Incorrect percentage taken from bonus

Company had a bonus run mid-March.  They told everyone mid February that the employees would have to go into the recordkeeper to change their deferral rate for the bonus if they wanted it changed, then go and switch it back after the run.

This is a 360 integration and the recordkeeper sends a file feed to the payroll company with deferral changes on a pre-determined schedule.

Turns out, the payroll company did not get the change file until several hours after the bonus was run.

There were some 200 people who changed their rates and nearly all lowered or eliminated the deferral for the bonus.

So now we have excess allocations.  Simple enough fix:  distribute the excess amounts (with earnings) to the participant.

However, some people had very large amounts deferred.  How does the company/payroll take into consideration that amount when looking at the 402(g) limit later int he year.  many of these people max out each year.

For example, Laura was deferring $2,000/month, intending on maxing out in December.  Her bonus run had a deferral of $15,000 (yes, deferral was $15,000, not the bonus!).  So, at the moment her YTD deferrals aer $19,000 (and will be $21k on Friday). If we refund her the $15k, it brings her PLAN contributions back to $4-6,000.  But int he PAYROLL system she will still be at $19-21,000.

Do they just go in and manually change the YTD 401(k)?  I don't want them to stop her after May and having true deposits of only $10,000.

(And lets say for point of discussion, this is all Pre-tax)

No one? 

Is there an opportunity for the plan’s administrator to direct the plan’s trustee to return mistake-of-fact contribution amounts to the employer, and for the employer to pay each affected employee the employee’s unpaid wages?

And correct all records of elective deferrals?

How was it a mistake of fact (I am very conservative when if comes to MOF).

i see this as an EPCRS issue.  But I can envision a problem with the payroll system if they try to 'adjust' the amount of deferrals on the W2 (12 D or 12 AA) when the YTD report would show differently.

Also, I would not trust if we did do the MOF, the payroll run would be correct.  Remember, there were at least SOME taxes withheld before the deferrals.  So, if they ran the extra amount through payroll, they would have to omit the taxes previously taken.

And who gets the earnings?  The company?  I cannot see that is right.  Participant?  If so, how do they get them?  From the plan in a separate transaction?  From the company?  if the latter, then gross income for the affected employees would be higher than their actual earnings from the company, inflating what the company would have to pay in payroll taxes and remit on the W3.

I, too, am very conservative when it comes to using mistake-of-fact.

This situation technically could be seen as not being an operational error since payroll ran on schedule, and the 360 file arrived on the usual day.  Is there precedent where where a 360 file containing deferral elections was processed after payroll ran?  If yes, were any adjustments made to payroll to recognize the order of processing was not post the 360 file elections before running payroll?  The answers could color whether there was an operational error.

If there is no precedent, is there documentation that payroll was instructed not to run until after the 360 file was posted?  If yes, this would reinforce the point of view that an operational error occurred.

Certainly, any communications to participants that explained the change/change back procedure for excluding the bonus would support the notion that an operational error occurred.  This argument would be strengthened if the communication specified the dates by which the elections would need to be made in order for the elections to be in effect when the bonuses were payable.

Notably, this is not a situation where there was a violation of a plan limit.  A violation of a plan limit would allow the amounts to be considered excess allocations.  Excess allocations are refundable (with earnings) and are not considered in compliance testing.  If these are not excess allocations, then there is not a prescribed EPCRS list of steps to correct the problem other than to file a VCP with a proposed cure (old school).

If there is no operational error, then the participants should live with the consequences.  If there is an operational error and there is ambiguity about how to correct, then given the number of people involved it may make sense to file a VCP.  But that takes time and payroll is going to run again and again before there is any response to the VCP.

I agree that if payroll runs without adjusting the employees' YTD amounts, there will be additional layers of errors upon errors.  Almost every payroll has a correction process to rerun payrolls to correct prior payrolls.  The questions and concerns should be presented to the payroll company on how they would go about fixing the issue.

So what would I consider doing in this situation?  I would confirm there is an operational error (i.e., there is not a good argument it was not an operational error).  I would calculate amounts that should not have been funded the plan, remove the amounts from the affected participants' accounts and hold the amounts in a separate account inside the trust to be used against the next deferral deposit(s) and forfeit any positive earnings or fund negative earnings , have payroll adjust their records to reflect what should have happened, have all related payroll taxes paid asap, monitor the next few payrolls especially for the affected participants' paychecks, and review the year-end payroll reports to confirm they report the corrected amounts, and file a VCP asking for a blessing after the fact.

Hopefully this helps breakdown the many issues involved.  There are a lot of moving parts, likely there are some weak points in this process, and this is not advice to anyone on how to proceed.

Obviously, payroll has to cooperate or this will fail.  If payroll refuses to be part of the solution, then they are part of the problem and that needs to be fixed, too.

BG5150, seeing you then had no volunteers on your query, I invited you to consider one of many opportunities an employer or plan fiduciary might consider.

In my experience, retirement plans’ fiduciaries and practitioners who advise them have wide ranges of interpretations about how an ERISA § 403(c)(2)(A)(i) or Internal Revenue Code § 401(a)(2) mistake-of-fact concept applies regarding a particular set of facts.

If a plan’s fiduciary approves a return grounded on a mistake of fact, “[e]arnings attributable to the [mistaken amount] may not be returned to the employer” and “losses attributable [to the mistaken amount] must reduce the amount to be so returned.” And: “Furthermore, if the withdrawal of the amount attributable to the mistaken . . . contribution would cause the balance of the individual account of any participant to be reduced to less than the balance which would have been in the account had the mistaken . . . amount not been contributed, then the amount to be returned to the employer must be limited so as to avoid such reduction.” Revenue Ruling 91-4, 1991-1 C. B. 57, superseding Revenue Ruling 77-200, 1977-1 C.B. 98.

Consider also that if, following a mistake-of-fact decision, an amount taken from a participant’s pay is treated as not the participant’s elective deferral, the employer owes its employee the yet-unpaid wages, with interest provided under a State’s wage-payment law or otherwise to compensate the employee for the time value of money.

You know your client, the situation’s facts, and other surrounding facts. And you know about your client’s capabilities and weaknesses in implementing a correction.

Further, consider Paul I’s thoughtful suggestions.