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How to Fix Over-Contributions in a SIMPLE IRA?

If your business has contributed more to your employees’ SIMPLE IRAs than required by the plan document and annual notice, it’s important to correct this over-contribution promptly to avoid penalties and ensure compliance with IRS regulations.

Steps to Fix Over-Contributions

1. Generate the True-Up Report

To confirm if an over-contribution has occurred, generate a True-Up Report from the Reports Section in WealthRabbit. This report will compare your actual contributions against the amounts required by your SIMPLE IRA plan rules, highlighting any over-contributions.

2. Choose the Correct Method to Correct the Over-Contribution
   
   There are two main methods to fix an over-contribution:
   
   a. Distribution Method

   • Elective Deferrals: If the over-contribution was due to employee deferrals, distribute the excess amount to the employee. This excess is considered taxable income in the year the distribution is made. You must also report this on Form 1099-R to the employee.

   • Employer Contributions: If the over-contribution was made by the employer, the excess should be returned to the plan sponsor (the employer), not the employee. The custodian will process this correction and still issue Form 1099-R to the employee, but the taxable amount will be zero, since the funds are being returned to the employer rather than treated as employee income.

Example:

Let’s say you accidentally contributed $1,000 more than required in matching contributions for an employee. You would return the $1,000 excess contribution to you (not the employee).  The SIMPLE IRA custodian would process the correction and issue Form 1099-R to the employee showing a taxable amount of zero, since the excess wasn’t part of the employee’s income.

b. Retention Method

• If you decide to leave the excess amount in the SIMPLE IRA, you must pay a 10% penalty of the excess amount to the IRS. This correction method requires additional steps as outlined in Revenue Procedure 2021-30, Section 6.11(5). It’s important to note that this method isn’t available under the Self-Correction Program (SCP).
  
  Example:

If you have an excess contribution of $500, you’ll need to keep the $500 in the account (instead of returning it). But you must also pay an additional $50 (10% of the excess amount) as a penalty. Plus, if you go through VCP, you’ll need to pay any applicable fees.

C. Small Excess Contributions

• If the total excess amount is $100 or less, you’re in luck! You don’t need to distribute the excess, and you’re not subject to the special additional fee.

IRS Correction Program

If you're dealing with excess contributions, the IRS has set up a couple of correction programs to help you fix the error. These programs vary depending on the size and nature of the error.

1. Self-Correction Program (SCP):
   The SCP allows you to correct certain mistakes on your own without notifying the IRS. This is available if the mistake is insignificant, meaning the error doesn’t result in a significant tax issue or penalty.

2. Voluntary Correction Program (VCP):
   The VCP requires you to submit a correction request to the IRS for approval. This is typically used for larger errors or when you want formal approval from the IRS. If you're using the Retention Method or if the mistake is significant, you must submit a VCP application. There’s a fee for submitting under VCP, and the correction must be approved by the IRS.

3. Audit Closing Agreement Program (Audit CAP):
   If the IRS is already auditing your SIMPLE IRA plan and finds an over-contribution, you’ll need to correct the issue through the Audit CAP. This program allows you to reach an agreement with the IRS to resolve the mistake, but it typically involves paying penalties and additional fees. Learn More About IRS Correction Programs