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Returning Contributions under a Mistake of Fact

My client made an excess contribution to his 401(k) plan. A provision in his plan document states, ‘Any contribution made by the Employer because of a mistake of fact must be returned to the Employer within one year of the contribution.’  When can a plan sponsor take back a contribution made to a plan based on a mistake of fact? 

ERISA consultants at the Retirement Learning Center (RLC) Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare.  We bring Case of the Week to you to highlight the most relevant topics affecting your business.

A recent call with a financial advisor from California is representative of a common inquiry related to plan errors.

Highlights of the Discussion

The circumstances under which a contribution can be returned timely to a plan sponsor are limited under ERISA Sec. 403(c)(2):

  1. The contribution was made because of a mistake of fact provided it is returned to the employer within one year;[1]
  2. The contribution was made on the condition that the plan is qualified and it is subsequently determined that the plan did not qualify; or
  3. The contribution was made on the condition that it was deductible.

Rev. Rul. 91-4,[2] provides that a qualified pension plan may contain a provision authorizing return of employer contributions made because of a “mistake of fact” as provided in section 403(c)(2)(A) of ERISA.

Focusing on the meaning of mistake of fact, neither the Internal Revenue Code nor ERISA (or regulations there under) define “mistake of fact” for purposes of qualified retirement plans. Through private letter rulings the IRS has revealed it views this exception as “fairly limited.” Consider the following excerpt from IRS Private Letter Ruling (PLR) 9144041:

“Mistake of fact is fairly limited. In general, a misplaced decimal point, an incorrectly written check, or an error in doing a calculation are examples of situations that could be construed as constituting a mistake of fact. What an employer presumed or assumed is not a mistake of fact.”

Plan sponsors have attempted to zero in on the meaning of mistake of fact through the request of private letter rulings. For example, in PLR 201424032, the IRS concluded that an excess contribution made to the plan based on the incorrect asset value was made because of a mistake of fact. An “erroneous actuarial computation” was a mistake of fact in PLR 201228055. A “mistaken belief about the number of participants and beneficiaries” in the plan constituted a mistake of fact in PLR 201839010.

Before correcting an excess contribution to a retirement plan, plan officials should consider all available correction methods, including those outlined in the IRS’s Employee Plans Compliance Resolution System found in Revenue Procedure 2019-19.

Conclusion

While it may be permissible to return an excess employer contribution as a result of a mistake of fact, bear in mind, such mistakes are very narrowly defined by the IRS.

[1] Within six months for a multiemployer plan

[2] Revenue Ruling 91-4 Internal Revenue Service 1991-1 C. B. 57

Section 401.-Qualified Pension, Profit-sharing and Stock Bonus Plans

26 CFR 1.401-2: Impossibility of diversion under the trust instrument.

Reversions; remedial amendments. Circumstances under which reversions of employer contributions to a quali­fied plan are discussed. Rev. Rul. 77-200 superseded and Rev. Rul. 60-276 obsoleted.

Rev. Rul. 91-4

PURPOSE

The purpose of this revenue ruling is to obsolete Rev. Rul. 60-276, 1960-1 C.B. 150, and to supersede Rev. Rul. 77-200, 1977-1 C.B. 98, for reversions occurring on or after December 22, 1987, the date of enact­ment of section 9343 of the Omnibus Budget Reconciliation Act of 1987 (“OBRA 87”), Pub. L. 100-203.

ISSUE

Under what circumstances may a qualified pension, profit-sharing or stock bonus plan permit reversion of employer contributions?

FACTS

A plan permits reversion of em­ployer contributions under the condi­tions described in section 403(c)(2) of the Employee Retirement Income Se­curity Act of 1974 (“ERISA”), Pub. L. 93-406, as amended by section 9343(c) of OBRA 87.

LAW AND ANALYSIS

Section 401(a)(2) of the Internal Revenue Code of 1986 generally re­quires a trust instrument forming part of a pension, profit-sharing or stock bonus plan to prohibit the diversion of corpus or income for purposes other than the exclusive benefit of the employees or their beneficiaries. Sec­tion 403(c)(1) of ERISA contains a similar prohibition against diversion of the assets of a plan.

Section 403(c)(2) of ERISA, for which there is no parallel provision in the Internal Revenue Code, generally provided, prior to its amendment by OBRA 87, that the general prohibi­tion against diversion does not pre­clude the return of a contribution made by an employer to a plan if: (1) the contribution is made by reason of a mistake of fact (section 403(c)(2)(A); (2) the contribution is conditioned on qualification of the plan under the Internal Revenue Code and the plan does not so qualify (section 403(c)(2)(B)); or (3) the con­tribution is conditioned on its deduct­ibility under section 404 of the Code (section 403(c)(2)(C)). The return to the employer of the amount involved must generally be made within one year of the mistaken payment of the contribution, the date of denial of qualification, or disallowance of the deduction.In Rev. Rul. 60-276, the Service held that a provision permitting the reversion of the entire assets of a plan on the failure of the plan to qualify initially under the Code would be allowed. In Rev. Rul. 77-200, the Service held that plan language pro­viding for the return of employer contributions under the circumstances specified in section 403(c)(2)(A) and (C) of ERISA could also be included in a plan intended to qualify under the Internal Revenue Code.

The Tax Court, in Calfee, Halter, & Griswold v. Commissioner, 88 T.C. 641 (1987), held that a plan may qualify under section 401(a) of the Code if it permits reversions under pre-OBRA 87 section 403(c)(2)(B) of ERISA, even if such reversions are not limited to initial qualification of a plan. In reaching this conclusion, the Tax Court assumed that the standards and guidelines in Title I of ERISA were applicable in interpreting the Code.In enacting section 9343 of OBRA 87, Congress legislatively overturned the holding in Calfee, Halter, & Gris­wold. It amended section 403(c)(2)(B) of ERISA to provide for the return of employer contributions under that section only if: (1) the return of the contribution is conditioned on initial qualification of the plan; (2) the plan received an adverse determination with respect to its initial qualification; and (3) the application for determina­tion is made within the time pre­scribed by law for filing the employ­er’s return for the taxable year in which such plan was adopted, or such later date as the Secretary of the Treasury may prescribe. Section 9343 also provided that, except to the ex­tent provided by the Code or the Secretary of the Treasury, Titles I and IV of ERISA are not applicable to interpreting the Code. Both amendments were effective on the date of enactment of OBRA 87, De­cember 22, 1987.

Section 1.401(b)-1 of the Income Tax Regulations provides a remedial amendment period for disqualifying provisions. Any such section 401(b) remedial amendment period is a later date as the Secretary may prescribe for filing the application for determi­nation.

HOLDING

Pursuant to this revenue ruling, language providing for a return of contributions in the circumstances specified in section 403(c)(2)(A), (B) and (C) of ERISA, as amended by OBRA 87, may be included in a plan intended to qualify under the Internal Revenue Code. Thus, plans that are amended to include such language will not fail to satisfy section 401(a)(2) of the Code solely as the result of such an amendment. For example, a plan provision permitting the reversion of the entire assets of the plan on the failure of the plan to qualify initially under the Internal Revenue Code will be allowed only under the circumstances described in section 403(c)(2)(B) of ERISA.The determination of whether a reversion due to a mistake of fact or the disallowance of a deduction with respect to a contribution that was conditioned on its deductibility is made under circumstances specified in section 403(c)(2)(A) and (C) of ERISA, and therefore will not ad­versely affect the qualification of an existing plan, will continue to be made on a case by case basis. In general, such reversions will be per­missible only if the surrounding facts and circumstances indicate that the contribution of the amount that sub­sequently reverts to the employer is attributable to a good faith mistake of fact, or in the case of the disallow­ance of the deduction, a good faith mistake in determining the deductibil­ity of the contribution. A reversion under such circumstances will not be treated as a forfeiture in violation of section 411 (a) of the Code, even if the resulting adjustment is made to the account of a participant that is partly or entirely non-forfeitable.

The maximum amount that may be returned to the employer in the case of a mistake of fact or the disallow­ance of a deduction is the excess of (1) the amount contributed, over, as relevant, (2) (A) the amount that would have been contributed had no mistake of fact occurred, or (B) the amount that would have been con­tributed had the contribution been limited to the amount that is deduct­ible after any disallowance by the Service. Earnings attributable to the excess contribution may not be re­turned to the employer, but losses attributable thereto must reduce the amount to be so returned. Further­more, if the withdrawal of the amount attributable to the mistaken or nondeductible contribution would cause the balance of the individual account of any participant to be reduced to less than the balance which would have been in the account had the mistaken or nondeductible amount not been contributed, then the amount to be returned to the employer must be limited so as to avoid such reduction. In the case of a reversion due to initial disqualifica­tion of a plan, the entire assets of the plan attributable to employer contri­butions may be returned to the em­ployer.

EFFECTIVE DATEPlans have until the end of the section 401(b) remedial amendment period to be amended retroactively to conform with OBRA 87. Operation of a plan in a manner inconsistent with section 403(c)(2)(B) of ERISA, as amended by section 9343 of OBRA 87, on or after December 22, 1987, the effective date of section 9343, will cause the plan to fail to satisfy sec­tion 401 (a) of the Code.

EFFECT ON OTHER REVENUE RULINGS

Rev. Rul. 60-276 is obsoleted. Rev. Rul. 77-200 is superseded for rever­sions of employer contributions ocurring on or after the date of enact­ment of section 9343 of OBRA 87.

 

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Deferral limit, multiple plans and excess deferrals

“What is a plan participant’s deferral limit if he or she participates in more than one 401(k) plan?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs, qualified retirement plans and other types of retirement savings and income plans, including nonqualified plans, stock options, and Social Security and Medicare. We bring Case of the Week to you to highlight the most relevant topics affecting your business. A recent call with a financial advisor from Connecticut is representative of a common inquiry related to contribution limits.

Highlights of the Discussion

The IRC § 402(g) annual limit on employee salary deferrals is an individual taxpayer limit—not a per plan limit. Consequently, an individual under age 50 for 2018 was limited to deferring 100 percent of compensation up to a maximum of $18,500 (or $24,500 if age 50 or more)—regardless of the number of plans in which he or she participated during the year. For 2019, the respective limits are $19,000 and $25,000.

This annual limit is inclusive of employee salary deferrals (pre-tax and designated Roth) an individual makes to all of the following plan types:

  • 401(k),
  • 403(b),
  • Savings incentive match plans for employees (SIMPLE) plans [both SIMPLE IRAs and SIMPLE 401(k) plans[1]] and
  • Salary reduction simplified employee pension (SARSEP) plans.[2]

(Note: A person who participates in a 457(b) plan has a separate deferral limit that includes both employee and employer contributions.)

If a taxpayer exceeds the annual limit—the result is an excess deferral that must be timely corrected. The IRS could disqualify a plan for violating the elective deferral limitation, resulting in adverse tax consequences to the employer and employees under the plan. But there are ways to correct the error. It is important to follow the correction procedures contained in the governing plan document.

Generally, if a participant has excess deferrals based on the elective deferrals made to a single 401(k) plan or plans maintained by the same employer, then the plan must return the excess deferrals and their earnings to the participant no later than April 15th of the year following the year the excess was created [Treas. Reg. § 1.402(g)-1(e)(1)].

In the case of an employee who participates in more than one salary deferral-type plan of unrelated employers, it may be difficult for the plan sponsor to recognize there is an excess deferral. Therefore, the onus is on the participant to notify the plan administrator of the amount of excess deferrals allocated to the plan prior to the April 15th correction deadline (usually a notification date is specified in the plan).

[1] The 2018 limit for deferrals to a SIMPLE IRA or 401(k) plan is $12,500 ($15,500 if age 50 or more).

[2] The 2018 limit for deferrals to a SARSEP plan is 25% of compensation up to $18,500 ($24,500 if age 50 or more).

document). The plan is then required to distribute the excess and earnings to the participant no later than the April 15th correction deadline [Treas. Reg. § 1.402(g)-1(e)(2)].

If the excess deferrals are timely withdrawn by the April 15th correction deadline, then

  • The excess deferrals are taxed in the calendar year deferred;
  • The associated earnings are taxed in the year distributed;
  • There is no 10% early distribution penalty tax; and
  • There is no 20% withholding (since the amounts are ineligible for rollover).

If the excess deferrals are withdrawn after the April 15th correction deadline, then

  • Each affected plan of the employer is subject to disqualification and would need to go through the IRS’s Employee Plans Compliance Resolution System (EPCRS) to properly correct the error;
  • The excess deferrals are subject to double taxation—taxed in the year contributed and in the year distributed;
  • The associated earnings are taxed in the year distributed; and
  • The excess deferrals could also be subject to the 10% early distribution penalty tax if no exception applies.

EXAMPLE 1

Joe, a 45-year old worker, made his full salary deferral contribution of $18,500 to Company A’s 401(k) plan by October 2018. He then left Company A to go to work for Company B, an unaffiliated company, on November 1, 2018, and was immediately allowed to participate in the 401(k) plan. Not understanding how the 402(g) limit works, he begins making salary deferral contributions to Company B’s 401(k) plan. In December his financial advisor informed him that may have over contributed for 2018.

The onus is on Joe to report the excess salary deferrals to Company B. Company B is then required to distribute the excess deferrals and earnings by April 15, 2019.  The plan document also requires forfeiture of any matching contributions associated with the excess deferral.

Conclusion

Although the annual IRC §402(g) employee salary deferral limit is an individual employee limit, exceeding it can have consequences for both the employee and the plan sponsor. Timely correction of the excess is key to minimizing possible negative effects.  Plan sponsors should review the correction procedures outlined in their plan documents, and follow them carefully should they detect or be informed of an excess deferral. Also rely on the IRS’s EPCRS corrections program.

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401(k) and Nonqualified Deferred Compensation plans

 

“My client has a 401(k) excess contribution as a result of a failed actual deferral percentage (ADP) test.  However, he was told he could roll over the excess contribution to another of his employer’s plans.  How could that be; I thought excess contributions were ineligible for rollover?”

ERISA consultants at the Retirement Learning Center Resource Desk regularly receive calls from financial advisors on a broad array of technical topics related to IRAs and qualified retirement plans. We bring Case of the Week to you to highlight the most relevant topics affecting your business.

Highlights of Discussion

  • You are correct; 401(k) excess contributions are not eligible to be rolled over to an “eligible retirement plan” pursuant to Internal Revenue Code Section (IRC §) 402(c)(8)(b). The term eligible retirement plan is defined as an individual retirement account under IRC §408(a); an individual retirement annuity under IRC § 408(b); a qualified trust; a qualified annuity plan under IRC § 403(a); a governmental plan under IRC §457(b); and an IRC §403(b) plan.
  • However, it is possible that, in addition to the 401(k) plan, your client’s employer maintains a plan that is not an eligible retirement plan, such as a nonqualified deferred compensation plan (NQDC) under IRC §409A.
  • An NQDC plan is an agreement, method, or arrangement between an employer and an employee (or service recipient and service provider) to pay the employee or independent contractor compensation in the future for service presently performed. NQDC plans allow employees to defer compensation until retirement or some other predetermined date. A thorough discussion of NQDC plans is beyond the scope of this writing.
  • NQDC plans are an attractive benefit for highly paid employees because they are free from the contribution limits, participation requirements and nondiscrimination restrictions that apply to qualified plans. Because NQDC plans are not subject to the limitations of qualified retirement plans, they can allow some executives and high-level managers to defer a much larger portion of their compensation than permitted under qualified plans.
  • If permitted under the terms of the plan document, participants may have the option to contribute to the NQDC their excess contributions that occurred in their 401(k) plans. These NQDC plans may be referred to as “401(k) excess plans” or “401(k) wrap plans.” The contribution to the NQDC plan is not a rollover, but is considered an additional type of permissible deferral under the NQDC plan.
  • A best practice would be to get a copy of the NQDC plan document and check to see if there is language in the plan that addresses the ability of participants to defer excess contributions. The consultants at the Learning Center review NQDC plans documents, as well as other types of plan documents, daily.

 

Conclusion

While 401(k) participants may not roll over excess contributions to another eligible retirement plan, it may be possible for them to defer their excesses into a NQDC or 401(k) wrap plan, if one exists. Check the NQCD plan document for accommodating language.

 

 

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