Bonuses excluded from plan compensation - for 20+ years

[M Norton]

Traditional large 401(k) plan (not safe harbor) with 9/30 year end - original effective date 1987.

Volume submitter adoption agreement defines compensation as W-2 wages and does not exclude bonuses.

This is a new client for us; our firm is doing the audit for the 9/30/2019 plan year end, taking it over from the prior auditor (who recommended us).

We see that various bonuses were paid to employees for performance, safety, etc. at year-end.  However, the plan sponsor did not calculated or withheld deferrals from bonuses.  As far as we can tell, they have never withheld deferrals from bonuses, and did not realize they were supposed to do so.  They are restating the plan to give employees the option to elect out of deferring from future bonuses.

The question is: what to do about the past?  The plan sponsor has been operating in a manner that would have been permissible under law but not in conformity with their plan document.  Does their consistency for the past 20+ years show that they never intended to include bonuses in the definition of 401(k) compensation?  Will that consistency protect them from penalties and sanctions?

If not, what is the fix for this?   How far back would they need to go to "make it right"?  Do they need to include all plan participants who have deferred or can they elect to exclude the HCEs from the fix?

Thanks!

[justanotheradmin]

If that type of compensation was excluded - would it have passed §414(s) testing?

I would start by looking into a VCP submission. If the sponsor isn't comfortable 'fessing up so to speak, an anonymous submission is an option (though that comes with it's own pros and cons). 

In the submission you can propose a retroactive amendment that excludes bonus from deferrals. I'd think the VCP fee and submission cost would likely outweigh any corrective QNEC that would be due for a missed opportunity to defer or a failure to follow deferral election. 

Was anyone's ability to defer actually impacted? Or were participants able to reach their deferral goals? i.e. maximizing deferrals through regular pay? Can you make the argument that the NHCE weren't harmed?

I know there are lots of folks with good ideas on these boards, hopefully some will chime in other options to consider. 

[Luke Bailey]

M Norton, I have had this case twice. One time involving 10 years, a small company, and $1 million in back contributions, the other a larger company involving about $4 million in missed contributions over a similar period. The questions you need to ask include (1) was the exclusion consistently applied across all time periods, (b) as justanotheradmin points out, does the plan pass 414(s) with the exclusion, and (3) were the employee communications such as SPDs consistent with plan language or exclusion. To make a long story short, in both cases we had a consistent practice of exclusion, we passed 414(s) for all years with the exclusion, and at least arguably the employee communications were more consistent with what the plan had done, rather than how it read. In one case I was able to convince myself and the CPA auditor who had discovered the problem that the plan language could be interpreted reasonably to support the exclusion. In the other case (which was discovered in connection with a vendor change), no such argument was possible. We filed a VCP request and were able to get some of the years (the largest) retroactively corrected by conforming plan document retroactively to the exclusion.

[M Norton]

Finally have additional information:

Plan has been in existence since 1987.  From inception, the plan has excluded bonuses from the definition of plan compensation.

In 2014 a new adoption agreement was signed to restate for PPA.  The exclusion of bonuses from plan comp was inadvertently omitted from that restatement.

The plan sponsor changed service providers in 2019.  The new TPA prepared a new adoption agreement and asked about excluding bonuses.  It was then that the plan sponsor became aware of the error in the 2014 adoption agreement.  They had continued to exclude bonuses in operation as they always had, without realizing the clerical error in the 2014 adoption agreement.

Could the change in the 2014 adoption agreement be classified as a "scrivener's error", because of the documented history of plan operation in which bonuses were excluded from inception of the plan, with evidence that the plan sponsor continued to operate the plan using the same definition of compensation as it always had done?

Thanks!

[ESOP Guy]

Scrivener's errors sound great in theory.  I don't think I have ever seen that argument win if challenged.   I think this fact set helps not hurts the VCP route. 

I have also seen VCPs allow for a retroactive amendment.  VCPs are costly but that is the only way to know the plan is safe.    A Scrivener's error is a high risk route.   If the plan gets audited I don't think that is where you want to be defending the plan.  

[Luke Bailey]

1 hour ago, ESOP Guy said:

Scrivener's errors sound great in theory.  I don't think I have ever seen that argument win if challenged.   I think this fact set helps not hurts the VCP route. 

I have also seen VCPs allow for a retroactive amendment.  VCPs are costly but that is the only way to know the plan is safe.    A Scrivener's error is a high risk route.   If the plan gets audited I don't think that is where you want to be defending the plan.  

M Norton, it is a scrivener's error, but it should not be called that in the VCP request. The VCP should lay out the facts of what occurred as persuasively as possible and then request correction by a plan amendment retroactive to the inadvertent change. Again, do not call it a 'scrivener's error," though, as that seems to be a red flag for IRS.

[M Norton]

Thanks, ESOP Guy and Luke Bailey!  You have been so helpful!

[Luke Bailey]

Good luck, M Norton.

[Cardscrazy]

Any update M Norton?