While it can be easy to make clerical errors when processing payroll or 401(k) contributions, it’s not always possible to simply reverse the transaction for funds that are contributed into the 401(k) plan.
In many cases, once deposited, plan sponsors cannot remove those funds, even if they were accidentally entered. This is because the Employee Retirement Income Security Act of 1974 (ERISA) prohibits the use of plan assets for anything except the exclusive benefit of plan participants and severely restricts the ability to revert plan assets to an employer. If plan assets are reversed, the transaction is subject to a 50% excise tax under Internal Revenue Code section 4980.
However, a certain type of deposit error, known as a “mistake of fact,” can be corrected by removing the improperly contributed funds from a 401(k) plan trust. The “mistake of fact” rules set in place by the IRS are quite narrow, so it’s important to understand when they may apply.
When “mistake of fact” may apply
The IRS has defined “mistakes of fact” to include mathematical and typographical errors that occur during the contribution process.
For example, adding an extra 0 to the amount remitted to the trust account for a payroll deferral or including a participant multiple times on the same report could potentially be characterized as a “mistake of fact.”
When “mistake of fact” would not apply
A “mistake of fact” does not apply in the following examples or similar scenarios:
An employer or participant takes an action not realizing it will have an unintended outcome
An employer or participant unintentionally contributes an amount that causes the plan to fail annual compliance testing
Contributions are made on ineligible compensation
Contributions are made for an ineligible employee who was unintentionally allowed to participate
In these cases, the IRS has created an alternate system to allow correction for operational errors.
How Guideline handles “mistake of fact” errors
Because it is often unclear whether a set of facts meets the “mistake of fact” standard, and due to the risk of potential excise taxes that applies to reversals if the determination is not correct, it is always recommended to leave the funds in the plan’s trust to offset future contributions.
As a result, if contribution or payroll errors occur within a Guideline 401(k) plan, the funds will typically be placed into your designated plan cash account (adjusted for gains or losses) and the funds will be used to offset future plan contributions.