2004 Payroll Error

[Guest ActuaryWannabe]

Due to a programming error, the payroll provider for one of our clients failed to take any 401(k) deferrals out of the final 2004 paychecks.

I searched thru prior threads and didn't see anything exactly on point, but I am thinking that the correction will need to be an employer contribution equal to the missed deferrals (for which they would obviously expect to be reimbursed by the payroll provider).

Is there any less onerous correction that would be correct? The expectation is that it will be revenue-neutral to our client, but I am sure the payroll provider will try to argue for something less costly to themselves.

[SoCalActuary]

Start by filing a claim against the payroll firm for negligence.

Then insist that they revise their work to get the correct amounts.

The overpayments to participants are the next problem. Talk to your labor & ERISA attorneys. One avenue to pursue is to fix it in the next payroll cycle.

[ERISAatty]

Help - I'm trying to figure out the solution to a similar problem. Here, there is no payroll administrator to blame (the employer failed to withhold for 401(k) on 401(k)-eligible bonus compensation to some executives on the last check of the year).

We're thinking of just advising that the employer pay to put the money into the 401(k)s now, out of the employer's pocket, but we are wondering how to do it correctly. I.E., would this contribution be subject to FICA?

I'm just starting to research the EPCRS guidelines. Maybe I'll find help there. In the meantime, if anyone has an idea, I would welcome it!!

Thanks.

[GBurns]

What is wrong with re-running the payroll correctly, so that the W2s are correct? Adjustment to withholding deposits will be reported on the 941 which has not been done yet so that can be corrected. Then either ask the employees for the difference between the 2 paychecks or have the employer write it off.

The write off might constitute taxable income to the employee so you might need to run an extra payroll to handle the "gross up" of the taxes as per the IRS Revenue Procs etc which give the formula for handling employer payment of employee taxes. You can look at Pub 15 for reference or the BNA Payroll Adminstration guide for an excellent explanation.

It also is not so difficult to export the payroll to an Excel spreadsheet and use that to calculate the tax liability for each employee then adjust the YTD figures instead of doing another payroll run.

[mbozek]

Since the money was included in income in a prior tax year recission is not available e.g. Rev. Rule 79-311 required that the over payments be returned by year end. You might be able to reverse the transaction under the claim of right doctrine if the employees returns the amounts paid on the theory that they never had a right to the funds which legally were required to be contributed to the plan. You need to research the application of the claim of right doctrine to this kind of situtation.

[GBurns]

Rev Ruling 79-311 deals with an employee returning unearned income and really is not on point. However, it is on point enough to clearly allow the procedure that i contemplated:

"The company reported the adjustment with respect to excess commissions paid to B in 1975 when it filed its Form 941 for the first quarter of 1976. Also at the time the adjustment was reported on Form 941, the employer furnished B with a W-2 marked "Corrected by Employer" showing B's corrected FICA earnings and FICA employee tax pursuant to section 31.6051-1© of the regulations. B was given credit for the FICA employee tax attributable to the excess commissions B received in 1976 pursuant to section 6413(a) of the Code and section 31.6413(a)-1(a)(1) of the regulations."

Here is a link where you can read Rev Ruling 79-311:

http://www.taxlinks.com/rulings/findinglist/revrulmaster.htm

[Harwood]

If the money was received by employees in 2004, you cannot rerun the payroll and take out 401(k) deductions at this late date. The employer is stuck with the consequences of the error.

[ERISAatty]

Thanks, everyone. Harwood, I agree that the employer is 'stuck with the consequences.' The employer is willing to make a contribution to the affected employees' accounts to make up for the failed 401(k) deduction, and this will come out of the employer's coffers (without trying to get these execs to agree to return the excess).

Where I'm stumped on is how to do that, exactly. For now, I'm working on the assumption that this is an insignificant Operational Failure under EPCRS, and that, since we are within two years of the event, we can self-correct (by making a QNEC contribution, subject to any applicable FICA).

[GBurns]

Harwood et al

Why can you not run the payroll? Where does it say so anywhere?

How do you think the examples in Rev Rul 79-311 were done?

This is something done very often by all the payroll processors so why can't an employer who processes his own payroll do it? Just ask the nearest ADP or Paychex sales rep how they correct the last payroll od the W2s. Correcting W2s is major money for ADP and how they do it very often is to rerun the last payroll without cutting checks.

[mbozek]

H: If an employer mistakenly paid a bonus of $1,000,000 instead of $10,000 which was wired to the employee's checking account on Dec 31 would the employee have 1M in income if the funds were returned on Jan 2? By the way were employees paid by check or wire?

[Harwood]

I think it is a principle of 401(k) deductions that you can't have a deduction after receiving the wages. These people already have received their bonus checks.

The error of a lack of deduction is different than an error of receiving a paycheck for the wrong gross amount.

[mbozek]

There is no distinction between a mistaken payment and a failure to deduct a 401k contribution from the employee's wages under a binding salary reduction agreement because in both cases the employee does not have a claim of right to the funds received. Both payments are reported as income on the w-2. I thought the requirement is that a binding salary reduction agreement must be in effect before the funds are available to the employee.

[Harwood]

If the company's qualified tax advisor says it is ok to re-run the payroll, then I defer to that advice. It is too risky for my tastes but mbozek and GBurns make good points.

[Guest Jayco]

The way I read the EPCRS procedure, the approved correction method would be that the employer would make the contribution on behalf of the employees and it would be reported on their 2004 W-2s along with the gross-up for the FICA. However, I also think that an after the year adjustment works just as well. The employer makes the contribution on behalf of the employees, regardless of whether the employee re-pays, e.g., $100, as if the money had been deducted from the employee's check. At that point, the employee has been overpaid by $100 based on the employment agreement (probably, oral) between the employee and employer. Doesn't the employee then owe the employer the $100 overpayment? If the employer deducts the $100, in 2005, they're even and all that happened was the employee repaid his debt or overpayment. For W-2 purposes, the $100 is reported as a contribution to the plan for 2004. I agree that there is some risk with this correction procedure, but it seems to make a lot more sense than saying the employer is stuck with the payment. That gives the employee a windfall. There are a couple of other issues with this method. First, if the employee objects to the deduction from his 2005 check, can the employer still make the deduction under state law? Second, if the plan is audited, then the auditors should sign off on this method of correction.