Spectra Newsroom

Most Frequent 401(k) Plan Compliance Penalties
by R. Brent Bennett, Partner, Spectra Management

With IRS regulations pertaining to 401(k) plans increasing concern, plan sponsors are paying more attention to related liability issues. According to the IRS, listed below are some of the more pressing compliance issues facing business owners today. It is more important than ever to build an understanding of these so that costly audit penalties, fines and additional taxes can be avoided.

1. Late Deposit of 401(k) Deferrals

Employers are required to deposit salary deferrals as of the earliest date on which such amounts can reasonably be segregated from the employer's general assets. In most cases, the salary deferral amounts can be segregated within a day or two of the date the employee’s paycheck is issued or even on the same day. The IRS does not allow under any circumstance salary deferrals deposited later than the 15th business day of the month following the month in which such amounts would otherwise have been payable to the participant in cash. Unfortunately, many employers have misinterpreted this rule, believing that it provides them with a “safe harbor” that allows them to delay deposit until the 15th business day of the following month.

2.  Improper 401(k) Accelerated Deductions

Employers are finding that they improperly claimed a deduction on their current year federal income tax return that relates to 401(k) deferrals made on account of and paid during the subsequent tax year. Employers should be wary of deduction or other schemes related to their 401(k) plans. If the transaction is not corrected in a timely manner or disclosed properly, the employer may be liable for penalties (i.e. accuracy-related or fraud penalties) in addition to any income taxes due.

3.  Failure to Use Correct Compensation

Plan administrators are finding that they’ve used the incorrect definition of compensation when calculating the Average Deferral Percentage (“ADP”) and Actual Contribution Percentage (“ACP”) tests; computing the salary deferral and employer matching contributions; and verifying that contribution limitations are satisfied. Employers and plan administrators need to be familiar with the terms of the plan document to ensure that they use the proper definition of compensation for nondiscrimination testing, deferral and contribution calculations and limitation purposes.

There are other compliance issues that 401(k) administrators should be aware of as well. For more information on the top ten compliance monitoring procedures that should be adhered to, visit http://www.irs.gov/retirement/article/0,,id=135260,00.html.

R. Brent Bennett of Spectra Management is a Registered Representative of and offers securities products and advisory services through Royal Alliance Associates, Inc. Member FINRA/SIPC, a registered broker-dealer. Spectra Management is not affiliated with Royal Alliance Associates, Inc. This information is not intended to be a substitute for specific individualized tax or legal advice. Please note that individual situations can vary. Therefore, the information should be relied upon when coordinated with individual professional advice.