Paul I

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.

If there is no explicit language or example in the plan document, then the Plan Administrator needs to step up and provide an interpretation. This can be one of those interpretations that says the entry date is 1/1 because the eligibility computation period was not completed until the stroke of midnight on December 31. Another Plan Administrator may decide that the ECP ended at close of business on December 31 and says to use the compensation earned on that one day. Or not. Whatever the interpretation, document and communicate it.

I agree. Roth elective deferrals in the 401(k) plan are subject to a limit of the lesser of compensation and the annual deferral limit, so the employee can defer up to $10,000 (paying payroll taxes is a whole other topic). The contributions to the plan come out of the employee's paycheck. Contributions to the Roth IRA are subject to the lesser of compensation and the annual IRA contribution limit which has a phase-out depending on adjusted gross income. The employee does not have a high enough income to be affected by the phase-out, so the employee's IRA limit is $6,500. The contributions to the IRA can come from any source and is not limited to coming from current compensation. The employee's compensation is merely a factor in calculating how much can be contributed for a given year. The IRS has an interesting example at https://www.irs.gov/retirement-plans/plan-participant-employee/retirement-topics-ira-contribution-limits. Example 1 says the IRA contribution for the individual can be made by the individual's grandmother.

Coverage testing may seem like a bright line pass/fail, but I wouldn't look elsewhere right away. There are many different strategies to get a plan to pass coverage. Keep in mind that a "plan" for coverage testing is performed separately for elective deferrals, matching contributions and non-elective employer contributions (without getting into average benefits testing). You may be able to structure some of the benefits in a way to pass coverage at an affordable cost and provide a meaningful benefit to your client.

Depending upon the individual's perspectives and priorities on taxes, generational wealth, Social Security and current income level: Elective deferrals are not included in the calculation of the deductible limit on contributions to the plan, so an individual with relatively low net income can get a disproportionately larger tax deduction. On the other side, mega Roth deferrals/Roth conversions/Roth NECs start laying the foundation for no RMDs. If the entire amount in the plan is Roth, then there is no taxable income on payments. When the individual begins taking Social Security benefits, the payments will not count as income that could trigger income taxes on those Social Security benefits. Payroll taxes apply to elective deferrals which, if the individual's net income is below the SSTWB, adds to the individual's Social Security retirement benefit (and possibly to a spousal benefit. These things can work against each other, so the individual needs to decide what is more important.

Consider granting everyone immediate eligibility who is actively employed on the effective date of the plan. Anyone hired after that date have work One Year of Service. Anyone rehired after the effective date is subject to the One Year Holdout rule where they have to work One Year of Service before any past service is recognized. The tricky part is an individual subject to the One Year Holdout needs to be given an employer contribution retroactively to the point they would have been otherwise eligible, but they are not able to make deferrals during the holdout period. Arguably for testing purposes, the individual was not eligible at any time in the that first year. The retroactive contribution is a contribution made, deducted and allocated in the following year. I've never seen this done and haven't researched it, but others here with plans with the holdout rule may have addressed whether the individual was included or excluded in the ADP testing.

Double check the safe harbor notice rules. You don't need a safe harbor notice if the plan uses the SHNEC as as ADP test safe harbor. If the plan uses the SHNEC for both as as ADP test safe harbor and as an ACP safe harbor, then you need to provide a safe harbor notice. See 1.401(m)(3)(a). This is an easily overlooked requirement. The match formula can be fixed or discretionary as long as the formula used to calculate the match does not exceed 4% of safe harbor compensation and based on deferrals not greater than 6% of safe harbor compensation. See 1.401(m)(3)(d)(3).

Check out the preamble to regulations regarding Retirement Plans; Cash or Deferred Arrangements Under Section 401(k) and Matching Contributions or Employee Contributions Under Section 401(m) Regulations published in the Federal Register / Vol. 69, No. 249 / Wednesday, December 29, 2004 page 78151 "The proposed regulations did not include any exception to the requirements for safe harbor matching contributions with respect to catch-up contributions. As part of the proposed regulations the IRS and Treasury solicited comments on the specific circumstances under which elective contributions by an NHCE to a safe harbor plan would be less than the amount required to be matched, e.g., less than 5% of safe harbor compensation, but would be treated by the plan as catch-up contributions, and on the extent to which a safe harbor plan should be required to match catch-up contributions under such circumstances. After reviewing the comments and the applicable statutory provisions (including the amendments to section 414(v)(3)(B) made by the Job Creation and Worker Assistance Act of 2002, (JCWAA) (Public Law 107–147)), the IRS and Treasury have determined that no such exception is appropriate." Basically, the safe harbor match applies to all deferrals and, the IRS having thought about it, decided not to make an exception for catch-up contributions.