401k Salary Deferrals Not taken from Bonus Pay

[Jean]

The plan document defines compensation as W2 for all plan purposes. The last paycheck for 2000 was a bonus check. All employees (HCEs and NHCEs) received a bonus, but no salary deferrals were taken. The bonus wage was included as compensation when the 2000 ADP / ACP test was run.

I cannot seem to find any answers on this type of operational failure. If the contributions were made, the ADP / ACP and Top Heavy test results would not change significantly.

Any suggestions?

[QDROphile]

You may not have an operational failure. First, look at what the plan documents and election forms say about about the deferral elections. Some plans do not allow elections from bonus amounts. Others are ambiguous. Some apply the election against all checks. Some allow a special election on the bonus check.

Just because some amount is in the definition of compensation does not mean that the participant can elect to have some part of the amount deferred.

Be careful about matching contributions and other contributions that are claculated based on compensation. You may not have a problem with deferrrals, but if the bonuses were not added to compensation for purposes of calculating other contributions, you may have a problem.

[Jean]

The plan document does require that all W2 income is compensation for deferrals.

I believe this is an operational failure. Any suggestions for how this could be self corrected?

[david rigby]

Is the employer aware of this issue? It may be an operational failure, merely because someone did not know what the plan said, rather than intentional action. The first step should be to make sure the employer knows of the potential problem.

[Jean]

It was not believed to be intentional. The check was considered to be a special bonus. There were no other benefit contributions deducted -- such as health, life, and dental from the check. Only the appropriate taxes.

[QDROphile]

So how do you defer amounts out of W-2 compensation that is not paid in the form of cash?

[Guest Karen Geiger]

I contacted the IRS regarding the correction for a similar situation. The IRS said that the proper correction for this type of operational failure is for the company to make a corrective contribution (including earnings) equal to the amount that would have been contributed from the bonuses.

It did not matter that the employees would effectively receiving a windfall by this corrective contribution. This is because the intent of EPCRS is to place the plan in the position it would have been if the failure had not occurred.

[card]

Hi Karen-

I'm in the midst of a similar problem. Did the IRS indicate the contribution should be in the form of a QNEC? This would be consistent with the EPRCS safe harbor correction for improperly excluding eligible employees (Appendices A and B of Rev. Proc. 2001-17).

My problem is that the plan has never made QNEC's and the recordkeeper may have a problem with these dollars. You can't throw them into the 401(k) pre-tax bucket because QNEC's aren't eligible for hardship withdrawal.

card

[Guest Nodak]

I know this thread is quite old, but JEAN, could you tell me how you resolved this issue? I am in a similar situation right now.

[Kirk Maldonado]

I had the same situation. We determined that correction was necessary. (This case involved hundreds of thosands of dollars of Section 401(k) contributions that were not taken out of bonus checks.)