SIMPLE Over-Contribution by Employer

[Guest Noidy]

An employer contributed too many matching dollars to SIMPLE IRA's for two employees. All of this was for the 2001 tax year and the employer was doing the dollar per dollar match up to 3% of compensation and the two employees had much less in compensation than expected.

How can we undo this without problems and penalties? The mutual fund company holding the SIMPLE IRA's claims that we have to pull the money out of the SIMPLEs by law but the withdrawal will be considered a taxable distribution from an IRA that's subject to taxes and an extra 10% penalty because the employees are younger than 59 1/2. Isn't there a better way?

Thanks for any help.

[Archimage]

If it is for the 2001 plan year ending 12/31, you have until 3-15-2002 to correct your excess contributions without incurring a 10% excise tax. If you do not correct it by 12-31-2002, the plan will be disqualified for the 2001 plan year.

You will be subject to applicable income taxes for the amounts of contributions that are in excess.

[Gary Lesser]

In the case of a SIMPLE, the excess sd be reported on Form W-2. That will end the 10% penalty if done befor the due date of the employers return. The employees may have to pay 6% penalties if their IRA contribution limit is exceeded, unless timely corrected. The plan is not disqualified.

[Guest Noidy]

The over-contribution was not salary deferral, it was an over-contribution by the employer during 2001. We are still somewhat confused as to how to handle this. Are the specifics to correct this as follows ?:

(1) remove the employer over-contribution prior to 3/15/02 and the employee keeps the amount that's withdrawn? The Simple custodian wants to code this as an early distribution that's subject to the 25% penalty. I suppose we can try to explain this to the IRS to eliminate the penalty.

(2) Issue corrected W-2's to show the extra amount contributed by the employer as compensation to the employee?

Or is there a better or different way to handle this employer over-contribution problem? Thank you very much for your comments.

[Archimage]

The custodian is completely wrong. There is no 25% penalty. I would find the code and give it to the custodian. Unfortunately I do not know what the reg number is or I would give it to you. If they still do not address this correctly, then I do not know what to tell you. Maybe threaten to report them to the DOL or something like that.

[There may be a 25% penalty if 2-year rule violated. See below - GSL]

[Gary Lesser]

It is unclear whether the 25% or 10% penalty under Code Section 72 applies. Perhaps it can be explained away regardless of how coded by the trustee. For what it's worth--

In a meeting held on September 25, 2000 (in Arlington, VA), between representatives of ASPA and Paul Shultz, Director of Employee Plans, Rulings and Agreements and Richard Wickersham, Chief, Projects, Branch 2 of the IRS they stated that the 25% penalty would NOT not apply when an employer adopted a 401(k) plan invalidating the qualified salary reduction plan in the SIMPLE. I am not aware of any other guidance on this issue. In my opinion the 25% penalty should not apply. If there is/was a loss, it might not matter

The over-contribution (whatever it was) is now an excess contribution. The employer sd include the amounts on the e/ee's W-2 as regular wages in Box 1 to avoid the cummulative 10% nondeductible excise tax on nondeductible contributions. If not placed on Form W-2 a 10% penalty will apply for many years as the employer must correct (AND that's about all it can do, turn the amount into a prohibited employee contribution, by reporting the amount as income (=distribution/correction)).

The employer sd (but not required to) give explanation letter that excess simple contributions were added to form W-2 and MUST be removed by employee with any gain by 3/15/2002 (or due date) to avoid 6% penalty. Can't be used up by employee. E/er can not remove money, but can reduce future compensation if not in violation of any contract or state law. The employee sd request a correcting distribution and that the 25% penalty code not be used (an include a copy of the employers letter explaining the excess). Hope this helps.

[martha]

I have a situation where the employer was contributing double the amount they should have to two employee's simple IRA due to an error on the payroll companies report total. Now the kicker is the employee's W-2 and pay-stubs read the correct amount for a total of 4 years this went on. The employee's do not have the money in their simple IRA anymore for us to do any type of return of funds so the only other option if any is to let the employee's keep it and then they will have to claim it as income, get corrected W-2's and amend their taxes for all 4 years? Does anyone have any advice