As to Deferral Deposits, Define Timely:
As Soon as You Can; ASAP; Chop, Chop; Pronto; What Are You Waiting For?!?!
Tell Me What You Want, What You Really, Really Want
The timeliness of deferral deposits — a topic that has been beaten to death with a stick and is still the source of discussion at every industry event. The rules are not black and white because they use the words “earliest” and “reasonably”, leaving what the regulators really want wide open for interpretation. DOL Regulation § 2510.3-102(b)(1) indicates that deferral deposits must be remitted on ‘the earliest day on which such contributions or repayments can reasonably be segregated from the employer’s general assets, but no later than the fifteenth business day of the month following the month of withholding.” Note that participant plan loan repayment withheld from employees’ pay are also subject to these timing of deposit rules. Based on ample discussion with the regulators, I don’t think there are any pension professionals left who allow deposit delays until the fifteenth business day of the next month after withholding, but the question still remains, can there be a little lenience for fashionably late deposits?
Delayed Deposits: Do You Have a Reason or an Excuse?
The DOL has provided some certainty for small plans: under a safe harbor, the deposit of deferrals within seven days will be considered timely, however large plans (those with 100 accounts or more) don’t have that certainty. Pension professionals who service large plans are put in a position to interpret “earliest” and “reasonably” as they apply to each client’s circumstances. As you would expect, opinions abound. Some third party administrators and auditors feel like “Where there is a will, there is a way!” and they enforce a consistent number of days that applies to every payroll. No exceptions. Other auditors will accept delays in connection with recordkeeper changes, IT challenges, illness of vacation of the sole person who approves the remittances in a thinly staffed employer, etc. To avoid exercising judgment about how quickly each employer could or should be able to complete the remittances, some pension professionals use the employer’s required date to deposit payroll tax withholdings as an objective date for deferral deposit timeliness.
For large plans, the industry standard seems to be around three days, likely based on the IRS’ Semi-weekly Depositor Schedule for payroll taxes:
- Employers whose total payroll withholding taxes for the four quarters in the lookback period are more than $50,000 must follow a semiweekly deposit schedule. Employers who follow a semiweekly deposit schedule must deposit employment taxes on the:
- Wednesday after payday (if payday fell on a Wednesday, Thursday, or Friday)
- Friday after payday (if payday fell on a Saturday, Sunday, Monday, or Tuesday)
This means that semiweekly depositors have at least three business days following the end of the semiweekly period to make a deposit. Monthly payroll tax withholding depositors can wait until the 15th business day of the month following the withholding, but the Department of Labor has been clear that this outer limit of the regulation that applies to large plans is not effectively available for large retirement plan sponsors for the deposit of their deferral withholdings.
But there are participants for whom deposits don’t have to be made within 3 days, or seven days, or promptly after their payroll checks, because they have self-employment earnings,
Sole Proprietors and Partners: Participant Deferrals that Are Not Withheld
Making a Deferral Election: Since a partner in a partnership’s (or a member of an LLC taxed as a partnership) earned income is deemed to be currently available not until the last day of the partnership’s taxable year, a partner in a partnership or sole proprietor can wait to make an election to defer up to the last day of the year. However, a partner or sole proprietor may not make a salary reduction election after the last day of the partnership or sole proprietorship’s tax year -Treas. Reg. § 1.401(k)-1(a)(6)(iii). Generally, partnership distributions are not part of payroll. However, partners are not precluded from deferring from distributions of self-employment income paid to them throughout the year.
Depositing the Deferral: Sole proprietors and partners (and LLC members who are taxed as partners) don’t know their total earned income for a year until the end of the year. For sole proprietors and partners, the deadline to deposit deferrals is the deadline for filing the individual income tax returns of the partners, not the return of the partnership of LLC. If a partner does not make the contributions when due, not only is the partner engaging in a prohibited transaction, but they may also lose the deferrals as an income tax deferral. Note that plans that cover only partners or sole proprietors and their spouses are not subject to ERISA.
Who Decides Whether a Deferral Was Remitted Late?
Often, when auditors find operational errors that are very small, the client and service providers invoke “materiality”, or the lack thereof, to advocate for the auditor to look the other way. The AICPA guidance to auditors addresses the “Regulatory Impact of Internal Control Matters Noted During the Audit”. The guidance states that when exceptions are noted during the course of the audit, they may be immaterial to the financial statements, but they may not be immaterial operational defects, since they affect the qualified status of the plan. In fact, the tax status of the plan is a required financial statement disclosure and certain errors are also required disclosures on the Form 5500, such as the Delinquent Participant Contributions Supplementary Schedule, regardless of their amount. The DOL and IRS have repeatedly stressed that there is no materiality level for matters that affect participants and participant accounts. To address findings, auditors evaluate whether they have a material impact on the financial statements, and then, they must evaluate the regulatory impact. The guidance states that “consultation with the client should include the determination of the magnitude and frequency of the error. Finally, the plan administrator should make a determination about whether such error or difference represents an operational defect or a prohibited transaction….The plan administrator in conjunction with ERISA counsel should decide on such matters and the appropriate path forward.” As a practical matter, errors may just be prohibited transactions by default in the case of late deferral deposits, and not every audited plan has ERISA counsel to help them decide whether delays beyond their control constitute a prohibited loan from the participants to the employer in need of correction, reporting, and disclosure. Hence, the need for judgment.
When Instead of Pronto, Deferrals Are Deposited Mañana
Whether the plan sponsor and its service providers are enforcing a 3-day, 7-day, or some other version of “My best should be good enough”, remittances that are determined to be late must be corrected.
Generally, correcting a late deferral involves crediting earning lost during the period of delinquency and paying a 15% excise tax on the lost earnings by filing a Form 5330. If a plan sponsor chooses to self-correct, computing the interest owed can be complicated and costly as discussed in our previous blog Calculating Earnings for 401(k) and 403(b) Plan Corrections: Do Your Best to Do Better!. Alternatively, a plan sponsor can submit backup for the correction through a VFCP filing, which allows the employer the use of the DOL Calculator to compute the lost earnings on the late deferrals, and the DOL gives the employer a No-Action-Letter indicating that there will not be an investigation with respect to this issue.
Effective March 17, 2025, the revised VFCP program officially allows plan sponsors to use the DOL calculator to compute lost earnings, if they deposited the delinquent participant contributions within 180 days of payroll and lost earnings on the late deferral deposits or loan repayments is $1,000 or less, but they must also submit a notice of “self-correction” through their website and maintain certain backup in their records. Our next blog will discuss this concept of “self-correction with a confession”.
