Employee included by mistake

A plan sponsor provided a hire date that was actually months before the employee was actually hired.  As a result the employee was included in the profit sharing contribution calculation.  A contribution was made on the employee's behalf.  This is a straight PS plan, not a 401(k).  Do we have to honor the contribution, or actually, do we have to take it away ?

Thanks

You have to take it away.

If you read the document closely it will have a provision telling you what happens if a person is given a contribution in error and I can't imagine it says anything but take it away. 

Read the document closely I am sure that provision is in there and what it says.   If you are using a prototype it will be in the base document. 

Failure to fix is a failure to follow the document which can disqualify the plan. 

Maybe one of the lawyers that come by here can tell you if you can do some kind of correction that allows you to amend the plan document to fix this.  But my guess is if you can do this the change won't be worth it.  I seem to recall it might be possible to change the eligibility for everyone to something short enough to allow this person into the plan but that would mean you would have to do it for everyone. 

Assuming the employee is a NHC, this can be corrected by a retroactive plan amendment. See Revenue Procedure 2021-30, Appendix B, Section 2.07(4)

It's not that you would have to let "everyone else" into the plan, it's just that you have to use the most liberal eligibility provisions in your coverage tests, so suddenly you'd potentially be facing several other non-benefiting folks if they were indeed not also let in.  (But then hey all these folks might be tested as otherwise excludables, too....)

1 hour ago, ESOP Guy said:

Failure to fix is a failure to follow the document which can disqualify the plan.

So he has to fix

It's a small heating oil company, 5 employees total, and everyone is participating.  The owner is happy to pull the contribution because this burner tech has burnt him by quitting after the owner went over and above to accommodate him.  At the same time he doesn't want the terminated employee to spread bad blood.  The owner is ok with paying the 20% vesting ($1,600) to just make him go away.  Can't leave it alone?  

5 minutes ago, Basically said:

Can't leave it alone?  

As it stands, you have a qualification failure because the plan document (which says he wasn't eligible) doesn't agree with the plan's operations (since he received a contribution). If you do nothing, this operational failure will jeopardize the tax-qualified status of the plan. The IRS provides two ways to fix the failure and restore the plan's qualified status:

• Change the document to match operations, that is, adopt a retroactive amendment to allow this person to enter the plan earlier than they otherwise would have, and the contribution will remain in their account; or
• Change the operation to match the document, which would mean pulling the money out of this person's account.

Rules for both of these options can be found in the most recent version of EPCRS, rev. proc. 2021-30.

Thanks so much

It's not a big deal either way, is it?  What year are we talking about; does the employee even know about the contribution?  If he does, then yeah it is a bit ugly to take it back.  It shouldn't be a big deal to amend the plan either (and, saying the quiet part out loud, if you do just leave everything alone, nobody is going to question it).

I have a plan who gives safe harbor/PS  to 3 family members who do not work there at all.  Ever. So they get a nice salary in addition to their real jobs, the max 401k, etc.! 

There's always something new in this business, isn't there? Do they certify to you, in writing, that these people work there, and that their W-2 (or Schedule C, whatever) is "x" amount, that supports the contributions? If not, (and this is just me) I'd resign post-haste. I wouldn't want to knowingly be complicit in tax fraud. Sounds like a pretty unusual situation...

15 minutes ago, Belgarath said:

There's always something new in this business, isn't there? Do they certify to you, in writing, that these people work there, and that their W-2 (or Schedule C, whatever) is "x" amount, that supports the contributions? If not, (and this is just me) I'd resign post-haste. I wouldn't want to knowingly be complicit in tax fraud. Sounds like a pretty unusual situation...

Really? I don't see it as our job to police that.  

You work without certified census data? Yeesh, I wouldn't go out on that limb...but I expect that's maybe not quite what you meant?

41 minutes ago, Belgarath said:

You work without certified census data? Yeesh, I wouldn't go out on that limb...but I expect that's maybe not quite what you meant?

Define certified. 

Do you actually get them to sign something saying the census is true and complete?

If so, I have never worked for a place that does that in all the decades I have been in this business.  

Nope, by certified I just mean something in writing from the client giving the salary amounts (e-mail, letter, whatever). The fact that they give us salary and hours (if applicable) in writing is sufficient for our purposes - it pretty well "certifies" that they are actually working there. As opposed to a phone call where we write it down. Just to cover our posterior...

Back to the original question:  since it's a PSP and since it allocates to all participants, you should not only take the money out of the non-participant's account but reallocate it to the others, as it should have been allocated to begin with.  I would imagine that any "bad blood" that the terminated employee would spread could be tempered by a notice from the employer that says, "We accidentally include Nasty Guy in the plan when he wasn't eligible.  Pursuant to IRS-prescribed procedures, we've taken the money out of his account and given it to you guys, which is where it belongs."

Just sayin'.....

5 hours ago, Belgarath said:

There's always something new in this business, isn't there? Do they certify to you, in writing, that these people work there, and that their W-2 (or Schedule C, whatever) is "x" amount, that supports the contributions? If not, (and this is just me) I'd resign post-haste. I wouldn't want to knowingly be complicit in tax fraud. Sounds like a pretty unusual situation...

Yep, they are on the census every year and their W2s back up their compensation, contributions, but they absolutely do not work there.  Every year their CPA asks me if they can max out to both plans they are all in (in their "real" jobs) and every year I have to say no.  The CPA is a good friend of both the owner and myself so I know he's not lying. 

Hi Eileen - just to clarify, are you saying you cannot correct this under RP 2021-30, Appendix B, Section 2.07(4), or are you providing instructions on one normal correction for this error? Thanks.