Erroneous profit sharing funding correction

[Tom]

We have a client who over-funded profit sharing for 2022 and 2023.  The "over-funding" is not relating to testing or 415 limits.  The TPA calculations provided a uniform profit sharing rate for all HCEs.  The plan was funded accordingly.   In providing the funding summary for 2024, the new CFO reviewed and indicated certain HCEs (non-owners) were not to receive PS at the same rate as owners and raised the question of prior years.  The 2024 year can be fixed of course since not yet funded but 2022 and 2023 are an issue.

One alternative is to short them going forward to make up for this but it is a large amount and will take several years.  Another alternative would be to remove the excess from their accounts.  Reduction of PS  for 2022 and 2023 would not be an issue since they are HCEs and they are getting the top heavy.  The 5500s would have to be amended as well as the corporate tax return.  

Comments about prior year "claw-back"?

Thankyou

[Bill Presson]

This doesn’t sound like a mistake of fact or an erroneous deposit. This sounds like the new guy doesn’t like what some participants got in prior years. Too bad, so sad as far as I’m concerned. 

[Paul I]

I agree with @Bill Presson since the company had the opportunity to review the calculations and it was the company that wrote the checks and took the deduction on their tax return.

The only possibility that this was done in error would be if the plan document has a fixed allocation formula and with no discretion to decide each year how the contribution should be allocated.  This is pretty rare these days.

Take a close look at the plan document.  The comment that only "certain HCEs" were not going to get the same rate as the owners implies that there different allocation groups among the HCEs, and there is no mention of what NHCEs (if any) received as an allocation.

Has the CFO thought about the employee relations aspect of taking contributions away from participants?  One would think that HCEs in general are making substantial contributions to the success of the company, so why create a disincentive by saying the company made a mistake and wants to take back part of their contributions (probably including related earnings)?

Any change from past practice is a decision that should be made by the owners.

[Kevin C]

If the amounts allocated to participant accounts for 2022 and 2023 fit within the allocation formula and other plan provisions in effect for 2022 and 2023, there was no operational failure and there is nothing to correct.

[Tom]

Thanks all.  We can reduce the PS for 2023 and apply to 2024 since it was paid in 2024 and will amend the 5500 for 2023.  The large remaining "overpayment" of their PS (what they got v. what mgt now thinks they should have gotten) will be "paid back" by reduced PS for 2025 and their DB will be frozen for 2025 which was suggested by the actuary.  

There's a chance the shareholder physicians might let the past be the past and move on.  These non-shareholders doctors are created wealth for the others and I think that should be recognized and give them good PS.  But we'll see if that flies.

You all slammed the door on the claw back which I appreciate.  I didn't feel comfortable about  that for various reasons and that would have been an HR nightmare to take money away from doctors!

Thank you

[David Schultz]

The term-of-art here is "cutback" and the anti-cutback rule (Code §411(d)(6)) prohibits the retroactive reduction of an accrued benefit - and it applies to HCEs every bit as much as it applies to NHCEs.  While the employer can decrease yet-to-be-declared discretionary contributions for 2024 and beyond, going back and changing an already deposited 2023 contribution seems like a clear-cut improper cutback to me.  For my part, I would not be comfortable doing that.

That is, I agree with Mr.@Bill Presson but used more words to say it.