Another TH 401(k) Issue

[Guest TitusracerX]

A client that has a TH 401(k) Plan decided not to make a profit sharing contribution for the past two years and therefore, no funds were deposited into the plan that potentially could be used to provide the TH minimum contribution.

For 2002, the plan had a normal matching contribution and was not safe harbor.

The client has indicated that the contributions for the key employees should be treated as mistake of fact contributions for the past two years and should be returned to the affected participants.

Any thoughts on the clients suggestion?

G

[Archimage]

You said there were no ER contributions for the past two years. How can you return money that isn't there? Are you saying there is a matching contribution in the past two years? If that is the case then you still must meet the top heavy minimum for those years even if the keys only had deferrals.

Matching contributions could have been used to help satisfy the TH minimums for those years but you couldn't use those matching contributions in your ACP test which would probably result in more trouble.

[pmacduff]

I think TitusracerX is saying that the keys deferred and the client wants to return the key deferrals because, under the old rules, if ANY key deferred over 3%, you still had to give the non-keys 3% for top heavy, which they didn't in this case...is that right? I don't think you can refund the key deferrals, I think you have to make the top heavy. Just my somewhat eductated guess, can someone else offer backup?

[Guest Kala]

I don't think mistake in fact is going to cover this. It is going to look way too fishy if ever investigated. They need to make top-heavy minimum contributions. Remember that for 2002 and going forward employer matching contributions can help satisfy top heavy minimums. Forfeitures that were allocated also help satisfy the TH minimum. Also, remember this: if the highest contribution percentage rate for a key employee is less than 3 percent of compensation, then they only have to meet that percentage.

[Guest TitusracerX]

Sorry about that, I meant to add that the client wants to return all elective deferrals to key participants which consists of family members only...

They did make a match in 2002 which could be used to offset the TH minimum. I'm assuming that the goal is to still get each employee a 3% ER contribution; does that mean that a person who does not defer to the plan will get a non-elective contribution up to 3% and the person that makes a deferral and gets a 3% match will get nothing other than the match?

I know its a risky proposition to return the deferrals, but the client may be adamant that it is corrected that way. It will be their decision and I am getting the proper documentation to cover our liability...

G

[R. Butler]

"...I know its a risky proposition to return the deferrals, but the client may be adamant that it is corrected that way. It will be their decision and I am getting the proper documentation to cover our liability..."

As you know returning the deferrals doesn't really correct the problem. It actually may make the problem worse. Whats the distributable event? Even you could plausibly argue that matching contributions be returned as a mistake of fact (which I don't see how that argument can be made), there is no basis for returning the deferrals. So not only is minimum contribution still required, but also a distribution has been made when there may not be a distributable event.

"They did make a match in 2002 which could be used to offset the TH minimum. I'm assuming that the goal is to still get each employee a 3% ER contribution; does that mean that a person who does not defer to the plan will get a non-elective contribution up to 3% and the person that makes a deferral and gets a 3% match will get nothing other than the match?"

The plan document should tell you to allocate minimum contributions. Assuming its been updated for EGTRRA you are probably correct.

[maverick]

A local company was in the same pickle. Keys deferred at least 3%, but the TH contrib was not made (pre-2002 plan years so the match did not help). This "problem" was uncovered during an IRS audit. The company claimed that they were not in a position, financially, to fund the TH (not even via a loan). The IRS auditor allowed them to return key ee deferrals to correct the problem. I don't know if this is a case of the kindler, gentler IRS, or a rogue agent on the loose.

[Guest TitusracerX]

Even you could plausibly argue that matching contributions be returned as a mistake of fact (which I don't see how that argument can be made), there is no basis for returning the deferrals

I agree, Butler, but under mistake of fact, wouldn't the deferrals be returned to the company and then returned to the employee through payroll? Obviously the matched would be fofeited..

I'm going to be against removing the contributions from the plan and suggest that they take their chances with an audit.

G

[R. Butler]

"...but under mistake of fact, wouldn't the deferrals be returned to the company and then returned to the employee through payroll?"

What is the mistake of fact? It always has been my undrestanding that mistake of fact is limited to match mistakes or other inadvertent mistakes (i.e. participant entitled to $250, but due to a transcription error $520 gets deposited). Neither situation seems to apply here.

Ultimately, I agree with you that it is not the tpa's decision. All we can do is advise and try to steer the client in the right direction. Its not even a matter of losing the client; my job is to advise, the fiduciaries job is to make the decision.

Besides Maverick points out this correction method was accepted at least on one audit, so maybe client will get by with this.

[Guest TitusracerX]

Butler,

I realize it would sound far-fetched to the IRS in my situation, but what if a particpant, who had previously been contributing to a plan, decided to stop and completed a form electing 0% rate and the employer withheld and deposited several months on their behalf? Could this not be considered a mistake of fact?

G

[R. Butler]

I noticed a typo en my previous reply it should be math mistakes, not [I]match mistakes [/i].

"...but what if a particpant, who had previously been contributing to a plan, decided to stop and completed a form electing 0% rate and the employer withheld and deposited several months on their behalf? Could this not be considered a mistake of fact?"

I don't know. I wouldn't want to tackle that situation; I am sure there are other legal issues that would require some kind of correction. That, however, is not analagous to refunding contributions to avoid top heavy contributions.