The IRS has never looked kindly on tax-withholding errors in benefit plans – even accidental ones.
But the agency offers some guidance to make it a bit easier and cheaper for sponsors of retirement plans – including 401(k), 403(b) and SIMPLE plans – to fix common minor errors before the feds impose penalties.
Here are some common errors, and suggestions on how to fix them before the IRS lowers the boom.
Discrepancies between written policy and actual practice
Innocent errors can happen in the best-run firms and usually stem from disconnects between what’s written in plan documents and the actual system for carrying them out.
The three most common errors:
- 401(k) eligibility. Look at your system for checking eligibility against an employee’s start date. Who makes sure the pre-tax contributions have actually come out of the employee’s paycheck?
- Plan loans. There are tax consequences when employees take out loans against their retirement accounts or cash out early. Your plan documents must spell out the exact method you use for processing such distributions and making sure the proper taxes are deducted.
- Rollovers. Your plan documents must match your system of moving funds to an IRA or another employer’s plan when an employee leaves.
Race against time
Under the IRS’s Employee Plans Compliance Resolution System, you’re in a race against time to correct these types of accidental errors. For “significant errors” (those which affect taxes, eligibility and/or benefit levels), you have two years to:
- request a determination letter from the IRS
- certify in the request that your firm made an honest mistake and wasn’t trying to get around tax laws
- outline your proposed corrections
- receive a favorable IRS ruling, and
- implement the changes.
If you follow this process, it’ll only cost your firm a fixed $250 fee – no penalties. And it really pays to check your retirement plan documents ASAP and make any needed corrections. Otherwise, things can start to get very expensive in a hurry.
Your firm wouldn’t be eligible for a penalty-free fix if the IRS finds the accidental plan error in a random audit – even if you discover it in preparation for the audit and then voluntarily report it to the IRS agent.