ADP testing in context of plan spinoff

[Guest Darrell]

My client X sold the assets of its subsidiary Y to an unrelated buyer Z and spun off a portion of X's 401(k) plan attributable to Y's participation in that plan to an identical new 401(k) plan established by Z. This happened on August 1 of 2004. In performing the 2004 ADP for X's plan (prior year testing is used), I believe X needs to include deferrals made to its plan through August 1, 2004 by HCEs who were spun off to the buyer's plan. The ADP test for X's plan fails. How can we return excess contributions attributable to the HCEs whose accounts were spun off to Z's plan if we don't have any of their money in our plan? Since Z will be testing only for deferrals made under its new plan, should it care about our testing problems? I don't see how we can force Z to make a distribution of excess contributions from its plan to help our ADP problem, unless we can argue that not all of the monies transferred to the Z's plan in the spinoff were qualified dollars (because they exceeded the ADP limits and had to be distributed to the HCEs), and thus Z's plan needs to distribute these dollars attributable to excess contributions to preserve its own qualification. Has anyone ever dealt with this situation? I do not think the Notice 98-1 provisions on plan coverage changes (which are also included in the final regs) are relevant. My client could ignore the HCEs who were spun off in performing its ADP test (very dubious) or ignore this group of HCEs in making the refunds of excess contributions to the remaining HCEs (equally dubious). I am leaning toward writing to Z and explaining that it needs to distribute the calculated amounts of excess contributions (and interest) from its plan to preserve the qualification of its plan. I would appreciate any thoughts. Thanks.