Regardless of how excellent an employer’s cafeteria plan administrative processes are, it’s not uncommon for oversights to occur. Whether it’s discovering the wrong amount of premiums being deducted during a payroll audit, an employee is enrolled in a benefit plan different from what they signed up for during open enrollment, or an HSA contribution was missed. Mistakes happen!
Unfortunately, neither IRS regulations nor the Code sections which govern cafeteria plans provide guidance. There are IRS publications and a Chief Counsel Advice memorandum which address correction for a few specific areas (e.g., Form W-2 corrections, improper health FSA reimbursements), however, other mistakes, in general, the IRS has not provided information nor a standardized process for correcting.
What Is An Employer To Do?
It is our experience, the best way to correct a mistake is to put the employee and the plan back into the position they would have been in had the mistake never occurred. Failure to do so could disqualify the entire cafeteria plan! This could mean employees’ pretax elections suddenly become gross income to employees, and they would be required to pay all the employment and income taxes that go along with it.
The specific correction will depend on the facts and circumstances (e.g., what type of mistake was made and was it discovered before, during, or after the plan year).
Example: Four months after open enrollment, an employer discovers an employee was enrolled in the correct benefits with the carriers, but somehow the wrong employee pretax deductions occurred and too little premium was withheld. The employer would want to let the employee know an oversight occurred and depending on the amount of the money needed to be made up, either ask for the employee to pay the entire amount or perhaps have double-premiums deducted until the shortfall is corrected.
Employers should make a reasonable good faith effort to correct past errors and document everything (e.g. date the failure was discovered, the decision made & why, the process to correct & steps to ensure won’t occur going forward).
If an employer is audited, their documentation could explain how the mistake occurred, show it was an honest mistake, that once realized corrective steps were taken to fix it in the least disruptive way. It will also outline the procedures implemented to ensure the mistake didn’t occur again. This could show an employer acted in good faith and was never intentionally trying to circumvent the tax code.
Note: Correcting payroll errors involves a variety of federal & state laws. Prior to implementing corrections, be sure all federal & state wage/tax laws are considered. Contact an experienced benefits attorney before implementing corrective measures if uncertainty exists.
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The Compliance Rundown is not a law firm and cannot dispense legal advice. Anything contained in this post or on their website is not and should not be construed as legal advice. If you need legal advice, please contact your legal counsel.