Leaderboard

I agree with your interpretation, in fact I think it's the only reasonable interpretation. Instead of 10/1, say we have someone who enters the plan on 1/1 - which is always a holiday. If they were allowed to defer from the previous paycheck, they would have contributions in the plan not just before their entry date, but actually in the prior plan year, which is problematic for lots of reasons.

I suggest providing these details to the recordkeeper. They should be able to zero out the participant's account and move the money (including any earnings) to a company account or forfeiture account within the plan. You can then deal with how best to apply the dollars in the plan that are due to the payroll error. Any recordkeeper that has been in the business for even a short while has had to deal with payroll errors where too much money is in the plan that doesn't rightfully belong to any participant.

It's going to be deducted on the 1040 so I'm not sure it matters which account it comes from as long as they keep good records and the accountant can follow it for deductions and you're able to support it to the IRS in the event of an audit. If it was me, I'd do it from the LLC bank account.

My experience may not be universal, but among other things: The 990 reporting, usually done by someone not administering the plan, is complicated with amounts credited, vested, taxed, distributed, or reported in prior years potentially all happening in one year. The participants do not see the value in receiving distributions to pay taxes, only to wait several years (or more) to actually receive a benefit, particularly where they leave employment before payment is made and they have been taxed on money that remains available to their former employer's creditors. Depending on the plan type, to calculate the taxable amount in a given year they may need to do present value calculations with unknown variables. As Carol notes, with other plan types, tax is imposed on vesting, then again on later earnings upon distribution. While not double-taxed, it's another set of calculations/recordkeeping. If any of this is done incorrectly or overlooked for a year because no one thought to look for amounts vesting (but not due) in a given year, tax returns must be amended, etc. 409A. Inevitably one of the employees will ask to accelerate payment after several years of paying taxes with no benefit. If you don't calculate the participant's estimated tax rate, or if you simply use the supplemental rate, and the participants are highly paid, they will owe more in tax when they file their return than was distributed to them on vesting/taxation. They will be unhappy. Usually a separate bonus will be paid to make them whole. Payroll software, or the people using it who may not be used to working with the above issues, can make it difficult to accurately reflect all of the above. Again, not all of these are always problems, but together they can make what would otherwise be a very simple plan design (contribution, earnings, vest, pay, withhold, tax, report) far more complicated. Just my two cents.

Sometimes we need to step back and see if we are solving a real-world problem or just enjoying a stimulating intellectual conversation. dragondon, since you are asking the question in September 2023 about a 5500 for calendar year 2022 plan, I must ask as there a Form 5558 Application for Extension of Time To File Certain Employee Plan Returns filed for the plan before August 1st (or is the taxpayer's 2022 income tax return otherwise on an approved extension)? If yes, then why bother discussing whether to file the 5500. Just do it. The filing will be trivial and you will not have to explain later why an extension was requested. If no, then I can understand it is worth the effort to look for an acceptable reason why the plan is not required to file for 2022. Facing the prospect of paying a bazillion dollar penalty for a late filing would be particularly unpalatable for a new plan. I have seen situations where a plan had reasons to argue whether having no assets meant the plan technically did not exist or was not fully formed. Where this has involved a new plan, an argument (simplified) is along the lines that a plan with no assets does not have a trust, and a trust is required for the plan to exist. This is not advice, and I do not advocate taking this position. If the plan is facing major penalties, I do suggest finding an attorney who has experience working (successfully?) with clients that have been in similar situations.

Agreed

I take it that it was the client that decided not to listen to the advice given by the legal team, and not the case of the legal team not listening to your advice. I am surprised that the legal team believes that a hold harmless agreement provides your firm sufficient protection. I cannot imagine this agreement would protect your firm from involvement should the participants (or the DOL or IRS) sue the plan to get them their top-heavy contribution. But, like Lou, I am not a lawyer. Some things are clear. The plan cannot avoid being top-heavy by refunding contributions to key employees. The IRS will not recognize this as a cure and likely, if discovered, will tell the company to make the top-heavy contribution or have the plan disqualified for not following the terms of the plan. Leaving the earnings on the deferrals in the plan is a bizarre decision. The earnings do belong in the plan, as do the contributions. If the company wanted to make this look like a correction, it failed. All correction methods require the earnings to be taken out of plan alongside any refunds of excess amounts. This only highlights the company's disregard for compliance. If you or others in your firm hold almost any professional designations or belong to professional organizations (e.g., CPA, EA, ERPA, QPA, QKA, ... or AICPA, ASPPA, NAPA, PSCA, ...), you are subject to a code of professional ethics. I strongly suspect that your professional credentials and membership are at risk for not only following the company's direction but also preparing replacement documentation that masks the facts. It would be interesting to hear from others on BL their opinion on the application of professional ethics codes in this situation. And now for the really tough decision. On a personal note, I would not prepare or put my name a test showing a $0 contribution for the owner. I also would not falsify any information on a 5500. If your employer or the legal team believes these actions are acceptable, then let them prepare and put their name on it (and you can take comfort that you can find work, including remote work, at a reputable firm within a week). This is not advice, and is somewhat overly dramatic, but there are some realities here that cannot be ignored. May you be at peace with whatever is your decision on how to respond this situation.

Payroll error seems more like an amended W-2 and not a 1099-R issue.

I agree 100% with Paul I. Not willing to risk my credentials for outright fraud. Ethics is a big factor in how this is reconciled.

I'll agree too! (And add, this at least smells more like a reasonable claim for "mistake of fact" than most excuses folks try to throw out there. But definitely just fix it the easy way as everyone above is suggesting.)

I "third" that motion...transfer to forfeiture account!

Makes sense. The compensation was made available to the person on 9/29, a date before the effective date of participation which is the earliest date any salary deferral could be effective.

Agree with Paul. Just move the dollars to a forfeiture/suspense account and have the company use it to offset a contribution. Don't overcomplicate it.

I have been involved with a few of these for clients - all put in place prior to my involvement - and every one of them has regretted it. I understand the logic behind the plan design, but from a taxation, withholding, 990, payroll reporting, recordkeeping, etc. standpoint it's a real pain.

The major issue is that they then have a plan subject to 409A, and need to make sure it complies. The investment earnings are not taxed until distribution.

It would help if you could be more explicit about the circumstances. Was the employee: terminated from employment, paid in full any and all compensation due to that employee, and then another paycheck was given to the now terminated employee even though the terminated employee was no longer entitled to any further compensation? If this is the case, then the situation is totally a payroll screw up and none of the money in the plan belongs to the participant. You could work with the recordkeeper to have the amounts removed from the employee's account, and possibly made available to pay a plan expense. If the circumstances are that any part of the paycheck represents compensation due to the participant, then payroll should void the paycheck and reissue a paycheck to the now terminated employee for the correct amounts. Any amounts that are in the plan that do not belong to the employee may be treated as above, and any amounts that to belong to the employee can be paid or forfeited under the terms of the plan. Keep in mind that this approach hinges on whether any part the paycheck was actual compensation due to the employee. If the answer is yes, then the plan received in part or whole some amount of a legitimate contribution that must be dealt with based on plan rules.

still active The definition of retired/separated in the instructions says "i.e., individuals who are retired or separated from employment covered by the plan...." and although that hints at some leeway since "hey does the union job no longer mean covered by the plan?", I think it's generally accepted they count among the actives while their employment with the sponsor is active.

I am 100% sure. You are reporting for the plan year, not the life of the plan. If the distribution took place in a previous year, you are no longer covering that participant, and cannot report them on the current return. I would reference the instructions to the SF and EZ, they are quite clear. A one participant plan is not eligible to file a 5500-SF, it must file on a 5500-EZ. The DOL will likely reach out when you don't file the 5500-SF because they cant tell that you filed an EZ with the IRS. When they reach out, you just tell them that the plan became a one participant plan and was no longer eligible to file an SF. They will tell you to have a good day and that is the end of it.

If his birthdate is October 1, 1961, say, then his social security full retirement age is 67. There is a 5/9ths of 1% reduction for each of the first (or last, depending on how you want to look at it) 36 months that you claim your benefit before full retirement age. And a 5/12ths of 1% reduction for up to 24 more months (67 being the oldest retirement age). So here, the individual would have a 30% reduction in his regular retirement benefit (36 * 5/9ths + 24 * 5/12ths). For someone in good health, it may make sense to wait, even to age 70, where this individual would get a 24% enhancement over the age 67 benefit (8% for each year). But for someone who may have a reduced life expectancy or other compelling reasons to take early, you may be leaving cash on the table, e.g. here, assuming out of thin air a $30,000 annual benefit at full retirement age, you'd be forgoing receiving $105,000 between ages 62 and 67 (5 * .7*$30,000). But then if you lived a long life, beginning at age 67 you'd be missing out on $9,000 a year for the rest of your life ($30,000 - $21,000). So it's worth thinking about. Note that if someone continues to work and earns substantial earnings between the age at which they claim (here, 62) and full retirement age (FRA), then they will have to pay back some of their benefits anyway, so it may not make sense to claim early in that situation. The calculations are explained on the social security website, and you can establish and account and do some what if modeling related to your benefit at certain ages and under certain pre-FRA earnings conditions. However, if you do have substantial earnings and SSA takes some of your benefit back, they add it back to your benefit later when you do reach FRA, as if you had waited to receive that amount. Once you reach FRA, you can earn as much as you want and your benefit is unaffected. The spousal benefit is unaffected by any of this. But precisely because the spousal benefit is unaffected, if the individual really believes he has a shortened life expectancy, and will not have substantial earnings (as computed by SSA, so again check the website) the general advice is to take as early as you can, because once you pass, your own benefit just stops, and therefore you may be leaving money on the table.

justanotheradmin, the audit requirement is determined at the adopting employer level, looking at its participants. If all the MEPs employers satisfy certain conditions, the MEP files a single 5500. But the audit requirement is separate and applies to each adopting employer.

I think if you have a loss, the DOL calculator for earnings is used to calculate the tax but I'm not 100% sure. The Fed underpayment rate might be the correct one, they might be the same, I don't remember. But if you are talking about $25K for a max of 50 days, like I said what is that? 3% is $750 and 15% of that is $112 that probably on the high side. I think the cap on the penalty is something like 25%. So your clients max exposure is likely under $150 even with the penalty if the IRS imposes. Your fee to calculate the lost earnings and prepare the form are probably going to be more than any excise tax in this case.

Yes. Financial information is only one part of the return.

I'm not a lawyer, but it sounds like fraud. I wouldn't touch it.

Yes. Unless it qualifies as a 1 person plan with less than $250,000 in assets. Whether you report an EOY balance and/or contributions will depend on whether you use the CASH or ACCRUAL method of accounting.

If you file the 5500 on an accrual basis, the 12/31/22 asset value would include the deferrals that were withheld but not yet deposited to the trust by EOY. This also avoids the problem of filing the "first year" 5500 for 2023 showing a 2022 plan effective date and having the IRS ask why no 2022 5500 was filed. Given the timeline you mentioned, I would recommend also confirming the timeliness of those deposits if you haven't done so already.

What is your relationship to the plan? Are you the TPA? Advisor? Do you provide recordkeeping services? Was your office the one that processed the reversal? Honestly at this point I'd probably resign. The client should have been told about ADP and TH testing (perhaps they were and it just didn't register) and if they are committed to doing it correctly (they can't even bother to take out earnings correctly?) which the money never should have been removed its an issue. and FYI 5500 are often on accrual basis. The schedules even have lines specifically asking about receivables and liabilities.