What to Do If You Make an Eligible Compensation Mistake

August 18, 2021

It happens… you’ve performed your audit and discovered some discrepancies. If you’ve ever found yourself in this position, you’re definitely not alone. In fact, eligible compensation errors are so common that they’re included in the IRS 401k Plan Fix-It Guide.

The good news is that you can correct these errors though a corrective contribution, reallocation, or distribution. Read on to learn more about how to correct eligible compensation mistakes.

First, find the mistake

The first step in fixing the mistake? Finding the mistake.

Start with a review of plan documents to ensure that you’re using the right definition of compensation for testing, deferrals and compensation.

Why is this important? Because plan sponsors may operate based on a plan summary… but plans are often amended over time. Compensation definitions may have changed, while plan operation continues as it always has.

For instance, the definition of “compensation” usually includes wages, salaries, fees for professional services, commissions and tips. But what about overtime pay? How about bonuses and commissions?

Do a close read of plan sections that cover deferrals and allocations. Here, you should find details such as how much of their compensation employees may defer. Then review the plan section that defines compensation.

This section should specify what, exactly, is included as “compensation,” such as overtime, expense reimbursements, car allowances and more. Cross-checking to ensure you’re using the proper definitions will help you identify (and fix) mistakes.

Take corrective action to fix the mistake

Once you identify the error, you may be able to fix it using a corrective contribution. Say you discover that an employee made fewer deferrals than they should have, due to an incorrect compensation definition. Make a corrective contribution to the employee’s account to solve the problem.

The employee receives what’s known as a corrective, qualified, non-elective contribution that’s equal to half of the missed deferral amount. This is based on the difference between the amount that should have been deferred if correct compensation was used, and the amount that was actually deferred.

If the employer offers matching contributions, they would then provide a corrective matching contribution that makes up the difference between what the employee should have received, if the compensation had been defined correctly. If the employee was entitled to profit sharing, the employer must also make up this difference.

Just remember to adjust for earnings when making corrective contributions.

If you have more questions about correcting eligible compensation mistakes, give us a call! Contact us today for more information and to schedule your virtual appointment with Cassell Plan Audits at 630.886.7669.

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