Partic elected Roth, company did pre tax--fix?

Participant elected to have Roth deferrals taken.

Company deducted funds pre-tax.  (However, the proceeds were "correctly" placed in the Roth source at the record keeper.)

Crossed tax years.

What might the fix be here?

Can you amend the W-2s?

That was my thought - how was it reported to IRS and correcting it there. Will also require employee to file amended tax return, so employer should do the right thing and cover any associated costs including interest and penalties on additional taxes owed.

Seems like it's OK at the plan level.

Have the employer talk to the employee.  Explain what happened and offer two options.

1) amend W-2, tax returns, owe taxes...

2) have the recordkeeper move the contribution plus earnings from Roth to Pre tax, ask the employee to live with the small amount in the 401k bucket, start processing the Roth contributions correctly, give them a $100 gift card to their favorite restaurant, call it a day.

JSample, but isn't this an employer mistake and not the employee mistake? It's fine for the employee to pay the taxes owed but the employer should be paying any penalties, interest and tax preparation fees the employee incurs dues to the employer error.

I agree than an amended W-2 needs to be filed.  This is a payroll tax issue so I would not drag the plan into it by reclassifying the deferrals as pre-tax.  My thoughts are that the employee bears a little responsibility for not speaking up about deferrals being deducted pre-tax so the employer shouldn't be responsible for all the penalties and interest.

21 hours ago, Dare Johnson said:

I agree than an amended W-2 needs to be filed.  This is a payroll tax issue so I would not drag the plan into it by reclassifying the deferrals as pre-tax.  My thoughts are that the employee bears a little responsibility for not speaking up about deferrals being deducted pre-tax so the employer shouldn't be responsible for all the penalties and interest.

I don't know if he started in 2021 he might not have known the deferrals weren't ROTH until he got his W-2 and filed his tax return. I mean the deductions came out and were showing 401(k), and the statements were showing it going in to the ROTH source. How is the employee supposed to know for sure that the payroll coding is wrong? It might have been his accountant who brought it to his attention.

Now if this has been going on multiple years all bets are off.

On 8/11/2022 at 4:28 PM, Lou S. said:

JSample, but isn't this an employer mistake and not the employee mistake? It's fine for the employee to pay the taxes owed but the employer should be paying any penalties, interest and tax preparation fees the employee incurs dues to the employer error.

Yes is it an Employer mistake.  My thoughts on the remedy are not the correct route to take.  However, in my opinion, we over complicate this industry so much trying to correct for such a minor error (minor in my opinion, I do not know the dollar amount involved or if the employee is steadfast in wanting Roth money for this short period).  If the employee is okay with the easier, incorrect, solution then document it and put procedures in place so it doesn't happen again.

The only fix is on the payroll side, the Plan is ok since deferrals were elected and deposited to ROTH.  No need to amend w-2 obviously the expense and penalties and interest would be of harm to the participant, or unreasonable expense to the employer.  Instead, for current year just make sure the deferrals are classified as ROTH, the tax difference will be negligible but the participant already got the benefit of last year. 

To correct last year, to be taxable this year, report the amount that should have been withheld as imputed income and make corresponding withholding payment in the same amount, grossed up for the withholding taxes on the imputed income itself.

This issue came up with a client of mine.  Per the IRS guidance:

Fixing the mistake

To fix the mistake of not following an employee’s election to designate the contribution as a Roth contribution you must transfer the deferrals, adjusted for earnings, from the pre-tax account to the Roth account. There are two options on how to report this transfer:

1. The employer issues a corrected Form W-2 and Marcie must file an amended Form 1040 for the year of the failure (2013).
    
2. The employer includes the amount transferred from the pre-tax to the Roth account in Marcie’s compensation in the year it’s transferred (2014). If the employer elects, it may compensate Marcie for the additional amount she owes in income tax in 2014. This must be included in Marcie’s 2014 income.

The client opted for #2 and is now running into an issue... their payroll company is saying they aren't able to transfer the amount without having SS and medicare be taxed again.  Has anyone else run into this?  

17 hours ago, CML526 said:

The client opted for #2 and is now running into an issue... their payroll company is saying they aren't able to transfer the amount without having SS and medicare be taxed again.  Has anyone else run into this?  

Payroll companies say and do a lot of stupid things harmful to Plans and employees.  Talk to a supervisor, someone with ASPPA credentials(ERPA's in particular are sensitive to following IRS guidance), or their legal team.