Client forgot to remove deferrals from payck

[doombuggy]

A client contacted me earlier this week to let me know that they have not been removing deferrals from soneones paycheck - since January! The new firm administrator let this woman know about an plan meeting and the partiicpant mentioned the fact that no deferrals have been coming out of her check.

Anyway, as much as I want to go the "to bad, so sad" route, we are looking at EPCRS to fix this mess. I just got a copy of her enrollment form (which was sent to Hancock in a timly fashion) and she elected to defer $40 per pay. This plan has a safe harbor match with the 100% to 3% & 50% on the next 2%. I have a list of her gross pay per pay period, and it varies each period, but the $40 is around 3%.

Opinions:

Should the company make up the $40 for each pay plus the SHM? (citing 2006 TEOB page 15.647 Issue 16) OR

Should the company make up 50% of the deferral plus the SHM (Rev Proc 2006-27 Appendix A page 60 ©)

I am having a hard time wrapping my brain around the fact that this woman went months without noticing that she was not deferring........

Your thoughts are appreciated.

[doombuggy]

Bumping...lots are looking but no one has an opinion. I am leaning more towards the 50% that I see in the rev. proc. This participant has to shoulder some of the burden...she has to be getting somekind of paper notice of what's taken out of her paycheck, whether it's direct deposited or not.......

Thanks for your help, guys...

[Just Me]

This has been answered in another thread somewhere, but I don't have time to look for it.

The gist is that you can go the 50% route, but an IRS represenatative has advised that this is only the case if you file under VCP. If you're going self-correction (i.e. because this may be insiginificant or very recent), then the IRS will not accept the 50% as "fully corrected" and the plan remains at risk. In the absence of the VCP deal, you have a valid election form that is essentially a contract that needs to be honored, regardless of how we all feel about the employee having some responsibility to have noticed this (I know I sure would have!).

[401_4_ever]

Was this IRS representative's comments made before Rev. Proc. 2006-27 came out? Appendix A section .01 (pg. 58) states that "The correction methods in this appendix are acceptable under SCP and VCP."

The next page, the example under .05 (pg. 59) describes the 50% of ADP route, which we've all cited before.

I don't see how it could be clearer that this method would be available for self-correction...

I completely agree as to the other point, the valid election form had to be honored, no matter how long an employee goes without noticing no deferrals being made.

[Just Me]

Yes. After the Rev. Proc.

The difference between your case and what the Rev. Proc. refers to is that in your case there was a valid election made (which could not be more clear). The Rev. Proc. (read it very carefully) talks about an error where the employee was not even given the opportunity to make deferrals. Look at page 59 - "the employee was not provided the opportunity TO ELECT and MAKE elective deferrals". We understand the IRS takes this literally. (ELECT and MAKE being two separate events). In your case, the employee elected, but did not actually make deferral contributions. The 50% correction was meant to be used where we don't know what the employee would have elected. In your case you know exactly what the employee elected.

Self correct at the plan's risk.

[jpod]

I agree with those who say that to fix the plan qualification issue the employer must deposit to the plan 100% of what the employee elected to contribute, plus any corresponding match.

However, that doesn't mean the employee is off the hook and can walk away with a freebie: she still owes the employer the money that shouldn't have been deducted from her paycheck. If this cannot be done on a pre-tax basis, then maybe her debt to the Company should be reduced a little bit to take that into account, but there's no reason why she must (or should) benefit from the employer's mistake.

[Kevin C]

However, that doesn't mean the employee is off the hook and can walk away with a freebie: she still owes the employer the money that shouldn't have been deducted from her paycheck. If this cannot be done on a pre-tax basis, then maybe her debt to the Company should be reduced a little bit to take that into account, but there's no reason why she must (or should) benefit from the employer's mistake.

jpod, I'd love to see the cite supporting for your statement. I'm wondering how the plan sponsor's failure to follow the terms of the plan document results in a debt owed by the employee.

[jpod]

No citation is necessary. Employee made an election. Per terms of plan, election cannot be revoked retroactively. What legitimate reason do you think the employee could have for refusing to part with the money she elected to put into the plan? Let me turn the tables on you: what citation can you provide for the proposition that the employee is entitled to both the money in the plan and the money in her pocket?

[wsp]

No citation is necessary. Employee made an election. Per terms of plan, election cannot be revoked retroactively. What legitimate reason do you think the employee could have for refusing to part with the money she elected to put into the plan? Let me turn the tables on you: what citation can you provide for the proposition that the employee is entitled to both the money in the plan and the money in her pocket?

Interesting thought...I went back and forth on this. Ultimately I sided with 402(e)3 which treats elective deferrals as an employer contribution. It seems to fit the situation more than anything else. If it's an employer contribution and the employer fails to properly withhold then he/she is out of luck and not the plan. Employer is still obligated to fund the plan per the terms of the document. If the employee paid the employer portion then the contribution ends up being after-tax voluntary contribution which isn't what we want and taking it pre-tax is not following the terms of the plan either.

Not arguing the side because I really am not sure...but this makes sense to me.

[J. Bringhurst]

I disagree with the argument that the employee is on the hook for the above situation...the Appendix B of the revenue procedure provides for a specific correction for a failure to let otherwise eligible employees participate for a partial plan year...this correction contemplates the employee being able to make up the missed deferrals if the employee has at least 9 months to do so...the situation described above went on for longer than 3 months...of course, the employee should have noticed...but the plan sponsor is responsible for administering the plan in accordance with its terms and would be considered more of an "expert" in the care and feeding of its own plan.

[Guest mjb]

Where does Appendix B say that? I thought the examples refer to an employee who is not not given the opportunity to elect to make deferrals, not one whose employer fails to withhold deferrals after an election is made. The employee is at fault for not notifying the employer of the failure to withhold contributions and should not profit from this mistake if he retains possession of funds that were subject to a binding election to remit to the employer. The employee should be given the opportunity to correct the mistake by remitting the after tax amounts paid since January less income tax withholding (e.g., $40 week- 20%= 32) before year end and have the employer adjust the employees taxable comp for the year and make the full contribution to the plan. The employee's w-2 comp and withholding will be reduced to take into account the return of the comp paid as permitted under either Rev. Rul 75-531 or 79-311. In this way both parties will be made whole (the employer could make an additional contribution for lost earnings.) Requiring the employer to remit the missing employee contributions to the plan unjustly enriches the employee and encourages employees not to report incorrect withholding of deferrals.

[J. Bringhurst]

I wasn't saying that Appendix B applies to this exact situation, but I was making the case that the employer is usually on the hook...except in this one case where the participant has an opportunity to make up the deferrals that it missed out on by not being provided with election forms.

[PLAN MAN]

We can all agree that good guidance is not available on this issue. I don't think the IRS anticipated this scenario. That being said, I think you must work within the IRS rules and regulations to fix the problem. As much as jpod and mjb would like to include the employee in the correction, I don't see any justification in the code or regs for that action.

As I see it, the employer failed to deduct salary deferral amounts from the participant's paychecks and the employer should deposit the missed elective deferral amounts to the plan. Yes, the employee should have notified the employer sooner, but the employer is the one responsible for administering the plan. The employer should have established internal controls and audit procedures to ensure that any errors are discovered as quickly as possible. The failure is the employer's, they set up the plan and they must be sure to operate it correctly.

My opinion is to recommend the company make up the $40/per pay period plus match and earnings - and do it as quickly as possible. I hope someone can find guidance or a reference to show another way to fix this type of error.

Here's a thought: do you think there is any benefit in putting a disclaimer statement on the enrollment form advising the participant they have a duty to review their pay records to cofirm the employer is processing the salary deferrals correctly and a failure to notify the employer of any discrepancy may result in a reduction in the amount of their deferrals?

[doombuggy]

We talked to the HR mgr Tuesday and advised her that she could correct thru VCP (at $1000 IRS fee) and hope for the cheaper correction, or self correct at 100% (meaning the $40 twice per month and the safe harbor match plus earnings). She was going to talk to the partners about it, but it sounds like they will go with the self correction. She is on the ball, and NOT the one who was there at the beginning of the year when this error happened.

She told me that she invited this partiicpant to a group meeting with the broker this month, and that is when the participant mentioned that the deferrals weren't bing with held. When Mags asked the participant why she didn't say anthing, she received an idiotic response along the lines of "I assumed that payroll knew what it was doing - I trusted you." Huh? I don't think she really understood the whole deduction thing. I recommended to the HR manager that in the future she might want to suggest that each new participant look at the pay stub the first time they get the 401k deduction. Believe it or not, the time I enrolled in a plan, mine was incorrect. As it turns out, the company I worked for did my enrollment form incorrectly! I won't name the company, but it is a large firm in PA....

Thanks for your help guys!

[jpod]

PLAN MAN: I have very little doubt that the employer must put the money in the plan in order to preserve the plan's tax-qualified status, not 50% as per Appendix B, but 100%. Perhaps in a vcp submission the IRS would allow less than 100%, but I wouldn't understand the logic in that. Nevertheless, what the employer must do to preserve the plan's qualified status is a separate issue from the employee's obligation to the employer, and that's all I was saying. If the employer puts money in the employee's account, I can't think of a defense that the employee would have to a claim by the employer to make the employer whole, albeit with some possible reduction due to the employee's loss of pre-tax treatment.

[Kevin C]

jpod, Why do you think the employee refused to part with the money she elected to put in the plan? I don't see anything in the post that says the employee caused the deferrals to not be taken from her check.

As for a cite, how about 1.401(k)-1(a)(3)(i)?

(i) Definition of cash or deferred election. --A cash or deferred election is any election (or modification of an earlier election) by an employee to have the employer either --

(A) provide an amount to the employee in the form of cash or some other taxable benefit that is not currently available, or

(B) contribute an amount to a trust, or provide an accrual or other benefit, under a plan deferring the receipt of compensation.

A cash or deferred election includes a salary reduction agreement between an employee and employer under which a contribution is made under a plan only if the employee elects to reduce cash compensation or to forgo an increase in cash compensation.

You are suggesting that the employee pay an amount to her employer so that the employer can deposit a salary deferral amount based on compensation previously paid to the employee. How does an amount paid from an employee to an employer become the result of a cash or deferred election?

The document for the plan in question may also shed some light here. What does the document say about salary deferrals? I’m betting the document says something like the following:

4.1FORMULA FOR DETERMINING EMPLOYER CONTRIBUTION

For each Plan Year, the Employer shall contribute to the Plan, except as otherwise provided:

(a) The amount of the total salary reduction elections of all Participants made pursuant to Section 4.2(a), which amount shall be deemed an Employer Elective Contribution.

The bottom line is that the employee made the election and the employer failed to contribute the appropriate amount to the plan. If you want to convince me that the employee is responsible for correcting the employer’s mistake, you can point out the section of (EPCRS) Rev. Proc. 2006-27 (or any other published cite) that says the employee is responsible for correcting a plan sponsor’s failure to follow the terms of the plan document.

In this case, at $40 per pay period, I would suggest the employer chalk it up as an inexpensive lesson that reminds them how important it is for them to fulfill their obligations to the plan. Of course, they should also review their procedures for implementing deferral elections and revise them as needed.

As for your claim that the employer’s mistake results in a legally binding debt on the employee, my response would be to ask the employer produce evidence that there really is a debt. The additional funds owed by the employer are the direct result of the employer’s failure to follow the terms of the plan document. I seriously doubt the employee entered into any kind of agreement with the employer to reimburse the employer for its own mistakes.

[rlb64]

I have the same situation. The ERISA Outline book refers to Q&A-38 of the IRS’ Q&A session at the 2005 ASPPA Annual Conference held in Washington, D.C.

Where can I get a copy of that? I'm an ASPPA member and don't see it on the website?

Anyone know?

[Guest jetfaninmn]

Is there a method for making up the interest on the contributions?

[Guest Robin.Wolf]

I have the same situation. The ERISA Outline book refers to Q&A-38 of the IRS’ Q&A session at the 2005 ASPPA Annual Conference held in Washington, D.C.

Where can I get a copy of that? I'm an ASPPA member and don't see it on the website?

Anyone know?

[J. Bringhurst]

Revenue Procedure 2006-27 provides earnings methods under Section 3 of Appendix B. With regard to a participant who made investment elections, I think that actual earnings is required...for administrative ease, the highest rate of return under the plan can be used if all affected participants are NHCEs.

For late deferrals (deferrals that have been taken from paychecks and just not remitted to the trust), the VFCP online calculator can be used.

[Guest Robin.Wolf]

Is there a method for making up the interest on the contributions?

See Section 3 of Appendix B of Rev. Proc. 2006-27 (which modified and superseded good ol' 2003-44) It contains various earnings adjustment methods and examples.