Failed ADP test

[Guest velll]

I am working on a plan that fails the 12/31/02 ADP test. Since we are now past 12/31/03, I had suggested either a QNEC or a contribution equal to the amount of the excess deferral distribution plus earnings would need to be made to the NHCE's in order to keep the plan in compliance. Following is the response I got from the administrator...

"In doing some research on how to handle this, our position is that we can use the sponsor's own remedy to correct the failure. The 2 suggested methods you mentioned are NOT required to be used if SCP is being used for correction of an operational failure. Therefore returning the excess amount and earnings to the participant/s and paying the excise tax would be the chosen remedy. Supporting this choice, is the fact that the % of assets is small" Also noted is the fact some of the HCE's have cashed out their accounts as taxable distributions.

Does this reasoning make any sense?

I would appreciate any input.

[Tom Poje]

Rev Proc 2003-44 sets forth the guidlines for correcting problems

Appendix A is titled 'Operational Failures and Correction Methods'

to me that means if a plan has an operational failure, here are the permissible correction methods.

.03 Failure to satisfy ADP/ACP test

permitted (I stress the word 'permitted' correction method is to make QNECs on behalf of the NHCEs

Appendix B Correction Methods and Examples

section 1

.01 This appendix sets forth correction methods relating to operational failures....

section 2

.01 ADP/ACP failures

1. Correction method - Appendix A section .03 sets forth a correction method for a failure...

b. One to One correction. (i) In addition to the correction method in Appendix A, a failure to satisfy the ADP /ACP test may be corrected using the one to one correction method....

I am unable to find any other permissible correction methods

The only other possible method I can find is Part III, section 6.02(5)(b)

if the total corrective distribution due a participant or beneficiary is $50 or less, the Plan Sponsor is not required to make a corrective distribution if the reasonable costs of processing and delivering the distribution to the participant would exceed the amount of the distribution.

In other words, I think the 'reasoning cited' makes no sense. What that reasoning is saying is that despite the fact the regs say correct a failed test by 12 months after year end, we are allowed to go beyond 12 months because the

1. amount is small as a % of assets (the self correction program merely says that because of it being small you are allowed to use the self correction program, not we can follow whatever method WE choose)

2. the fact that some HCEs have cashed out has no bearing on the correction method - it makes it a little more complicated if the $ have been rolled over, but again, there is nothing in the regs I have ever seen that says you don't have to follow the guidelines if some HCEs have already cashed out.

[Guest LoloV]

Thank you very much

[MWeddell]

I agree with Tom's result but disagree with his reasoning.

Rev. Proc. 2003-44, Section 6.02(2) makes clear that the correction methods listed in Appendices A and B are not the only possible correction methods. Hence, telling a client that its desired correction method isn't listed in the Appendices doesn't completely win the argument.

Instead, you want to look at Section 6.02(2)(b). It contains a weasel word "typical" but otherwise disposes of your client's argument:

The correction method for failures relating to nondiscrimination should provide benefits for nonhighly compensated employees. For example, for Qualified Plans, the correction method set forth in § 1.401(a)(4)-11(g) (rather than methods making use of the special testing provisions set forth in § 1.401(a)(4)-8 or § 1.401(a)(4)-9) would be the typical means of correcting a failure to satisfy nondiscrimination requirements. Similarly, the correction of a failure to satisfy the requirements of § 401(k)(3), § 401(m)(2), or § 401(m)(9) (relating to nondiscrimination), solely by distributing excess amounts to highly compensated employees would not be the typical means of correcting such a failure.

Another argument might be that if all of the correction methods specified in the 401(k) regulations were permitted under the SCP then it would make useless the 12-month correction deadline in the 401(k) regulations. IRS guidance shouldn't be interpreted to make part of it to have no effect.

[Tom Poje]

actually, if the 'proposed' method of correction

simply make the corrective distributions, then why would there even be a suggested method of one-to-one correction in which you make the corrective distribution plus you kick in an equal amount for the NHCEs.

why would you ever choose the one-to-one method?

[E as in ERISA]

Actually, I have asked an agent in my region a question similar to velll's and been told that might satisfy an agent on examination. It should be well documented why the problem was not timelydentified and why the distribution method was chosen. (The better your facts, the more likelihood of success upon examination. This includes not only the facts specific to this situation, but then entire plan operations. E.g., if other facts suggest that the plan is operated in favor of HCEs, then this might not succeed).

[Tom Poje]

I would agree, as long as you stress the word 'might'.

an agent 'might' except the method of self correction.

personally if I was to make a self correction, I would want to use one that was listed and approved, but I guess I should be more careful if I use the term 'you can only do it this way...'

[Guest LoloV]

Thank you for your responses. In this case I don't know that we have a good enough reason for being late. In fact I think my co. will need to reimburse the plan sponsor for the correction. The work was in from the client a year ago but was just forwarded to my dept. for processing last month.

[Blinky the 3-eyed Fish]

If you don't mind, could I get the names and phone numbers of your company's clients? Generally, and I don't mean to brag, we are able to beat a one-year turnaround.