(b)lines Ask the Experts – Correcting for Ineligible Participant

May 18, 2010 (PLANSPONSOR (b)lines) – “A governmental 457(b) plan covers only full-time employees, but a part-time employee has contributed to the plan since 2008. To remedy this operational failure, can the plan distribute the elective deferrals plus earnings back to the employee?  Is the plan sponsor responsible for covering any loss on the contributions made to the plan?”

David Powell, Groom Law Group, answers:  

Because it is a governmental 457(b) plan, there is a special remedial correction period under the so-called “flush language” between 457(b) and 457(c).  That language provides that a governmental457(b) plan which is administered in a manner which is inconsistent with the requirements of 457(b) shall be treated as not meeting the requirements of such paragraph as of the 1st plan year beginning more than 180 days after the date of notification by the Secretary of the Treasury of the inconsistency unless the employer corrects the inconsistency before the first day of such plan year.   

Thus, if the IRS has not notified the plan of the error, or if they have and the 180 days has not run, then the plan sponsor may still correct the error.  However, the regulation does not discuss what the correction of any particular failure might be, and the IRS has issued little authority on 457(b) corrections, including how the flush language may interact with the 457(b) plan exception for 409A.    

The IRS will consider provisional EPCRS applications for governmental 457(b) plans. (See, IRS Rev. Proc. 2008-50, at section 4.09.)  

As to whether the plan sponsor may be required to make up any losses to the employee from participating in the plan, it may depend on the facts and circumstances and the nature of any claims the employee may have.  

Note that if the plan had been a 457(b) plan of a tax exempt plan sponsor, there is no formal correction method for any error in complying with 457(b), and the consequence may be the application of 457(f) and 409A.  

NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.