Taking over a Plan with excess contributions

[Guest tbt]

I have a 401k plan which has contributions (deferrals & match) of 22 % of adjusted comp for the 1999 and 2000 Plan years. Major Insurance Co has been handling the Administration. Here is question, an employee was terminated & paid in Feb 2001 with money he is not entitled to, How can this be corrected? If no one was paid I could correct 1999 & file 5330, correct 2000 & file 5330, correct 2001 & file 5330. Any insight would be appreciated.

[Disco Stu]

The employer can always ask the participant for the money back. Unless it's a lot of money, it's been my experience that most employers don't bother.

Technically, you should probably make sure the ineligible amounts weren't rolled over. Even if they were, I'm not sure I'd spend a lot of time on it. I've heard anecdotally that the IRS doesn't try to track that kind of stuff down once it's out of the plan. Someone else may have a different opinion on that though.

BTW...if you're a new recordkeeper on the case, you should make sure the employer is certain that there is not carryforward available...it could be that those contributions really were deductible. It's a lot of work to try to figure that out, because the carryforward has to be from prior to 1987 (?). But given the choice of filing the 5330 and running an increased audit risk, it might be time well spent.

I should also mention that my comments assume that the question you ask refers to contributions in excess of the company's deductible limit for these years. When you posed this question on the "Corrections" board, you referred to these as excess annual additions. Given the facts stated, I doesn't seem likely that you are dealing with excess annual additions.

[Guest tbt]

I am talking about excess annual additions. Company deduction is overstated by 4000.00. The Prototype document is silent on how to correct. If I move the money to a suspense account and reallocate in 2000, my understanding is I have an excise tax due.

In 2000 I have the same problem only worse because of the suspense account. But in 2000 I could return deferrals and reallocate all the employer money (new & suspense)

The other issue is Term Employee A has $ 1000.00 of money in his IRA he was not entitled to and I have no chance of him returning.

Any insight or previous posts would be helpful. I am not oppose to going through a Resolution Program.

[Disco Stu]

If we are talking about contributions in excess of the annual additions limt (IRC 415©), there is no excise tax for a failure to correct. In fact, there is no written in stone deadline for correction.

What makes me think we still have problems with terminology is that the annual additions limit for 1999 and 2000 was 25% of gross compensation. The 22% of adjusted comp number you quote does not appear to be in excess of this limit. Also the annual additions limit applies to individual participants in the plan and not to the plan as a whole.

A company's deductible limit (IRC 404) for 1999 and 2000 was generally 15% of taxable compensation. There are excise taxes imposed for contributions made in excess of this limit. They compound if the non-deductible contributions spread across multiple years, which can be quite nasty.

[Guest tbt]

I am talking @ 415© and 404

1999 compensation of $ 100000.00

deferrals of $ 10000.00

employer contribution $ 12000.00

The situation in 2000 is almost the same.

If I set $ 7000.00 in suspense & rerun the 99 plan year I think I'm ok, and then file the 5330 for 99

Keep in mind the Adoption Agreement is silent on how to fix and employer wants the money returned to corp.

If I return 2000 deferrals and allocate 15 % of the employer money I still have $ 4000.00 in suspense. I then file 5330 for 2000.

The employer wants the $ 4000.00. I only have one active person left and 15 % has already been depositted for 2001.

Am I on the right track or what. The employer deducted amounts he was not entitled to for 1999 and 2000. Plus he distributed to an employee about $ 1000.00 of the 415 excess in feb of 2001.

I would like to go through the EPCRS for peace of mind. The new person in charge wants to fix it and pay the excise tax and not worry @ qualification issues.

[Richard Anderson]

Annual additions are a participant level limit. If the latest data is for one participant; that participant has not exceeded the annual additions limit (100,000 x .25 = 25,000). If the data is for more than one participant, then it is not possible to determine from the given data if any participants have exceed 415© limits.

[Guest tbt]

They had three employees.

emp A Comp 42010, deferral 3638 emp cont 3704

emp B Comp 41220, deferral 5729 emp cont 7409

emp C Comp 16770, deferral 633 emp cont 887

Total Comp 100000, total def 10000 total emp 12000

My thinking is max plan contribution is 15000.00 & 22000 was depositted 7000 over.

And so it goes. Any suggestions?

[Disco Stu]

Well...based on the facts given, the company's maximum deductible contribition is only $13,500 (15% of gross wages less pre-tax items). And this assumes that there were no cafeteria plan deferrals. If there were, the deductible limit would be less.

But since participant B has a 415 excess of $2,833, this amount is not deductible under section 404, so don't count this in your deductibility anaysis. By my calculations, there are non-deducitble contributions of $5,667.

I would not stop there in deciding whether or not there were really non-deducitlbe contributions though. As I mentioned in my first post, the company should at least explore the idea of pre-87 carry forward. If any exists, it could save their skins. Their tax accountants should be able to help them with this.

If in fact you do have non-deductible contributions, I don't beleive that distributions or forfeitures are allowed to "correct" the problem. The non-deductible amount is carried over and deducted in the next year. This creates compounding problems if you have multiple years in a row of non-deductible contributions.

With the client that I had that went through an IRS audit, they had to stop making all contributions until they reached the year when they could deduct everything that had been carried over. It was painful.

You are correct about the need for 5330s and excise taxes for all of the years involved if there are non-deductible contributions.

Should we ask why two participants with such similar compensation received vastly different employer contributions?

[Guest tbt]

Disco thanks for your help. The plan started in 1998 and if I had the data I probably would find the same errors. Because we paid out part of this excess should I go through the Resolution Program as a matter "better safe than sorry". The employer knows he has penalities as it is. This small co. is owned by some people who don't like surprises or trouble. Thanks Again!