Paul I

The final 5500 must show an ending balance with zero assets. Completing the 5500 for 2022 would seem to be trivial unless an audit is required. Check the filing deadline. The date the assets go to zero ends the plan year.

It sounds like the horse is out of the barn. When was this addition to the appendix made to the document? If it was executed after 12/31/2022, it will not be applicable to 2022 (see the TAM). Read the VS document, basic plan document and the IRS approval letter very carefully. They all limit the types of modifications that can be made in "Describe" entries and Appendixes to core plan provisions like eligibility, vesting and allocation conditions. Crossing the line can rescind reliance on the IRS approval letter. You may want to talk to the document provider to confirm your understanding after reading everything. I would be surprised if the provider says this provision is permissible in their document. The fact that they adopted a provision like this without asking you about it in advance makes me feel this will be a toxic client for you - do stuff without telling you, wanting you to fix it when it is screwed up, and probably not wanting to pay for all of the extra effort. Hope not. Good luck.

Take a look at IRS Technical Advice Memorandum 9735001 where the analysis notes "the accrued benefit includes amounts to which the participant is entitled under the terms of the plan, even though the bookkeeping process of crediting those amounts to the participant's account has not actually occurred". Essentially, you cannot take away a benefit after it was accrued under the plan. It also considers whether contribution is discretionary. Interestingly, the 415 regulations 1.415(c)-1(b)(6)(i)(A) notes that "However, if the allocation of an annual addition is dependent upon the satisfaction of a condition (such as continued employment or the occurrence of an event) that has not been satisfied by the date as of which the annual addition is allocated under the terms of the plan, then the annual addition is considered allocated for purposes of this paragraph (b) as of the date the condition is satisfied" which acknowledges that there can be allocation conditions like continued employment up to the date the contribution is allocated. If so, then the annual addition counts in the year the allocation is made. (I believe this provision is intended to address contributions that are made very late or made under certain correction methods.) If there is a path forward for this client, it would be to not lock in the benefit accrual as of the end of the plan year. Lou is right that simply having the 1000 hour/last day allocation condition would not accomplish this. You may be able to add the continued employment requirement. The benefit would become an annual addition in the year it is funded to the plan. (This likely shifts the year of deduction.) In other words, this year's calculation of an accrued benefit is based on last year's hours, compensation, last day of employment and this year's active status on the funding date. The plan likely will have to test for non-discrimination since the allocation formula would not be among the safe harbors. The non-discrimination test would be done for the year in which the contribution is made as opposed to the prior year information used to calculate the benefit amount. Any required contributions such as top heavy, gateways, and similar contributions that have a mandated contributions would still have to be made. What is the client's motivation? Do they feel giving a contribution to a terminated employee is rewarding disloyalty? This is not worth the effort just to be spiteful. Are the annoyed because a terminated participant took a distribution and closed out their account which then is re-opened to accept the new contribution? The recordkeeping industry routinely handles this situation. Something else? I'm sure there are more technicalities to trying to do this. This is one of those times when "just say no" feels like the best choice.

Plan administrators are expected to operate the plan in uniformly and consistently for all participants all the time. Writing a check to the plan should not have happened and it is an operational error that should be addressed. The PA will decide how to address it and will need to be able to defend the fix. Without a prescribed explicit fix to point to in regulations, the PA should be comfortable that the they are not accommodating the participant because the participant is an HCE. It has long been a concern of the IRS that plans should not unduly favor higher paid individuals. In discussing alternative fixes to operational issues, I have asked the PAs if they would be confident explaining, while sitting at the table with an IRS or DOL agent, that their decision was reasonable and fair.

Why was there a concern about getting the contribution invested by 12/31? It is not unusual for the final payroll of the year to be invested after the close of the plan year, and payroll still reports the deferrals as made during the plan year. Did payroll report the amount on the individual's W-2 as a deferral? Were payroll taxes withheld from a paycheck and submitted to the appropriate taxing authorities? The more of these items were not done, the more likely there is no argument for letting the money stay in the plan. If all of the issues associated with the making a deferral are fixed as best as possible, then consider at least writing up a complete description of the circumstances including the payroll error and what was done to fix the issue, and keep the documentation with plan records. Writing a personal check creates a clear trail that the individual had control of the funds - a key requirement for an elective deferral. Hopefully the individual is not a plan fiduciary or an HCE. That would taint the situation even more.

That works as long as all of the HCEs are key employees and key employees are excluded from getting a top heavy minimum contribution. Your design could appeal to a plan sponsor that wants to use liberal eligibility requirements. I have seen more often a plan allowing everyone employed on the effective date to enter immediately upon adoption of the plan, and any new hires after that date are subject to age 21 and 1 YoS (1000 hours or elapsed time) with semiannual entry dates. This gives the plan some time to react to hiring new employees. Being able to adopt a SHNEC feature retroactively is also another available tool to use if there is a concern about new hires causing ADP problems.

Is the PS contribution immediately vested? If not, taking the position this is a CODA could trigger a whole other topic of whether individuals who left employment before reaching full vesting were underpaid. There also could be issues with in-service withdrawals before age 59 1/2. If the plan has immediate vesting and no in-service withdrawals, then they can try to take the position that it operated like a CODA and everyone is in the same place they would be if the plan had all the 401(k) features in place. This would of course also mean that no one's contribution exceeded the annual deferral limits. Too bad anonymous VCPs are no longer available. Good luck!

in Safe Harbor Explanations – Eligible Rollover Distributions IRS Notice 2020-62, the IRS published 2 sample rollover notices - one for distributions not from a designated Roth account, and the other from a designated Roth account. This was before the Form W4-R was released, although I am not aware of any update to the Notice. Both sample rollover notices include this language: For payment not from a Roth account "If your payments for the year are less than $200 (not including payments from a designated Roth account in the Plan), the Plan is not required to allow you to do a direct rollover and is not required to withhold federal income taxes. However, you may do a 60-day rollover." For payment only from a Roth account "If your payments for the year (only including payments from the designated Roth account in the Plan) are less than $200, the Plan is not required to allow you to do a direct rollover and is not required to withhold federal income taxes. However, you can do a 60-day rollover." The key phrase is "the Plan is not required to allow you do a direct rollover". Unless there has been a more recent comment from the IRS, you need to see if the plan requires a cash out of small amounts less than $200. If yes, then based on the above I would say no Form W4-R is required. If the plan is silent on the $200 cash-out or explicitly says these amounts are available for rollover, then you would treat them the same as an eligible rollover distribution.

In a nutshell, if you are an avid (rabid maybe) fan of maximizing Roth and have a non-PBGC combo, you can have Roth contributions up to the maximum annual additions limit in the 401(k) using the conversion of after-tax to Roth and the new SECURE 2.0 provision (if the plan allows) conversion of the NEC to Roth.

As a side question, why did they have a safe harbor in the first place? (A plan with all HCEs would pass NDT by default - 1.401(k)-2(a)(i)(B)(ii).) Nate S is right, the partnership as an entity needs to have formal documentation that the individual contributions are decided and authorized by the partnership. The documentation preferably will show these actions were taken on or before the date the contribution is funded.

How long ago was "many years ago"? Formal, tax-deferred profit sharing plans came into existence in 1916. Cash or deferred arrangements - CODAs - where employees were given a choice to receive cash now or have tax-deferred contribution made to a profit sharing plan became a popular benefit in the 1950s. The IRS Revenue Ruling 56-497 addressed principles of coverage and nondiscrimination. A period of controversy followed which put a damper on new CODAs and ERISA did not address them. The Revenue Act of 1978 subsequently included section 401(k), but it was not until November 10, 1981 when 401(k) regulations were published that CODAs began their meteoric rise in popularity. (I know, because I led the implementation of the plan accounting system for a 9000+ participant 401(k) plan that received the 3rd IRS plan approval.) From the point of the release of regulations going forward fundamentally, if the plan gives an employee the right to receive a contribution in cash now or defer the contribution before it is received into a tax-deferred plan, then the plan is subject to all of the 401(k) rules and regulations. Justatester, the plan's sponsor likely is very proud of their generosity towards their employees and the simplicity of their profit sharing plan. I don't envy your breaking the news to them.

I suggest starting with your plan document. The document should contain the ADP testing rules for the plan including disaggregation rules for testing and the determination of otherwise excludable employees for testing. If you are using a pre-approved document, then this language most likely will be in the associated basic plan document. The provisions I typically have seen refer to the age 21 and One Year of Service rules in IRC 410(a). This section references the 12-month eligibility computation period and the 1,000 hours of service rules. The discussions about using semi-annual entry dates together with the age 21/One Year of Service rule focus on language the IRS has used referring to the "greatest minimum participation requirements". These discussions do not explicitly address the 1,000 rule, but it seems it would be reasonable that the 1,000 rule is a greater minimum requirement than an elapsed time rule. This is not legal advice. Most importantly, follow the document.

I must say in the interest of your long-term financial wellness it is worth participating at some level now. The longer you are in a plan, the easier it is to achieve your financial goals. This is a personal decision, and if you truly do not need to save any more for retirement, then congratulations because you are better off than most. If you currently cannot afford to support a deduction from your paycheck of even a modest amount, then you do have ways to address your situation. Do you have documentation of the election that you filed? For example, do you have a copy of a signed form, or an email/printout of a confirmation of the election from the plan's recordkeeping system? This would go a long way to supporting your position. Hopefully, the documentation shows you made the election in a timely manner to allow time for the election to be provided to and processed by payroll before the payroll check date. If you have this documentation, then the money that was deducted in a plan operational error and the funds should be distributed to you as an Excess Amount. You also should have received a notice about the automatic contributions the would include how to opt out. Also check the Summary Plan Description to see if the plan is an Eligible Automatic Contribution Arrangement (EACA). If yes, then check to see if you can have the amounts already contributed paid out to you. Please note that the government recently adopted new rules that increase the affordability of participating in a 401(k) plan. Some of these features may not be available until next year or the year after that, but stay informed and take advantage of these features as they do become available. Otherwise, you could be leaving money on the table.

You can correct W-2s for the current year and up to three prior years by filing Form W-2c with a Form W-3c. The Social Security Administration will be informed of the changes and likely will correct the earnings history associated with the deceased. This may or may not affect the spouse's benefit depending on whether the spouse is or will be have benefits based on the deceased's earnings history. Hopefully, you do not have retirement plans that include considering in the plan definition of compensation distributions from NQDCs, or considering Social Security benefits in a defined benefit plan formula. I would expect the service providers for those plans would be aware of the death of a participant and would have questioned having W-2 income reported on plan census data. I do wonder if or how the spouse may have been reporting W-2 income reported for the deceased on the spouse's personal tax return. That can be a whole other mess, but it is not really your mess to sort out.

Wait until you get to the discussion about taxable fringe benefits for S-corp owners who own 2% or more of the company. You will need to be careful on how the plan defines compensation for various plan purposes. There is a good article on what is or is not taxable to these owners here: https://www.troutcpa.com/blog/common-fringe-benefits-rules-for-2-s-corp-shareholders-and-changes-under-the-cares-act If the CPA already is having issues, I don't envy you discussing this with him.

The topic of whether a self-employed individual is or is not an employee if the individual has no (or negative) income for a plan has come up when discussing plan administration. This has been an issue in particular for purposes of coverage and compliance testing. There is no conclusive guidance, with closest direction is to be consistent in treating the individual for all plan purposes and this would tie into the individual being otherwise treated as an employee. I expect this is also the case for determining service. With respect to elapsed time rules, the a period of severance of less than 12 months will be included in elapsed time service. One could build an argument that having documentation that the SE individual was compensated for one hour of service would be enough to continue the accrual of elapsed time service. This would not be invalidated if the net earnings from self-employment at year end was zero. I note that being available for service differs from actually performing an hour of service (unless there is some form of on-call compensation). While SE compensation is deemed earned as of the end of the plan year, there is no deemed service rule other than the service spanning rules (including certain leaves of absence, military service...) Good question, with pathways to differing conclusions.

The IRS addressed this situation directly in the article Fixing Common Mistakes - Correcting a Roth Contribution Failure. You can find it at https://www.irs.gov/retirement-plans/fixing-common-mistakes-correcting-a-roth-contribution-failure It offers 2 solutions: Fixing the mistake To fix the mistake of not following an employee’s election to designate the contribution as a Roth contribution you must transfer the deferrals, adjusted for earnings, from the pre-tax account to the Roth account. There are two options on how to report this transfer: The employer issues a corrected Form W-2 and Marcie must file an amended Form 1040 for the year of the failure (2013). The employer includes the amount transferred from the pre-tax to the Roth account in Marcie’s compensation in the year it’s transferred (2014). If the employer elects, it may compensate Marcie for the additional amount she owes in income tax in 2014. This must be included in Marcie’s 2014 income. Note that is says you must transfer the deferrals.

The draft instructions for the 2023 form indicate that the 80-120 rule remains in effect and for 2023 will be based on the 1/1/2023 count of participants with account balances.

The plan just started 1/23. There is a lot of time to address the situation particularly since his net earnings from self-employment will not be determined until the end of the year. The contributions so far should not be treated as elective deferrals. I agree with Peter's observation to consider the contributions already made as non-elective employer contributions. Then the goal for the owner is to have sufficient net earnings at plan year end (after accounting for the reductions due to the already contributed NEC and related employer-paid payroll taxes) to be able to deduct the contribution and not violate plan limits. If his net earnings from self-employment are going to be substantially more, he then can consider making deferrals from future draw payments against self-employment compensation. It likely will take less time to do the math on this than it will to go through the gyrations of terminating a plan that not only has a fully executed document but also has trust assets. There is no "never mind" solution to forget the plan did not exist.

The employee was not eligible so the deferrals are an Excess Allocation and refundable under EPCRS 6.06(2) using the Reduction of Account Balance Correction Method. I agree with CuseFan that scenarios where the individual keeps the account can easily morph into an employee relations issue. Further, is the cost of amending the plan and sending out an SMM to everyone less of a hassle than closing out the account? Also think of all of the effort to track this special amendment as the plan ages, benefits staff turnover, recordkeepers change, special provisions in plan documents are not carried forward proper during a restatement cycle... For the sake of future generations, keep the plan clean.

The amount to be refunded is based on the percentages needed to pass the test. The refunds will be made first from the HCEs with the largest amount of deferrals until such time as all of the amounts to be refunded is paid out. Bottom line, the HCE who maxed out at the deferral is going to have a refund even if all of the amount of the refund is due to the other HCEs.

EPCRS calls these Excess Amounts with respect to employee deferrals and prescribes a refund to the employee with earnings. The refund is taxable to the employee in the year the refund is made, and the amounts are not included in any of the compliance tests. Unfortunately, there is no rule for presuming everything is correct and using that presumption to refuse to correct an operational error. I have seen service agreements that included language that say if an error was due to someone other than the service provider and the error is not timely reported or corrected in accordance with the agreement, then the plan sponsor must pay for the full cost of the service provider's efforts to help make the correction. Just another item where the terms of a service agreement may not align with the operational requirements of the plan.

Calling it a mess is being polite.

It sounds like this is a participant error and the participant has to live with it. If the fact pattern showed that the participant followed plan procedures (e.g., entered an effective date in 2023) and the plan did not follow those procedures, then the plan could consider treating the 2022 deferral as an Excess Allocation and refund it with earnings under EPCRS 6.06(2). The nice thing about this correction is the refunded deferral would not be included in any 2022 testing should this amount otherwise have contributed to test issues.

If we define permissive as whatever the regulators agree to, then No could become a Maybe. Do we miss the days of anonymous VCP? What led the brothers and sisters to believe they could aggregate all of the businesses in one plan in the first place? And how did they just find out they could not? Hopefully, the answer is based on outside, allegedly credible advice and not because Mom said they had to all be together as a family. The IRS and DOL like to say the ultimate goal of corrections is every participant at least winds up with the benefits the participant was entitled to had the plans operated properly. If the data are available, then a massive rebuild of the plan accounting is possible but likely not very practical. You could try to build a case for being allowed to separate the plan into multiple plans based on existing individual account balances grouped by the company each individual works for currently. You would have demonstrate that the allocations formulas were uniform (like NECs allocated over compensation), and there are not distortions like using the top-paid group rule for determining HCEs. The trust similarly would be treated as a master trust with a separate accounting for each company. Hopefully, you could get a pass on fling historical 5500s and be allowed to treat the new plans as spinoffs. I doubt it, but why not shoot for the moon? Hopefully, the tax deductions for the contributions to the plans correlated to the contributions allocated to the employees of each company. If the current situation honestly was the result of ignorance and the end result is participants are made whole, with some hope and a prayer this could fly.