Employer forgot to make a Roth deferral

The NHCE elected to make a $5,000 Roth deferral. Pay was not reduced and no deferral (Roth or pre-tax) was made at all. The only EPCRS correction I see is for the employer to make a 40% pretax contribution, with earnings, to a QNEC. The employer and employee would like to do more.  (1) contribute the 40%, with earnings, to an employee Roth account (2) and amend the 2024 W-2 to include the 40% with earnings.

The IRS website (not EPCRS) allows retroactive characterization if a deferral had been made but incorrectly designated as non-Roth. https://www.irs.gov/retirement-plans/fixing-common-mistakes-correcting-a-roth-contribution-failure  However, I don't see anything in EPCRS that would allow this for an employer QNEC. 

I'm inclined to tell the client to act in good faith but it would be nice to know if there is more creative guidance for this issue than making a 40% pre-tax QNEC.

The 40% correction you reference is the correction for missed employee/after-tax contributions, not Roth. Missed Roth contributions will follow either the 0%, 25% or 50% QNEC correction method depending on amount of time of the failure and the timing of the correction (or you could go straight to 50% regardless of the lower priced options). The correction would not be funded to the Roth source, it would be a pre-tax QNEC. One idea for 2025, since you said the employer wants to do more, give the employee a bonus (not contingent on it being deferred) and let the employee make a choice if she wants to make a Roth deferral from the bonus, assuming the plan allows for deferral of bonus. I think it is too late to do anything about the 2024 W2. Be careful with being more creative than EPCRS allows, a more generous correction could be considered a contribution, not a correction. 

I am not aware of anything in EPCRS that provides an explicit correction method for missed Roth deferral.  (This is different from when a pre-tax deferral is made when it should have been Roth,which is addressed in the IRS article for which you provided the link.)

The IRS article does provide a suggested approach which get the participant close to where they wish to be.  Assuming the plan allows transfers from pre-tax to Roth, make the appropriate QNEC correction and then have the participant elect a transfer from the amount of the QNEC to Roth.  This would be taxable to the participant in the year the transfer is made.  Note that the IRS proposed using a similar transfer in the recently released rules for allowing participants to elect to have an employer contribution made to their Roth account (and a QNEC is an employer contribution).

Absent specific guidance, think through the correction steps and any associated plan provisions needed to implement the correction, and discuss all of the implications with the client.  The rapid proliferation of Roth throughout the plan easily may have unintended consequences.

Thanks Paul! Your comment made me think more about my response. I have always interpreted EPCRS (maybe incorrectly) that "elective deferrals" meant pre-tax and Roth. If this does not mean Roth, then I am curious how everyone else is correcting missed Roth deferrals? Are other practitioners following some other correction method? 

Thanks, curious what everyone else is doing. 

Page 93 Rev Proc 2021-30:

(10) Employee Elective Deferral Failure. For purposes of sections .05(8) and .05(9), an “Employee Elective Deferral Failure” is a failure to implement elective deferrals [emphasis mine] correctly in a § 401(k) plan or § 403(b) Plan, including elective deferrals pursuant to an affirmative election or pursuant to an automatic contribution feature under a § 401(k) plan or § 403(b) Plan, and a failure to afford an employee the opportunity to make an affirmative election because the employee was improperly excluded from the plan. Automatic contribution features include automatic enrollment and automatic escalation features (including automatic escalation features that were affirmatively elected).

Roth Deferrals are Elective Deferrals.  The IRS now calls them Roth Elective Deferrals.

The issue with the correction rules is they specify that the corrective contribution is a QNEC, which is a pre-tax employer contribution, but there is no Roth QNEC.  The challenge is how to try to get the QNEC into a Roth source which is what the participant originally wished to do.

The IRS possibly could have come up with some Roth QNEC rules, but I suspect their focus was elsewhere and Roth transfers seem to be a reasonable solution.  I don't expect any clarification on this anytime soon given everyone in the IRS is probably wondering if they will still be employed at the end of this year (or if they are shut down come the March 14th deadline to fund the government).

Great input from WCC and Paul I. My conclusions so far:

1. Agreed. There is no distinction for correction purposes between Roth deferrals and pre-tax deferrals. As noted in .03 of Appendix B: "Designated Roth contributions. The examples in this Appendix B generally do not identify whether the plan offers designated Roth contributions. The results in the examples, including corrective contributions, would be the same whether or not the plan offered designated Roth contributions."

2. This means that a failure to implement a Roth elective deferal for a full year (that is caught timely within the SCP correction period) allows the employer to make a 25% QNEC, not 50% (and not 40% for after-tax failures).

3. A 2025 QNEC of 25% + earnings is pre-tax for 2025, subject to providing a 90 day notice. There is no official option to do this retroactively for 2024, which would be a mess anyway.

4. For any empoyer desire to do more, I agree that an extra bonus in 2025 (deferrable to Roth) is the simplest "extra." 

Conceptually. I do question why the after-tax default QNEC of 40% should not apply (if the IRS thought harder about). Were this in litigation, I also wonder whether 25% pretax would be adequate for Title I determination.  For "safety" this employer will probably contribute 40%.

Thank you, colleagues. 

Roth gets the 50% QNEC per Rev. Proc. 2021-30, App. A. .05(3)

that's for improperly excluded employees. OP states this is a failure to implement an employee elective deferral which is defined in .05(10)

sorry for not giving full references...

Everyone. I think we are all agreed that for this 2024 error the 25% "safe harbor" in Appendix A applies, subject to the 45 day Notice.  It's a weird result and Paul I identified the problem precisely. EPCRS authors mistakenly did not distinguish Roth Elective Deferrals from Elective Deferrals generally. If they had thought about it more, I think they would have required the QNEC to go to a Roth source. That can be remedied for those plans that allow in-plan Roth rollovers. No harm.

On to the next issue. Great getting to know you all (virtually.)