Ineligible after-tax contribution

[Belgarath]

The things you find out long after they have already happened months ago!

Employer apparently, in mid-2016, simply wrote a check to a participant - did not run it through payroll. This was apparently treated as a "bonus" for no discernible reason. The employee held the check, then deposited it in DECEMBER. It was deposited (endorsed directly by the participant to the vendor) to the employee's deferral account at the vendor.

This is wrong on several levels. First, as an aside, the plan does not allow a separate deferral election on bonuses, so even if this had been done directly and otherwise correctly through payroll, it wouldn't have been allowable. Aside from that, this isn't a "deferral" because the participant already received the check directly. So really, this is an employee after-tax contribution. Also not allowable under the terms of the plan.

Only correction I see is distributing the amount, plus earnings. Seems like this would be reported in Box 1 and Box 5  on the 1099-R, since it is a return of after-tax employee contribution, (and a Code E in Box 7?) and the earnings would be reported in Box 2? Earnings, of course, would be taxable.

As to whether the employer correctly reported this on W-2 and did appropriate SS tax, etc., etc., it is their problem. We'll mention it to them, and they can work with their CPA...

Any thoughts would be appreciated.

[CuseFan]

I think you got it nailed. I assume this is a 403(b) if the participant was able to pay directly to the "vendor". The vendor should also be scolded for accepting an impermissible contribution outside of the payroll process.

[Belgarath]

Thanks - actually, it isn't a 403(b) - I just used the term "vendor" generically. Could have said custodian, fund, etc...

[AMDG]

The money should never have been deposited into the trust under the plan in the first place. Why not treat it as a mistake of fact contribution, and return it directly to the plan sponsor? The plan sponsor can then address the payroll withholding failure issues.

The amount appears to be wages and should have been reported through the payroll system.  It is not an "after-tax" amount because it appears that the amount was not even included in the participants' w-2 wages. The earnings on the amount can be retained in the trust in the forfeiture account.