Employee deferrals in excess of plan limitation

[Guest Kathleen Meagher]

If these contributions did not result in an ADP failure and were not excess annual additions under 415, were they excess deferrals that violated the $10,000 limit of 402(g)? If not, I don't think you can return them just because they violated the plan's non-statutory 15% contribution limit--I believe the Code and regs permit such refunds only if one of the statutory limits is violated.

Contributions in excess of plan limits would be qualification defect on account of a failure to follow the plan's terms and could be corrected through one of the IRS's correction programs. (But I'm not sure they'd let you pay the money back--they might require you to make additional contributions to the other employees.)

[Guest rrahn]

In the prior year, a limited number of participants (13) made deferrals in excess of the plan's limitation (15% of compensation). The ADP and 415 tests were passed. Eight of the participants are still employed, five have terminated. Does anybody have experience with making refunds of excess deferrals and the earnings to the participants using Form 1099-R?

[Guest Beavis]

I wouldn't have much of a second thought about distributing these amounts with attributable earnings.

While I agree with the previous post that this is an operational issue, this could easily be corrected using APRSC. By distributing the excess amounts plus earnings , you would have put the plan and the participant in the same position has the error not occurred. While the standard correction for not fixing a failed ADP test is to make QNECs, making contributions to other employees in this scenario doesn't make sense. It would just create more problems.

Having said that...for the participants that have already received distributions of their entire balance, I'd issue revised 1099R's for their distributions. For the excess amounts, use a distribution code of 7 or 2, or something that won't buy them an excise tax.

For the participants that are still in the plan, I'd distribute right away and issue a 1099R as described above.

I would put this on a 1998 1099R and make it taxable in 1998. Some might argue to put it on a 1997 1099R. It's been my experience though that the IRS doesn't like to see 1099Rs for prior years unless you are revising something that has already been reported. What I wouldn't do is put it on a 1998 1099R and make it taxable in a prior year. One of the other two options is much better.

Other ideas?

[david shipp]

I believe Kathleen is right that none of the standard refund mechanisms is available to cover the return of contributions that exceed a plan imposed limit. In this case, it appears that all affected ees are nonhighly compensated based on the fact that they contributed in excess of 15% of comp. I would either return the "excess" plus earnings, taxable in year of return, under the APRSC (if you can meet the conditions for eligibility) or simply hold on to the excess and document that you will "sin no more."

I realize that the APRSC guidelines indicate that it is preferable to keep assets in the plan, but since we are talking about NHCE deferrals, I don't see how throwing addtional employer money at the plan can resolve the defect.

[Guest Kathleen Meagher]

Maybe I'm a nervous Nellie, but I'd be concerned about making a distribution of deferrals from a 401(k) plan without any statutory authority to do so. Looks to me like this method of correction would violate the "no in-service distributions" rule that generally applies to deferrals. The EPCRS guidelines say that a corrective measure shouldn't violate other qualification requirements. (Although the "no distributions" rule is not a 401(a) requirement, it is a requirement for favorable tax treatment as a CODA.)

I agree that giving more money to the other participants is an unattractive prospect, and would not solve the operational problem. I like David's idea of holding the money in the plan--maybe it could be placed in a suspense account for each employee and then used to offset their next year's contributions.

[Guest Beavis]

I'd be equally leary of leaving this money in the plan.

I'm only making a guess here, but I'd speculate that if certain employees are allowed make deferrals that exceed plan imposed limits, wouldn't that "feature" (for lack of a better word) have to meet 401(a)(4) non-discrimination requirements? The question said nothing about whether the affected participants were HCEs.

[This message has been edited by Beavis (edited 09-01-98).]

[david shipp]

I'm guessing that the ees are NHCEs since 15% of $80,000 is $12,000 which would have brought 402(g) into play.

Leaving the money in the plan does leave the possibility that the operational failure is discovered on audit. The hope in that case would be that since we are dealing with NHCEs, we acknowledge the problem and redoubled efforts to avoid the problem in the future, the issue wouldn't blossom into a problem. Again, this assumes discovery on audit. (The dreaded "audit lottery"!)

[Guest Paul Hinderegger]

Our firm has seen this problem with participants deferring greater than the plan limit for several years. We, too, have used APRSC to correct these situations.

The issue I see is how the "excess amount" gets back to the participant. We have taken the position that the excess amount gets returned to the employer so that they can "make whole" the participant through their payroll system. By going through the employer's payroll, the appropriate taxes (FICA, FUTA, etc) and withholdings are taken out. I realized that this looks like a reversion of plan assets to the employer but we couldn't find anything in the 1099 Instructions which would have allowed us to do a 1099.

My question is - - Is it better (less illegal) to refund the amounts to the employer so they can return the amounts via a W-2 or refund directly to the participant via a 1099-R?

[Guest Beavis]

I don't think that the issue is how the money gets back to the participant, but just that it does.

If you're going to rely on an IRS self correction program, the best approach is to be as simple and up front as possible. In that vein, I think all the monkey buisiness with reversions and W2s is an overcomplication and may create more problems than it solves. Distributions from qualified plans should always be reported on a 1099R.

One of the other suggestions was to leave the money in the plan in a suspense account until the next plan year. 401(k) plans however aren't allowed to maintain unallocated accounts from one plan year to the next.

Whether or not you feel that this problem may be corrected under APRSC via the distribution route, honesty is still the best policy. If you're going to distribute, do so without all the monkey business. If you feel more comfortable leaving the money in the plan and playing audit roulette, just do it. Don't try to twist the situation around so it looks like nothing ever happened. It will just look worse when it's discovered.

[Alonzo]

If you repay the over the limit contributions,

you have to re-run the ADP and ACP tests, if you are using the current year method. So things may not be as simple as

"just pay it out."

Has anyone considered just doing a retroactive amendment increasing the limit for the year in question? As long as it's just NHCEs who've fouled up, and the limit has not been enforced on anyone by the administrator (which sounds like the case), this would appear to be the simplest solution.

[Guest LOhmer]

McKay Hochman provided me with the following on this issue:

Two option to correct:

1) Treat as a mistake of fact. Issue a check to the employer for the amount of the excess and earnings. Employer then issues checks to the participant and corrects W2. Earnings calcualed in same way as earnings on excess annual additions.

2) Treat in the same manner as an excess deferral.

Tax reporting:

Correct W2 for the effected participants. Excess and earnings should be taxed in year returned to employer for inclusion in the employee's W2.