Correcting deferral contributions made by ineligible employee

hello -

I have a client where the payroll dept allowed an employee defer into the plan prior to meeting eligibility.  The Trustee does not want the participant in early.  Therefore, i need to distribute the mistaken deferrals.  

It does appear that a correction method is to have the investment company return the deferrals adjusted for gains or loss.  There is no mandatory withholding.

I've read that some have done it as EPCRS or as a 402g.  Which is correct way to complete? 

Thank you!

I'd say 415 excess.  Zero plan compensation from which to defer.

50 minutes ago, BG5150 said:

I'd say 415 excess.  Zero plan compensation from which to defer.

Actually, she did have 415 comp. I think it is a failure to follow plan document, which probably qualifies for self-correction under EPCRS as "insignificant" issue, and anyways is likely being caught within the two-year period for correction of significant operational errors. The correction is as described in the question.

16 hours ago, BG5150 said:

I'd say 415 excess.  Zero plan compensation from which to defer.

No, this is an operational failure. Should not have been a participant. Follow EPCRS correction method in Appendix B and do a SCP memo to file. Put in place procedures to make sure this does not happen in the future.  Section 415 is a limitation on contributions/benefits for participants. Technically, this person was/is a participant (although by mistake), so there is a 415 limitation (it would not be zero). 

Great.

Thank you for the information!

6 hours ago, FORMER ESQ. said:

 Technically, this person was/is a participant (although by mistake), so there is a 415 limitation (it would not be zero). 

No she wasn't.  Just b/c someone puts funds into a plan doesn't "technically" make you a participant.

14 minutes ago, BG5150 said:

No she wasn't.  Just b/c someone puts funds into a plan doesn't "technically" make you a participant.

Disagree with you, but it is a moot point. This is an EPCRS issue, not 415 compensation being 0. 

1 minute ago, FORMER ESQ. said:

Disagree with you, but it is a moot point. This is an EPCRS issue, not 415 compensation being 0. 

But, to be more precise, this person had 415 compensation, it was not 0.

Getting into semantics, but 415 excess are EPCRS issues nowadays...

4 minutes ago, BG5150 said:

Getting into semantics, but 415 excess are EPCRS issues nowadays...

It is semantics, but the fix under EPCRS is not excess 415, it is ineligible employee inclusion. 

1 hour ago, BG5150 said:

No she wasn't.  Just b/c someone puts funds into a plan doesn't "technically" make you a participant.

BG5150, what you are saying, I think, is that, e.g., if the plan doc says that "a participant's 415(c) comp is his/her Box 1 W-2," that the Box 1 W-2 of someone who should not have participated is not good 415(c) comp, because "participant" is not to be read as merely descriptive of the folks you are probably interested in, but as a requirement, i.e., 415(c) comp = "participant" and "W-2." I don't think that is correct, but I can see the basis for it. Could depend on plan document, but I really just don't think it's correct.

I should know better than to argue w/ attorneys (and/or former attorneys), but:

415(c)(3): 

Quote

 

[quote](3)Participant’s compensationFor purposes of paragraph (1)—

(A)In general

The term “participant’s compensation” means the compensation of the participant from the employer for the year.

(B)Special rule for self-employed individuals

In the case of an employee within the meaning of section 401(c)(1), subparagraph (A) shall be applied by substituting “the participant’s earned income (within the meaning of section 401(c)(2) but determined without regard to any exclusion under section 911)” for “compensation of the participant from the employer”.[/quote]

 

And what is the fix under EPCRS?  The only section I see that addresses it is in Appendix B in .07 about correction by amendment.  The ER does not want to correct it by amendment.  I don't see anything about not including this person and removing their money..  (I searched EPCRS for 'inclusion'.  This was the only section other than instances of things "included" in VCP filings.

 

Quote

(4) Early Inclusion of Otherwise Eligible Employee Failure. (a) Plan Amendment Correction Method. The Operational Failure of including an otherwise eligible employee in the plan who either (i) has not completed the plan’s minimum age or service requirements, or (ii) has completed the plan’s minimum age or service requirements but became a participant in the plan on a date earlier than the applicable plan entry date, may be corrected by using the plan amendment correction method set forth in this paragraph. The plan is amended retroactively to change the eligibility or entry date provisions to provide for the inclusion of the ineligible employee to reflect the plan’s actual operations. The amendment may change the eligibility or entry date provisions with respect to only those ineligible employees that were wrongly included, and only to those ineligible employees, provided (i) the amendment satisfies § 401(a) at the time it is adopted, (ii) the amendment would have satisfied § 401(a) had the amendment been adopted at the earlier time when it is effective, and (iii) the employees affected by the amendment are predominantly nonhighly compensated employees. For a defined benefit plan, a contribution may have to be made to the plan for a correction that is accomplished through a plan amendment if the plan is subject to the requirements of § 436(c) at the time of the amendment, as described in section 6.02(4)(e)(ii).

 

Do we look to Section 6 on Excess allocations?  

Quote

[quote]Excess Allocations that are attributable to elective deferrals or after-tax employee contributions (adjusted for Earnings) must be distributed to the participant.[/quote]

What 1099-R code do you use?  Can't use 1--if the person is under 59.5 otherwise that would trigger a penalty tax, I think.

9 minutes ago, BG5150 said:

I should know better than to argue w/ attorneys (and/or former attorneys), but:

BG5150, I cannot speak for Luke, but I enjoy these arguments. Being an attorney, ex-attorney, or whatever does not give me any special wisdom. The exchange of ideas and reasoning is why I am on this board. I am still learning. 

59 minutes ago, BG5150 said:

And what is the fix under EPCRS?  The only section I see that addresses it is in Appendix B in .07 about correction by amendment.  The ER does not want to correct it by amendment.  I don't see anything about not including this person and removing their money..  (I searched EPCRS for 'inclusion'.  This was the only section other than instances of things "included" in VCP filings.

 

 

Do we look to Section 6 on Excess allocations?  

What 1099-R code do you use?  Can't use 1--if the person is under 59.5 otherwise that would trigger a penalty tax, I think.

I think you have an excess allocation that should be corrected under 6.06(2) under the provision you quote.

If you look one paragraph before, in 6.06(1), it says excess amounts should be treated/reported as described in Section 3 of Rev. Proc. 92-93 (https://www.msbo.org/pdf/403b/92-93.pdf)

EBEC, you beat me to this. Thanks! It is called the "Reduction of Account Balance Correction Method" in that paragraph. 

3 hours ago, EBECatty said:

I think you have an excess allocation that should be corrected under 6.06(2) under the provision you quote.

If you look one paragraph before, in 6.06(1), it says excess amounts should be treated/reported as described in Section 3 of Rev. Proc. 92-93 (https://www.msbo.org/pdf/403b/92-93.pdf)

That describes a 415 excess.

True, but if you look at Section 5.01(3)(a) of EPCRS, the definition of an "Excess Amount" is much broader than just a 415 excess.

I've always taken the language in 6.06(1) referencing Rev. Proc. 92-93 ("...generally treated in the manner described...") as meaning "use rules similar to." 

Just my two cents. 

5 hours ago, BG5150 said:

I should know better than to argue w/ attorneys (and/or former attorneys), but:

415(c)(3): 

Quote

 

[quote](3)Participant’s compensationFor purposes of paragraph (1)—

(A)In general

The term “participant’s compensation” means the compensation of the participant from the employer for the year.

BG5150, I don't think that settles it at all. I think the reg phrases it that way because there is no reason to be interested in an individual's 415 comp if he or she is not a participant. The problem is this person is not a plarticipant, but was allowed to defer. Ergo the violation is not following plan doc, not 415 violation. IMHO.

Carrying on with this - we have a Plan that excludes highly compensated employees.  In 2019 there was a participant who had compensation of 140,000 making them highly compensated for 2020.  And the participant continued to participate in the Plan even though communicated he could not.

Same correction - ineligible employee allowed to participate?

Thanks in advance.

 

2 hours ago, TPA Bob said:

Same correction - ineligible employee allowed to participate?

TPA Bob, of course I have not reviewed documents or facts, so I need to treat your very brief, conclusory description as a hypothetical. That said, I would say "Yes," either that or VCP.

Thanks very much.

Hello All- 90% of these regulations are over my head and I am looking for some 401(k) for dummies advice.  I have same scenario- a client allowed 2 employees to defer to the 2020 plan year of their 401(k) who had not met the 6 month eligibility test.  Fidelity caught this recently and refunded the employee deferrals to the employer.  We are their payroll company.  They are asking us how to give the money back to the employees and what corrections need to be made to their 2020 W2s.  Should they just give the employees the money back and correct the 2020 w2s to increase the box 1 wages, and remove their box 12 code D deferral amounts?  It seems logic, since they were not really participants in the plan and those would have been box 1 wages had they not been sent to the 401(k) by mistake, but in all my reading, I have not seen anything about correcting a W2.  I've seen things suggesting it be reported on a 1099-R, but then what about the W2 for 2020.  It is reported that they were participating in a plan when they really were not.  Does it just stand as is?  That doesn't seem right either.  Fidelity is giving them no guidance on this, and I don't really want to either, but would like to point them in the right direction.  Thanks for any assistance!

It should be paid from the Plan to the Participant and reported on a 1099-R. Presumably with Code E indicating an EPCRS correction.

And the 2020 W2 stands as is?

 

No adjustment to W-2. The 1099-R will be the reporting of the income to the Participant.

On 9/10/2021 at 6:06 PM, Lou S. said:

It should be paid from the Plan to the Participant and reported on a 1099-R. Presumably with Code E indicating an EPCRS correction.

10% withholding unless otherwise elected by the person?