Participant exceeding salary reduction limit stated in document

[Guest elizabeth]

A participant exceeded the salary reduction limit of 15% of compensation for 1998. Should the plan return the excess, plus gains and issue a 1099-R in the same manner as a participant exceeding 402(g)? How does this affect the discrimination testing. Is the excess included in the ADP test? Does the employer match on the excess deferral?

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lisa

[MWeddell]

I think the recommended course of action depends on whether the participant who exceeded the 15% limit was a highly compensated employee.

If the mistake affected a HCE, then if left uncorrected you have a discriminatory benefit, right, or feature in violation of 1.401(a)(4)-4. I'd correct the mistake (using APRSC if the plan meets those requirements) by refunding the elective deferral over 15% and any match attributable to it and issue a 1099R similar to other corrective distributions taxable in the year of receipt.

If it's not a HCE, then realize that the 15% limit you're referring to is a plan document rule, not an Internal Revenue Code rule. The only problem is a failure to follow the plan document under ERISA. There's no self-correction procedure available from the DOL, so I think I'd just leave the situation alone and only correct it if a DOL auditor requires it. Naturally, you'll want to prevent a similar problem from reoccuring in the future.

[Alonzo]

Rev. Proc. 98-22 indicates that a failure to follow the plan document is a qualification issue as well as a DoL issue. You should use MWeddell's correction procedure even if the participant is an NHCE.

[MWeddell]

I'm unsure that I agree with Alonzo's correction and would appreciate reading others' input whether any failure to follow the terms of the written plan document constitutes a qualification problem (and hence might be corrected through the APRSC).

The APRSC is available for Operational Failures. If one tracks through the definitions of Operational Failures and Qualification Failures, an Operational Failure is defined as "any failure that adversely affects the qualification of a plan" "that arises solely from the failure to follow plan provisions." I question whether having an NHCE contribute more than a 15% of pay limit specified in the plan document constitutes an operational failure that can be corrected through APRSC because I don't see how it affects the plan's qualification.

In response to Elizabeth's original inquiry, if the mistake affected a highly compensated employee, go ahead and correct. Otherwise, you might want to wait for input from others.

[This message has been edited by MWeddell (edited 01-07-99).]

[Chester]

I would agree with Alonzo's recommendation that this correction should be made using APRSC. Failure to follow the plan's provisions applies to both NHCEs and HCEs. I think it would be foolish to just leave the money in the NHCE's account and hope an audit never uncovers it. The APRSC was designed to address issues such as this one.

[Guest elizabeth]

Our attorney suggested that the excess amount (plus gains) be refunded as if it was an excess over 402(g), and that the excess not be included in the ADP test. (Note: the participant is NOT an HCE) Also, a 1099-R will issued using a Code P.

[Guest Eric L]

I agree with Chester, Alonzo and Beavis.

I had this situation come up a couple of years ago. I spoke (informally) with a friend at IRS' National Office, EP Division. I proposed a disgorgement like this, and she said it was what the Service would expect. Of course, that was entirely informal guidance, but it reflects their mind-set.

[Guest Susan]

By the way, regarding failure to follow plan document being a qualification issue: Treas. Reg. 1.401-1(a)(3)(iii)

[Guest Beavis]

I, too am with Chester and Alonzo. Operational failures are what APRSC was invented for.

[MWeddell]

Well, I'm definitely outvoted (by FIVE others at last count!).

This issue has become tangential to Elizabeth's original posting because she discovered that the erroneous contributions exceeded the $10,000 402(g) limit which is a qualified problem under IRC 401(a)(30). Therefore, Elizabeth should correct the problem under APRSC if possible. However, I still don't understand everyone else's position.

I know the failure to follow the plan is an ERISA violation. I know that Treas. Reg. 1.401-1(a)(2) requires that a qualified plan be "a definite written program." Where does it say that any failure to follow the written plan document is a qualification problem? I looked up Susan's cite, and it doesn't help me understand.

If it's not a qualification problem (literally "a failure that adversely affects the qualification of the plan"), then I question whether a failure to follow the plan document that doesn't violate some substantive qualification requirement constitutes an operational failure susceptible to APRSC correction as explained in my prior posting.

Thanks for your responses thus far.

[Alonzo]

"Failure to follow the terms of the plan is a disqualifying defect even if the operation of the plan would otherwise satisfy the qualification requirements."

Rev. Proc. 94-62, Section 4.03.

(This is the rev proc that made vcr permanent.)

[Guest DEllis]

Question 95 of Plan Defects: Correction/VCR/CAP, found under the Q&A Columns on this site may shed some light on the operational failure issue.

That question involves a plan that allowed 5 NHCEs to participate in a plan after only 6 months of service where the plan requires 1 year of service. According to the IRS, the plan's failure to operate in accordance with its written terms amounted to a qualification failure under Sec. 401(a)(1) and Reg. Sec. 1.401-1(a)(2).

This case study was presented by the Walk-in CAP Coordinator for the Western Key District at a conference last September and was reviewed by the National Office.

While I agree that nothing contained in 401(a) or the regulations appears to explicitly provide that a failure to operate a plan according to its terms (without a corresponding violation of a specific Code provision) is a qualification failure, the IRS certainly appears to have taken that position.