Every year millions of dollars are withheld from employees’ salaries for their retirement. And employers are required to deposit the employee’s salary deferral contributions to the retirement plan’s trust account “as soon as administratively possible”.
As Soon as Administratively Possible
“As soon as administratively possible” means what it says. An employer that has a history of remitting employee contributions 2-3 days after payroll, is expected to be able to meet the same transmission time for all employee contributions.
There can be several reasons that there is a delay in depositing the funds into the retirement plan trust account; staff shortages, vacations, clerical oversight to name a few. But as in many industries there are always a few bad apples such as employers that use employee contributions for business purposes. Employers justify to themselves that it is only a loan but employees lose earnings from interest and dividends as well as market value increases on their investments if contributions are not timely deposited.
“Lending of money or other extension of credit between a plan and a disqualified person” is considered a Prohibited Transaction. The IRS defines a disqualified person as a person who is an “employer any of whose employees are covered by the plan” or “an employee organization any of whose members are covered by the plan.”
Failure To Make Timely Deposits
What happens if an employer intentionally or inadvertently fails to timely deposit the employee contributions?
Internal Revenue Code Section 4975 imposes a 15% excise tax of the amount involved. If the transaction is not corrected within the taxable period, there is an additional tax of 100% of the amount involved. Excise taxes are paid using Form 5330 Return of Excise Taxes Related to Employee Benefit Plans.
The Form 5330 instructions define the “amount involved” as “the greater of the amount of money and fair market value of the property given or money and fair market value of the property received.” This is generally the amount of earnings lost for failure to timely deposit the contribution. More later on calculation of amount involved or lost earnings.
The taxable period is the period of time beginning with the date of the prohibited transaction and ending on the date the correction is completed. Each prohibited transaction has its own separate taxable period. Meaning that a prohibited transaction not fully corrected in one tax year will incur an additional and separate prohibited transaction the following tax year.
Amount Involved
The amount involved is based on interest in the elective deferrals. Interest rates are determined using the IRS published underpayment rate for each quarter of the taxable period. The taxable period may extend over several quarters and interest rates may vary. Interest on See IRC 6621 Table of Underpayment Rate, for each quarter. Interest on lost earnings must also be compounded for every quarter if the prohibited transaction is not corrected.
The IRS has a voluntary Fiduciary Correction Program (VFCP) online calculator that can assist in the calculation of the lost earnings. However, it does not constitute correction under the VFCP.
If any Principal Amount, such as the employee contributions that was not deposited, was used for a specific purpose that generated a profit, you must “Calculate Restoration of Profit”. The VFCP Online calculator will compare such profit to the interest calculation and if it exceeds the Lost Earnings and interest calculation, the Restoration of Profit must be used for the correction.
When is the Prohibited Transaction fully corrected?
To correct the prohibited transaction, the disqualified person must “undo the transaction without putting the plan in worse financial position than if the transaction never occurred”, such as depositing the employee contributions into the plan as soon as possible. However, the transaction is not fully corrected until not only the employee contributions are deposited but any lost earnings are also deposited into the Plan’s trust.
Paying the excise taxes
The disqualified person must file Form 5330 and complete Section C, Tax on prohibited Transaction, and pay a 15% excise tax on the amount involved.
The Excise taxes will be assessed for every tax year (or partial tax year) when the prohibited transaction is not fully corrected. Additional interest on the lost earnings will be subject to the 15% excise tax as well.
Tax on Prohibited Transactions should be reported by the last day of the 7th month following the end of the tax year for the employer.
The Internal Revenue Service (“IRS”) recognizes that when it comes to money there will always be a bit of corruption and such behavior should be discouraged.