Deferrals erroneously withheld from bonuses, not remitted to plan

How do you correct the following error?

401k Plan permits special elections for "irregular pay" and absent making an affirmative election, nothing should be withheld. 

Dec 2017 a small amount of deferrals were withheld from "Christmas" bonuses for some but not all employees. These deferrals however were never remitted over to the Plan as the employer never realized they were in fact withheld. This was just found with year end reconciliations and 5500 prep (off calendar fiscal/plan year).

How best is this corrected? If remitted over to the plan they violate plan operation because they were not elected, should not have been withheld from payroll. Since withheld on a pretax basis, no income taxes were withheld on these amounts nor were the amounts reported as taxable income however social security taxes were withheld and amounts reported. Given all of this, is it best to remit them over to the plan along with corrective earnings and then do an amendment for those specifically affected for the specific paydate? Adjust via payroll somehow?

Thank you!

Was the amount reported as 401(k) on the W-2?

Yes it was

On the bright side, if the payroll was run for Christmas, you may be able to argue the "lateness" of the deposit didn't start until early January 2018, so this could be one year's 5330 instead of two to prepare.

This sounds like a payroll error to me.  Talk to your payroll company about how to fix it.  You MAY have to contribute something to the plan but since the withholding wasn't authorized, it should have been corrected by payroll anyway.  Had the fund been deposited into the plan, it should probably be refunded. 

28 minutes ago, JackS said:

This sounds like a payroll error to me.  Talk to your payroll company about how to fix it.  You MAY have to contribute something to the plan but since the withholding wasn't authorized, it should have been corrected by payroll anyway.  Had the fund been deposited into the plan, it should probably be refunded. 

Actually, I can't tell from the question whether these wee authorized or not. The plan apparently permits special elections for irregular pay, so the question becomes whether these folks made the election for these amounts (in which case the contributions should be made, but are late, so will need to be grossed up for interest/earnings) or they made no election and the plan should not have applied their regular deferral percentages to the irregular pay, in which case the money should probably be refunded under local employment law rules, whatever those may be.

7 hours ago, Luke Bailey said:

Actually, I can't tell from the question whether these wee authorized or not. The plan apparently permits special elections for irregular pay, so the question becomes whether these folks made the election for these amounts (in which case the contributions should be made, but are late, so will need to be grossed up for interest/earnings) or they made no election and the plan should not have applied their regular deferral percentages to the irregular pay, in which case the money should probably be refunded under local employment law rules, whatever those may be.

They deferrals were NOT elected to be withheld from payroll. This occurred in Dec 2017. So they were withheld but so far not remitted over to the Plan. 

I agree with JackS - this is 100% a payroll problem and not a plan problem. The withholding was not authorized by the plan and the funds never touched the trust so the plan has nothing to do with it.

You might need to:

• Run the amounts though payroll
• Issue corrected 2017 W-2s to the affected employees
• Ask the employees to redo their 2017 taxes

I don't know if the IRS offers a correction program for payroll screw-ups like they do for qualified plan errors. This seems like something your payroll company should be able to advise you on.

So cheersmate, if I understand you correctly, the employer's withholding them was the mistake, not its failure to contribute them. Contributing them would have been contrary to the plan's terms.

If my understanding as expressed in preceding paragraph is correct, then you have an employment law issue, not an ERISA issue. Presumably if the amounts are reasonably small your state employment law would be practical about this, and a refund, perhaps with some interest, would be in order. You might want to talk to the employees and, if your plan allows, permit them to make a special 2019 election regarding these funds, if they would rather have them contributed to the plan.

There are W-2 reporting issues here for 2018 or 2019, but I can't really provide you with individualized advice for that.

6 minutes ago, C. B. Zeller said:

I agree with JackS - this is 100% a payroll problem and not a plan problem. The withholding was not authorized by the plan and the funds never touched the trust so the plan has nothing to do with it.

You might need to:

• Run the amounts though payroll
• Issue corrected 2017 W-2s to the affected employees
• Ask the employees to redo their 2017 taxes

I don't know if the IRS offers a correction program for payroll screw-ups like they do for qualified plan errors. This seems like something your payroll company should be able to advise you on.

cheersmate, I had not reread your question, and I see from C.B. Zeller's input that this goes back to 2017. You need to talk to your own adviser, but quite arguably, since the individuals in question are cash basis taxpayers and the employer DID NOT pay them, you don't need to change their W-2's (unless you want to show the amount as not contributed to the K plan, which won't affect their gross income, and is merely informational) and they do not need to file amended returns.

Query, in applying their correct deferral percentage for 2017, were the unpaid and uncontributed amounts included as 2017 "compensation?"

27 minutes ago, Luke Bailey said:

cheersmate, I had not reread your question, and I see from C.B. Zeller's input that this goes back to 2017. You need to talk to your own adviser, but quite arguably, since the individuals in question are cash basis taxpayers and the employer DID NOT pay them, you don't need to change their W-2's (unless you want to show the amount as not contributed to the K plan, which won't affect their gross income, and is merely informational) and they do not need to file amended returns.

Query, in applying their correct deferral percentage for 2017, were the unpaid and uncontributed amounts included as 2017 "compensation?"

The amounts involved are very small per employee...some as small as $10. No one had elected 401k deferrals from their bonus pay. The total involved is less than $700. None of these amounts were remitted to the Plan. 

To me here is the dilemma:

1. Correct 2017 payroll somehow - FL residents, so Fed returns only. I was hoping someone may have experienced this in the past and knew of a fairly simple correction that didnt involve going back to 2017 W2s and returns, under some prescribed reasonableness approach.

** OR **

2. Remit amounts over to the Plan now, albeit (i) late and (ii) in conflict w the Plan's terms because the amounts were NOT elected deferrals. So in essence the employer would remit them over to the Plan along interest adjs because late deposit, and then, refund them along with interest because they should never have been withheld from payroll in the 1st place. This seems to me to be the easiest thing when compared to amending 2017 W2s and tax returns. BUT in doing so is this making the error worse?

I hope this helps to explain it further, as I do appreciate the help and insight.

1 hour ago, cheersmate said:

The amounts involved are very small per employee...some as small as $10. No one had elected 401k deferrals from their bonus pay. The total involved is less than $700. None of these amounts were remitted to the Plan. 

To me here is the dilemma:

1. Correct 2017 payroll somehow - FL residents, so Fed returns only. I was hoping someone may have experienced this in the past and knew of a fairly simple correction that didnt involve going back to 2017 W2s and returns, under some prescribed reasonableness approach.

** OR **

2. Remit amounts over to the Plan now, albeit (i) late and (ii) in conflict w the Plan's terms because the amounts were NOT elected deferrals. So in essence the employer would remit them over to the Plan along interest adjs because late deposit, and then, refund them along with interest because they should never have been withheld from payroll in the 1st place. This seems to me to be the easiest thing when compared to amending 2017 W2s and tax returns. BUT in doing so is this making the error worse?

I hope this helps to explain it further, as I do appreciate the help and insight.

I still think that you are overthinking this. It has NOTHING to do with the plan.

The employer kept some money from the employees that they shouldn't have. The employer now needs to give it to the employee.

Yes, the 2017 w-2 shows incorrect deferrals, but it doesn't change their tax situation. They paid taxes on everything they got.

I think the employer gives them the money now and moves on.

I agree that this is NOT a plan issue and that the money impermissibly withheld was not taxable in 2017, either for FIT purposes or FICA/Medicare, but is taxable if and when it is paid to the employees.  For $10 per person and $700 total the technically correct correction is way too complicated.  That would entail filing and distributing corrected 2017 W-2s to back out the amount reported as FICA/Medicare wages and filing a 941c for the fourth quarter 2017.  I think the simplest reasonable approach is to just pay the employees what they should have received, report it as current W-2 wages, and withhold the FIT and FICA/Medicare taxes.  Yes, they and the employer will be paying the FICA/Medicare tax twice on the same dollars, but on $10 that amounts to a maximum of $0.765 each for the employee and the employer.  If you skip the FICA/Medicare taxes on this payment you will be asking for trouble from the IRS.  Whether State employment law requires something further beyond just paying out the $10 is not something I know anything about.  

Bill Presson and Jpod, this seems like a reasonable common sense approach, given the amounts involved. Thank you everyone for all your insights and replies. Always appreciated.