Employee excess deferrals moved to forfeiture account

[Guest Quacka]

We have an employee who contributed in excess of the 402(g) limit in 2010, all into the same 401(k) plan. This errored-out after the deferrals had already been funded in the participant's account.

The plan administrator moved not only the associated match, but also the excess elective deferrals into the plan's forfeiture account, then refunded the employee's excess deferrals through company payroll.

So now the question arose, is this a prohibited transacation (or other issue), and if so how do we fix it? Ideally we'd like to justify the action, or at least determine a painless way to fix it.

I was not at the company at the time, so this is a post-mortem.

Thanks

[Jim Chad]

It is not pretty. But I think it is OK. All of the tax effects will turn out correct at the end. But an audit would be ugly because the paper trail is all wrong. Instead of a 1099 the results will be on his w-2.HIs company contribution for the match will not be the separate deposit that would be clear.

I would tell the employer that he should go back and correct everything. But if he doesn't want to pay my hourly fee to fox this, I would not loose any sleep.

What do you all think?

[Guest Quacka]

I am actually the plan administrator now and have to fix this. The accounting department found it, and we will have to tell the auditors.

So it sounds like the participant should have gotten a refund from the plan and a 1099-R, but it would have the same tax treatement payroll and a W-2.

That doesn't give me as much heartburn as a possible plan qualification or prohibited transaction issues. That is what I need to clear up, hopefully with some citation of authority.

Any thoughts?

Thanks again

[masteff]

Question: did they fix it thru payroll in 2010 or 2011? My opinion is if it was 2010 then it's not a real problem. At my former job, we actually did this semi-commonly with minor adjustments (floating them in and out of the forf account) (w/ 2500 active employees, it was hard to avoid minor adjustments).

If it was fixed via payroll in 2011 then the employee should have already had a problem preparing their taxes because any good tax software should have complained about the excess amount.

One of the important things to do to CYA for an IRS or DOL audit is document clearly what happened now and document what changes in procedure have been made to prevent it happening again (like deduction limits in the payroll system).

[Guest Quacka]

It was fixed during 2010, so not concerned from an income tax standpoint.

However our accountant department is saying this doesn't pass the smell test because employee money was moved into the forfeiture account. They would have been more comfortable if the money had been paid out of the plan to the participant, or at least back to the company since the company repaid the participant.

I believe there is an ERISA rule that a contribution by mistake of fact must be refunded within one year...not sure if that is relevant here...more than one year has passed.

Whenever an issue arises on audit at this organization, the accountants ask me to document it in a memo. I need some ammunition for that memo. Without at least a citation or two (however weak), they'll remain skeptical.

[masteff]

I'd call it a self-correction under EPCRS (whether or not that's 100% on point), direct them to Rev Proc 2008-50 and tell them you need something more definitive than a "smell test" and their personal "comfort level". Corrections are sometimes messy but necessary to fix an error such as this.

http://www.irs.gov/irb/2008-35_IRB/ar10.html

Personally, internal and external audits who only have a passing understanding of qualified plans can be infuriating... they misread the code and then scream "disqualification" so fast and loud that management nearly panics before you can get the situation under control.