IRS Reports High Level of SARSEP Errors

An IRS review of salary reduction simplified employee pension (SARSEP) plans has uncovered errors that could affect plan sponsors and employees.

SARSEP plan sponsors must meet certain requirements each year to maintain a SARSEP's eligibility for contributions (Sec. 408(k)(6)). The requirements for eligibility include:

• The employer (plan sponsor) must have fewer than 25 eligible employees at all times during the year;
• At least 50% of all eligible employees must elect to make deferrals to the plan in any year;
• The deferral percentage for each highly compensated employee must be compared with the average of the deferral percentages of all other employees; and
• The plan must meet certain top-heavy minimum contribution requirements for eligible non-key employees.

According to a report by the IRS's Robert Cremeens, SARSEP group analyst for publications, the Service has found that some employers do not meet the requirements every year, and therefore their plans are not eligible plans. The tax consequences of this failure can be significant. Employees who make salary deferrals to ineligible plans must include the amount of the salary deferral in income. Employers who sponsor ineligible plans lose the deduction for discretionary contributions to the plan.

The IRS reports that some SARSEP plans have been terminated as a result of their examinations. The Service estimates that around 30,000 SARSEP plans still exist (no new plans have been established since the end of 1996).