Roth vs. Pre-Tax Snafu

[austin3515]

Participant elected in 2015 to contribute Roth 401(k).  From 2014 through June 2018, the participant contributions were inadvertently set up as pre-tax in all respects (w-2 reporting, deposits at recordkeeper, withholding calcs, etc). 

What to do?  Note: The participant has since rolled his entire balance out to an IRA, but if it helps we can start by assuming the money is still in the plan...

[Belgarath]

Ugh. How much money is involved?

Does this help?

https://www.irs.gov/retirement-plans/fixing-common-mistakes-correcting-a-roth-contribution-failure

[austin3515]

ummm.... YEAH!!!

[austin3515]

They are saying in this article that people can self-correct.  I certainly will take them at their word but unless I am missing something this is not part of EPCRS?  What are your thoughts on that?

[Belgarath]

Agreed.  Or perhaps more accurately, it doesn't fall under one of the "pre-approved" fixes under RP 2018-52, but still an operational error. The correct amount of deferral was withheld - just misclassified, so given that it was only for one participant, certainly an "insignificant" error IMHO, and eligible for self-correction.

[austin3515]

Are you sying that you can self correct under EPCRS even using methods that  are not listed in EPCRS? I didn't realize that was a possibility.

[Belgarath]

Yes. The IRS recognizes that they can't possibly list every possible failure/correction that could happen or be reasonable. The corrections listed in Appendix A and B are deemed to be "reasonable and appropriate" and I would generally use them for those failures specifically listed, if those corrections are appropriate for the situation. Nevertheless, see the following from RP 2018-52, Appendix A:

 (3) Other reasonable correction methods permitted. As provided in section 6.02(2), there may be more than one reasonable and appropriate correction of a failure. Any correction method used that is not described in Appendix A or Appendix B would need to satisfy the correction principles of section 6.02. For example, the sponsor of a 403(b) Plan that failed to satisfy the universal availability requirement of § 403(b)(12)(A)(ii) might propose to determine the missed deferral for an excluded employee using a percentage based on the average deferrals for all employees in the plan instead of using the rule for calculating missed deferrals set out in .05(6)(b). In doing so, the proposed correction method would fall outside Appendix A, and the Plan Sponsor would need to satisfy the general correction principles of section 6.02 and other applicable rules in this revenue procedure.

[DreamJob]

But what would the correction be and, as a practical matter, how would correction be possible?  The money is in the plan, the amounts were not reported as income for any years, and the participant (presumably) hasn't made a peep ... even after having rolled over the whole account.  Is the employer's failure to implement the participant's election to have amounts withheld and contributed as Roth an operational (qualification) failure if the participant essentially acquiesces to the tax treatment of his or her contributions by failing to notice that his or her Forms W-2 and plan statements reflect pre-tax contributions?  Is the procedure for electing Roth vs pre-tax spelled out in the plan or incorporated by reference in the plan?  In other words, perhaps there's a reasonable basis for arguing that there's no operational failure in a case like this.

[jpod]

Participant made a roth election.  Consequently, employer has a tax reporting and tax withholding problem.  This needs to be corrected to be consistent with the participant's elected roth treatment.  If the first year was 2015 then the sol is still open for all years to implement an appropriate fix via corrected W-2s and 941s.  Yes, the employee will owe back taxes to Uncle Sam (and maybe his State) for four years, but that's the tax treatment he elected. 

[austin3515]

41 minutes ago, jpod said:

Yes, the employee will owe back taxes to Uncle Sam (and maybe his State) for four years, but that's the tax treatment he elected. 

But really if the employer doesn't pick up the tab here, or at least half that's just really not cool...

[jpod]

Regrettably, if the employer picks up the tab, it's not really picking up the whole tab because the employee owes taxes on the amount which the employer gives him to "pick up the tab."  A full gross up would be necessary which could be in the neighborhood of 150% of the back taxes plus interest.  Nevertheless, far be it from me to advise an employer not to be generous if it feels like it's the right thing to do.