ineligible employee defers

[AndyT]

I've used this correction method before. It is taxable in the year of distribution and coded 7 on the 1099.

I haven't looked at the revised EPCRS info from earlier this year, but I don't think this kind of defect has been addressed by the IRS.

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Andy Treece

[Guest Paulaangell]

Employee begins deferrals 7/1/99. Should begin 7/1/2000. Employer misunderstood eligibility requirements for new plan. Should the entire deferral balance (contributions and income) be distributed now to the employee? Is it reported on a 1099-R? Is it a Code 7, since nothing else seems to apply? Is it taxable in 2000, or does it have to go back to 1999 (in which case code 7 won't work)?

[Guest]

I think I would refund the deferral as an administrative error.

[Guest Paulaangell]

I have been informed that at the most recent ASPA conference, Dick Wickersham stated that the ineligible deferrals could not be refunded, since there was no distributable event. His interpretation was that the deferrals (and match and income) must be forfeited and then used to offset the next contribution(s). The employer then must make a payment to the employee of the amount of deferrals plus interest through payroll.

This is a horrendous procedure. If this is not a distributable event (error) then how does the IRS justify distributing 415 excesses, 402(g)excesses, etc. This is certainly a correcting distribution.

In addition, it would seem to have the participant paying FICA twice, along with the employer.

Has anyone dealt with this pronouncement by Mr. Wickersham? Has there been any criticism or guidance?

[Guest Mister Charlie]

I know this issue has not been addressed for a while, but doesn't the "distributable event" apply to eligible participants? If the person was never eligible, why would they be subject to the distributable event reg?

[Guest]

I recall Wickersham's statement at the ASPA conference, however I still feel he may have missed something.

See Rev Proc 2001-17

Section 6.02(2) Reasonable and appropriate correction

The correction should be reasonable and appropriate for the failure.

I would say ee should not have deferred. Plan document was not followed. Make plan whole as if had not deferred. e.g. company would not have put the money in the plan if they followed terms of the document. This one seems strange to leave the money in the plan, because IRS is requiring employer to take a larger deduction than they normally would!

further on 6.02(2)© says (Emphasis mine) The correction method SHOULD keep plan assets in the plan. (seems to support Wickershams statement)

But this paragraph goes on to say

For example, if an excess allocation (not in excess of the 415 limits) made under a qualified plan was made for a PARTICIPANT under the plan (OTHER THAN A CASH OR DEFERRED ARRANGEMENT), the excess should be reallocated to other participants, or, depending on the fact and circumstances, used to reduce further employer contributions.

so, if ee was a participant, definitely leave the money in the plan. It doesn't address the issue if ee was not a participant.

There is, of course, the exception in a deferred arrangement of the distributable event for ADP failures, etc. Again these involve particpants.

You get back to the famous 'What is reasonable', and until IRS issues something in writing, your approach may be reasonable. see also Q & A #129 under the correction of plan defects board. (of course this was before Wickersham's statement)

The one thing the IRS has committed to writing is to retroactively amend the plan to change eligibility and allow person to defer (along with all others in the same situation)