Vanguard Solo 401k - rectifying excess funds addition - CPA is confused

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Topic Author
ekot
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Vanguard Solo 401k - rectifying excess funds addition - CPA is confused

Post by ekot »

My company has a Solo 401k with Vanguard. Contributions to Vanguard are physically made by my company using ACH after the appropriate payroll journal from my Payroll processing company is received that reflects the employee deferral.

One of our employees indicated that they would like to defer $18000 as employee contribution for 2016. Prior to year end 2016, the payroll journal reflected a total employee deferral of $18000. Consequently, my company contributed $18000 to the 2016 employee deferral in October 2016. A W-2 was issued to the employee in Jan 2017 depicting $18K deferred for 2016 and a Box1 salary greater than 50K.

In April 2017 (2 days before tax deadline), the payroll company indicated that it had made a mistake and issued a W2-C for the employee. In the corrected W2, some of the money that the employee thought was going to their 401K was rerouted toward Federal and State tax withholding. Consequently, the 2016 W2-C reflects an employee 401K deferral of $15100, instead of the $18K indicated on the originally issued W2.

Fortunately, the company had not yet filed its 2016 business taxes and the employee had not yet filed their 2016 personal taxes. So when the taxes were filed on April 18, 2017, all deductions and documentation filed with the IRS (both for business and personal) reflected the reduced $15100 amount in their records.

Now the question is that the company has contributed an excess of $2900 to the employee's tax deferral account for 2016 that does not belong. How does the company rectify this error? I have contacted Vanguard twice and received different answers both times. With the usual "not a tax adviser" caveats, once they suggested that it be treated as "Excess Deferral", which involves tax penalties to rectify and should have been rectified by April 15 2017. The second time they said that it was a simple "Excess Annual Addition" and needs a form submitted that will return the funds to the company. My CPA appears to be out of his depth on the subject and basically just referred me to talk to Vanguard.

Are any of the experts on this forum able to offer any specific guidance - so that I can avoid having to hire a separate tax adviser just for this issue? Since no one has received any specific tax related benefits from this erroneous contribution, intuition suggests that I should be able to pull the money out without much fuss.. But I obviously do not want to run afoul of any IRS guidance.

Also, who should be doing the correction? Is it the company or is it the employee?

Any suggestions, including pointers to qualified tax advisers who understand situations like this will be much appreciated.

Ekot
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Earl Lemongrab
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Re: Vanguard Solo 401k - rectifying excess funds addition - CPA is confused

Post by Earl Lemongrab »

You say "solo 401k" then mention employees. Solos are for sole proprietors or partners.
ERISA Stone
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Re: Vanguard Solo 401k - rectifying excess funds addition - CPA is confused

Post by ERISA Stone »

I'm not sure I follow. The employee elected to defer $18k, and you have indicated that $18k was deposited to the 401k plan for his benefit. How did the payroll company decide that the deferral should be $15,100, and not $18k?
ERISA Stone
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Re: Vanguard Solo 401k - rectifying excess funds addition - CPA is confused

Post by ERISA Stone »

Another question - you said one Vanguard phone call indicated an excess contribution, which would make me think the participant either contributed over $18k, or he/she exceeded a plan imposed limit.

The next Vanguard call indicated it's an annual addition excess, which would mean, assuming your plan doesn't have special imposed provisions, the participant received more than $53k (or greater than 100% of compensation; you indicated more than $50k but I don't know the exact number) in total contributions (employEE + employER contributions).

Can you clarify which excess happened?
Topic Author
ekot
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Re: Vanguard Solo 401k - rectifying excess funds addition - CPA is confused

Post by ekot »

Thank you all for the prompt replies and inquiries. Let me respond with some more details.

Earl: The employee in question is my spouse. So we are both eligible for participation in the Solo 401K.

ERISA Stone: The payroll company incorrectly calculated withholding taxes when it issued the first W2. Later at their end of quarter checks in 2017, when they checked their books, they realized that they were supposed to have deducted more taxes. Consequently, since the year end had already passed, they just filed an amendment and re-issued a new W2-C directing some of that money from employee earnings into withholding taxes and thus shortchanging the 401K employee deferral. Since the year end had already occurred, there was no opportunity for me to make up the difference by increasing employee gross wages.

Total employee contribution to 401K for 2016 is reported to IRS as $15100 on employee's taxes and on company balance sheets and K1s. So it definitely is not over the plan imposed limit of $18K. However, the total amount transferred to Vanguard is $18K. So Vanguard's records show $18K as employee deferral right now and they still have the extra $2900. This is what I wish to correct.

Employee has not received more than $53K for 2016 year (employee deferral + employer contribution). Hope this clarifies things. It appears from your question that neither of the excesses you described is what happened.
Topic Author
ekot
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Re: Vanguard Solo 401k - rectifying excess funds addition - CPA is confused

Post by ekot »

ERISA Stone wrote:The next Vanguard call indicated it's an annual addition excess, which would mean, assuming your plan doesn't have special imposed provisions, the participant received more than $53k (or greater than 100% of compensation; you indicated more than $50k but I don't know the exact number) in total contributions (employEE + employER contributions).

Can you clarify which excess happened?
Employee Deferral + Employer Contribution < $50K
Total Compensation > $80K

Without getting into too much detail, does this help provide clarity?
Spirit Rider
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Re: Vanguard Solo 401k - rectifying excess funds addition - CPA is confused

Post by Spirit Rider »

ekot wrote:ERISA Stone: The payroll company incorrectly calculated withholding taxes when it issued the first W2. Later at their end of quarter checks in 2017, when they checked their books, they realized that they were supposed to have deducted more taxes. Consequently, since the year end had already passed, they just filed an amendment and re-issued a new W2-C directing some of that money from employee earnings into withholding taxes and thus shortchanging the 401K employee deferral. Since the year end had already occurred, there was no opportunity for me to make up the difference by increasing employee gross wages.
This was absolutely improper for the payroll company to retroactively reduce proper employee deferrals. The W-2C is what is wrong here and needs to be corrected. The payroll company compounded their original mistake with an even worse mistake, violating IRS regulations.

The employee made an timely election to defer $18K. That $18K was legitimately deducted from their paychecks and deposited into their 401k account. They did not and do not have an excess deferral. Those employee deferral contributions belong in their account. The employer and the plan have a responsibility to ensure that the employee election was properly exercised. In fact failure to do so would be a serious plan error requiring an EPCRS corrective action.

The W-2C needs to corrected, I'm not sure whether it can be retracted or a new W-2C issued. The bottom line is that the employee deferral was correct. The payroll companies actions were not. Any ramification of the insufficient income tax withholding should be addressed as needed. The withholding company should be responsible for any payroll penalties or any income tax under withholding penalties.
ERISA Stone
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Re: Vanguard Solo 401k - rectifying excess funds addition - CPA is confused

Post by ERISA Stone »

I'm not going to speak to the payroll side because I'm not quite sure what your payroll company was attempting to do. I'm with Spirit here. The employee elected an $18k deferral, and $18k was deposited to her account, timely it appears. There is no excess contribution. There is no annual additions violation. From the 401k perspective, the only thing I can see is the deferral amount is incorrectly reported on the amended W-2.

I'm baffled at what your payroll company was attempting to accomplish by submitting an amended W-2. I feel like I'm still missing a piece of the puzzle.
Topic Author
ekot
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Re: Vanguard Solo 401k - rectifying excess funds addition - CPA is confused

Post by ekot »

Spirit Rider wrote:This was absolutely improper for the payroll company to retroactively reduce proper employee deferrals. The W-2C is what is wrong here and needs to be corrected. The payroll company compounded their original mistake with an even worse mistake, violating IRS regulations.
Even looking at the situation through the layman's lens, it appears to me that the payroll company acted rather capriciously and in the bargain caused my spouse to lose $2900/- of tax-deferred space.
Spirit Rider wrote:The W-2C needs to corrected, I'm not sure whether it can be retracted or a new W-2C issued. The bottom line is that the employee deferral was correct. The payroll companies actions were not. Any ramification of the insufficient income tax withholding should be addressed as needed. The withholding company should be responsible for any payroll penalties or any income tax under withholding penalties.
As you might guess, I have since terminated my relationship with the payroll company. So getting them to do the right thing and issue yet another corrected W2-C and then having to amend my tax returns is probably more bother than it is worth.

Given that no inaccurate numbers were reported to the IRS in my filed tax returns (both corporate and personal), is there any other simple way to address this problem? I am not hopeful that the payroll company will jump through the hoops needed. Additionally, the employee's expressed intent is not really captured in writing anywhere (other than me telling my spouse that we'll contribute the max for the year and then instructing the payroll company accordingly), and since my spouse is OK with the loss of the tax-deferred space and will not hold the employer responsible here, what other recourse do I have?
Spirit Rider
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Re: Vanguard Solo 401k - rectifying excess funds addition - CPA is confused

Post by Spirit Rider »

ekot wrote:As you might guess, I have since terminated my relationship with the payroll company. So getting them to do the right thing and issue yet another corrected W2-C and then having to amend my tax returns is probably more bother than it is worth.

Given that no inaccurate numbers were reported to the IRS in my filed tax returns (both corporate and personal), is there any other simple way to address this problem? I am not hopeful that the payroll company will jump through the hoops needed.
That was true with the original W-2, but if in the W-2C they reduced the deferral they should have also increased Box 1 Wages. This would mean that the W-2 Box 1 and the reported wages on line 7 will not match the W-2C. You really should get the payroll company to correct this mess. If not this will most certainly be caught by the IRS. If they will not correct this, I would proactively call the IRS or visit a taxpayer assistance center, but not before your documentation is in order (see below).
Additionally, the employee's expressed intent is not really captured in writing anywhere (other than me telling my spouse that we'll contribute the max for the year and then instructing the payroll company accordingly), and since my spouse is OK with the loss of the tax-deferred space and will not hold the employer responsible here, what other recourse do I have?
This is a real problem, because a verifiable election to defer is mandatory before a 401k deferral can occur or all deferrals before the election are excess deferrals. The way this should be accomplished with a one-participant 401k is to make a written election before any deferrals and retain it in your records. I'm sure if you look in your records again you will find such an election.
user76586
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Re: Vanguard Solo 401k - rectifying excess funds addition - CPA is confused

Post by user76586 »

I am not familiar with the specifics of these specific transactions, but as a general rule, reality takes precedence over what the forms say. Meaning, if you get an incorrect form and can't get it corrected, you use the real numbers when completing your tax return and attach an explanation stating why what you entered is different than the form. Based on a quick search, this might be a situation where the employee would file a Form 4852 Substitute W-2. But the problem is that the IRS then contacts you, the employer, to find out what's going on.

The employer is ultimately responsible for providing correct returns. I don't think the IRS would let it slide as "OK, leave the incorrect W-2 as is because the payroll company made a mess of it." You should get it fixed by either someone else or the payroll company. The payroll company should care even if you're no longer a client since it's their error and their reputation is on the line, but depending on who's on their staff, they may not actually know how to handle this.

I'm more concerned with the CPA being confused. I can understand needing time to research it and get back to you. I can understand referring you to a tax specialist if this isn't their area. But to not have a plan of action and sending you to Vanguard (who the CPA does or should know can't give tax advice) is for me time to start thinking about a new CPA.
Topic Author
ekot
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Re: Vanguard Solo 401k - rectifying excess funds addition - CPA is confused

Post by ekot »

That was true with the original W-2, but if in the W-2C they reduced the deferral they should have also increased Box 1 Wages. This would mean that the W-2 Box 1 and the reported wages on line 7 will not match the W-2C. You really should get the payroll company to correct this mess. If not this will most certainly be caught by the IRS. If they will not correct this, I would proactively call the IRS or visit a taxpayer assistance center, but not before your documentation is in order (see below).
Thank you for the guidance. They did increase the Box1 wages in the W2-C. Can you clarify which Line 7 you are referring to? All the numbers we used for 1040 filing incorporated the changes in the W2-C.
The way this should be accomplished with a one-participant 401k is to make a written election before any deferrals and retain it in your records. I'm sure if you look in your records again you will find such an election.
[/quote]

And what do you know, I did find the election. :D
Topic Author
ekot
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Re: Vanguard Solo 401k - rectifying excess funds addition - CPA is confused

Post by ekot »

I'm more concerned with the CPA being confused. I can understand needing time to research it and get back to you. I can understand referring you to a tax specialist if this isn't their area. But to not have a plan of action and sending you to Vanguard (who the CPA does or should know can't give tax advice) is for me time to start thinking about a new CPA.
I will revisit the issue at length with my CPA again and hopefully he has a more responsive answer this time. A niggling thought though is - given the multiple levels of uncertainty here as to the right course of action - can I trust that the IRS will be satisfied with whatever course of action my CPA recommends. Can my spouse's 401k situation become unnecessarily complicated in the future because this issue was resolved incorrectly?

What is the worst case scenario? 20 years from now, will I be asked to pay more taxes on the contributions, or is the penalty more dire? I am wondering as to what lengths I should go to get this situation resolved. I've already spent many hours on addressing this issue - and none of it is my fault.
Spirit Rider
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Re: Vanguard Solo 401k - rectifying excess funds addition - CPA is confused

Post by Spirit Rider »

ekot wrote:Thank you for the guidance. They did increase the Box1 wages in the W2-C. Can you clarify which Line 7 you are referring to? All the numbers we used for 1040 filing incorporated the changes in the W2-C.
1040 Line 7 is where you report W-2 Box 1 wages
Spirit Rider
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Re: Vanguard Solo 401k - rectifying excess funds addition - CPA is confused

Post by Spirit Rider »

ekot wrote:I will revisit the issue at length with my CPA again and hopefully he has a more responsive answer this time. A niggling thought though is - given the multiple levels of uncertainty here as to the right course of action - can I trust that the IRS will be satisfied with whatever course of action my CPA recommends. Can my spouse's 401k situation become unnecessarily complicated in the future because this issue was resolved incorrectly?

What is the worst case scenario? 20 years from now, will I be asked to pay more taxes on the contributions, or is the penalty more dire? I am wondering as to what lengths I should go to get this situation resolved. I've already spent many hours on addressing this issue - and none of it is my fault.
I am not a professional, but I do not see the correction for this as anything but to the W-2C reporting. The 401k election and contribution were proper and timely deposited. Evidence of this overrides the payroll company's withholding error.

There is no reason to file an amended return, because the original W-2 was correct. The problem is simply how to get the IRS to accept that the revised W-2C was in error.
user76586
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Re: Vanguard Solo 401k - rectifying excess funds addition - CPA is confused

Post by user76586 »

ekot wrote:I will revisit the issue at length with my CPA again and hopefully he has a more responsive answer this time. A niggling thought though is - given the multiple levels of uncertainty here as to the right course of action - can I trust that the IRS will be satisfied with whatever course of action my CPA recommends. Can my spouse's 401k situation become unnecessarily complicated in the future because this issue was resolved incorrectly?

What is the worst case scenario? 20 years from now, will I be asked to pay more taxes on the contributions, or is the penalty more dire? I am wondering as to what lengths I should go to get this situation resolved. I've already spent many hours on addressing this issue - and none of it is my fault.
As the employee, you have three problems: (1) the records of your contributions may be off, (2) you may not have paid the proper amount of income tax this year [but seems like you overpaid if you reported $15k deferred instead of $18k], and (3) excise tax on the excess contributions in addition to additional income tax when withdrawn. And even if you didn't really make excess contributions (only on the incorrect W-2), it will still be a headache providing documentation to get out of the penalty.

The bigger problem is as the employer now. There's possible penalties for not filing a correct W-2 (https://www.irs.gov/government-entities ... enalties-2) as well as the chance of having the plan disqualified (https://www.irs.gov/retirement-plans/fi ... -deferrals). Plus you may also be liable for an excise tax/penalty as the employer.
Spirit Rider
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Re: Vanguard Solo 401k - rectifying excess funds addition - CPA is confused

Post by Spirit Rider »

user76586 wrote:The bigger problem is as the employer now. There's possible penalties for not filing a correct W-2 (https://www.irs.gov/government-entities ... enalties-2) as well as the chance of having the plan disqualified (https://www.irs.gov/retirement-plans/fi ... -deferrals). Plus you may also be liable for an excise tax/penalty as the employer.
The original W-2 was correct, the payroll company compounded their withholding error with a more egregious error. Trying to retroactively reduce a validly elected, contributed and deposited employee deferral.

You are so off base with your final link and comment. There was no excess deferral here. If you actually read your link, an excess deferral only occurs when you exceed the excess deferral limit (2017 = $18K), which did not occur here.
user76586
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Re: Vanguard Solo 401k - rectifying excess funds addition - CPA is confused

Post by user76586 »

Spirit Rider wrote:
user76586 wrote:The bigger problem is as the employer now. There's possible penalties for not filing a correct W-2 (https://www.irs.gov/government-entities ... enalties-2) as well as the chance of having the plan disqualified (https://www.irs.gov/retirement-plans/fi ... -deferrals). Plus you may also be liable for an excise tax/penalty as the employer.
The original W-2 was correct, the payroll company compounded their withholding error with a more egregious error. Trying to retroactively reduce a validly elected, contributed and deposited employee deferral.

You are so off base with your final link and comment. There was no excess deferral here. If you actually read your link, an excess deferral only occurs when you exceed the excess deferral limit (2017 = $18K), which did not occur here.
Is this not what happened?

1) $18k contribution to 401(k)
2) Original W-2 showing $18k to 401(k)
3) Corrected W-2 showing $15.1k to 401(k)
4) Tax return filed showing $15.1k to 401(k)

If so, there's $2,900 more in the 401(k) than the IRS thinks there is and should be. That's what's at risk of being called an excess unless the paperwork is fixed. Not that OP wouldn't eventually prevail, but it's still a mess to be avoided.
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