Employers often provide various benefits to their employees, such as retirement plans and health coverage, that must comply with certain tax law requirements. Even with the best of intentions, however, mistakes can happen. Fortunately, there are some ways to fix these errors.
Correcting problems with qualified retirement plans
Qualified retirement plans, such as 401(k) plans, must meet requirements set by the Employee Retirement Income Security Act (ERISA). If the plans fail to do so, they can lose their tax-qualified status, triggering problems for employers sponsoring the plans as well as employees participating in them. The Internal Revenue Service (IRS) created a program called the Employee Plans Compliance Resolution System that allows sponsors to correct plan errors with little or no penalties.
The system has three programs:
- Self-Correction Program (SCP), which enables a plan sponsor to correct operational failures (e.g., not following plan loan procedures spelled out in the plan document) without contacting the IRS or paying any penalties.
- Voluntary Correction Program (VCP), which allows a plan sponsor to make corrections before the IRS catches the failures. There is a user fee for using this program, but the plan will receive IRS approval for the corrections.
- Audit Closing Agreement Program (Audit CAP), which allows a plan sponsor to correct plan failures during the course of an audit of the plan sponsor or the plan itself. There is a sanction cost for this program, the amount of which is based on the facts and circumstances of the failure(s) involved (e.g., the number of affected employees and the length of time the failure occurred).
An overview of the retirement plan correction program is in IRS Publication 4224. The highly technical operation of these programs — what, when, and how to make corrections — are spelled out by the IRS in Rev. Proc. 2018-52 and updated in Rev. Proc. 2019-19.
Recouping mistaken contributions to health savings accounts
Many companies find that offering health savings accounts (HSAs) coupled with high-deductible health plans is a cost-effective way to provide their staff with medical coverage. If employers make contributions to employees' HSAs, the employers deduct them up to the limits allowed annually. For example, in 2019 annual contributions are capped at $3,500 for an individual with self-only coverage and $7,000 for family coverage (an additional $1,000 can be contributed on behalf of an employee age 55 or older by year-end and not yet on Medicare).
Unfortunately, sometimes errors are made in these contributions. But mistaken contributions can be corrected in many instances. For example, if an employee was never eligible for an HSA (e.g., the employee was covered by a non-high deductible health plan through a spouse's employer, making the employee ineligible to be covered by an HSA), then in effect the HSA never existed; the employer can correct the error by requesting that the financial institution return the contribution to the employer. If the amount is not recovered before the end of the year, it must be treated as taxable compensation to the employee and reported as such on the employee's W-2.
If the contribution exceeds the permissible dollar limit due to an error, the employer can also correct this by asking the financial institution to return the excess. But if an employer contributes to the HSA of an employee who ceases to be eligible for a contribution during the year, the employer generally cannot recoup any amount, other than for reasons stated earlier.
An employer can also recoup mistaken contributions if an amount that was withheld and deposited in an employee's HSA for a pay period is greater than the amount shown on the employee's HSA salary reduction election. You can find other examples listed in informal guidance from the IRS.
Recouping mistaken reimbursements from a QSEHRA
Small employers (those with fewer than 50 employees) that do not have a group health plan can reimburse employees for their premiums for individually obtained health coverage and other costs under a Qualified Health Reimbursement Arrangement (QSEHRA) up to set dollar limits each year. If an employer mistakenly reimburses an employee (e.g., a reimbursement is made for an unsubstantiated medical cost), this can be corrected by having the employee timely repay the excess reimbursement. Timely repayment does not include those made after the earlier of:
- March 15 of the year following the year of the excess reimbursement, or
- The date the employer receives notice from the IRS of the excess reimbursement while the employer is under an audit.
If the mistake is not corrected, then all reimbursements to the employee on or after the mistake are treated as taxable income.
Good intentions to furnish benefits to your workforce are not enough; you must offer and administer them in line with applicable rules and requirements. Learn more about employee benefit options here.