Salary Deferral Errors Made By Employer

[waid10]

Hi. We had an error in our payroll department and salary deferrals for a few employees were messed up. Most of them involved employees that were over 50. They wanted to maximize their deferrals with the catch-up contribution. Mistakenly, they were capped at $16,500 and the extra $5,500 was not deferred, but rather was paid out in wages. What are we required to do in this situation? Can we have the employees return the $5,500 to us, make the contribution to their accounts for 2009, and issue revised W-2s? Or since it is already 2010, is it too late?

The second situation we have is where an employee wanted to max out her deferrals at $16,500 by making a $1,000 deferral at the end of 2009. She submitted the proper paperwork, but due to our error, the $1,000 didn't come out of her last paycheck in 2009. It came out of her first paycheck of 2010. Again, can we have her refund the $1,000 to us, make the contribution to her plan account, and issue a revised W-2? Or is there another solution?

[Guest Sieve]

You need to correct under EPCRS (Rev. Proc. 2008-50). You may be able to use self-correction, depending on other facts.

But I think, Yes, the employer can correct under EPCRS for not making deferrals available properly during 2009, and ask the employees to make the employer whole in 2010.

[Kevin C]

But I think, Yes, the employer can correct under EPCRS for not making deferrals available properly during 2009, and ask the employees to make the employer whole in 2010.

Can you provide a cite? I don't see anything in the Rev. Proc. where the employee is responsible for funding the correction. All I see are methods for the plan sponsor to correct failures. Is the employee responsible for reimbursing the lost earnings deposited, too?

I don't see any way an amount taken from the employee's paycheck in 2010 to reimburse the employer could be counted as deferrals for 2009. But, suppose the employee does reimburse the employer in 2010, what is the tax treatment for the reimbursement? It isn't salary deferrals, so wouldn't it be an after-tax payment? I also wonder if the reimbursement would violate any wage laws, but that issue is way outside my area.

[waid10]

The way I read 2008-50 is that we (the employer) cannot require the employee to return the money that should have been deferred. They keep the cash they received as taxable wages. It appears that the proper correction is to make a QNEC to each employee's account equal to 50% of what they would have deferred plus earnings.

Do you agree?

[Guest Sieve]

You can ask the employee to reimburse--that's not specifically disallowed--but you certainly could not demand reimbursement and withhold a correction until receiving reimbursement. Any reimbursement would be with after-tax dollars, so it might be a net number.

I don't recommend this approach, by any stretch of the imagination--especially with NHCEs--but it could be used, I think, under the right circumstances (e.g., HCEs who agree).

[Kevin C]

You can ask the employee to reimburse--that's not specifically disallowed--

That's a scary road to start down. I don't recall seeing anything that specifically disallows asking employees to reimburse for profit sharing or matching contributions, either. I actually had a client ask if he could do that. I told him no, you can't do that.

waid10, assuming the deferral elections were made timely, I think you need to follow the correction method in the Rev. Proc., which you summarize in your post #4. The timing of the election is most likely to affect your second situation. Did the employee make the deferral election for $1,000 from her final 2009 paycheck in time to have it in effect for that paycheck? Does the plan have a written policy for the timing of implementation of a deferral election? If for example, she turned in the election change on 12/30, it could be that the change wouldn't be effective until the first payroll in January.

[Guest Sieve]

Kevin --

I agree with you completely: employee reimbursement is a scary road to start down. I mentioned it in my post, but I disavow its utility--don't know what I was thinking (except, I certainly was thinking not clearly).

Perhaps it was actually Mr. Hyde Sieve who posted the suggestion--and now, Dr. Jekyll Sieve is retracting the suggestion.