Employer never withheld deferrals but deposited the $$ anyhow

[Guest esi-jht]

I still don't understand HOW this could happen, but apparently it did. For all of 2005 the employer NEVER actually reduced anyone's compensation by the amount of their elective deferrals. The employer, did, however, made a deposit to the mutual fund company of an amount equal to the employee's deferral election as it applied to each pay period (for example 10% of comp). So, the employees get W2 at end of the year, with no reduction in taxable amount for the elective deferrals. The deposits were made to the mutual fund as employee deferrals and are being treated as such by the mutual fund company.

My question is how do we correct this? My first thought is that the amount that was deposited should be allocated as a discretionary profit sharing contribution. The document has a comp to comp allocation formula so this means that some accounts at the mutual fund company will be reduced while others will be increased. I'm worried about the ramifications of doing this.

My other concern is what about the error the employer made of NOT reducing compensation by deferral amounts? Is this a qualification issue that must be corrected somehow.

Any thoughts or suggestions?

[jpod]

This has to be the goofiest elective deferral glich I've ever heard about.

You could try to get a ruling from the IRS that there was a mistake in fact, so the money can be returned to the employer. (The mistake in fact would be the mistaken assumption that the money was or would be deducted from employee paychecks, but I admit this seems like a stretch). Assuming that won't fly, the money would have to stay in the plan.

Absent EPCRS relief, the money would be allocable in accordance with the Plan's general profit sharing formula. (Although it's unlikely, I have no idea what one would do if there was not profit sharing formula set forth in the plan.) You have many competing and conflicting interests here. On the one hand, employees may end up with free employer contributions which were never intended. On the other hand, if the employer attempts to "collect" the amount it should have deducted from the employees' paychecks, how would the employees be made "whole" for the taxes which they should have not had to pay if the employer had acted correctly.

Maybe you can get VCP relief to treat the contributions as elective deferrals subject to the employee "repaying" the amount that should have been deducted from his/her pay via deductions from his/her current pay (i.e., if the employee does not "repay," the employer would treat that employee's allocation as a plan-wide profit sharing contribution). Maybe you can also secure relief on the 415 issues (if applicable). However, I don't think you can get relief on the 402(g) issues if the repayments plus an employee's elective deferrals for the current year exceed the 402(g) limit for the current year.

[austin3515]

Let's say the problem was a little more aggregious - that is, the employer ignored a deferral election and never put the money away. Wouldn't it be reasonable to make a contribution equal to the missed deferrals? I'm certain at least half of the responders would tell you that you should at LEAST put in 50%. So haven't you gone above and beyond by putting in 100%?

Depending on how big the plan is, I'd go in under VCP - I mean lets face it, the only one getting screwed here is the Company. Unless the deferrals were deducted on the return, not even the government is getting screwed.

I too have seen lots of things go wrong, and this definitely at the top of the list!!!

[Belgarath]

Wow! I agree with the comments that it will generally need to be allocated as an employer discretionary allocation. As far as the missed deferrals, there is a potential specific fix now under Rev. Proc. 2006-27. See Appendix A, .05, and examples 3 through 10 in Appendix B. Although this is meant for people who were not provided the opportunity to make a deferral election and to defer, I'd argue that you have effectively the same problem.

If it is a large plan and there's really a substantial amount of money involved, you could consider a "John Doe" submission with some creative solution which is less expensive for the employer, but I have no guess as to how this might work out.

Just when you think you've seen it all...