It’s time for your annual 401(k) audit and it turns up that there was a failure to contribute the employer matching contribution according to the plan document. So now you have to go through the process of correcting the failure. There are a myriad of reasons why a plan may end up failing to contribute the proper employer’s matching contribution. For example, the wrong definition of compensation may have been applied in calculating pre-tax contributions, with this error also resulting in the miscalculation of the related matching contributions. Another common mistake is incorrectly applying the cap on the amount of pre-tax contributions that are eligible to be matched. What can you do prior to an audit to ensure these types of errors will not happen or will be corrected as soon as possible? First, you need to review your plan to understand exactly how the matching contribution is determined and whether there are any existing errors.
How to find the mistake:
- Review the plan document to determine the correct matching contribution formula and compare it to what you used in operation.
- Review the definition of compensation used to calculate matching contributions.
~Incorrect compensation used to determine elective deferrals normally
leads to mistakes in the match.
- Review the timing of the matching contribution in comparison to the plan document requirements.
~If the plan document states the match is a percentage of the deferrals made on a yearly basis and you calculate the match on a weekly basis, you may have a mistake.
- Be aware of any changes to your plan document.
If you take these steps and do find that an error was made in calculating matching contributions, the important thing is to correct the error as soon as possible.
How to fix the mistake:
You should base correction of an incorrect employer matching contribution on the plan’s terms and other applicable information at the time of the mistake.
Employer D sponsors a calendar-year 401(k) plan with 20 participants. The plan document provides that Employer D will make matching contributions equal to 50% of the amount deferred by the participant for the year up to 6% of compensation. A participant deferring 6% of compensation should have a matching contribution of 3% of compensation.
During the 2014 plan year, Employer D erroneously computed its match based on 50% of the amount deferred by Carla for the year up to 3% of compensation instead of 6% of compensation. Carla received $50,000 in compensation and elected an 8% deferral rate ($50,000 x 8% = $4,000 elective deferrals). Employer D provided a matching contribution to Carla totaling $750 ($50,000 x 3% x 50%). Under the plan terms, Carla was entitled to a $1,500 match ($50,000 x 6% x 50%). As a result, Employer D needs to make a corrective contribution of $750, plus earnings, for Carla.
Correction programs available:
Self-Correction Program (“SCP”):
The example illustrates an operational problem because the employer didn’t follow the plan terms and improperly applied the plan’s matching contribution formula. If the other eligibility requirements of SCP are satisfied (which is likely for an error involving only one participant), Employer D may use SCP to correct the failure.
- No fees for self-correction.
- Practices and procedures must be in place.
- If the mistakes are significant in the aggregate (for example, if the matching calculation error applied to all participants and other operational errors also occurred):
~Employer D needs to make a corrective contribution by December 31, 2016.
~If not corrected by December 31, 2016, Employer D isn’t eligible for SCP and must correct under VCP.
- If the mistakes are insignificant in the aggregate, Employer D can correct beyond the two-year correction period that applies to significant errors. Whether a mistake is insignificant depends on all facts and circumstances.
Voluntary Correction Program (“VCP”):
The correction method is the same under VCP as it is under SCP. The difference is that Employer D must also make a VCP submission to the IRS according to the IRS correction program under Revenue Procedure 2013-12. The IRS recently issued modifications to the IRS correction program in Revenue Procedure 2015-27 and Revenue Procedure 2015-28 (including some changes which are not required until July 1, 2015). The fee for the VCP submission is $750 (because Employer D’s plan has 20 or fewer participants).
When making its VCP submission, Employer D must include Forms 8950 and 8951 and consider using the model documents provided by the IRS. Beginning July 1, 2015, if Employer D chooses to use a “model” VCP format to prepare its VCP submission (which is very common) the IRS will require that the model documents (Form 14568 and, if appropriate, one or more Schedules 14568-A through 14568-I) be used for VCP submissions instead of using the Appendices included at the end of Revenue Procedure 2013-12.
Audit Closing Agreement Program (“Audit CAP”):
Under Audit CAP, the correction method is the same as under SCP or VCP. The difference is that, because Employer D didn’t discover and correct the error before the IRS audited the plan, Employer D and the IRS must enter into a closing agreement outlining the corrective action and negotiate a sanction based on the maximum payment amount.
Of course, the best plan of action to avoid the need to use these IRS correction programs is to take steps to ensure that you are correctly administering your plan.
How to avoid the mistake:
- Be familiar with your plan document’s terms and implement procedures to ensure that your plan operates according to your plan document.
- Work with your plan administrators to ensure that they have sufficient employment and payroll information to calculate the employer matching contribution per the plan document’s terms.
- Identify payroll services performed in-house, or outside services used, and how payroll is communicated to other in-house staff or outside providers servicing the plan. Identify who’s in charge and his or her responsibilities.
- Know how deferrals, loans, QDROs or other deduction payments are remitted.
- Be familiar with the procedures for how payroll errors are corrected, how corrections are communicated to the plan administrator and how records of corrections are maintained.