failure to deduct pre-tax

[wsp]

In 2006, company went to trouble to set up a cafeteria plan to deduct medical premiums on pre-tax basis. Made all proper notifications and elections but then failed to set it up on payroll system as a pre-tax deduction. Error is not found until 2nd quarter of 2007. What's the correction?

[J Simmons]

What is the correction? Ugly.

Re-do all the affected Forms W-2 for 2006, and payroll reporting. You'll have overpaid FICA/FUTA. Not sure how you'll recoup the credit for doing so, but I'm sure the Service has a procedure.

The revised Forms W-2 would in turn cause all the employees to have to amend their Forms 1040 for 2006 to take advantage of the lower reported taxable income per the revised Forms W-2.

[LRDG]

EEs are entitled to a refund of Fed, FICA, State, local and municipal tax EE paid on the premiums.

[wsp]

Ok, thanks. Figured as much....not fun to be the bearer of this kind of news even if we had nothing to do with it. Fortunately for us we were just installing the payroll system and had nothing to do with the plans.

[LRDG]

Lucky you.

[wsp]

Now assume the situation is reversed. Turns out there is no plan document. The person doing the setup was told that there was a plan in place and deducted funds pre-tax when there obviously shouldn't have been given that there is no document. All within current plan year but not within current quarter (don't know if the latter matters).

Can you just make adjustments on current payroll and submit taxes to various agencies?

[Guest mjb]

Are you proposing that the employees be taxed on what they thought were pre tax contributions under Fed, state and fica since the beginning of 2007?

[wsp]

Are you proposing that the employees be taxed on what they thought were pre tax contributions under Fed, state and fica since the beginning of 2007?

Employees were not aware of it unless they actually took the time to understand. They were not told that a plan was in place. Not sure if any noticed the deduction that was previously taken post-tax had changed to a pre-tax one.

Obviously a putting a plan in place at this juncture is not an option...so what else are my options but to modify their checks over a reasonable period in time?

[jpod]

wsp: With a caveat, the answer to your question is basically "yes." The instructions to the 941 and W-2 explain what to do.

This is my caveat. You say no "plan document," but you don't necessarily have to have a single document that resembles the type of 125 plan document we are accustomed to seeing. Is there a written explanation of how the plan would work that was distributed to employees? Are the rules of the plan described in the election form which was used? Are there Board of Directors resolutions that describe or refer to some set of rules governing the plan? Either one or a combination of the three MAY satisfy the written plan document requirement.

[wsp]

wsp: With a caveat, the answer to your question is basically "yes." The instructions to the 941 and W-2 explain what to do.

This is my caveat. You say no "plan document," but you don't necessarily have to have a single document that resembles the type of 125 plan document we are accustomed to seeing. Is there a written explanation of how the plan would work that was distributed to employees? Are the rules of the plan described in the election form which was used? Are there Board of Directors resolutions that describe or refer to some set of rules governing the plan? Either one or a combination of the three MAY satisfy the written plan document requirement.

jpod,

It's a current year issue so w-2's won't be effected. Quarterly deposits of taxes are an issue as well as modification of employee payrolls.

As for plan document, Thought of that already...everything was based upon statements made by HR person who obviously didn't understand the questions being posed. According to the HR Rep they thought that a document wasn't needed because their insurance guy told them since they were under 100 people they could just start withholding on a pre-tax basis.

[LRDG]

The biggest problem is probably that there are no employee election forms, and is the most difficult problem to correct without violating rules prohibiting constructive receipt.

The course of action to correct would be to enroll employees asap. Pre tax payroll effective date should be no earlier than the EEs enrollment date. It will require reversal of payroll and other taxes that pre-date EEs date of election/enrollment.