How to handle deferrals that were never made?

[Guest Shmedd]

I am a CPA who recently has come across in the course of performing different audits missed salary deferrals on Manual Checks, Special Payolls, Commission Checks, etc.

Who is liable for the missed deferrals? Does it fall back to the plan sponsor as a prohibited transaction? Does the plan sponsor have to recalculate the payroll taxes and social secruity for that period missing the salary deferral? These are all 2002 transactions all the necessary fillings should have been done by the EE and ER. I am want to make sure the W-2s, 941s etc don't need to be amended.

Would I now need a Sch G and 5330 for excise tax?

Thank you in advance,

[Guest twalters]

I am also a CPA and discovered the same error on a recent 401(k) audit (deferrals never remitted on manual payroll checks throughout 2002). We treated the deferrals as late remittances with interest calculated from date they were due until the end of September 2003 (when the transfer was going to occur). Schedule G and 5330 will be filed. Therefore, no change to W-2's or 941's are needed.

[JanetM]

I too am CPA, now plan sponsor. Do you mean deferrals were never taken or deferrals taken were never deposited. If never taken - it is the employees responsibility to check pay stub for accuracy. If never deposited you have Schedule G and 5330 to file.

[Guest twalters]

Good point -My response assumes that the deferrals were taken but never deposited but in reading the question again I realize they may not have been taken. I agree with you completely - if the deferrals were never taken but authorized on a salary deferral election form, I would have a management letter comment only.

[Guest Chaffee]

I too am CPA, now plan sponsor.  Do you mean deferrals were never taken or deferrals taken were never deposited.  If never taken - it is the employees responsibility to check pay stub for accuracy.  If never deposited you have Schedule G and 5330 to file.

Unfortunately, it would not be sufficient to say it is the employee's responsibility to check the pay stub. If your Plan's definition of compensation does not exclude commisions, bonuses, etc., then you would have an operational failure that needs to be corrected to maintain the Plan's qualified status.

In Rev Proc 2003-44, Appendix A; Paragraph .05 addresses this issue "Exclusion of an eligible employee from all contributions or accruals under the plan."

According to this section, if the employee should have been eligible to make an elective contribution under a cash or deferred arrangement, the correction is for the EMPLOYER to make a corrective contribution to the plan on behalf of the employee that is equal to the ADP for the employees group (HCE or NHCE). Further, if also eligible for a match, a similar contribution must be made based on the ACP of the group. As with most corrections, lost earnings must also be corrected. Appendix B, Section 2.02 also discusses this.

As for the Schedule G or Form 5330, I don't believe there is a prohibited transaction as no funds were initially withheld, so there is no improper "loan" to the Plan Sponsor.

Hope that helps.

[Guest jashendo]

If the contributions were never withheld (as opposed to being withheld but never deposited), they cannot be "made up" after the fact, since elective contributions cannot be made after the salary has been made available to the employee. However: (1) additional withholding can be taken from yet-to-be-paid salary checks (if there is any salary remaining to be paid in the year); and (2) if not, the EPCRS correction mechanism described above (employer contributes to make up for the missed deferrals) would be applicable. Failure to withhold (as opposed to failure to remit) would not constitute a prohibited transaction, but would be a qualification issue.

[R. Butler]

However: (1) additional withholding can be taken from yet-to-be-paid salary checks (if there is any salary remaining to be paid in the year); and

The original post stated that the problem occurred in 2002 so its really irrelevent, but even if it occurred in 2003, it seems to me that this would only be prudent if you caught the error in the first quarter of the plan year. If the participant didn't have the opportunity to defer for at least 9 months out of the plan year, the EPCRS correction method still requires a corrective contribution for the portion of the plan year in which the participant was not allowed to defer.