IRS provides tips on how to correct failure to timely deposit 401(k) salary deferrals

In the latest edition of Retirement News for Employers, the IRS has provided guidance to employers on what to do if they fail to timely deposit salary deferrals to a 401(k) plan.

Employers with 401(k) plans are responsible for depositing their employees’ salary deferrals to the plan’s trust on the earliest date that the deferrals can reasonably be segregated from the employer’s general assets. The earliest date is based on individual facts and circumstances. If a plan has fewer than 100 participants, a deposit is considered timely if it’s made within 7 business days after the salary deferrals are withheld even if the employer is able to deposit them earlier. If the employer doesn’t deposit the salary deferrals within 7 business days after they are received or withheld, then the individual facts and circumstances will determine whether the deposit was considered timely. For larger plans (100 participants or more), the determination of whether the deposit was timely is based on the individual employer’s facts and circumstances.

Regardless of the individual facts and circumstances, salary deferrals must be deposited no later than 15 business days in the month following the month in which the amounts would otherwise have been payable to the employees in cash. If the facts and circumstances show that the employer could have made the deposit on an earlier date, then the employer must have deposited the salary deferrals by that earlier date for them to be considered timely.

Consequences of not segregating and depositing salary deferrals timely

The IRS notes that failing to timely deposit withheld salary deferrals to the plan is a plan error. Failing to timely deposit salary deferrals is a fiduciary violation and could subject the plan to the Department of Labor’s civil penalties and could violate the plan’s terms and jeopardize the plan’s tax-exempt status. Furthermore, failing to segregate salary deferrals from the employer’s general assets and timely forwarding them to the plan’s trust allows the employer prohibited use of plan assets. This can result in the employer engaging in a prohibited transaction for which it can be assessed an excise tax.

Correction programs available

An employer can correct the fiduciary violation for failing to timely deposit salary deferrals using the DOL’s Voluntary Fiduciary Correction Program (VFCP). However, the VFCP isn’t available if the plan is under a DOL investigation or an IRS examination. The employer may also be eligible to take advantage of a prohibited transaction class exemption in conjunction with VFCP if it: (1) deposited the salary deferrals to the plan’s trust within 180 days from the date the amounts would otherwise have been payable to the employees in cash; (2) satisfied all VFCP requirements; (3) received a no-action letter for the VFCP application; and (4) notified all interested persons in writing within 60 days of submitting the VFCP application. There is an exception to this notice requirement if the employer’s excise tax liability would have been $100 or less; it contributed the amount of its excise tax liability to the plan; and it allocated this amount to participants and beneficiaries according to the plan’s terms for allocating plan earnings. If the transaction qualifies for the PT class exemption, then the employer will not be liable for an excise tax under Code Sec. 4975. If the plan’s tax-exempt status is in jeopardy, then the employer can use the IRS Employee Plans Compliance Resolution System (EPCRS).

If the plan is not under IRS examination and meets the other eligibility requirements, the employer can use either the self-correction or voluntary correction programs. If the plan is under examination, the employer can still self-correct if the failure is insignificant, or it can resolve the issue in a closing agreement through Audit CAP.

Correcting the error

If the employer failed to deposit salary deferrals to the plan, then it must make corrective contributions in the amount of the salary deferrals that it should have timely deposited adjusted for earnings. The adjustment for earnings is measured from the earliest date the employer could have segregated the salary deferrals from its general assets to the date it actually make the corrective contribution.

If the employer deposited the salary deferrals, but not timely, then to correct this mistake, it must contribute the earnings on the late deposited salary deferrals. Earnings are what the late deposited deferrals would have earned measured from the earliest date the employer could have segregated them from its general assets to the date it actually deposited them to the plan.

Making sure it doesn’t happen again

The IRS recommends that employers establish a procedure for depositing elective deferrals with or after each payroll date, or according to the terms in the plan document. If the employer has instances when its deferral deposits are later than the normal timely deposit (because of vacations or other disruptions, for example), the IRS advises keeping a record of why those deposits were late. The IRS also recommends that the employer coordinate with its payroll provider and others who provide service to the plan to determine the earliest date it can reasonably make deferral deposits. The date and related deposit procedures should match the plan document provisions, if any, dealing with this issue.

Source: IRS Retirement News for Employers, Fall 2012 Edition, December 13, 2012.

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For more information on this and related topics, consult the CCH Pension Plan Guide, CCH Employee Benefits Management, and Spencer’s Benefits Reports.

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