404 limit exceeded in prior years

[2muchstress]

Working on a messy takeover plan. Company has deferral and match, and then funds a 10% contribution to all employees on the last day of the year.

For 12/31/01, they funded the 10% to everybody, but now that we have all of the data, we know that there is a 404 violation. Because the money was funded in 2002, the excess can be allocated as a 2002 cont.

However, company claims that they have always funded 10% to everybody and have never had any problems before. Putnam did their administration for prior years. When I look at Putnam's 415 test, the average annual addition for everybody is 15.27%, thus there was an obvious 404 violation. Also, this 15.27% does not include any contributions to a 125 plan.

How would the 2000 violation be corrected? Company claims that because it was funded in 2001, then why couldn't the excess just be claimed as a 2001 cont? If possible, this would then reduce the contribution previously allocated for 2001, and then create an even greater excess to be allocated in 2002.

What's the easiest solution at this point????

[mbozek]

Could you explain the 404 violation? Was it that contributions to the plan for 2001 exceeded 25% of covered compensation or is it that the the er 10% discretionary contributions plus the deferral and match exceeded 25% of compensation under IRC 415 for each employee. What is the connection between average annual addition of 15.27% and the 404 violation?

[2muchstress]

A 404 violation meaning that the contributions to the plan were greater than 15% of total eligible compensation. This is more of a deductibility issue and not an annual addition issue. However, since the average annual addition for all eligible participants was over 15%, then there was obviously a 404 violation.

Also, contributions to a 125 plan were obviously not included in any tests done by prior administrator, but could have serious impact on the 404 limit as well.

[Tom Poje]

the following is, quite possibly, mathematically an incorrect statement

"However, since the average annual addition for all eligible participants was over 15%, then there was obviously a 404 violation."

consider a plan in 2002, we will make it easy, 2 employees

ee 1 comp = 200,000 contribution = 5%

ee 2 comp = 10,000 contribution = 25%

average annual addition (5 + 25) / 2 = 15%

but total contribution is only 10,000 + 2500 = 12500 which is only 5.95% for purposes of 404 deduction.

[2muchstress]

Tom,

Point taken, however that doesn't help my situation.

Here's how the TOTALS line on the 415 test looks

Compensation $3,448263.81

Annual Additions $526,393.55

Percent of Comp 15.27%

So I may have been inadvertantly confusing some people, (and I may even be confused myself).

Also, ADP for NHCE's was over 5% - so all indications are that the 404 limit was exceeded in 2000.

We are responsible for 2001 admin, and know that for 2001, the limit was exceeded. I just don't know if I can go forward with the 2001 until I know how the 2000 corrections will effect my balances.

[Tom Poje]

2muchstress-

the problem should not change your balances. Only 415 limit violations should change your balances.

However, the deductibility amount is a different issue. If my mind is working correctly, you have to [ok, you are suppose to] keep carrying the excess amount (and paying the 10% penalties each year) until you use it up.

and double ugh, cuz the 125 contributions are going to hurt you even more.

The contribution made in 2002 for the 2001 plan year is deductible in either 2001 or 2002, and with the new rules in effect for 2002 you might be able to use everything up along with 2002 plan year's contribution. That of course doesn't take care of the possible 2000 over contribution . on the other hand, you didn't handle the 2000 plan year, so you didn't cause that problem.

[2muchstress]

Tom,

I appreciate your responses, they have been helpful. But they also bring new questions to the table. I guess I'm confused as to how the 404 violation in 2000 would not change any balances. Please correct me if I'm wrong, but I thought that you could not allocate contributions above the 404 limit. If that's the case, then money was allocated to participants when it should not have been.

I guess because the money was always funded after the end of the year, it could be considered funding for the current year. That being the case, then maybe I understand your point.

Nextly, and I am just talking out loud at this point, there have been many participants who received distributions during the past couple of years. These people would have received more money than they were entitled to. Does this not create a violation of the exclusive benefit rule??? That's probably a whole different can of worms that I shouldn't be opening.

Ideally, I would love to say that nothing needs to be done, and the prior administrators should hold some liability if the plan were to be audited. But, since I discovered the problem, I also feel some obligation to correct it.

So as I see it, at a minimum of what needs to be done is:

amend 5500 for 2000

amend corporate tax returns for 2000.

amend corporate tax returns for 2001.

I'm thinking that we will not need to do a 5330 because all of the contributions were funded after the end of the year.

On the other hand, what's the point of correcting 2000, if 1999 is not correct. How far back would we need to go?

Is there anything I missed? Additional comments would be great.

Thanks

[Tom Poje]

In this case, you are incorrect, but it doesn't hurt to learn along away. don't get confused on what is allocated and what is deductable.

you can contribute more than the 404 limit, you simply can't deduct it. plus you pay 10% penalty every year the excess exists.

so for example (I will use the example from The ERISA Outline Book, but I have seen similar examples elsewhere)

plan year is 2000

total comp is 1,000,000

deductible amount is 150,000

compnay contributes 180,000 in Nov 2000 for 2000 plan year.

there is a nondeductible portion of 30,000, so an excise tax of 3,000.

if the contribution had been made in 2001, the company could have deducted 150,000 in 2000 and 30,000 in 2001 and avoided the penalty (see page 7.377, 2001 edition)

"If the deduction limit is exceeded for a taxable year, the excess amount may be carried forward and deducted in the suceeding taxable year. This carryforward is charged against the 15% deduction limit in the suceeding year" page 7.292 2001 edition

"An employer contribution is still allocable to the plan participants, regardless of whether it is currently deductible under 404." page 7.292, 2001 edition

[2muchstress]

Thanks again.

I guess its obvious that I'm a newbie to this industry. But, maybe in several years, I'll be moderating this board.

[Tom Poje]

If it makes you feel any better, I'm forever learning.

at least you aren't afraid to ask, and at least there is a good web site like this available!