Small employers* now have added certainty in knowing their time frame for transmitting employee 401(k) contributions to the plan. Compliance with deadlines is important, because holding on to employee contributions too long constitutes a prohibited transaction that could result in penalties. The U.S. Department of Labor’s establishment of a safe harbor period eases up the rules and can help small employers avoid this dilemma.
The DOL has long required that amounts withheld from an employee’s paycheck — such as elective deferrals to a 401(k) plan — must be transmitted to the plan on the earliest reasonable date.
• In the case of a pension plan (including 401(k) plans), the DOL had set an outside limit of the 15th business day of the month following the month in which such amounts would have been available to the employee.
• In the case of welfare plans, the outside limit is 90 days from the withholding.
Despite setting these outside limits, if an audit should occur, the DOL will look for the earliest date by which the contributions could have been transmitted to the plan. If the agency determines that this date is earlier than the outside limit, it will be the earlier date that applies. In some cases this may be just a few business days.
For employers, the difficulty is in adhering to the earliest-reasonable-date rule. After that time, employee amounts are considered plan assets and holding onto them is a prohibited transaction.
Since January 14, 2010, small employers have been granted a little breathing room. As long as the employee contributions are deposited into the plan within seven business days of the date they are withheld from the employee’s paycheck, they will be deemed to be handled in a timely manner. This is true even if the amounts are deposited in an account of the plan, but not yet credited to specific participants. This is the seven-day safe harbor rule, and it can apply even if the funds could have been deposited earlier, therefore, employers can use this rule to avoid prohibited transaction violations of the general rule.
The safe harbor rule can be used for 401(k) elective contributions as well as for participant contributions to any plan, or for participant loan repayments.
Is the Safe Harbor Rule Optional?
The simple answer is yes. Even if small employers deposit the funds after seven business days, they may still rely on the general rule to avoid a prohibited transaction — assuming the money was transferred as soon as possible.
Also, the safe harbor is applied on a deposit-by-deposit basis. So, an employer can miss the seven-day window for a particular pay period and instead use the earliest-reasonable-date approach and may then use the seven-day safe harbor for subsequent payroll periods.
If a small employer misses the seven-day safe harbor date and also misses the earliest reasonable date, penalties are calculated from the earliest date contributions could have been deposited, not from the safe harbor date.
Why did the DOL issue the safe harbor rule?
They did it to address concerns from employers and advisers about the previous rules and the uncertainty they brought. Also, the DOL admitted that it was expensive and time consuming to pursue violations. We devote “significant enforcement resources to cases involving delinquent employee contributions, and the vast majority of applications under the Department’s Voluntary Fiduciary Correction Program involve delinquent employee contribution violations,” a DOL spokesperson said. With the safe harbor, small employers will be able to make timely deposits and rest assured they are within the law. We have several team members who have earned their Advanced Defined Contribution Plan certificates. Fill out the form below to learn more.
*For this purpose, small employers are defined as having fewer than 100 plan participants, determined at the beginning of the plan year.
© 2023 CPA Site Solutions.
Disclaimer of Liability
Our firm provides the information in this article for general guidance only, and does not constitute the provision of legal advice, tax advice, accounting services, investment advice or professional consulting of any kind. The information provided herein should not be used as a substitute for consultation with professional tax, accounting, legal or other competent advisors. Before making any decision or taking any action, you should consult a professional advisor who has been provided with all pertinent facts relevant to your particular situation. Tax articles in this blog are not intended to be used, and cannot be used by any taxpayer, for the purpose of avoiding accuracy-related penalties that may be imposed on the taxpayer. The information is provided “as is,” with no assurance or guarantee of completeness, accuracy or timeliness of the information, and without warranty of any kind, express or implied, including but not limited to warranties of performance, merchantability and fitness for a particular purpose.