Payroll advance - and repayment issues

[Guest MaryMac]

I'm a plan administrator/plan sponsor seeking any info about an issue we've run into. Not entirely sure I even have a problem here.

We changed from semi-montly to biweekly payroll in 2003. The result to employees to shore up the payroll calendar would have involved a short paycheck. An executive decision was made to provide a one-time payroll advance to ease the financial impact to employees. The advance was subject to 401(k) contributions and match.

The advance was to be paid back upon termination of employment - and over 160 people have done so since 2003. A few employees are also making payments without terminating. It has recently come to my attention that 401(k) contributions are also coming out of the earnings before the payroll deduction to pay back the advance. Sounds like maybe that should not be happening, and maybe it results in improper contributions to the plan, like double-dipping or something.

Plan doc: payroll advance is not included or excluded from the definition of compensation or deferral pay.

What do we have here? Is it wrong to take the 401(k) deductions before the repayment of the advance? Am I looking at refunds, forfeiture of match, retesting, refiling, and re-examining my career choice?

My next step is to consult with ERISA counsel, but looking for a preview of what is to come from board members.

Thanks for any comments.

[SteveH]

I might just be thinking virtually out loud here...

For employees still employed - If the payroll advance wasn't due to be paid back necessarily until termination, was it counted on their W-2 at the end of the year? My guess is that it was. If it was part of their gross income at the end of the year, then has anything gone wrong yet? I don't think so.

For employees that were terminated the same year as the advance originally happened. For those people I am thinking that their deferrals were higher than maybe their election form has stipulated on the last payroll. The advance payroll was probably done corectly, the last payroll probably had a lower gross pay than what their election form indicated. Has anything gone wrong from a plan persective? Well the employees probably haven't gone over their deferral limit for the year ($15,000 max for 2006), so there isn't any major plan issue. The employee might be upset, but I bet no employee even noticed.

Now what about the match...you might have some match calculation problems. I don't know how your plan allocates matching dollars. Is it discretionary at the end of the year? Is it with every payroll, but limited to a % of the person's wages? if it is a 5 of wages, then the last payroll maybe didn't receive a full match depending on whether the match was calculated before or after the repayment. For instance if the company matches 100% of the first 4% deferred each payroll, I may have set my deferral to be 4%. My last payroll though, after the repayment might look like I deferred 8% of my pay and I wouldn't have been matched on 4% of it. Now that wasn't my intention as a participant to defer more than what I would be matched on. But this might not have been the case at all.

Should 5500s be refiled? I only think this happens if you determine that you should hav emade additional match to the plan for some reason. Although I am not sure I would come to that conclusion. In my example above the only thing I think has happened was that you maybe withhled more money from the last paycheck than an employee wanted. Do you have to take that out of the plan and go through a huge process, I don't think so. If you were short on match dollars then you would have to go the lost earnings route, the late desposit route, and refile. I suppose you should retest the ACP, but if you passed before, adding more match for rank and file employees that hav etermianted shouldn't cause you to fail now.

If you think you ahve overpaid the match, depending how you calculated that last payroll, then you probably haven't necessarily broken anything either. If the plan allows for discretionary match, then you have given some people a small additional discretionary match. As long as it wans't given to Highly Compensated Employees, you won't fail discrimination testing. Now your plan may not allow for an additional discretionary match, but you might be surprised. We write our docuemtns to include it, even though most plans never use it. Sort of a just in case.

I think it boils down to has someone gotten screwed here?

Have youoperated the plan incorrectly or did you only mess up payroll?

What is the dollar cost of this?

Is it worth trying to fix?

Is your plan large enough that it is subject to an audit each year by a CPA? They haven't caught it yet. Are you certain someone else will? Maybe the company should announce that because of the wonderful 3rd quarter results, anyone that had a payroll advance back in 2003 does not have to pay it back! YAY!

I don't think you have problems with the advance back in 2003 assuming that it was included in their gross wages for the year. I think the problems are cropping up on the last payroll becuase you aren't reducing their gross wages first.

Or maybe I misunderstood everything you said.

[Guest MaryMac]

Thank you for your reply.

To address your questions:

The advance occured in late Dec of that year, so I don't think anyone paid it back in the same year they received the advance.

We match 200% on the first 6% (no typo) and we do that every payroll. We also do a year end true-up if necessary. In the payroll that included the advance, the advance plus the regular earnings were subject to 401(k) and to the match formula. If you've elected 6%, 6% came out of the total of your regular earnings plus advance earnings.

We do have an audit requirement. We also consulted the same audit firm before paying the advance. They just never (nor did we) give much thought to the repayment process. We are also seeking their guidance now relating to the payroll considerations (we use them as corporate auditors, as well).

We included the advance in gross income and taxable wages for 2003. We've included it in gross income and taxable wages again upon repayment. The audit firm is suggesting that we have to file amended W2s and allow employees (mostly former) who repaid the advance to reclaim taxes withheld in error. It seems that this all would somehow impact the 401k plan.

YOU SAID

"I don't think you have problems with the advance back in 2003 assuming that it was included in their gross wages for the year. I think the problems are cropping up on the last payroll becuase you aren't reducing their gross wages first."

I SAY - yes, that is the crux of the concern. Not with the advance, but the repayment.

[SteveH]

I'm not sure I would reissue W-2s. The problem is that then 160 former employees are going to ask you to pay for the refiling of their taxes also. So not only have you incurred the expense of reissuing the W-2s, but now what are you going to do about the complaints? Maybe reissuse is the best and right thing to do, I don't know. Just be ready for the firestorm.

By the way, 200% of the first 6% deferred is insane.

[Guest MaryMac]

Yes, the 200% is the highest I've ever seen. Many think it is a typo and young people we hire have a hard time convincing their parents that they've understood the plan correctly.

I too am troubled by the masses asking to have us pay for tax refiling.

Thanks again for your very thorough response.