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[Update] Excess deferral in 2017 (not corrected by April 15, 2018) with two unrelated employers/plans


Pxhesq

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  • Background:

Client hired employee in January of 2017. Employee maxed out deferral with client (including catch up) in 401(k) plan for 2017. Employee also was paid the remaining portion of his 2016 compensation from former employer in 2017, and former employer withheld based on employee's 2016 deferral elections. Excess deferrals resulted. Correction will obviously not be done by April 15, 2018.

  • Issue:

    What is the correct course of action in this situation? Set forth below are my basic thoughts:

    Code § 402(g)(1)-(2) and Reg. Sec. 1.402(g)-1(e)(2) clarify that, unless timely distributed, excess deferrals are (1) included in participant’s taxable income for the year contributed, and (2) taxed a second time when the deferrals are ultimately distributed from the plan. The excessive deferrals involved in the Error were not timely corrected because the April 15 deadline had already passed. Accordingly, the Error’s excessive deferrals must be taxed for the 2017 year (i.e. the year contributed) and again when the excessive deferral is distributed from the plan. 

    If a corrective distribution is not made within the correction period discussed above, then excess deferral cannot be distributed until either (1) the distribution is otherwise permissible under the terms of the plan, or (2) the distribution is necessary to avoid plan disqualification under Code § 401(a)(30) (note: there is not a plan disqualification issue under Code § 401(a)(30) because the Error involves excessive deferrals between two unrelated plans and employers).[[1]]

    Reg. Sec. 1.402(g)-1(e)(8)(iii) allows for distributions of excess deferrals after the correction period to be distributed from 401(k) plan only when permitted under Code § 401(k)(2)(B). As discussed above, plan disqualification is not an issue; accordingly, I believe the error’s excessive deferral can only be distributed if permitted under the terms of the plan (i.e. termination, age 59 1/2, or other Code § 401(k)(2)(B) permissible times).  

    I could be wrong on this analysis and this is my first go tackling this kind of problem so please let me know if I'm not on track and thank you for your help!

  • [Update]: So a little twist on this analysis; the plan document states that the plan will return any excess deferrals by April 15th of next year, which obviously did not occur. So now it appears as though we do have a plan disqualification issue. Trying to find out the correct course now with this thrown in  


  •  

 

[[1]] To elaborate on this point, under Code § 401(a)(30), if the excess deferrals aren't withdrawn by April 15, each affected plan of the employer is subject to disqualification and would need to go through EPCRS. However, in the situation involving the described error, the excess deferral amounts involve two unrelated plans with two separate employers. The IRS has stated on its website that “excess deferrals by a participant will not disqualify a plan if the excess is due to the aggregation of the participant’s deferrals to a plan maintained by an unrelated employer.” Accordingly, the fact that Error involves excessive deferrals among two unrelated plans/employers indemnifies the plans from experiencing a disqualifying event because of the Error.

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Interesting - so extending this, suppose it is a Roth contribution, and it sits in the plan earning interest until distributed 30 years later at age 65 when the participant retires. (For purposes of this discussion, I'm assuming no in-service withdrawals allowed.) Presumably this is then not a "qualified" Roth distribution even though more than 5 years/59-1/2 is satisfied, and the full amount INCLUDING earnings is taxable.

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  • Pxhesq changed the title to [Update] Excess deferral in 2017 (not corrected by April 15, 2018) with two unrelated employers/plans
20 hours ago, Phoenixlawyer said:

[Update]: So a little twist on this analysis; the plan document states that the plan will return any excess deferrals by April 15th of next year, which obviously did not occur. So now it appears as though we do have a plan disqualification issue. Trying to find out the correct course now with this thrown in  

 

20 hours ago, Phoenixlawyer said:

[[1]] To elaborate on this point, under Code § 401(a)(30), if the excess deferrals aren't withdrawn by April 15, each affected plan of the employer is subject to disqualification and would need to go through EPCRS. However, in the situation involving the described error, the excess deferral amounts involve two unrelated plans with two separate employers. The IRS has stated on its website that “excess deferrals by a participant will not disqualify a plan if the excess is due to the aggregation of the participant’s deferrals to a plan maintained by an unrelated employer.” Accordingly, the fact that Error involves excessive deferrals among two unrelated plans/employers indemnifies the plans from experiencing a disqualifying event because of the Error.

These two points seem to contradict each other. The participant has the problem and I believe the resolution is that the money is simply taxed twice, I don't see it becoming a disqualification issue or really having an actionable solution now that 4/15 has passed. I guess I place more emphasis on the 2nd quote since the employer(s) both operated in good faith at limited their payroll in their plan and that these controls cannot be sabotaged by an inattentive employee.

 

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