SARSEP Fix-It Guide - Eligible employee were excluded from participating in the plan
|Mistake||Find the Mistake||Fix the Mistake||Avoid the Mistake|
3) Eligible employees were excluded from participating in the plan.
|Review eligibility and participation plan document sections. Check when employees are entering the plan.||Corrective contribution that would place affected employees in the position they would have been in if there were no plan operational mistakes.||Review the participation status of all employees at least once a year.|
You must allow all eligible employees to participate in the SARSEP, including part-time employees, seasonal employees and employees who die or terminate employment during the year. An eligible employee is an employee who:
- Is at least 21 years of age.
- Has performed service for you in at least three of the immediately preceding five years.
The term “employee” includes a self-employed individual who has earned income and a working business owner.
You must treat certain leased employees as “employees.”
Your SARSEP document can provide for less restrictive eligibility requirements (but not more restrictive ones). “Service” means any work performed for you for any period of time, however short. A SARSEP may not impose an hours-of-service requirement.
Excludable employees: You don’t need to cover the following employees under a SARSEP:
- Employees covered by a union agreement whose retirement benefits were bargained for in good faith by you and their union.
- Nonresident alien employees who did not earn U.S. source income from you.
- Employees who received less than $550 in compensation during the year. This amount is subject to cost-of-living adjustments after 2013.
You many not exclude employees simply because they are classified as “part-time” or “seasonal.” “Employee,” for purposes of determining who is an eligible employee under a SARSEP, includes all employees of all related employers. Related employers include controlled groups of corporations that include your business, trades or businesses under common control with your business and affiliated service groups that include your business. This means, for example, that if you and/or your family members own a controlling interest in another business, employees of that other business are “employees” for purposes of determining who is eligible to participate in your SARSEP.
Example 1: Employer X maintains a calendar year SARSEP. The eligibility requirements under the SARSEP are: an employee must perform service in at least three of the immediately preceding five years, reach age 21 and earn the minimum amount of compensation during the current year. Joe worked for Employer X during his summer breaks from school in 2009, 2010 and 2011, but never more than 34 days in any year. In July 2012, Joe turned 21. In August 2012, Joe began working for Employer X on a full-time basis, earning $12,000 in 2012. Joe is an eligible employee in 2012 because he met the minimum age requirement, worked for Employer X in three of the five preceding years and met the 2012 minimum compensation requirement.
Example 2: Employer Y designs its SARSEP to provide for immediate participation regardless of age, service or compensation. Sue is age 18 and begins working part-time for Employer Y in 2012. Sue is an eligible employee for 2012.
Example 3: Alex owns Business A, a computer rental agency that has four eligible employees. Alex also owns Business B, which repairs computers, and has three eligible employees. Alex is the sole owner of both businesses. The SARSEP rules treat all eight employees (including Alex) as employed by a single employer.
How to find the mistake:
Review the section of your plan document concerning eligibility and participation. Check when employees are entering the plan.
- Make a list of all employees who received a W-2.
- Compare their dates of hire and annual compensation against the eligibility and participation requirements in the plan document.
- Determine the date that each employee is entitled to become a participant in the plan according to the plan document.
- Inspect plan records to make certain the employees timely entered the plan.
How to fix the mistake:
Generally, if you didn’t provide an employee the opportunity to participate in your SARSEP plan, you must contribute to the plan for the employee that compensates for the missed employer contribution and “missed deferral opportunity.” The corrective contribution is an employer contribution that is intended to place the employee in the same position had the employee participated in the plan timely. Open a SEP-IRA for the excluded employee and make contributions to the SEP-IRA equal to the same percentage of compensation received by other employees. Increase the amount contributed to reflect missed earnings through the date of correction. Do not reduce other employees’ SEP-IRAs. If it isn’t feasible to determine what the actual investment results would have been, you may use a reasonable rate of interest (see Revenue Procedure 2013-12 sections 6.11(4) and 6.02(5)(a)).
In 2011, Company X failed to include Jan in its SARSEP plan. Jan had met the SARSEP age, service and earnings requirements. Jan is a nonhighly compensated employee and earned $10,000. Company X had two other NHCEs who had deferral percentages of 3% and 5%. In addition, Company X’s SARSEP plan provides for discretionary employer contributions. The plan provides that the employer's contributions be allocated to account balances in the ratio that each eligible employee's compensation for the year bears to the compensation of all eligible employees for the year. For 2011, Company X contributed a fixed dollar amount to the plan. Jan did not receive an allocation of the contribution. The contribution resulted in an allocation for each of the eligible employees, other than Jan, equal to 10% of compensation. Most of the employees who received plan allocations for the year of the mistake were NHCEs. If Jan had shared in the original allocation, the allocation made for each employee would have equaled 9% of compensation.
Revenue Procedure 2013-12 provides different safe harbor methods for correcting eligible employees who have been excluded from participating. For SARSEPs, corrective contributions generally must be made since the assets of the plan are held in IRAs. The contribution method requires the employer to make a corrective contribution to the SEP-IRA of the excluded employee. The corrective contribution is determined taking into account the excluded employee’s compensation. Adjust this amount for earnings through the date of correction. No adjustments are made to the employees who shared in the prior allocation, even though their allocations would have been different had the excluded employee not been excluded. For the above example, the employer would contribute an amount that equals 10% of the excluded employee’s compensation for the 2011 year (adjusted for earnings), and does not adjust the 10% allocations made to the other employees. If it isn’t feasible to determine what the actual investment results would have been, you may use a reasonable rate of interest. You may use the Department of Labor’s Voluntary Fiduciary Correction Program Online Calculator for this purpose. (see Revenue Procedure 2013-12 sections 6.11(4) and 6.02(5)(a)).
Correction programs available:
The example illustrates an operational problem, because the employer failed to follow the terms of the SARSEP plan document by excluding eligible employees from participating in the plan. Therefore, if the other eligibility requirements of SCP are satisfied, the employer might be able to use SCP to correct the mistake. The employer would have to determine whether:
- Appropriate practices and procedures were originally in place to facilitate compliance with requirements regarding employee eligibility
- The failure is insignificant.
Voluntary Correction Program:
Under VCP, correction is the same as described above under “Reasonable correction.” Company X files a VCP submission in accordance with Revenue Procedure 2013-12, using the model documents, including Schedule 3 and Forms 8950 and 8951.The fee for the VCP submission is $250.
Audit Closing Agreement Program:
Under Audit CAP, correction is the same as described above under “Reasonable correction.” Company X and the IRS enter into a Closing Agreement outlining the corrective action and negotiate a sanction based on the maximum payment amount.
How to avoid the mistake:
Monitor census information and the participation status of all employees at least once a year. The person assigned the task should have a good understanding of the eligibility requirements and have access to the employment records necessary to make eligibility decisions for all employees.