SH non-elective 3% contribution not funded

[commishvp]

The client has not funded their 2007 non-elective SH contribution. If we run the ADP testing the test fails and the owner will get a refund of $14,000.

I understand we need to contribute the 3% SHNEL ($20,000) with earnings. Do we also need to run the ADP testing and process the refund, pay the excise tax on the late withdrawal?

Do we have to fund the SHNEL plus a QNEC? If a QNEC is required, would that be calculated under a scenario for late correction of ADP/ACP testing (with refund of the HCE’s deferral, as described in EPCRS), or would it be the QNEC that would have been required to bring the NHCE’s to high enough percentages to pass ADP testing without refunds?

This seems to be a bit of a grey area and not specifically addressed in EPCRS. Any help would be appreciated.

Thanks,

[Guest Sieve]

EPCRS does not specifically cover correction of failure to make a SH contribution--only failure to enroll an eligible employee in a match SH plan. (EPCRS Appendix A, Sections .05(2)(b) & (d).)

The IRS position is that you do not have the option of correcting a failure to make a SH contribution by performing (& correcting, if necessary) an ADP test. I believe that is stated in the final 401(k) regs' preamble, but I know it is mentioned in the new proposed SHNEC amendment regs: "a plan that uses one of these safe harbor methods [i.e., traditional or QACA] . . . must specify, before the beginning of the plan year, whether the safe harbor contribution will be the safe harbor nonelective contribution or the safe harbor matching contribution and is not permitted to provide that ADP testing will be used if the requirements for the safe harbor are not satisfied." (Emphasis added.) Look at the 2nd bullet point of post #1 here: http://benefitslink.com/boards/index.php?s...ic=39578&hl= (the last part of that bullet point is my supposition, not what Joyce Kahn said).

So, you must fund the SHNEC--no choice. And, when funding the SHNEC, you do not also make additional QNECs to correct the "failed" ADP.

As indicated in the above-cited post, you'd correct failure to make SH contributions by adding in appropriate interest when the contributions are eventually made.

[Belgarath]

Sieve - thanks for this:

"Joyce took the position that if a safe harbor plan fails (for example, if the safe harbor contribution is not made within 12 months after the end of the plan year), then the natural consequence contained in the regs--i.e., that the plan no longer is a safe harbor and must pass ADP--does not apply, and to correct you must make the late SH contribution (with interest). I think what she meant is that you can't rely on passing ADP if you fail to make the safe harbor contribution timely, because you would simply get out from under the SH contribution obligation without following proper procedures (such as in the "maybe"--supplemental notice--non-elective SH contribution situation). I would suspect, however, that if failure to timely make the SH contribution resulted in failure of the ADP, and correction of that ADP failure under VCP would give the NHCEs more than making the SH contribution would give them, then she would require that the failed ADP test be corrected rather than that the SH contribution be made."

We ran into this precise situation a couple of weeks ago, and after much cogitation I came up with precisely the same fix, using precisely the same thought process, as you have outlined above. Wish I'd seen this (or remembered it) then - would have saved me a ton of time!

[Guest Sieve]

Belgarath -- Remember that that's my thought process--and apparently yours, too--but is not something that was discussed, or even hinted at, during the seminar I participated in.

[Belgarath]

I fully understand that. But I figure that two such obviously brilliant minds can't possibly be incorrect.

The line for rebuttals will please form to the left.

[Guest Sieve]

I just found the reg provision which does not permit language in a plan allowing a failed SH to use the ADP test. I had thought that rule was only in the preambles and not in the regs--although most of you out there probably knew otherwise. It's in 1.401(k)-1(e)(7). (Not so brilliant after all, Belgarath . . .)

[Belgarath]

I'm not so sure. We knew that the plan couldn't contain "fallback" language that permitted a plan to rely on ADP instead of the safe harbor contribution. But under 1.401(k)-3(h)(1), the contribution must be made withing the 12 month period after the close of the plan year.

So when it comes to the "fix" I'm not sure it is invalid to make the requisite contribution, then ADP test. (I think you must always make the 3% nonelective, regardless of whether you then ADP test or not.) RP 2008-50 does not address this specific situation, so I think there is a bit of latitude. In our case, we just had them make up the 3% with interest, then ADP tested and did the necessary refunds. We did, if course, refer them to legal counsel to make the final decision, and they gave us the go-ahead.

This might be a good one for someone to bring up at the ASPPA meeting this fall for clarification?

[Guest Sieve]

So, in fact, you disagree with my conclusion in post #2 when I said "So, you must fund the SHNEC--no choice. And, when funding the SHNEC, you do not also make additional QNECs to correct the "failed" ADP."

You are saying that (i) the more-than-12-months-late SHNEC must be made, and then (ii) an ADP test must also be passed. And that's because you can't count a SHNEC for SH purposes if it's made more than 12 months after the end of the plan year, right?

So, if the ADP test also fails in that circumstance, you're suggesting that the failed ADP must also be corrected under one of the methods permitted in EPCRS? Is that the proper analysis?

[Belgarath]

Yup.

I'm not sure it's correct, mind you, only that it seems a "reasonable" fix. It may be that the IRS is being more generous, and allowing you just to fix the SHNEC, plus interest, and be done with it.