Business owners reversing prior paychecks due to cashflow. Need deferrals refunded.

[401king]

A business is having poor cashflow as they get to the end of the year. 4 Owners have chosen to reverse their Q4 paychecks, of which the payrolls have already been processed including 401k deductions & company contributions. These paychecks each had deferrals, safe harbor match, and some had loan payments associated with them. The owners will be returning the amount of their net paychecks to the company.

It's the first case I've come across where a business is reversing payrolls. Has anyone dealt with this before? With a detailed letter of explanation signed by a trustee, my plan is to reverse the contributions, including gains/losses, as if it were erroneously transmitted & funded. A check for the lump-sum would be issued, payable to the company.

Any other thoughts?

[david rigby]

This sounds like the owners are putting additional capital into their company, and the amount just happens to be the net amount of the paycheck(s). If so, this is a non-event to the plan (and to everyone else), so no action is needed with respect to tax withholding, 401(k) deductions, etc. Am I missing something?

[QDROphile]

ERISA and the tax code wouldn't like it and I don't think the circumstances fit the IRS concept of mistake of fact, which is a suggestion you will get. For income tax purposes I do not think the payees can walk away from the income -- this goes beyond constructive receipt to actual receipt. If the owners want to plow their pay back into the Company, they can do it, but on an after tax basis. They can give themselves a pay cut prospectively, but beware the rules under section 409A if they think they are deferring the pay to better times. I don't think any competent ERISA fiduciary who knows the facts as you tell them will part with the contribution money.

[401king]

This sounds like the owners are putting additional capital into their company, and the amount just happens to be the net amount of the paycheck(s). If so, this is a non-event to the plan (and to everyone else), so no action is needed with respect to tax withholding, 401(k) deductions, etc. Am I missing something?

Their plan is to, essentially, delete their payroll entries for the affected periods - returning the Gross amount to the company. Return the net paycheck, all deductions (401k included) and any taxes.

Edit: Their words are that they are "forfeiting their 4th quarter pay" retroactively.

[My 2 cents]

I am not a lawyer and not expert with respect to compensation issues, but wouldn't the money put back in be in the nature of an increased investment and not negative compensation? That is, the amounts previously paid out would continue to be treated as taxable ordinary income, and the amounts put back in would be treated as increasing each owner's tax basis in the company, or is that not how the rules work?

[hr for me]

Coming at this from a payroll perspective -- I think they have constructive receipt issues on ALL the income and the IRS will not like this at all. This was not a mistake, but a changing of their minds. From a payroll/tax perspective this is a nightmare approach especially if they have also already submitted FIT/FUTA/FICA and then any state consequences.

I don't see where this could be claimed a mistake in fact. They got the compensation, they have deferral elections in place, etc. This is just bad planning on their parts.

If I were their accountant, while it does cost them more in taxes, I would suggest leaving it as is and doing a cash investment of the net pay back to the company. Because might just cost more than they had in taxes to fix all the different parts (of which the 401k deductions are just one). Add in loan repayments and it gets even nastier.

[masteff]

If it's truly just a short-term cash flow problem then you might look at treating it as a loan to company rather than an investment. Simple loan document with, say 3 to 5% interest compounded monthly, and be done with it.

[EBECatty]

I agree with a few of the prior posts: Whatever they call the "reversal," it's additional capital invested in the company, not a reversal of their paychecks retroactively. Or at least that will be the IRS's position.