Excess Annual Addition

[bzorc]

During the course of an audit, it was determined that an incorrect amount of compensation was used for the owners of an S-Corp (Payroll records showed a gross amount of wages; however, one of the line items was for "reimbursements", which was not reported on the owners W-2). Therefore, all of them had excess annual additions (both for a Safe-Harbor nonelective contribution and discretionary employer profit sharing) for 2017. The Plan Sponsor wishes to correct this error by removing the excess (and associated earnings) from each owner and transferring it to the plan forfeiture account, to use in reducing future employer contributions. In reviewing, I believe that this can be self-corrected in reading the IRS Fix-it Guide.

A complicating matter here is that one of the owners left in 2018 and rolled his account balance over to an IRA.  Technically, I believe, he has an excess IRA contribution subject to excise tax until it is removed from the IRA account. However, the plan sponsor does not wish to inform the owner of that. The amount was around $4,000, so I don't know if it's material enough to warrant pursuing further with the former owner.

Any comments on the above would be helpful, thanks!

 

[Belgarath]

I find that the term "excess annual additions" often means different things to different people. Do you mean there was a 415 violation, or that under the terms of the plan they received more than the maximum allowed by plan formula, (e.g. comp used was $100,000, and they received a 3% SH of $3,000, when their comp was really $90,000, so the SH 3% would have been only $2,700), etc., or something else?  

[bzorc]

The latter; got a 3% SH on the 270,000 maximum compensation, when compensation was only $240,000.

[CuseFan]

Then you have an operational error to correct and forfeiting contributions to which they were not entitled, and attributable earnings, is the proper correction. Regarding the owner that left and rolled over the distribution - correction is not complete unless/until they inform that person and attempt to retrieve the distribution (and earnings) and correct the tax reporting. 

[BG5150]

Fix under EPCRS.  Excess (and earnings) get moved to a SUSPENSE account.  (It is not forfeiture!)

 

[BG5150]

Just now, CuseFan said:

Then you have an operational error to correct and forfeiting contributions to which they were not entitled, and attributable earnings, is the proper correction. Regarding the owner that left and rolled over the distribution - correction is not complete unless/until they inform that person and attempt to retrieve the distribution (and earnings) and correct the tax reporting. 

And the tax reporting cannot be corrected until you know if the guy returns the money or not.

[CuseFan]

Exactly - either way you have a correct rollover eligible amount to report and then, depending on repayment or not, an excess amount not eligible for rollover that may need to be reported.  

[bzorc]

I would think that if the former owner does not return the excess, he does have an excess IRA amount, subject to excise tax until it is removed. If the current owners notify him of this, and he does not return the excess, then I would think his accountant when filing the former owner's 1040 for 2018 to report the excess and subject it to the excise tax, until it is removed. The impetus then switches to the former owner to report apprpriately.

[BG5150]

Well, the funds have to come out of the IRA, but the tax forms will be determined by what he does with the disgorged funds.

Example:  Total distribution $20,100, with $100 excess.  So, initially 1099-R, code G, $20,100

1:  He returns the money to the plan. remedy: Revise 1099-R to show $20,000, code G.

2: He does not return the money.  Revise 1099-R:  One 1099 $20,000 code G and on 1099 $100, code 1 or 7, zero withheld.

[bzorc]

Interesting concept, I hadn't thought of that as an alternative.

[Appleby]

On 2/6/2019 at 2:42 PM, bzorc said:

I would think that if the former owner does not return the excess, he does have an excess IRA amount, subject to excise tax until it is removed.

It depends. If he is eligible for a $4,000 contribution, then he does not have an excess.

[401king]

If he doesn't return the money would the proper next step be for the Sponsor to fund that $4k to the Plan (making it 'whole') or to re-run nondiscrimination testing with this owner receiving the extra $4k allocation?

Or, both?

[bzorc]

Going to BG5150's post above:

In getting the actual numbers, the excess was around $10,000. As he was an active plan participant, there is no ability for a deductible IRA for 2018. He can certainly have a non-deductible IRA, but what about the amount over $6,500 (owner is over age 50)?