If your company offers its employees a 401(k) or 403(b) plan then it is your fiduciary responsibility to ensure those salary reductions are paid into the plan assets in a timely manner. If money taken out of your employees’ paychecks is paid late, then you, the employer, may owe excise tax and be subject to penalties.
When is it considered late? Technically, the legal definition states that the salary reductions should be paid into the plan, “…as soon as it is reasonably possible to segregate them from the company assets, but no later than the fifteenth day of the month following the payday.” While this rule seemingly appears to define a grace period (i.e., no later than the fifteenth business day of the month following the payday) it was written years ago when most transactions were still recorded with a pen and paper and payments were made on a check through snail mail. Times have changed and technology has made it easier for employers to forward money to the plan quickly – in many cases as soon as the day of payroll. That being said, the IRS and Department of Labor (DOL) have been strict in recent years in enforcing the rule that the money reach the plan “…as soon as it is reasonably possible.”
How will I know what is “reasonable” for my business? You know your business and you know your business administration team. You probably have a pretty good idea just how quickly you can pull the payroll information to compile the employees’ individual data, and, if you have access to the internet you can probably work with your bank to arrange for same-day payments. But, every business is different and depending on variables such as payroll providers and your own business internal controls, you are in the best position to come up with the best definition of what is “reasonable.” After you reach your determination, it never hurts to run it by your plan administrator, plan advisor, or yes, even your plan auditor to gather feedback and establish agreement on what is reasonable.
I was late on sending in the payments, what do I do now? At first glance it can be a little scary. The IRS states that an employer holding on to these assets past the reasonable date, “…will have engaged in a prohibited transaction… and will attach Form 5330 to the Form 5500 and will pay applicable excise tax.” But, if you catch your mistake early, you can correct this violation using the DOL Voluntary Fiduciary Correction Program (VFCP), avoid excise taxes, and keep your plan in compliance. Correcting mistakes on your own accord also looks better than when formally requested by DOL or the IRS. Keep in mind that late payments, even those corrected under the VFCP, need to be reported on the Form 5330 when filing your annual Form 5500.
The Department of Labor has informative resources available on the subject in its Compliance Assistance section at www.dol.gov/ebsa
There are also safe harbor rules specific to small plans (less than 100 participants) that can also be found at the website.
Kevin E. Brown, CPA