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I have no idea, but the attached article provides some interesting information. https://www.cpajournal.com/2019/10/28/defining-reasonable-compensation-under-the-tax-code/

Pay credit can exceed the salary, all depends how the formula is written in the document e.g. if written as "the lesser of 100% or X amount" then the pay credit is limited to the salary. This does not mean your deduction is limited to the pay credit. Also, your pay credit could be lower than the required minimum contributions. All calculations depend on the ages and salaries and also 415 limits under 415(b).

415 limits for DB plans are discussed at 1.415(b)-1 (This won't help illustrate the calculation turning their pay credit into the accruing benefit to compare it to one's limit, though.)

As Mike and Cusefan indicted, the otherwise excludable employees do not have to get the gateway, but they would get the DC plan top-heavy minimum (if top-heavy). They don’t get a gateway if you are “testing” the OEEs separately from those over 21/1/1000etc. and if that separately tested OEE group can pass nondiscrimination testing on some basis other than cross-testing. Remember, the gateway merely allows the nondiscrimination test to be done on a benefits-tested basis, that does not mean you pass just because you provided the gateway.

As you noted, since the plan is under examination by the IRS, SCP is only available for insignificant operational failures. The IRS agent will decide if it is insignificant. I would try suggesting your plan in your first post. If they don't approve it, I would probably suggest removing the ineligible people from the plan as an SCP correction. The IRS usually wants amounts left in the plan, so that might encourage them to reconsider your first option. If they don't let you correct under SCP, you will be under audit CAP. Best case for the Audit CAP sanction Is the amount the VCP filing fee would have been. It may be higher. Good luck.

Sorry, never got an email about this response...and I don't see reply button so hope you see this. In the two weeks since my above comment, we have contacted our family attorney to do exactly the above, particularly redo For 5498 for 0 dollars instead of the whole cd, and also retitle the cd as inherited based on vanguard sending them the money as a trustee to trustee transfer of an inherited ira. Proof is that vanguard never issued a 1099 for that transfer, so it can't be a new IRA at another bank since it's logically still in a different IRA. At least we hope they agree. Thanks.

Back to the original question: since it's a PSP and since it allocates to all participants, you should not only take the money out of the non-participant's account but reallocate it to the others, as it should have been allocated to begin with. I would imagine that any "bad blood" that the terminated employee would spread could be tempered by a notice from the employer that says, "We accidentally include Nasty Guy in the plan when he wasn't eligible. Pursuant to IRS-prescribed procedures, we've taken the money out of his account and given it to you guys, which is where it belongs." Just sayin'.....