|Mistake||Find the Mistake||Fix the Mistake||Avoid the Mistake|
|10) You didn’t make required top-heavy minimum contributions to the SARSEP.||Review the rules and definitions for top-heavy in your plan document. Determine whether your plan is top-heavy for each plan year.||Contribute and allocate the required top-heavy minimum contribution, adjusted for earnings, to affected non-key employees.||Perform a top-heavy test each year. If your plan is top-heavy or deemed top-heavy, ensure that you’ve made all top-heavy minimum contributions.|
You're required to make a minimum contribution for non-key employees whenever your SARSEP is top-heavy - when more than 60% of all employer contributions go to key employees. SARSEPs are often drafted to operate as if they’re always top-heavy, eliminating the need to calculate the annual 60% determination.
When determining if your plan is top-heavy, employee elective deferrals are considered employer contributions. You may not use employee elective deferrals, however, to satisfy the minimum contribution requirements for top-heavy plans. To determine if your SARSEP has met the top-heavy minimum 3% contribution requirement:
- Count employee elective deferrals made by key employees.
- Don’t count employee elective deferrals made by non-key employees.
You’ll satisfy the top-heavy requirements by making a minimum contribution each year to the SEP-IRA of each non-key employee eligible to participate in the SARSEP. This minimum contribution isn’t required for key employees. This contribution, in combination with other nonelective contributions, must be the lesser of:
- 3% of each eligible non-key employee’s compensation, or
- the highest percentage of compensation made for any key employee of elective (not including catch-up contributions) and nonelective contributions for the year.
A key employee is any employee who, at any time during the preceding year was a(n):
- officer of your company with compensation greater than $185,000 in 2020, $180,000 in 2019 and $175,000 for 2017 & 2018 (subject to cost-of-living adjustments),
- 5% owner of your company, as defined in Internal Revenue Code Section 416(i)(1)(B)(i), or
- 1% owner of your company with compensation greater than $150,000.
How to find the mistake:
Review the top-heavy rules and definitions found in your plan document. Determine whether your plan is top-heavy for each plan year. Be careful to identify the owners and their family members employed by your business and apply the family aggregation rules.
How to fix the mistake:
Under EPCRS, Revenue Procedure 2019-19, Appendix A, section .02, if you didn’t contribute the minimum 3% top-heavy contribution, follow these steps to correct this error:
- Identify the affected employees
- Contribute the required top-heavy minimum, adjusted for earnings, to the affected non-key employees. In a SARSEP plan, the top-heavy minimum contribution is 3% of compensation.
However, if the highest percentage of contribution for a key employee is less than 3%, the top-heavy minimum is equal to that percentage. Adjust the corrective contribution for earnings through the date you correct. If it isn’t feasible to determine what the actual investment results would have been, you may use a reasonable rate of interest. Consider using the Department of Labor’s Department of Labor’s Online Calculator for this purpose.
Employer J, a husband and wife business, have sponsored a SARSEP plan for themselves since 2002. They hired two other employees on July 31, 2016. According to the SARSEP plan document terms, the new employees became eligible for the SARSEP plan on January 1, 2017. Both new employees made elective deferrals to the plan and it passed the deferral percentage test for 2017, 2018 and 2019. Assume the husband and wife owners made salary reduction contribution equal to the 402(g) limit. No employer contributions were made to the plan during this timeframe. During a review of the plan, Employer J determined the plan was top-heavy for the 2017, 2018 and 2019 plan years; however, it did not make the 3% minimum top-heavy contributions. To fix the failure, the employer must make top heavy contributions equal to 3% of compensation to each participant’s IRA associated with the SARSEP. Adjust the corrective contribution for earnings through the date you correct. If it isn’t feasible to determine what the actual investment results would have been, you may use a reasonable rate of interest. Consider using the Department of Labor’s Online Calculator for this purpose.
Correction programs available:
The example illustrates an operational problem because the employer failed to follow the plan document top-heavy provisions. Therefore, if Employer J satisfies the other eligibility requirements of SCP, Employer J may be able to use SCP to correct the failure. Employer J would have to determine whether:
- Appropriate practices and procedures were originally in place to facilitate compliance with requirements for the top-heavy rules.
- The failure is insignificant.
Voluntary Correction Program:
If the plan is not under audit, Employer J may make a VCP submission to the IRS under Revenue Procedure 2019-19 via the Pay.gov website following the procedures in Section 11. Employer J uses Form 14568, Model VCP Compliance Statement (PDF), and narrative attachments to identify the failure and describe how it’s being fixed. User fees for VCP submissions are generally based upon the current value of all IRAs that are associated with the SARSEP plan.
Audit Closing Agreement Program:
Under Audit CAP, correction is the same as described above under “Corrective action.” Employer J 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. 2019-19.
How to avoid the mistake:
Perform a top-heavy test each year. Properly identify ownership interests under the family aggregation rules so the test is accurate. Be especially careful if you have a smaller plan or one that only covered owners for a period and now has other participants. Verify that each non-key employee received the required top-heavy minimum contribution.