston]

I have always felt exactly as mbozek describes. However, EPCRS seems to have a "theory" that moneys should never be paid out of the plan, even for the reason stated here. I wonder whether the IRS would really do anything to a plan that refunded monies in this situation? I somehow doubt it. However, with that said, since the EPCRS revenue procedure seems pretty clear on the issue, I think a plan Administrator would be well advised to get specific advice from counsel before taking this route without an EPCRS filing of some sort.

[KJohnson]

For what its worth this is from the 2001 ASPA Q&As Obviously this is based on prior guidance when SCP was call APRSC.

34. A 401(k) plan mistakenly allows an employee to defer before he is actually eligible. Under APRSC the plan refunds the ineligible deferrals plus earnings.

We don’t believe APRSC allows for a refund. We would suggest you amend the

eligibility to make the contribution “good”. The next two parts of the

question are moot.

Is the corrective distribution subject to the additional tax imposed by Code

Section 72?

Is the corrective distribution counted as a distribution for purposes of

determining whether the plan is Top Heavy?

Reish and Luftman, at least back in early 2001, thought that a refund to the particpant is an option although they dismissed the "mistake of fact" concept.

http://benefitslink.com/modperl/qa.cgi?db=..._defects&id=143

[KJohnson]

And this is from the 2003 Q&As

49. What is the best method for correcting early entry into 401(k) (i.e., deferring prior to date of eligibility)?

Answer: The normal corrective method is to retroactively conform operation of the plan document. However, it is possible under EPCRS-VCP that a retroactive conforming amendment may be permitted if nondiscrimminatory and otherwise appropriate based on all the relevant facts and circumstances. See Rev. Proc. 2003-44.

[jaw1004]

If the plan sponsor does not want to amend the plan document, how should ineligible deferrals for the 2015 PY be refunded / handled for a terminated employee? The employee actually terminated before he should have even been enrolled in the plan. I've been told to refund the contribution and earnings to the terminated participant and that a 1099 will then be sent. Thoughts /opinions?

[BG5150]

That's what we do. And also place the match and/or safe harbor and/or PS into a suspense account to be used to offset immediate future ER contributions.