Failed ADP Test failure to distribute timely

[zimbo]

I have a client who never did ADP tests for 2005 or 2006. In 2006, they failed ADP Test. Their Plan Document calls for Prior Year Testing.

Since this plan had only a 3 month wait for eligibility, we used to Otherwise Excludable option to run the ADP test and this made the extent of the failure less severe. But, since no refunds were taken by 12/31/2007, we need to self correct. I have 2 questions:

1. Using the "One to One" Correction Method in Appendix B, the Rev Proc. says that "the plan may not be treated as two separate plans with one covering excludables…” . Does that mean that I must re run my test without the otherwise excludable option or may I keep the test the same, but share the resulting "One to One" employer contribution with ALL eligibles and not exclude otherwise excludables from sharing?

2. Can I make a QNEC as allowed in Appendix A, even if I used Prior Year Testing? If so, can I derive my QNEC percentage from my ADP Test that excluded "Otherwise Excludables" as long as I share the resulting QNEC contribution percentage with ALL eligibles?

[Guest Sieve]

Remember, of course, you can correct using any reasonable method of correction if you can convince the IRS (either before or after the fact, depending on the situation) that the correction method was appropriate for the violation. So, my comments are based on interpretation of the EPCRS approved corrections for ADP failure as outlined in EPCRS.

1) You cannot use otherwise excludable testing with 1-on-1 correction (Appendix B). I think the 1-on-1 method is pretty clear re: not permitting alternative testing techniques.

2) The QNEC correction (Appendix A) is permissible whether you are using current or prior year testing. It would appear that you can use otherwise excludable testing to determine the ADP prior to correction and then share the necessary QNEC with all eligible NHCEs.

[zimbo]

I tend to agree with you on #1.

In analyzing the Appendix A QNEC correction and whether Otherwise Excludable testing options can apply, I assume that we can rely on the wording in .03 of Appendix A of Rev Proc 2008-50 which says that "a plan may not be treated as two separate plans....in order to reduce the number of employees eligible to receive QNECs". The implication being that they are limiting the employer's options to allocate the QNECs only to non-excludables only while not interfering with the employer's option to run the ADP/ACP tests separately for non-excludables and otherwise excludables in order to derive the applicable QNEC percentage? I sure wish these things were clearer.

[Guest Sieve]

It's not crystal clear, but that certainly is a consistent and reasonable interpretation. I think that the difference in wording in the 2 Appendices supports that conclusion.