Find the Mistake
Fix the Mistake
Avoid the Mistake
|2) Employees of related businesses were excluded from participating||Identify any companies that you own or with which you have a financial relationship||Apply reasonable correction method that would place affected employees in the position they would've been in if there were no operational plan mistakes||Determine if you own any other businesses|
“Employees” for purposes of determining who's an eligible employee under a SEP 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's eligible to participate in your SEP.
How to find the mistake:
All owners or partners of your business should identify any companies they own or with which they have a financial relationship. If any of these companies or relationships exist, review the requirements of Internal Revenue Code Sections 414(b), (c) and (m) to ensure that all required employees are included in the plan.
How to fix the mistake:
Generally, if you didn’t provide an employee the opportunity to participate in your SEP plan, you must make a contribution to the employee's SEP-IRA to make up for the missed contribution. You should treat employees of the related business as improperly excluded employees, and you should make corrective contributions for each excluded employee of the related business. The corrective contribution is an employer contribution that is intended to place the employee in the same position had the employee participated in the SEP plan timely.
Edward owns Business A, a restaurant that has 40 employees. Edward also owns Business B, a copy shop that has 30 employees. Edward established a SEP plan in 2015 and only included the eligible employees of Business A in the plan.
The 30 employees of Business B are eligible employees who Edward’s business improperly excluded. Revenue Procedure 2016-51 provides different safe harbor methods for correcting eligible employees who’ve been improperly excluded from participating. The contribution method requires the employer to open a SEP-IRA for each improperly excluded employee and make a corrective contribution to each of those SEP-IRAs. The corrective contribution is determined taking into account the excluded employees’ compensation, and must be adjusted for earnings through the date of correction. No adjustments are made to the SEP-IRAs of employees who shared in the prior allocation, even though their allocations would’ve been different had the excluded employee not been excluded. For the above example, Edward would contribute to each of the 30 improperly excluded employees an amount equal to the same percentage of compensation as was made to the 40 included employees for the 2015-year (adjusted for earnings) or an alternative correction method that satisfies Revenue Procedure 2016-51’s general correction principles. If it isn’t feasible to determine what the actual investment results would’ve been, you may use a reasonable rate of interest, such as the interest rate used by the Department of Labor’s Voluntary Fiduciary Correction Program Online Calculator.
Correction programs available:
The example illustrates a significant operational problem, because Edward failed to follow the terms of the plan by improperly excluding Business B employees. Because it’s a significant operational failure, SCP isn’t available for the mistake and it must be corrected using VCP.
Voluntary Correction Program:
If the plan isn’t under audit, Edward may make a VCP submission to the IRS under Revenue Procedure 2016-51 identifying the failure, using Form 14568, Model VCP Compliance Statement, including Form 14568-C, Model VCP Compliance Statement - Schedule 3: SEPs and SARSEPs, and Forms 8950 and 8951. Beginning in 2018, the user fee for VCP submissions is generally based upon the current value of all IRAs that are associated with the SEP 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.” Edward 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. 2016-51.
How to avoid the mistake:
You and all owners or partners of your business should review 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 and payroll records necessary to make eligibility decisions for all employees of all related employers.