SARSEP Fix-It Guide - Employee elective deferrals exceed the IRC Section 402(g) limit for the calendar year ($17,500 in 2013) and excess deferrals haven’t been distributed
|Mistake||Find the Mistake||Fix the Mistake||Avoid the Mistake|
|5) Employee elective deferrals exceed the IRC Section 402(g) limit for the calendar year ($17,500 in 2013) and excess deferrals haven’t been distributed||Inspect deferral amounts for plan participants to ensure that you haven’t exceeded the limits.||Two possible correction methods
a. Distribution method
b. Retention method
|Have sufficient payroll information to verify that the deferral limitations of IRC Section 402(g) were satisfied.|
Limit on employee elective deferrals: The most a participant can choose to defer for the 2013-calendar year is the lesser of:
- 25% of the participant’s compensation or
The dollar limitation (subject to cost-of-living adjustments) applies to the total employee elective deferrals the employee makes for the year to the SARSEP and any:
- Cash or deferred arrangement (401(k) plan),
- Salary reduction arrangement under a tax-sheltered annuity plan (403(b) plan), or
- SIMPLE IRA plan.
Catch-up contributions: A plan may permit participants who are age 50 or over at the end of the calendar year to make additional elective deferrals. These additional contributions (commonly referred to as “catch-up contributions”) are not subject to the above general limits. You aren’t required to provide for catch-up contributions; however, if your plan does allow catch-up contributions, it must allow all eligible participants to make the same election with respect to catch-up contributions.
The limit on catch-up elective deferral contributions for 2013 is the lesser of $5,500 or the excess of the employee’s compensation over elective deferrals that are not catch-up contributions. After 2013, the $5,500 amount may be increased for cost-of-living adjustments.
Excess deferrals: The law considers amounts deferred for a year in excess of the above limit “excess elective deferrals.” An employee may have excess elective deferrals even if the amount deferred under this SARSEP alone does not exceed the applicable limit. If an employee who elects to defer compensation under a SARSEP of one employer and any other SARSEP or employee elective deferral arrangement of the same or other employer has made excess elective deferrals for a calendar year, the employee must withdraw those excess deferrals by April 15 following the calendar year to which the deferrals relate.
Deferrals not withdrawn by April 15 - the SARSEP contributions will be subject to the IRA contribution limits ($5,500 in 2013; $6,500 if age 50 or over) and may be considered excess contributions to the employee’s IRA. For the employee, these excess elective deferrals are subject to a 6% tax on excess contributions under Internal Revenue Code Section 4973. Income earned on excess elective deferrals for the year contributed is includible in the employee’s income in the year it is withdrawn from the IRA. The income must also be withdrawn by April 15, following the calendar year for which the deferrals were made. If the excess elective deferral and related income is withdrawn after that date and the recipient isn’t 59½ years of age, it may be subject to the 10% tax on early distributions.
How to find the mistake:
Inspect deferral amounts for plan participants to ensure that they haven't exceeded the limits by reviewing year-end employee deferral and payroll records.
How to fix the mistake:
When there is a deferral in excess of the Internal Revenue Code Section 402(g) or 408(k)(6)(A)(iii) limit, you have until April 15 of the calendar year after the end of the year in which the excess occurred to make correction. After that, you must use VCP. To correct, you, as the plan sponsor, may effect distribution of the excess amount, adjusted for earnings through the date of correction, to the affected participant. The amount distributed to the affected participant is includible in the participant’s gross income in the year of distribution. The distribution is reported on Form 1099-R for the year of distribution with respect to each participant receiving the distribution. In addition, you must inform affected participants that the distribution of an excess amount is not eligible for favorable tax treatment accorded to SARSEP plan distributions (and, specifically, is not eligible for tax-free rollover).
As an alternative, you may use the Retention of Excess Amounts method (see Mistake #4). If you retain an excess amount in the SARSEP plan, a special fee, under section 6.11(5)(b) of Revenue Procedure 2013-12, in addition to the VCP submission fee, will apply. You aren’t entitled to a deduction for an excess amount retained in the SARSEP plan.
If the total excess amount in your SARSEP plan, whether attributable to elective deferrals or employer contributions, is $100 or less, you aren't required to distribute the excess amount and the special fee doesn’t apply.
Employer X maintains a SARSEP. For calendar year 2010, Bill defers $18,500 to the plan. Bill is under age 50 so he is not eligible to make catch-up contributions. Bill has excess deferrals of $2,000 because $16,500 is the maximum amounted permitted for 2010 ($18,500 - $16,500 = $2,000). Employer X didn't discover this mistake until after April 15, 2011. On November 1, 2011, X effected distribution of the excess deferral (plus applicable earnings of $100, totaling $2,100) to Bill.
For 2010 (year of deferral), Bill must include the $2,000 in gross income. For 2011 (year of distribution), Bill must include the $2,100 distribution in gross income. This amount would be shown on a Form 1099-R and Bill must pay the 10% early distribution tax.
Correction programs available:
When correction occurs timely, SCP may be used provided the other eligibility requirements of SCP were satisfied and practices and procedures were in place. The example illustrates a situation in which SCP can't be used because correction didn’t occur within the period required by the Revenue Procedure and VCP must be used to correct the mistake.
Voluntary Correction Program:
Under VCP, correction is the same as described under “Reasonable correction.” Employer 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. If Employer X chooses to retain the excess amounts, an additional compliance fee equal to 10% of the excess amounts will have to be paid.
Audit Closing Agreement Program:
Under Audit CAP, correction is the same as described above under “Reasonable correction.” Employer 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:
You should ensure that you have sufficient payroll information to verify that the deferral limitations of 402(g) were satisfied. Determine the 402(g) limits for each year and monitor deferrals throughout the year to ensure that no excess amount is placed into a participant’s SEP-IRA.