Unusual question about recouping a forfeiture

Background: We processed a forfeiture last year that impacted 4 individuals.  Three were still plan participants so we deducted the forfeitures from their account balances, but the other individual was no longer an employee and had already withdrawn his account balance.  We sent him a notice, but he did not repay the forfeiture.

Now: We are considering having this individual do some future work on a subcontractor basis, not as an employee, so not eligible as a plan participant. 

Question:  Are there any implications for us making future payments to this individual given that he failed to repay his forfeiture?

Maybe it is jut me but your facts and questions don't make any sense.  Please re-read it all and see if you think it makes sense.

Here are some observations:

1) You make it sound like you forfeited 3 people who were still active employees.

2) You say you sent a notice to the 4th person about repaying the forfeitures.  Why did you do that?  Was this person rehired?  If so, then why are you asking now about them being a sub-contractor?  If the rehire was this person as a sub-contractor then why did you send the repay notice as that would only apply to a person who is rehired as an employee. But otherwise why would a person who termed and was paid ever repay a forfeiture? 

3) You ask if there is any implications regarding "future payments".  Payments from the plan?  If so, does this person sill have a balance in the plan? (Not sure it matters) Payments as a contractor? 

I will make this observation right off the bat.  If an IRS or DOL auditor comes in one of the issues they will raise was the termination a bonafide termination or done to merely get the person a distribution from a qualified plan.  Likewise, if this person is doing the exact duties as they were as a former employee they are going to ask is this a legit contractor relationship   Someone might want to look into those issues. 

Like I said it might just be me but I am more confused as to what your question is now then before I started to read your post. 

In my effort to not waste your time with a wordy original question, I guess I moved too far in the other direction - sorry!

Early in 2017, we discovered that we had mistakenly used wages above the IRS Annual Compensation Limit in calculating the employer profit sharing allocations in prior plan years.  This impacted 4 people - 2 current employees, 1 retiree, and 1 former employee who left the company in 2015 and rolled over his plan balance to an IRA.

We did all of the forfeiture calculations and deducted the proper amounts from the first 3 individuals' account balances in the plan, but since this 4th person no longer had any funds in the plan, we instead sent him a letter letting him know that a portion of his rollover was not eligible and should be returned to us.  He chose not to return these funds, so we let him know that he may have tax consequences from that decision.

We now have a small project that we would like to have this person perform as a subcontractor, and I was wondering if the fact that we would be paying him would cause any tax issues based on the history.

If that is still not clear, please let me know!

Was this person an NHCE?  How much money are we talking about?

No - he was an HCE.  About $8k.

31 minutes ago, parks777 said:

No - he was an HCE.  About $8k.

Darn

I think what you do is rend revised tax forms showing $8,000 less distributed.  If he doesn't return the money, the ER is on the hook to replace it.  It wasn't merely an overpayment, but payment of funds that belonged to others in the plan.

Check EPCRS correction of  overpayments, thought.

Don't forget, he has to send back earnings, too.

I don't see any obvious issue with hiring him.  The plan should try and recoup the money from this person.  I guess you could see if he is willing to pay the plan back as part of the negotiations of hiring him for the work.  The plan does need to be made whole as BG5150 says. 

In these circumstances, is this a forfeiture when the employer overfunds an account? Should the extra contribution be considered a NEC (or QNEC) for that year ? 

True.  It was never unvested money.  Those funds should go to an unallocated account (as opposed to the a forfeiture account) and be used to offset future ER contributions.  (In fact, EPCRS says there can be NO ER CONTRIBS until the unallocated account is exhausted.)

You may have another problem:

If the facts show that he was "over-allocated" and overpaid, but does not re-pay, does that alter the viability of hiring and/or contracting with this person?  And think about this from the viewpoint of the rank-and-file EE.

Regardless of any laws, I'd have a tough time justifying paying this guy any wages or income at all knowing that he was unwilling to make an error right that the employer is now on the hook for (it might be different if there was no loss to the employer, but $8k?)  Does it bring into account any ethics or moral issues?

As usual, I will have a different take on this....

He is not REQUIRED to automatically agree that what he was paid was incorrect (even though we might all understand that is the case). And therefore, he does not HAVE to agree to return those funds.  Apparently, he was paid what his benefit statements said he was entitled to. It's not like when his account of $10,000 is paid at the rate of $100,000!

The distribution was made from the plan and properly reported.  We will agree that the plan admin was done wrong and is being corrected and that the employer has to make everyone whole.  As to getting the money back from this guy, if he does not agree, all you can do is bring him to court, and for $8,000, no one is going to go to court!

As to hiring him for independent contractor work, there certainly is no legal issue and I would suggest there is no ethical issue.  The participants in the plan will be made whole by the employer, so they have no vested interest in whether he returns the money.  If the employer thinks the guy is worth hiring for whatever skills he has and will overlook the $8k it cost them, then that is their decision.  

BTW, you do NOT send revised tax forms; he was paid that amount of money from the plan and he rolled over what he was paid.

And that's my two cents......

Larry.

Make hiring him for contract work contingent on him repaying the funds to the plan.

50 minutes ago, Larry Starr said:

BTW, you do NOT send revised tax forms; he was paid that amount of money from the plan and he rolled over what he was paid.

Agreed with everything until you said the above.  If, from the plan's perspective this participant was overpaid, I believe the EPCRS correction involves what was described by BG5150.  He might be unjustly enriched to the tune of 8k, but that amount is taxable (as opposed to rollable) and doesn't enjoy further tax deferral.  And, in fact, if it is not removed from the IRA generates ongoing excise taxes until removed.

Agree with Mike.

Thanks to everyone for the input.  I believe that we have handled everything as required for the EPCRS correction of the over-allocations. 

On 1/12/2018 at 2:04 PM, Mike Preston said:

Agreed with everything until you said the above.  If, from the plan's perspective this participant was overpaid, I believe the EPCRS correction involves what was described by BG5150.  He might be unjustly enriched to the tune of 8k, but that amount is taxable (as opposed to rollable) and doesn't enjoy further tax deferral.  And, in fact, if it is not removed from the IRA generates ongoing excise taxes until removed.

We communicated to him at the time that portion of the distribution was ineligible for rollover and would cause tax issues if left there. 

On 1/12/2018 at 2:04 PM, Mike Preston said:

Agreed with everything until you said the above.  If, from the plan's perspective this participant was overpaid, I believe the EPCRS correction involves what was described by BG5150.  He might be unjustly enriched to the tune of 8k, but that amount is taxable (as opposed to rollable) and doesn't enjoy further tax deferral.  And, in fact, if it is not removed from the IRA generates ongoing excise taxes until removed.

Mike, we don't disagree generally , but here the account statement shows certain numbers over the years (which the plan now claims were wrong).  Assume the participant disagrees that there was an error (I had a case like this where we fought the employer on their request for return of money and we won!).  The plan may even be estopped from claiming the error (that's for the lawyers).

Suppose the plan reports a smaller rollover and some part of it as taxable income. And if there is a 1040 mismatch because of the plan reporting, the participant gets a correspondence audit and here's what he says: 

"Dear IRS: Here is a copy of my account statements for the last several years; here is a copy of my distribution which was rolled over to an IRA which was equal to my account statement; here is a copy of my 1099R which was prepared by the plan and incorrectly shows the amount of the rollover with some amount as a taxable distribution.  That is an error;  I have done nothing wrong and have properly reported the rollover!" The IRS will almost definitely accept that. 

In fact, the word "forfeiture" has been incorrectly used to describe this situation.  Assuming the plan is right, it was not a forfeiture but an incorrect allocation OVER A NUMBER OF YEARS that was not properly calculated due to the employer utilizing the wrong maximum compensation limit.  The participant has a good chance of making the claim for the amounts stick!  I know, because I have had the exact case and we won it.

FWIW.