excluded HCEs

[K2retire]

Client called wanting to know if the former company owner who has sold the business and been hired by the new owners must meet eligibility now that he receives W-2 income. Apparently they were under the mistaken belief that because the business is a partnership, and the partners receive only K-1 income, they were not eligible for the plan.

The plan has other HCEs and has failed ADP testing for several years, requiring them to take refunds. If we add the partners to the test with zero deferrals it will likely pass. The company anticipates that the folks who got those refunds won't want to repay them to the plan and they've asked what happens in that case.

But then there is the issue of QNECs for missed deferral opportunities. Are they included in the test? Are they based on the other HCEs' deferral rates before or after the testing correction?

We anticipate that the new owners will not be happy about the company paying money to the old owner because of the old owner's error. The more I think about this, the worse it gets! Any suggestions?

[Guest Sieve]

ADP/ACP corrections must be made BEFORE making the QNECs for those inadvertently left out of the Plan. (EPCRS, Appendix A, .05(2)(g).) Notice that the referenced paragraph seems to allow an old ADP/ACP test to be used, but doesn't require it--that apparently permits a plan with many omitted NHCEs NOT to have to re-compute the NHCE ADP/ACP with all additional NHCEs at 0% (which may cause a test that otherwise had passed to fail), but allows a re-computation with the omitted HCEs at 0% (which may cause a failed test to pass).

Therefore, you may, in fact, be able to use 0% for the omitted HCE (prior to the HCE refunds that were made), and, if the test (as re-computed) passes, then make appropriate QNEC corrections. But, since you've already made refunds as a result of a failed ADP, that's a whole 'nother ball game, and I don't know if getting all refunded amounts back into the Plan is a viable approach.

So, in your case, I think you'd base the HCE QNEC on the test as calculated to determine the total amount of the refunds, and not as recalcualted after the refunds are actually allocated.

Why not adjust the former partner's W-2 to "repay" the co. for the QNECs that are made for him?

[K2retire]

Why not adjust the former partner's W-2 to "repay" the co. for the QNECs that are made for him?

That's a brilliant solution.

Of course the HR person who called originally has now "found" a zero deferral election in the file dating back to 2004. If one doesn't look too closely, that works even better.

[Guest Sieve]

K2 --

Funny how those things seem to pop up out of nowhere when they're needed the most, isn't it??

Now I guess you'll have to deal with the correction of the ADP failuires that were made when the 0% deferral election was "overlooked" for all those years. As you point out, that's a VCP issue in and of itself, or else improper and disqualifying distributions were made from the Plan. The client's diligent search (!!) has not caused the problems to disappear, by any means, but at least QNECs will not be necessary.