Failure to Deposit Deferrals...sort of

[Archimage]

We had a client install a new 401(k) plan for 2005. The employees elected to defer. The payroll company calculated the deferrals and actually took the deferrals from the checking account to deposit into the plan. However, the deferrals were never actually withheld from the participants. How should this be handled and/or corrected?

My initial thought is this is payroll issue and the company is going to have to amend the W-2s. Any other thoughts?

[Guest mjb]

Are you stating that funds were contributed to the 401k plan as participant's contributions but that the participants salary was not source of thes funds. Whose checking account were the contributions taken from? the employer's?

[Bill Presson]

Yes, the money was taken from the employer's checking account.

[GBurns]

Since W-2s are involved, I have to ask, How long did this go on for?

I have no answer for you.

This is something that defies imagination especially if it went on for many pay periods without either the participants, the payroll dept, the accounts payable dept or the bookkeeper and accountant at the end of 1 of the periods either month or quarter, noticing it. I wonder what was the authorization used by AP to draw the checks and then How did the Bookkeeper made the entries?

[Bird]

This is a good one (chuckle).

Two possibilities come to mind -

Void the whole thing. Change the W-2s (I assume they reflected the phantom deferrals). The big problem is that the money is in the plan, and I don't like the idea of taking it out, or trying to convert it to profit sharing contributions. Bad idea; forget it.

Treat the phantom deferrals as loans from the company to the participants. Re-pay the loans by deducting the money from their paycheck(s) now (or let them write checks to the company). I like it - that's exactly what happened. Of course, if someone terminated, you're SOL, except for asking for repayment.

I think I should get a prize...

[Guest TAG]

I am not sure how adjusting the W-2 would correct this as the participants received the comp in '05 and never had anything deferred. The year is over and it is now mid Feb. Think twice about this one as it would be incorrect reporting of wages actually received.

The deferral election form (assuming you have them) is a contract between the ER and EE which apparently was not fufilled. Sounds like a freebee for the EEs and I would go after the payroll vendor to make me whole if I was the Company.

On another note, was there an ER contribution - you may want to check the definition of comp for allocations...could get interesting. Deduction for the company should be interesting as well.

TAG

[Guest mjb]

The point of least regulatory issues is to treat the contributions as employer discretonary contributions to the plan for 05 and leave the contributions on the W-2 since they were paid to the employees and reported as wages for 2005. Any attempt to fix this mess by backing out the wages, etc will require retention of tax counsel which will be very expensive.

[Bird]

Like I said before, the employees owe the money to the company. It is clearer and simpler every time I look at it. It's not even a plan issue - the W-2s were right, the plan got the money, but there was a screw-up in the withholding that should be treated as a loan(s) from employer to employee.

[GBurns]

How do you collect "de facto" loans from employees who do not agree to salary deductions or any other repayment method?

How much money is involved versus the cost of legal counsel, "redoing" the payroll, plus amending tax returns etc?

[Bird]

How do you collect "de facto" loans from employees who do not agree to salary deductions or any other repayment method?

They agreed to the salary reduction for the deferrals, didn't they? So now the money is actually being deducted from their paycheck. A little late, maybe.

How much money is involved versus the cost of legal counsel, "redoing" the payroll, plus amending tax returns etc?

I dunno. But I haven't heard of a better solution that would have less exposure. And this doesn't involve amending any tax returns. I would NOT just "let it go" - i.e. have the company and/or p/r company eat the contributions - then the co. would be under-reporting taxable income for the employees.

[GBurns]

They agreed to the conditions stated in the Salary Reduction Agreement, BUT. The salary reduction agreement states its specific purpose, and that is not what was done. Additionally many are worded with a time frame such as being for the plan or calendar year.

Taking money that is not going to the Plan but is for reimbursing the employer would not be consistent with its stated purpose. Taking the reductions after the stated period would also not be valid since the authorized period has already expired.

[Bird]

Taking the reductions after the stated period would also not be valid since the authorized period has already expired.

"stated period" - "authorized period" - where do you come up with this stuff? And not taking the reductions at all would be fine?

Let's compare it to your solution, which was...?

[GBurns]

As I clearly said in my first post "I have no answer for you. " regarding what can/should be done. Reasons beings that I do not know enough of the facts such as wording of the Salary Reduction Agreement, Plan Document provisions on this issue (if any), employer/employee relations, amount of money involved etc.

Where do I get this stuff ""stated period" - "authorized period" ? Just read a few Salary Reduction Agreements and you should see where. They are not usually indefinite.