BGBC Partners, LLP Tax Update: 401(k) and SEP Employer Contribution Plans – Matching Contributions
As a business owner, you know the important role that employee benefits play in keeping employee morale high. Today’s Tax Update focuses on a couple of those benefits – retirement contributions for your employees!
Do you offer your employees a matching 401(k) contribution? Are you sure you are contributing the correct amount to each employee? This may seem like a silly question, but when employees begin and/or stop contributing in the middle of the year, you may want to revisit the plan to see what you promised. The IRS has advised its employees (i.e. the ones performing audits on taxpayers) to review the documents carefully and make sure the plan requirements are being met.
Many employers set up 401(k) matching plans for employees. While the matching parameters may differ for each employer, you must follow the plan you put in place. For employees who participate the entire year, this is usually not a problem to make sure all of the matching parameters are met. However, when employees begin and/or stop contributing during the year, it is important to make sure all of the matching parameters are met as these can easily slip through the cracks.
You may have to “true up” contributions if an employee stops contributing to their 401(k) at some point through the year or if an employee begins contributing in the middle of the year. A plan that allows for matching contributions up to a percentage of a participant’s total compensation (i.e. 100% of the employees’ contributions up to 3% of their annual salary) for the plan year must match the entire stated percentage.
For example, an employee elects to contribute 5% of his $48,000 annual compensation through salary deferrals. The employee stops contributing, but continues working for the employer, in May with a total of $800 contributed for the year. The employer matches the employee contributions 100% up to 3% of wages and has contributed $120 per month for a total of $480. Although, the employee has stopped contributing, the employer will have to match the full $800 (lesser of $800 employee contribution or $1,440 (3% of annual salary)) and contribute an additional $320.
Simplified Employee Pension (SEP) plans, which are often used by self-employed individuals, must be mindful of the structure of their plan. A sole proprietor who has several common-law employees must include the employees in the SEP plan. Even if the sole proprietor sets up a corporation, is the only member of that corporation, and adopts a SEP plan in the corporation rather than in the business with the common-law employees, the sole practitioner will likely still have to include the employees in the SEP plan. Why? The sole proprietorship and corporation will fall under the common control rule and any fringe benefits available to the corporation are now available to the common-law employees as well. The common-law rule is in place for these specific situations; to prevent businesses from avoiding various plan qualification requirements.
Take the time today to review your 401(k) and pension plan requirements to ensure compliance and fairness to your employees. Consult your CPA to make sure you are in compliance before filing your plan’s annual tax return. After-all, if you are trying to contribute to your employees’ future, you shouldn’t be penalized by the IRS for doing so!
