Roth contributions made to plan from employee bank account

what is the best method to correct this?  I haven't seen this one before.

Are we certain it was a genuine Roth contribution, and not a voluntary after-tax contribution? Roth contributions are 401(k) contributions, so they have to be made by the employer with money withheld from the employee's paycheck. VAT, on the other hand, is money contributed by the employee and generally doesn't need to come directly out of the employee's paycheck.

If this was truly a Roth contribution, then what happened to the money that was withheld from the employee's paycheck? Is it still sitting in the employer's bank account?

the participant (who is also an owner) thought they could contribute Roth through payroll and Roth through their personal back account without asking me.  I assume they were just going to report the person Roth contributions from their bank to their CPA.  I am not sure how to go about correcting this.

the plan is owned by an LLC that is taxed as an S Corp if that makes any difference.  he is a 20% owner of this LLC.

If it wasn't withheld from payroll then it isn't a deferral. It should be returned to the owner, adjusted for earnings. The earnings would be taxable.

Fix payroll? Amend W-2? Is this for 2022 or 2023 or both?

I had a similar situation come up today, but for a SIMPLE plan deferral by the owner-only (no other EEs, also llc w s-election). She was adamant that she didn't want the hassle of involving the payroll company to handle it and preferred to write a single check this year to fund. I responded as follows (edited for privacy) and I'm open to any ideas/suggestions to improve if that didn't explain the issues at hand (btw not a TPA, just an IAR and tax advisor and deferral in question involves 2023 funding, not 2022):

• Sole proprietors (filing Schedule C) have a little more “flexibility” in timing of the funding and mechanics similar to what you are doing now; anyone filing an 1120-S (s-corps), 1120 (c-corps), or 1065 (partnerships) do not have those same flexibilities.
• For 1120-S filers, doing it your way creates several complications and red flags:
  • Timely deposit of deferrals:  Department of Labor rules require that the employer deposit deferrals to the trust as soon as the employer can; however, in no event can the deposit be later than the 15th business day of the following month. The rules about the 15th business day isn't a safe harbor for depositing deferrals; rather, that these rules set the maximum deadline. DOL provides a 7-business-day safe harbor rule for employee contributions to plans with fewer than 100 participants. By holding back the salary deferrals and making one deposit per year, this would violate these rules and they do apply to SIMPLE IRAs as well as other types of retirement plans. 
  • Mismatched adjustments on the W2: SIMPLE IRA deferrals should not be included in “Wages, tips and other compensation” box of your W2, but must be included in the social security and Medicare portion. This creates a discrepancy between the federal taxable wages on the W2 and the other notification the IRS gets, the 5498 (see next bullet). 
  • Contribution notifications to the IRS: While SIMPLE IRAs don’t report the annual 5500 plan disclosure, the trustee of the SIMPLE IRA will report contributions to the IRS on the 5498. The mismatch with the W2 between the Wages, tips and other compensation box and the 5498 may draw attention.

The mismatch on the W2 might be manageable if we could get (payroll vendor) to amend/include the deferral in the W2, but I have a feeling their compliance/legal department would not permit it. The first bullet concerns me the most, because that is the type of violation the DOL/IRS look for and could result in that nuclear option we discussed (plan disqualification). There could also be what are known as “prohibited transactions” ramifications as well, which could increase fees and penalties. 

The correct way to handle this moving forward is to have (payroll vendor) handle the withholdings through payroll; there really isn’t another good option."