403(b) Audit/Requiring Employees to Use Catch Up election

[Guest Jeff Kropp]

My client's 403(B) program has been audited by the IRS. In order to both prevent a number of individuals from contributing excess in the audit year, and for administrative ease, our client would like to limit the amount that may be deferred to the plan to the amount described in Catch Up C. Basically, this is substituting 415 limit for exclusion allowance for all future years. Of course, no other special catch up elections would be available for certain long-time employees, who would be penalized. Yet requiring that a catch up be used (probally on the annual deferral form) would make life easier on client and satisfy IRS with regard to those who failed exclusion allowance in audit year.One gray area is whether client can require, as a condition of participation in its 403(B) plan, that employees to use a catch up election, because the election is normally used to justify an individuals tax return. Any thoughts? The IRS informally has said that this is probally ok, as long as it does not appear that the IRS is requiring that catch up elections be made.

------------------

[Dowist]

I would think that your client would have the right to get assurance from the employees that the amounts contributed don't exceed the exclusion allowance, before contributing an amount in excess of that amount. If the only way to get the extra amounts into the plan is if the ees have made a special election, I would think you could condition the extra contributions upon receiving such assurances.

[Guest Jeff Kropp]

Requiring employees (or providers) to verify that they are not contributing in excess of the exclusion allowance, through hold harmless agreements or deferral agreement language, is the standard approach. However, this does not work once the plan is audited by the IRS. The employer is ultimately responsible for withholding income and payroll taxes on excess contributions, despite employee verification. Also, employees, employers, and providers generally have no idea how to run the exclusion allowance tests, or don't want to because of the burden. Under my approach, administration is simple, though some long time employees may lose out on additional deferrals.

[Dowist]

You're right. I see no problem with limiting contributions to a certain amount - say a percentage of compensation or the C election.