Calculating lost earnings on late 401(k) deposits.

[R. Butler]

Employer failed to remit deferral contributions for 9/99 - 12/99. The employer has now remitted the contributions, but still must make up lost earnings. What is the best way to calculate those earnings?

[Guest helmethead]

The late deposit of deferrals has resulted in a prohibted transaction. If the problem was not corrected until 2000, a prohibited transaction has occurred on the first date the deferrals were late and on the first day of 2000. These prohibited transactions must be reported to the IRS. An excise tax will be imposes. As for earninings, there are basically three methods: (i) actual earnings, i.e., the earnings that would have accrued had the money been invested in accordance with the participants' instructions or as otherwise provided in the plan; (ii) the highest earnings under the plan; or (iii) a blended average of the earnings under the plan. If HCE's are involved, option (ii)is probably not as good as options (i) or (iii). You should also review the IRS' requirements under APRSC to insure a full correction of the operational failure has been implemented.

I have assumed that the late deposits were a mere oversight rather than circumstances which could give rise to a breach of fiduciary duties.

[Guest lforesz]

The correction was not made by January 1, 2000. Therefore, when you say a prohibited transaction has ocurred for both 1999 and 2000, does this mean that a Form 5330 must be filed for 1999 (due by March 31, 2001) and for 2000 (due by March 31, 2002). If so, what is the amount involved in the prohibited transaction for each year?

[Guest helmethead]

Rev. Proc. 2001-17 should be consulted for the available methods of calculating losses and/or earnings.

As a general matter, the amount of the excise tax assessed on the late deposit of deferrals will depend on whether it is characterized as a "taking of plan assets" or as a "use or loan of plan assets". Unless some malice or gross negligence is involved, the late deposit of deferrals are generally characterized as a "use or loan". Under the "use or loan" theory, the “Amount Involved” for purposes of calculating the excise tax is determined by multiplying the deferrals at issue by a reasonable interest rate, i.e., a loan transaction. It is not the full amount of the deferrals that have been deposited on an untimely basis. The instructions to Form 5330 should be consulted for further detail concerning the calculation of the applicable excise tax.

Since you are aware of the 1999 and 2000 prohibited transactions, both of them should probably be reported on the 1999 Form 5330 as separate transactions. Waiting to file a separate Form 5330 for the 2000 prohibited transaction will only increase the amount of the excise taxes, increase the administrative burdens, and leave the fiduciary vulnerable to a claim of a breach of fiduciary duties, i.e., the failure to promptly correct a known prohibited transaction.

I hope this helps.

[Guest Brenda Schachle]

Let me get this straight. The "amount involved" NOT the deferrals that were depposited late but on the applicable EARNINGS on the "amount involved." Correct? For example, late deposit of deferrals of $5,000 an interest rate of 10%, the excise tax for the "use of the funds" would be ($5,000 X .10 (Approx interest for example) X .30 (excise for 1999 15% and 2000 15%)= $150. Is this correct?

[KJohnson]

I think you are right you use earnings. But if the delinquency carries over into the next year, each month would actually generate 3 separate excise taxes: one for 2000 and two for 2001.

For example, let's say the $5,000 9/2000 contribuiton is not paid until 5/1/2001. The contribution could have been depostied on 10/1 2000. My understanding is that you would have a 2000 excise tax (using your 10% interest rate) calculated as follow: $5,000 X .10 X .25 ( 3/12 for the three month delinquency in 2000) X .15 for an excixe tax of $18.75. THEN since the 2000 PT carried over into 2001, you would have to pay the $18.75 excise tax again in 2001. THEN for 2001, you would have a new P.T. beginning on January 1 calculated as follows. $5,000 X .10 X .33 (4/12 for the four month delinquency in 2001) X .15 for an excise tax of $24.75. Thus the total excise tax for 2000 and 2001 would be $62.25:

$18.75 for 2000

$18.75 for 2001 (the 2000 PT not cured until 2001)

$24.75 for 2001 (the "new" PT beginning January 1, 2001)

You would then do this "tripling" for each month of the deliqnquncy (but probably not for December since this may not have been "due" until January.)