Tips and Deferrals

[Randy Watson]

Employer has a 401(k) plan. Employees are paid a low base wage and also collect tips. Although the full amount of the tips are reported as income, the employer allows the employees to take cash tips home with them the day they are earned. This leaves very little actual compensation for purposes of elective deferrals and the payment of participant loans.

In a case where there is insufficient compensation to make the deferrals AND the loan payment, I believe the employer is responsible to contribute the compensation toward the deferral first. Anything left over would then be used to pay the loan. Someone is telling us that if there isn't enough compensation to make the full deferral that the employer is responsible to make up the difference. This makes absolutely no sense to me. Does anyone have any thoughts on this?

[Nate X]

"Someone is telling us that if there isn't enough compensation to make the full deferral that the employer is responsible to make up the difference."

I agree. The election to defer into the plan must be made prior to withholding from the employee's salary. So the Employer should be well aware that he/she may need to withhold tips to cover the desired deferral percentage. Failure of the Employer to do so puts the liability on the Employer. This is because once compensation is in the hands of the employee (or in this case when the employee takes the tips home) the money can not be deferred.

Keep in mind that allowing employees "to take cash tips home with them the day they are earned" is different than Excluding tips from the plan.

[Randy Watson]

That certainly sounds reasonable, but how can an employee who receives cash tips directly from customers defer that money under a 401(k) plan? In other words, how can you defer what you have already received?

[TPA Bob]

We currently have a client with the same issue. Would seem that since for federal withholding and FICA the employee can reimburse the employer for any deficit the same would hold true for the 401(k) - a procedure in place to have the employee pay the deferral amount back to employer. Any thoughts?

[Guest 401karl]

We have an employer with an employee that is mostly salaried but does earn tips (more than $20 per month). They have realized that the employee's deferrals have only been based on the salary portion of her pay. The plan has a basic safe harbor match. Since the deferral was less than it should have been the SH match was less than it could have been.

How does a plan correct? My thought would be the employer would at least be responsible for the lost SH match but does the employee need to make up the amount that was not deferred?

[MWeddell]

401karl,

Typically, the employer has to make up 50% of the employee pre-tax deferrals that were not made due to the operational failure.

This is covered somewhere within Rev. Proc. 2008-50, which is not the easiest thing to read:

http://www.irs.gov/pub/irs-drop/rp-08-50.pdf