Payroll Company Error May Cost Big $$$ - Any Alternatives?

[Guest orangehorse]

For unknown reasons, our payroll company implemented stop dates in there system for several employees that shut off their 401(k) contributions a few months into the year. This was done without our knowledge. The issue was eventually detected. Our TPA (not the payroll company) now says that we have to make a QNEC contribution of $30k+...which is a substantial amount for our company. Their specific statement was:

Revenue Procedure 2008-50 covers the required corrective action when an employer fails to implement an employee deferral election. The procedure requires corrective action on the part of the employer whereas the employer makes a QNEC contribution to the plan on the participant's behalf in an amount equal to 50% of the employee's missed deferral plus matching contributions equal to the matching contribution the employee would have received had the employee made a deferral. The contribution must also include earnings to the date the corrective contribution is made to the plan.

Excerpt:

(5) Failure to implement an employee election. (a) Missed opportunity for elective deferrals. For eligible employees who filed elections to make elective deferrals under the Plan which the Plan Sponsor failed to implement on a timely basis, the Plan Sponsor must make a QNEC to the plan on behalf of the employee to replace the “missed deferral opportunity.” The missed deferral opportunity is equal to 50% of the employee’s “missed deferral.”

Two questions:

1. Do you think this falls under this provision given that we, as the Plan Sponsor, implemented it and a third party caused the error?

2. Do you think this is the proper provision for handling this issue or is there another alternative that would allow the employees to make catch up contributions?

[ETA Consulting LLC]

Two questions:

1. Do you think this falls under this provision given that we, as the Plan Sponsor, implemented it and a third party caused the error?

Ultimately, the plan sponsor must take responsibility to ensure the participants rights under the terms of the plan are enforced. With that said, the 1/2 of the missed deferral (calculated at the average rate for the other members of the allocation group) would be made plus any matching contributions that would've been made on those amounts. Remember, this is a preferred method under SCP, but the IRS "MAY" be more lenient under VCP. The plan sponsor may seek recourse from the payroll provider that created the error.

2. Do you think this is the proper provision for handling this issue or is there another alternative that would allow the employees to make catch up contributions?

It's possible under VCP given the potential hardship it may create for the plan sponsor when trying to correct under the "preferred method" outlined in Rev. Proc. 2008-50. In theory, VCP submissions are entirely negotiable between the employer and the IRS. I'd give it a shot. You may attempt to see what you can get from the payroll provider (dependig on how large they are, they may have E & O to cover these types of damages).

Good Luck!

[chc93]

Ultimately, the plan sponsor must take responsibility to ensure the participants rights under the terms of the plan are enforced. With that said, the 1/2 of the missed deferral (calculated at the average rate for the other members of the allocation group) would be made plus any matching contributions that would've been made on those amounts. Remember, this is a preferred method under SCP, but the IRS "MAY" be more lenient under VCP. The plan sponsor may seek recourse from the payroll provider that created the error.

I thought that the average rate for other members would apply to employees who the employer missed their eligibility date. In this case, there appears to have been deferral elections, since there were deferrals for a few months. So, I think it's probable that the "missed deferrals" would be based on the actual deferral elections for those that elected deferrals... which may end up being more or less that the average rate for all members in the group whether they deferred or not (assuming those that didn't defer had the opportunity to elect zero).

[BG5150]

I agree with chc93.

If deferral elections were in place, you use those.

I think the OP is beyond the time to have the participants make up the missed contributions--you need at least 9 months left in the plan year to do that (under SCP).

How long did this go on? Did the people think they all got raises all of a sudden?

[ETA Consulting LLC]

I agree with chc93.

If deferral elections were in place, you use those.

No argument here. Was a bit scatter-brained when making the point that the method in Rev. Proc. 2008-50 is a preferred method which "may" be negotiable with the IRS during a VCP filing. There has to be some limit to applicability of any approach (i.e. suppose the makeup contribution was calculated at $10 million).

Good Luck!