ADP failure refunds

[pmacduff]

Before I start, I have already referred the client to their attorney, I'm just looking for opinions. I have a 401(k) plan with 14 HCEs due deferral refunds due to a failing ADP test. I advised the client of the refund amounts (along with the QNEC amount - however, the client doesn't want to contribute the QNEC). A broker is telling the client that each HCE due this distribution can have the Employer put the refund in a deferred comp plan AND AVOID TAXATION. This just isn't possible according to all I have ever learned! These $ were already reported on the participant's W-2 forms as deferral, and FICA may have been withheld on some. Has anyone heard of this? Seems to me that if this were a way to avoid taxation on a failing test refund, it would have been all over Pension news in the 14 years I have been an administrator. All opinions welcome!

[mbozek]

Why not have the HCE contribute an amount equal to the refund to a NQDC plan to 0 out the taxable income? eg. employee receives 3k refund in 2004 and defers an equal amt in a NQDC plan.

[Mike Preston]

In order to make this "work", which as mbozek points out it does so just fine, there are two things that need to happen:

1) The refunds must be taxable in 2004 - which means they must be refunded after the deadline and the employer therefore pays a 10% excise tax.

2) The NQDC plan must be something the participants and plan sponsor are willing to create, live with, etc. Not as simple as it seems and probably cost prohibitive between hard dollar expenses to establish and soft dollar expenses to get up and running. Unless this is something that already exists within the culture of the plan sponsor it is a non-starter without a lot of grief, typically.

[R. Butler]

The broker is most likely talking about a Nonqualified Deferred Compensation plan, but in my limited experience it works the other way. Money is deferred into the NQDC plan & then sometime before 3/15 money is transferred to the qualified plan in an amount equal to that which is allowed to pass ADP nondiscrim testing.

I would ultimately defer judgment to mbozek or someone else more knowledgeable on this issue, but at first blush it seems to me that the only way mbozek's suggestion works is to distribute refunds after 03/15 (assuming calendar year plan) & eat the excise tax. If you distribute prior to 03/15, its taxable in 2003 & there is no NQDC plan to defer into for 2003. If you distribute after 03/15, the distrib. is taxable in 2004 (but again you got the excise tax) & then mbozek's suggestion works. If you are going to setup a NQDC, why just have the refund deferred? Management should defer alot & then transfer to 401(k) plan at year end.

[pmacduff]

Thanks for the input everyone, as many mentioned, the Employer has no desire to pay the 10% excise tax to distribute after 03/15 and, if the refunds occur prior to 03/15, they are taxable to the participant in 2003. That was my whole problem with this set up. I did know that in the future, they could utilize a deferred comp plan to avoid refunds, however the Client also wasn't too keen on having the deferred comp assets part of the Company assets and subject to general creditors. Thanks again.