Paul I

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.

I have seen a plan that pretty much has all of these provisions including the last day rule, and it had a 1000 hour rule. Administratively, the match throughout the year was accounted for separately and allowed participants the ability to direct the investments. If the employee reached the end of the year without meeting all of the plan provisions, the year's match account was taken away and used to offset the matching contributions beginning with the next year (much like a match forfeiture account). It was not the best plan design from the standpoint of employee relations.

If the employer deposits more into the plan than the employee elected to defer, that additional amount is an Excess Amount. If you look at EPCRS §5.01(3)(b), you will find the definition of an "Excess Allocation. The term "Excess Allocation" means an Excess Amount for which the Code or regulations do not provide any corrective mechanism." and " Excess Allocations must be corrected in accordance with section 6.06(2)." EPCRS §6.06(2) notes that "... Excess Allocations that are attributable to elective deferrals or after-tax employee contributions (adjusted for Earnings) must be distributed to the participant. For qualification purposes, an Excess Allocation that is corrected pursuant to this paragraph is disregarded for purposes of 402(g) and 415, the ADP test of 401(k)(3), and the ACP test of 401(m)(2)..." Using these rules, it seems you should be able to refund the $1000 to the employee with earnings, and not include the $1000 in the annual deferral limit or ADP test (among other tests). I believe EPCRS goes on to say the refund is taxable in the year the refund is made. It's worth a look.

Did the employee already meet the plan's eligibility requirements and had reached an entry date? If not, then there is good reason to take the deferral away from the employee's account for allowing an ineligible individual to participate. Does the plan have a provision that deferrals must be effective as of the beginning of the quarter (or month)? If yes, then there is a good reason to take the deferral away from the employee's account for not following the plan document. Did the plan administrator suspend deferrals for HCEs in anticipation of a test failure and the employee was an HCE? This would be a failure to enforce the plan administrator's plan directive. A tough IRS agent may say the deferral has to be removed from the employee's account and the deferral has to be included in the ADP test. If the plan essentially said a deferral election is effective as soon as administratively feasible, the plan would have no way to know the employee intended to make the election effective in January and there would be no such thing as an election made "too soon". In this case, the employee and the plan sponsor need to live with the consequences of their actions (gee, the employee made a deferral!) Mechanically, you may want to keep the deferral in the plan, let the employer use it as a credit against the next payroll, and let the employer square up with the employee. Hopefully, there was not a match involved.

ESOP Guy, you are not being self-serving because failing 409p really is not an option. Gilmore, 401(k)s and S-corp ESOPs are very different. I believe you will find ESOP service providers who will work closely with you where you continue to service the 401(k) and they will service the ESOP. In can be a win-win-win for the plan sponsor, for you and the ESOP provider.

The above comments about 5%-owners address issues for determining HCEs and Key Employees. There potentially is a whole other set of rules tied to ownership if the corporation an S-corp. If it is an S-corp, then you will need to track ownership to identify Ineligible Persons. If the sum of ownership of all Ineligible persons is 50% or more, the plan will have to address a nonallocation year for the ineligibles including impermissible accruals and impermissible allocations, plus some tough tax consequences. The shares actually allocated to an individual in their ESOP account, plus "deemed owned" shares which are a proportion of unallocated shares, e.g., in the suspense account, are added together to see if an individual is deemed to own more than 10% of the company. Toss in some family aggregation rules (that are similar to but not the same as 5%-owner attribution rules) for some extra complexity. Any synthetic equity such as stock options, warrants, restricted stock, deferred issuance stock right, that give a participant the right to obtain more stock in the future also are added into the deemed owned number of shares. This can get complicated, but an S-corp that is 100% owned by an ESOP passes through all of its income to a qualified plan.

If the sole proprietor gets a match based on a draw and the match is limited to 6% of pay, then come year end when net earnings from self-employment is determined and sole proprietor's compensation is higher, then does the sole proprietor get a match on 6% of the additional net earnings from self-employment over and above the sum of the draws? If the net earnings from self-employment is significantly lower so that the sum of the matches on the draws exceeds 6% of the final net earnings from self-employment, then is this treated as an excess match contribution?

The plan is a different entity from the company. Since the financial institution apparently doesn't submit the taxes on behalf of the plan, the plan should have its own TIN, register with EFTPS as the filing entity, and make the payment. Be prepared to deal with late filing and late deposit penalties.

I suspect it will depend on whether the company has used this type of payment for other reasons. For example, the company already could offer incentives tied to achieving certain goals in wellness programs, or the company could have a history of sending holiday gifts cards. If payroll already has experience with small incentive payments, then this will be just another one. If payroll does not have that experience, then this likely will be an onerous task for them. It will be interesting to see how many companies that do decide to offer financial incentives wind up messing up the calculation of plan compensation.

My experience with fee structures for larger service providers is they are driven fundamentally by profit. A service provider calculates the cost of operations based on the same factors as any other business - salaries and benefits, physical facilities, operational expenses, technology, consumables... They then set a target profit and add the two together to get a "required revenue" number. Statistics about utilization of various services are compiled and an estimated price is assigned to each service. These two factors combine to see if required revenue can be achieved. For example, it is assumed that every plan will need a 5500, and the cost of a 5500 for a large plan differs from the cost of a 5500-SF or -EZ for a small plan. Similarly, there are assumptions about the number of payments and types of payments, loans, QDROs, investment menu complexity, disclosure requirements, compliance testing complexity, managed accounts... Starting with this a la carte menu and pricing, the service provider may assume that on average 10% of participants will take a payment during the year, or 5% will take a loan. This all is akin to an underwriting process. The process now allows for a lot of flexibility in negotiating the terms of a service agreement with a plan sponsor. If the plan sponsor is amenable to an all-in fee, then the fee agreement will bundle all of the services for the a equal to the required revenue number (and likely converted into a basis point charge on the investment funds). If the plan sponsor wants to disincentivize a certain transaction type, the that transaction type gets a participant-paid fee assigned to it. For example, the plan sponsor may wish to discourage loans so there is a loan setup fee (amortization schedule and promissory note), a loan check fee and a loan maintenance fee. The service provider adjusts reduces the required revenue number by the projected fees to be collected from participants who take loans, and the plan sponsor pays or there is a basis point charge or both. If the plan sponsor does not want a particular service, then the expected revenue from that particular service is subtracted from the required revenue. (The one participant fee that I have seen that is more blatantly self-serving for the plan sponsor than most is charging a plan administration fee solely on the accounts of terminated participants who leave their balance in the plan.) Deciding on a fee for a transaction type may be rationalized in many different ways, but at the end of the day profit margin drives the whole process.