Eligible compensation issue and correction

We've run into multiple situations where it is discovered companies are not taking employee deferrals from bonuses and commissions, despite there being no exclusions specified in the adoption agreement. What is the typical correction? Would analysis need to be done for every plan year going back to when the AA was restated? Or since inception? 

This seems to be a recurring issue for plans that are being audited for the first time (first year over 120 ppts).

This is a very common error and falls under "Missed Deferral Opportunity" 

Typically a QNEC and lost earnings are calculated and deposited, and there is a make-up for any missed match. 

You will want to read Appendix of Revenue Proc 2021-30

https://www.irs.gov/pub/irs-drop/rp-21-30.pdf

More general information about EPCRS is available here: https://www.irs.gov/retirement-plans/epcrs-overview

In an old presentation by IRS on EPCRS (when RP 2008-50 was still in effect) they provided the following example for a failure to include bonuses in deferrals: 

Correction: Missed deferrals attributable to excluded 
elements of compensation need to be determined. Generally, 
the employee’s elected percentage of compensation would 
be used to determine the amount the employee would have 
deferred from the excluded elements. The corrective 
contribution for the missed deferral opportunity would be 50% 
of the missed deferral (adjusted for earnings). If the plan calls 
for matching contributions, a corrective contribution must be 
made equal to the full matching contribution that the 
employee would have received (adjusted for earnings) had 
the missed deferral (attributable to the excluded element(s) 
of compensation) been made to the plan. Do not apply the 
50% missed deferral opportunity rate. Any missed 
discretionary contributions on the omitted compensation (plus 
earnings) must also be contributed.

Ginco, Inc. had 4 employees in 2010. The plan document for the 
Ginco 401(k) plan provides that bonuses are included in the 
definition of compensation. Alan and Lourdes were the only 
employees receiving bonuses in 2010, and each received a $20,000 
bonus. They each also elected to defer 5% of compensation. In 2010 
Ginco decided to make a discretionary profit sharing contribution 
equal to 6% of compensation on behalf of each employee. In 
operation, the contribution was calculated without regard to Alan and 
Lourdes’ bonuses. The total compensation for all 4 employees 
excluding bonuses was $200,000, with each employee earning 
$50,000. Thus, each employee received a $3,000 profit sharing 
contribution. The missed deferral for Alan and Lourdes is $1,000 
each  (5%x$20,000). Ginco must contribute 50% of this amount 
($500) plus earnings each to Alan and Lourdes’ account. Alan and 
Lourdes should also each receive a $1,200 (6% x 20,000) 
contribution for the discretionary profit sharing contribution.

Did you check your base document? Many of them have paragraphs regarding "irregular compensation" or some term similar.  It's typically under the elective deferral section in the base document and gives you some flexibility on what compensation you withhold deferrals from even if the compensation isn't explicitly excluded in the adoption agreement.  I've seen wording like this is many base documents.

Regardless of the definition of Compensation shown in Article I, the Administrator may adopt a uniform policy, for
purposes of determining the amount of a Participant's Elective Deferrals, of disregarding some or all items of Compensation
which are not regularly paid in cash or cash equivalents to the Participant, such as premiums for group-term life insurance. In
addition, Participants' deferral election forms may optionally provide a separate election, or for no elections permitted, or for a
default deferral percentage of 0%, with respect to all or a portion of Compensation that is not paid on a per-payroll-period basis
(e.g., bonuses, commissions, etc.), and may optionally provide that a Participant's failure to make any such separate election shall
result in no deferral being made from such irregular Compensation.

PamR makes a good point. I would also check to see what the deferral election forms say before coming to a conclusion as to the correction needed. Are participants allowed to make a separate election for bonuses and commissions? What else does the form say?

Zach Del, I would second (or, actually, third) what PamR says. Even with weaker language, you may be able to get a legal opinion that the auditor will accept. I handled a case like that once.

I also had a separate case involving VCP where there was no such language. We were able to demonstrate to the reviewer that we administered the plan consistently over the years and that we had communicated to employees (e.g. in employee meetings documented with PowerPoints and also job offer letters) that bonuses would not be included in comp. The SPD was neutral on the subject and comp without bonuses passed 414(s). We got a favorable result in VCP.

On 9/7/2023 at 11:06 AM, justanotheradmin said:

This is a very common error and falls under "Missed Deferral Opportunity" 

Typically a QNEC and lost earnings are calculated and deposited, and there is a make-up for any missed match. 

You will want to read Appendix of Revenue Proc 2021-30

https://www.irs.gov/pub/irs-drop/rp-21-30.pdf

More general information about EPCRS is available here: https://www.irs.gov/retirement-plans/epcrs-overview

For conversation's sake, we've been correcting it under the incorrect compensation definition - IRS Fix-It Guide #3 - as the bonus was incorrectly excluded from the eligible compensation. It all ends up as a QNEC contribution in the end anyhow, but the IRS website provides a pretty specific correction for this. 

https://www.irs.gov/retirement-plans/401k-plan-fix-it-guide-you-didnt-use-the-plan-definition-of-compensation-correctly-for-all-deferrals-and-allocations

"If you've determined that an employee made deferrals that were less than what should have been made had the correct compensation amount been used, then a corrective contribution needs to be made to the employee's account within the plan. The employee would receive a corrective qualified non-elective contribution (which is an employer contribution in which the employee is fully vested) equal to 50% of the missed deferral (i.e., the difference between the amount that should have been deferred based on the use of correct compensation and what was deferred). In addition, the employee would receive a corrective employer matching contribution, if applicable, equal to the difference between what the employee would have received if the correct elective deferral was made and the actual matching contribution. Finally, the employee would receive a corrective employer contribution to the extent that he or she received a profit sharing allocation that was less than what he or she would have been entitled to had the correct compensation been used. All corrective contributions must be adjusted for earnings."