bonuses excluded in applying deferral percentage

[mariemonroe]

401(k) plan document defines compensation to include bonuses. Many participants earn bonuses on a weekly or monthly basis. The employer has never applied participants deferral percentages to their bonuses. The employer now realizes its error and wants to start applying the deferral percentages to bonuses. Enrollment is coming up and participants will sign new forms in which they will elect to defer and elect a deferral percentage. They will be told that this percentage applies to all compensation including bonuses. My concern is that if the plan is ever audited, the auditor may discover that the plan was not operated in accordance with the plan document in the past. Does anyone have any idea how to fix this?

[E as in ERISA]

Many participants may not like having their deferral taken out of their bonus. They may only want it to apply to salary. You could use two election forms -- one for regular salary and one for other forms of compensation. (Or one form with two sections).

There is nothing that says that a particular participant election has to apply equally to all of the plan's definition of "Compensation." Sometimes if you look at the form, you'll find that it asked the particpants how much they want to defer of their "salary" (or some term other than "Capital C" compensation). So you may not have been out of compliance from that standpoint. (But then hopefullly participants would have some other method of electing deferrals on bonuses, if someone actually asked -- which they never do).

[Kirk Maldonado]

E as in ERISA:

You position is in direct conflict with that of the IRS.

This is a very basic issue; ERISA 101.

You need to start doing your homework before you start posting advice on BenefitsLink or you will get many posts pointing out the errors in your advice.

[QDROphile]

I have been through ERISA 101 but maybe I was asleep. Could you specify what part of E's statement is wrong? I find nothing wrong with a plan that allows separate elections for bonus amounts and the IRS has never objected in a review for a determination letter.

Also, there are some items that can be included in "compensation" that are not paid in cash and therefore the deferral cannot be charged to that exact item -- the dollars have to come from some other cash source, such as regular wages, or the deferral.

Consequently, I don't think you are saying that single deferral percentage must apply across all compensation and be charged to each source of compensation.

[JDuns]

With regard to the future, the plan could be amended and then operated as proposed by E (separate elections for different types of compensation). However, if the plan did not provide for that (and for the prior years) you have an operational error that needs to be corrected.

I haven't looked at this part of EPCRS lately but I think that you need to credit the employee with the missed deferral and associated match (or maybe it was the ADP and ACP levels, I can't recall) plus earnings.

Windfall to the employees.

[Kirk Maldonado]

My position, stated in a rather cryptic fashion, was stated more expansively by JDuns.

My familiarity with this issue arose because I had a case where the correction amount was close to $500,000, even though this operational failure only affected one plan year. The unique feature of this situation was that the average bonus was $75,000 per employee, including every single employee in the company. In case you are wondering, this was not the Orange County, California employer that got all of the nationwide publicity for its monstrous sized bonuses.

[E as in ERISA]

Hmmm. I'm having a hard time seeing what was "cryptic" about your original post.

I interpret JDuns comment as being the same as mine (the difference being that he assumes that there are no facts that support a separate election opportunity. And I was advising mm to go back and see if there are: If the standard form is limited to regular salary and that there is then another method for deferring on bonuses.

Yet you say that you completely agree with JDuns and completely disagree with me (and so much so that you accuse me of flunking ERISA 101 and failing to do my homework).

[Kirk Maldonado]

E as in ERISA:

The question in the original post by mariemonroe was whether there was a problem in the past because deferrals weren't taken out of bonuses

You blithely stated:

There is nothing that says that a particular participant election has to apply equally to all of the plan's definition of "Compensation."

That is a clear response to the question in the original post by mariemonroe, with your saying that there's no problem here. Your original post missed the issue that if the election applies to "compensation" it applies to all compensation. Trying to argue the "compensation" doesn't mean "Compensation" is reminiscent of a similar semantical debate engendered by a recent president and will be equally unconvincing.

Failure to operate a plan in accordance with its terms disqualifies the plan according to the IRS. I consider that to be ERISA 101.

On the other hand, if you are saying that it is OK if the election form only applies to salary and not to bonuses, why doesn't that disqualify the plan because the plan doesn't authorize making elections only with respect to salary?

I agree with Jduns in that there is a problem in the past, but you could avoid the problem in the future by a plan amendment.

[E as in ERISA]

Maybe my response was a little "cryptic." But I didn't say that there is "no problem." There could very well be a problem. But I'm suggesting some facts that be looked into before that conclusion is made. And I think that I said pretty clearly that if the election form applies only to regular salary, then I hoped there was another form for making an election for bonuses.

I have had this very question before. And when I asked what the standard election form says, there are in fact some cases where it says something to the effect of "I defer ___% on regular salary" (even if the plan uses all compensation) So I think that would be an operational violation to have deferred on the bonus based solely on that form. So then the next question is whether employees had an effective opportunity to defer on bonuses. (And I would note that Notice 99-1 says that there are no rules or standards prescribing the media through which a deferral election must be made, so that may provide a little leeway.) There are various facts that may help -- clarity of employee communications about the fact that bonuses can be deferred --and any processes or forms that could be interpreted as allowing a deferral on bonuses. If the issue arose because someone asked to defer on their bonus, that may actually be a fact in your favor -- if they were allowed to defer. In most cases, the real effect of this analysis is that it makes it less clear what your correction amount is. If the percentages on the standard election form don't automatically apply, what percentage do you use? This may give you more room for negotiating a lower correction amount with an IRS agent. Why not at least affirmatively provide a separate election opportunity on the next bonus before making any correction. And use the average percentage elected in the current year. They may not get a lot of takers if people are accustomed to taking their full bonus in cash. (And that potentially allows them to use a lot lower than the average deferral percentage on salary). I would note that the IRS has said that employees do have some responsibility for making sure that there deferrals are being taken out of their checks. Maybe not right away, but eventually. And I think that in many cases they would recognize that this would be a windfall to fund a deferral on bonuses at the full percentage elected for salary. (You could take this position in EPCRS -- and provide a rationale for a lower correction amount). A lot of it is a matter of negotiating.

I would assume that before a client would pay $500,000 into the plan, they would pursue the alternatives I've suggested.

[E as in ERISA]

I have a friend who was previously a large case auditor. And he has told me you can save your clients a lot of money if you're creative in your approaches to corrections. Look for alternative ways to solve the problem. For example, if you've excluded a lot of employees with low hours and pay, don't automatically correct by funding deferrals at the average for the plan. Ask to use the average for employees in the bottom tier of pay. That's a perfectly reasonable solution.

And in this case, look for a way to argue a different solution than funding a deferral at the rate on regular salary. It may not be possible, but it's worth trying.

[Kirk Maldonado]

The error was caused by erroneous advice given to the client that was put in writing, so that the client had recourse against the party that gave that advice.

Again, I differ with E as in ERISA.

If the employer has an absolute right to indemnification for the losses caused by a third party, I think that the employer would be crazy if it exposed itself to even a .0001% chance of getting into a fight with the IRS just so that it can save some money for the person who gave blatantly bad advice to the employer that caused the problem.

Even if the employer decides to fix the problem through EPCRS, why should I expend any efforts to minimize the indemnification costs of the negligent party? It seems fair that if that party wants to keep its costs down, the burden should be on them to devise that methology. I would be willing to propose whatever correct technique that they would like me to propound to the IRS, but it isn't my job to spend time trying to save them money. (The negligent party was a major institution with ample resources to create innovative solutions if it wanted to.)