Employee Contributions from Off-Cycle Bonus Pay

[jaxon1225]

Client has provided employees with bonuses at year-end for many years.  While the plan document states that W2 compensation is eligible plan compensation, the client did not withhold employee deferrals from the bonus pays as they would with any normal payroll.  Instead, because employee feedback was that most employees did not want employee deferrals withheld, the client began communicating that employee deferrals would not be withheld unless the employee completed an election form specific to the bonus pay.  Each year, only about 3% of employees completed the election form. 

Would a QNEC be required for employees that did not have employee deferrals withheld from the bonus pay?  To your knowledge, how far back would the corrections need to go?

Thank you.

 

[jpod]

No good deed goes unpunished.  Maybe you can get a more favorable result in VCP, but absent that:  Q1 = yes; Q2 = forever.  

[ETA Consulting LLC]

So, employees were given a separate election for bonus pay; with the default being "no election -no withholding".  As long as that was properly communicated, there wouldn't be a problem.  The default could've easily been "no election - regular payroll withholding", but that's not relevant.  As long as each employee was given ample opportunity to elect to defer, then there is no issue.  It would even be nice if the regular salary reduction agreement for payroll advised that this election is for regular payroll only.  So, without actually looking at all the facts, you cannot really conclude there is a problem.  Until you ascertain there is a problem, there's really no need to vet a solution.

Good Luck!

[jpod]

ETA Consulting:  I assumed that the standing deferral election applied to all W-2 compensation, so as to include bonuses.  If the standing deferral election applied only to "regular pay" or something similarly-stated, you could be correct.  

[Larry Starr]

FWIW, our election has a separate provision with regard to non-regular pay so as to avoid this issue.  And, the participant can change their election at any time (prior to getting paid) so they can change their mind and just change the bonus election section of the form.  We changed the form to include this option maybe 10 years ago but before that it was not clear and could lead to problems.

[ETA Consulting LLC]

23 hours ago, jpod said:

ETA Consulting:  I assumed that the standing deferral election applied to all W-2 compensation, so as to include bonuses.  If the standing deferral election applied only to "regular pay" or something similarly-stated, you could be correct.  

We actually posted at the same time.  I didn't see your comment prior to posting mine.  When reading the initial question, I couldn't see enough detail to even ascertain if there was a problem.  But, yes, I can see the assumption you made in your position :-)

Good Luck!

[JamesK]

FWIW, most employers I've worked with prefer to have separate elections for regular and bonus payments if matching contributions are applied to both on a payroll by payroll basis, since deferrals on bonus payments can reduce the overall annual matching contribution for employees who defer the 402(g) maximum.

[Luke Bailey]

If your documents (plan, SPD, and deferral election forms) indicate that all W-2 pay would count for deferral purposes, and the procedure the employer was using was oral/informal, then, again without knowing all the facts, you may well have a "failure to follow the terms of your plan" qualification failure. If you could convince the IRS in VCP that substantially all the employees knew about the semi-documented change and that substantially everyone deferred what they intended, than as jpod already said you might get a better result in VCP.

[ACK]

Check the language in your plan document.  We use the ASC document and the adoption agreement states that "If bonus payments are not excluded from the definition of Plan Compensation under AA §5-3, Employees may defer any amounts out of bonus payments, subject to the Elective Deferral Dollar Limit and the Code §415 Limitation".  So you may not have a problem with how this has been handled.  But I would say that absent an election to withhold a different amount on the bonus payment, then the default should be that the same withholding on normal wages should be applied to any bonus payments, as well (unless you have clear language in the document otherwise).

[BG5150]

I second the call to the plan doc.  Some allow for separate elections for bonuses even though the comp is included for plan purposes.