Dependent Care

[Guest Nini]

We have a client that just discovered that for the 2006 calendar year that two employees enrolled for dependent care, were reimbursed for dependent care expenses (the employer "fronts' the money for dependent care), but they never withheld money from the salary of these two individuals (this is a large employer and they do not distribute pay stubs - employees go online to see deferrals).

Any ideas on what can be done to rectify this situation - the employer wants to take missed deferrals during the remainder of 2007.

[Guest taxesquire]

Technically, ERISA may obligate the employer to try to get that money back. The employer certainly has a right to it. However, unless this is a self-insured plan, you'll need to look at state law to determine if the employer can withdraw the extra amounts from salary without the employees consent and without violating wage garnishment laws.

Also, at this time, I don't think the amounts can be withdrawn on a pretax basis - it's a whole new planyear now, right?

[LRDG]

The ER can't, or shouldn't, do nothing. DC benefits have already been paid as untaxed income received by EEs. That's assuming that no plan exists for ER paid DCB other than as a salary reduction agreement/ reimbursement arrangement under Secs. 125 and 129.

There are 2 possible options that come to mind to correct in 2007 the untaxed Sec. 129 benefits received by EEs in 2006.

1st option, ER can allow the EEs to re-pay 2006 benefits on a pre-tax payroll deduction basis from 2007 income. If ER chooses this option, I would recommend distuingishing deductions intended for repayment of 2006 benefits from deductions intended to fund 2007 DC account. Deductions for 2007 should only fund the 2007 DCB reimbursement account, the 2006 deductions used to off-set the 2006 DC benefits EEs have already received.

2nd option, ER can issue amended/corrected W2s for 2006, by including in taxable income the 2006 DCB paid in error by the ER. This may require EEs to amend their individual 2006 tax returns. If this option is choosen, the 2006 salary reduction agreement may need to be voided with clear explanation of events, providing a clear payroll and benefits audit trail.

Documentation is important. 5yrs from now, a benefits, payroll or IRS auditor should be able to understand the transactions. Wouldn't want to trigger an otherwise unnecessary audit.

Technically this is not an ERISA plan, nor are the amounts tax 'deferred', but are more accurately amounts excludible from taxation.

[J Simmons]

If the two EEs are willing, I'd have them pay the ER the amounts that should have been held out of their paychecks per the day care plan, and then amend the 2006 Forms W-2 to show a lesser amount of taxable income by the amount so repaid. The EEs will need to amend their 2006 Forms 1040 to take advantage of the tax savings. It was the ER's error, so the ER ought to be willing to pay the tax-preparation costs of the EEs to do the amended 1040s.

If the EEs are not willing, then as taxesquire mentioned

you'll need to look at state law to determine if the employer can withdraw the extra amounts from salary without the employees consent and without violating wage garnishment laws.

As LRDG said,

Documentation is important. 5yrs from now, a benefits, payroll or IRS auditor should be able to understand the transactions. Wouldn't want to trigger an otherwise unnecessary audit.

I also agree with LRDG that

[t]echnically this is not an ERISA plan, nor are the amounts tax 'deferred', but are more accurately amounts excludible from taxation

unless the day care reimbursement plan is part of a cafeteria or other ERISA plan. If the day care program is a stand alone, it should not be subject to ERISA.

[QDROphile]

It is very unlikely that ERISA is involved in this matter.

It is unlikely that there is any tax problem, except maybe FICA. The amounts that were supposed to be taken out of pay, but were not, were probably included in regular pay and reported as taxable income on form W-2. If the employer covered eligible dependent care benefits and did not exceed the applicable limits, the employee has not received any taxable income, except maybe FICA. I doubt the situation caused the plan to fail applicable discrimination tests.

Maybe discretion is the better part of valor and the employer should back off. Righteous indignation is unbecoming when one participates in the outrage. Yes, the employees got a windfall, but if the employees will not do the right thing and voluntarily pay the employer some fair amount (taking into account tax benefits in some way), is it worth it? If it is worth it for some reason, the employer should go pay for competent professional advice rather than dumping the problems on you.

[Guest taxesquire]

I think there is some confusion as to the type of plan we are discussing. Mybe it's just me, but I assumed the initial reference to employees who enrolled in "dependent care" meant employees who elected dependent coverage in the medical insurance plan. That is why I referenced ERISA. The subsequent posts discussed DCAP FSAs and correctly noted that ERISA doesn't apply to DCAPs. 1 of the later posters referred to an employer-sponsored daycare center. I actually don't know whether ERISA applies to those.

What are we dealing with here?