HCE made deferrals, had NO Compensation

[Alex Daisy]

I recently discovered that a HCE made a deferral for 2006, but he never received compensation for that year.

This is a self employeed individual.

Since the HCE had no income, he cannot have any deferrals. The contribution could not have been a deferral, since there was no income to defer from.

What would be the correction method to get the contribuion out of the participants account?

[rcline46]

See Rev Proc 2005-80, 415 violations.

[Sully]

See Rev Proc 2005-80, 415 violations.

I think the numbers got transposed. It should be Rev Proc 2008-50

[K2retire]

It's also a 402(g) violation.

[Tom Poje]

Thinking out loud, if the amount is less than $5000 and the person is over age 50 then there is no 415 violation because it can be treated as a catch-up? That would seem strange, but ...

[Bird]

Thinking out loud, if the amount is less than $5000 and the person is over age 50 then there is no 415 violation because it can be treated as a catch-up? That would seem strange, but ...

I think that is correct; (in that situation) it's not a 415 violation. Nor is it a 402(g) violation; that's just a dollar limit. But I don't think it is doable, since the plan would have a (max) 100% of pay deferral limit that would apply, even to catch-ups. So it creates an interesting reporting situation - I think the plan just disgorges the money and the participant doesn't report it as a deduction on the front end or as a taxable distribution on the back end.

[david rigby]

Hmmm. Perhaps I'm just an idiot.

How can the employee have a deferral if there is no compensation? Was there an actual deduction from a paycheck? Did the plan accept a contribution that was not deducted from a paycheck?

Is it possible that the plan did everything correct, but the 2006 payroll may have been "jimmyed"? (In case you were wondering, "jimmyed" is the technical term.)

[Kevin C]

Sorry, but no compensation also means no catch-up.

1.414(v)-1© Catch-up contribution limit

(1) General rule. --Elective deferrals with respect to a catch-up eligible participant in excess of an applicable limit under paragraph (b) of this section are treated as catch-up contributions under this section as of a date within a taxable year only to the extent that such elective deferrals do not exceed the catch-up contribution limit described in paragraphs ©(1) and (2) of this section, reduced by elective deferrals previously treated as catch-up contributions for the taxable year, determined in accordance with paragraph ©(3) of this section. The catch-up contribution limit for a taxable year is generally the applicable dollar catch-up limit for such taxable year, as set forth in paragraph ©(2) of this section. However, an elective deferral is not treated as a catch-up contribution to the extent that the elective deferral, when added to all other elective deferrals for the taxable year under any applicable employer plan of the employer, exceeds the participant's compensation (determined in accordance with section 415©(3)) for the taxable year. See also paragraph (f) of this section for special rules for employees who participate in more than one applicable employer plan maintained by the employer.

[BG5150]

It's also a 402(g) violation.

...AND and document violation

[Tom Poje]

thanks Kevin, knew there must be something somewhere that wouldn't permit a catch up.

dave- it is conceivably possible to defer during the year, but when the sched C income is calculated you end up with nothing.

the preamble to the final 401k regs envisions this: (p12-13 on my copy)

One commentator asked for clarification of the interaction between these timing

rules and the rule under the regulations that treats a self-employed individual’s earned

income as being currently available on the last day of the individual’s taxable year and

whether this last day rule precludes a partner from making elective contributions during the

year through a reduction in the partner’s draw. The restriction on the timing of contributions

is not intended to prevent a partner from deferring amounts that are paid to the partner

throughout the year on account of services performed by the partner during the year, and

the final regulations have been modified to clarify this point. However, self-employed

individuals who take advantage of this opportunity to defer amounts during the year must

make sure that the amount contributed during the year will not exceed the limits (such as

the limits of section 415) that will apply to the individual, based on the individual’s actual

earned income for the relevant period.

[Jean]

Although many people allow a 415 distribution, I differ on the ability to return the contributions as a 415 failure. Per EPCRS Program Eligibility Rule, SCP is not available to egregious failures. An egregious failure includes a contribution paid to an HCE that is several times greater than their 415© dollar limit. Presumably, the contribution paid is several times greater than their 415 limit. Finally, you will find that this type of error occurs year after year with self employed individuals who overestimate their income. Isn't that in itself an egregious error?

.11 Egregious failures. SCP is not available to correct Operational Failures that are egregious. Egregious failures include: (a) a plan that has consistently and improperly covered only highly compensated employees; (b) a plan that provides more favorable benefits for an owner of the employer based on a purported collective bargaining agreement where there has in fact been no good faith bargaining between bona fide employee representatives and the employer (see Notice 2003-24, 2003-1 C.B. 853, with respect to welfare benefit funds); or © a defined contribution plan where a contribution is made on behalf of a highly compensated employee that is several times greater than the dollar limit set forth in § 415©.

[Bird]

I (still) don't think it's a 415 violation, but I don't think the egregious error reasoning applies since that refers to the dollar limit.

© a defined contribution plan where a contribution is made on behalf of a highly compensated employee that is several times greater than the dollar limit set forth in § 415©.

[Jean]

Isn't the dollar value under 415© for this individual $0?

[BG5150]

According to TAG, this is a 415 violation, since there are no allowable deferrals for the owner, it must be classified as a non-elective contribution. Since he had zero compensation for a non-elective contribution, there is an annual addition failure.

From TAG's reply to me:

"Under the general corrective principles of RP 2008-50, the excess annual addition would not leave the plan. The amount would be removed from the account of the self employed participant and treated as a forfeiture, pursuant to the terms of the plan document."

[Bird]

Isn't the dollar value under 415© for this individual $0?

I always took "the dollar limit under 415©" to mean, well, the dollar part of the limit, that is, $40,000 (as adjusted), as opposed to the percentage limit (100%). The fact that this participant's limit is $0 is a function of the percentage limit.

since there are no allowable deferrals for the owner, it must be classified as a non-elective contribution

I think this is debatable. What allows the plan administrator to re-classify a participant's elective deferrals as some other type of contribution?

[K2retire]

since there are no allowable deferrals for the owner, it must be classified as a non-elective contribution

I think this is debatable. What allows the plan administrator to re-classify a participant's elective deferrals as some other type of contribution?

I've always understood that if there was no comp from which to defer then the funds that were intended as deferrals must be employer money of some type. That is the rationale for not being able to refund them, since it was employer money, not something the participant paid.