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SARSEP Fix-It Guide - Eligible employees were excluded from participating in the plan

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3) Eligible employees were excluded from participating in the plan.


Review eligibility and participation plan document sections. Check when employees are entering the plan. Make a corrective contribution that would place affected employees in the position they would have been in if they were correctly included in the plan. 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 and 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.

Your SARSEP document can allow 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.

The term “employee” includes self-employed individuals who have earned income and working business owners.

You must treat certain leased employees as “employees.”

“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 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.

Excludable employees: You don’t need to cover:

  • 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 (subject to cost-of-living adjustments) during the year.

Example 1: Employer X maintains a calendar year SARSEP, which requires that all employees who 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 are eligible to participate in the SARSEP. Joe worked for Employer X during his summer breaks from school in 2010, 2011 and 2012, but never more than 34 days in any year. In July 2013, Joe turned 21. In August 2013, Joe began working for Employer X on a full-time basis, earning $12,000 in 2013. Joe is an eligible employee in 2013 because he met the minimum age requirement, worked for Employer X in three of the five preceding years and met the 2013 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 2013. Sue is an eligible employee for 2013.

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 on 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 to the plan eligibility and participation requirements.
  • Determine when each employee is entitled to participate 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:

Corrective action:
Generally, if you didn’t give an employee the opportunity to participate in your SARSEP plan, you must make a contribution to the plan for the employee to compensate for the missed employer contribution and “missed deferral opportunity.” The corrective contribution is an employer contribution 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 a contribution to the SEP-IRA equal to the same percentage of compensation that other employees received. Increase the amount contributed to reflect missed earnings through the date of correction. Don’t 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.

In 2012, Company X failed to include Jan in its SARSEP plan. Jan had met the SARSEP age, service and earnings requirements. Jan is a non-highly 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 contributions should 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 2012, Company X contributed a fixed dollar amount to the plan. Jan didn’t 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 the employee’s compensation.

Reasonable correction:

Revenue Procedure 2013-12 provides different safe harbor methods for correcting eligible employees who have been excluded from participating. For SARSEPs, the plan sponsor must generally make corrective contributions because the plan assets are held in IRAs. This contribution method requires the employer to make a corrective contribution to the excluded employees’ SEP-IRAs. The corrective contribution is calculated using each excluded employee’s compensation. Adjust this amount for earnings through the date of correction. Don’t reduce the other employees’ contributions, even though their allocations would have been different had the excluded employee not been excluded. For the above example, Company X would contribute 10% of Jan’s 2012 compensation and would not adjust the 10% allocations previously 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.

Correction programs available:

Self-Correction Program:
The example illustrates an operational problem, because the employer failed to follow the SARSEP plan document terms by excluding eligible employees from participating in the plan. If the other eligibility requirements of SCP are satisfied, Company X might be able to use SCP to correct the mistake. Company X would have to determine whether:

  • Appropriate practices and procedures were originally in place to facilitate compliance with requirements for 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 according to 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 this task should have a good understanding of the plan eligibility requirements and have access to the employment records necessary to determine if all eligible employees are participating in the SARSEP.

SARSEP Fix-It Guide
SARSEP Plan Overview
EPCRS Overview
IRA-Based Plans Additional Resources / Retirement Plans / Correcting Plan Errors / Fix-It Guides / SARSEP Plan Fix-It Guide / Potential Mistake

Page Last Reviewed or Updated: 05-May-2015