|Mistake||Find the Mistake||Fix the Mistake||Avoid the Mistake|
6) Less than 50% of eligible employees made employee elective deferrals.
|Review payroll records and ensure that 50% of eligible employees are actually making employee elective deferrals annually.||Stop all employee elective deferral contributions to the IRAs associated with the SARSEP.||Annually review plan document for eligibility requirements and payroll records. If less than 50% of eligible employees made elective deferrals during any year, cease withholding employee elective deferrals and notify all employees.|
Each year at least 50% of your eligible employees must choose to make employee elective deferrals into the SARSEP. If fewer than 50% of the eligible employees do so, the law disallows all employee elective deferrals made for that year and the deferrals must be withdrawn from the employees’ SEP-IRAs. In that case by 2 ½ months (March 15 for calendar-year plans) of the following year, you must provide each affected employee:
- The amount of the disallowed deferrals to the employee’s SEP-IRA for the preceding year,
- The year the disallowed deferrals and earnings are includible in the employee's gross income,
- Information stating that the employee must withdraw the excess contributions (and earnings), and
- An explanation of the tax consequences if the employee doesn't withdraw the excess.
See the Instructions for Form 5305A-SEP for information on how to treat disallowed deferrals.
This is a year-by-year rule. Each year the SARSEP doesn't meet the 50% rule, employee elective deferrals for that year cannot remain in the employees’ SEP-IRAs.
How to find the mistake:
Review the plan document and determine how many employees are eligible to participate in the plan. Review payroll records to ensure that at least 50% of the eligible employees are making elective deferrals each year.
How to fix the mistake:
Stop making employee elective contributions to the plan. If the plan isn't under IRS audit, you can file a VCP submission requesting that contributions made for previous years in which fewer than 50% of eligible employees made elective contributions be allowed to remain in the employees’ SEP-IRAs.
In 2016 and prior years, three of the four eligible employees made employee elective deferrals to the ABC SARSEP calendar-year plan. In 2017, one of the contributing employees separated from service from ABC and two other employees became eligible to make employee elective deferrals, but opted not to contribute to the plan. Thus, in 2017 only two of the five eligible employees made employee elective deferrals. In 2016 and prior years, three of the four eligible employees made employee elective deferrals to the ABC SARSEP calendar-year plan. In 2017, one of the contributing employees separated from service from ABC and two other employees became eligible to make employee elective deferrals, but opted not to contribute to the plan. Thus, in 2017 only two of the five eligible employees made employee elective deferrals.
Correction programs available:
Self-Correction Program (SCP):
ABC cannot correct this mistake under SCP, which is limited to insignificant operational problems. This mistake is an employer eligibility failure. To retain plan qualification, ABC must correct this mistake under VCP or Audit CAP.
Voluntary Correction Program (VCP):
ABC should file a VCP submission to the IRS under Revenue Procedure 2018-52 using Form 14568, Model VCP Compliance Statement, including Form 14568-C, Model VCP Compliance Statement - Schedule 3: SEPs and SARSEPs. The user fee for VCP submissions is based upon the current value of all IRAs that are associated with the SARSEP plan. For example, if the value is between $0 and $500,000, the user fee is $1,500. If the value of all IRAs exceeds $500,000, the user fee will be higher.
Audit Closing Agreement Program:
Under Audit CAP, correction is the same as described above under “Corrective action.” ABC and the IRS enter into a Closing Agreement outlining the corrective action and negotiate a sanction that is not excessive, considers facts and circumstances, and bears a reasonable relationship to the nature, extent and severity of the failures, based upon all relevant factors described in section 14 of Rev. Proc. 2018-52.
How to avoid the mistake:
Annually review your plan document eligibility requirements and compare them to your payroll records to determine which employees are eligible to participate. Compare the number of participating employees to the number of eligible employees. If you do not meet the 50% rule, stop transmitting elective contributions to participants’ SEP-IRAs and send a notice within 2 ½ months of the following year (March 15 for calendar-year plans) to each affected employee.