Correction of Coverage Testing Failure

[Saiai]

Our client is a controlled group of corporations with each controlled group member maintaining its own 401(k) plan. With the expiration of Code Section 410(b) transitional relief for 2009, some of the plans failed the coverage test. We have looked at multiple testing methods. The most viable is applying the average benefits test and converting the allocation rate to a benefits rate through cross testing. However, the contribution required to correct the failure is extremely significant even though it is the least expensive of the alternatives.

Has anyone had experience or heard of the IRS, through VCP or otherwise, permitting the correction of a coverage failure by reducing and forfeiting contributions made for the highly compensated rather than making additional contributions for the non-highly compensated or adding eligible participants? Will the IRS consider alternatives to the traditional correction approach in light of financial or business hardship that would result from the traditional correction method? We understand there may be anti cut-back issues with our alternative approach.

Please let us know your thoughts or any ideas.

[Tom Poje]

I have never heard that being done, and since the regs already provide for corrective amendment (increasing contributions to NHCEs) as a way of correcting the problem, I have my doubts that the IRS would approve reducing (forfeiting) contributions to someone who has earned them.

you mentioned testing on an accrual basis, I am assuming you would also provide the gateway minimum, if needed?

[MSN]

I have an anonymous VCP filing out requesting a similar corrective action. Our facts were a little different (we had a Scrivenor's error in the document that effectively caused the coverage failure). We decided that it was worth it to try...

[austin3515]

you mentioned testing on an accrual basis, I am assuming you would also provide the gateway minimum, if needed?

The gateway rules are under 401(a)(4), and the OP refrenced coverage testing failures. I didn't think the gateway applied if you were just running coverage testing.

[rcline46]

Austin - if you are trying to pass coverage using the ABPT instead of the ratio percentage test you could get caught in the gate way.

SAI - you said you used multiple tests - Austin's suspicion may be on target because you can get past 410(b) by permissively aggregating plans until you get by coverage. I am suspecting you are not getting by 401(a)(4) on a benefits basis from your question. This is where life can get really tricky. I also assume you are NOT worried about ADP/ACP testing, only profit sharing testing.

YOu have accrued to date rules to use as well as annual - many forget the accrued to date because most software cannot do it, you have to work by hand.

You have multiple definitions of compensation (if your documents are good enough) which can be very effective.

Within your permissively aggregated plan, you also can do component plan testing to get by 401(a)(4). This is really cool and totally arbitrary. See 1.401(a)(4)-9©.

YOur situation may not be hopeless, but your client must be ready to spend money on testing. It will be less expensive than the contributions you are looking at.

[John Feldt ERPA CPC QPA]

I have an example where it was not a coverage failure, but it was an inability to contribute a top heavy minimum issue.

The plan sponsor was bankrupt, not the kind where they are reorganizing, but the kind where they will no longer do business anymore. There were no plan sponsor assets available to fund the top heavy minimum for the prior year nor for the current year (up to the date of plan termination). The owner had deferrals in both years, so top heavy minimums applied.

Under a Form 5310 filing, the IRS was told tha the top heavy contribution was to be funded by having the HCE-owner forfeit a portion of their account. This is also what the bankruptcy court had suggested (actually it was a court order). That forfeited amount then was allocated to the NHCEs for their top heavy contribution allocations. We had some doubts going in, and we certainly wouldn't have suggested that the client try it without submitting to the IRS.

Bankruptcy must move your application to the top. Only 19 days after the application was sent certified mail, the IRS replied with a request for additional information. The D letter was issued only 70 days after the application was submitted to the IRS.

[austin3515]

From the OP:

With the expiration of Code Section 410(b) transitional relief for 2009, some of the plans failed the coverage test

Do we not all agree that no gateway is needed if cross-testing is used solely to pass coverage?

[Tom Poje]

That old TV show - Austin Space

Agreed that gateway rules do not apply to coverage.

but the way the question was worded, the plans were being 'cross tested'. maybe I read more into that than what was intended. If the plans are not aggregated, but only the avg ben % test (which has to include all plans/contributions) was being run on an accrual basis then I agree, no gateway.

[rcline46]

You know how I hate to quote regs - but here goes....

1.410(b)-5(d)(5) - Determination of employee benefit percentage.. This references directly 1.401(a)(4)-8©(2) (amoung other sections).

Going to 1.401(a)(4)-8 you immediately run into gateway. Of course when written for 1993 there was no gateway, that came into -8 later. I don't think you can get to 8© without going through -8(a) and have to introduce gateway. I am willing to be disabused of that if you have something else.

[Tom Poje]

the opinion expressed by the IRS at the 2009 ASPPA Conference (#44 Q and A)

(of course, the disclaimer applies that such opinions might not necessarily reflect the actual Treasury position)

you might have missed this while you were collecting toys from the different booths.

IRS response:

There is no gateway requirement for a general tested plan under Treas. Reg.

§1.410(b)-5(d)(5), unless cross-testing is used to determine the rate group testing.

The gateway rules are in §1.401(a)(4)-8(b)(1)(I).

[rcline46]

I was probably already out the door! Besides, the booths were closed on Wednesday.

That is good news - If passing 410(b) by using the ABPT, no gate way. Makes some sense because you are looking for 70% on the plan as a whole, and including deferrals in the test. No deferrals included in the a4 testing.

I hope SAI's tester got it right.

[austin3515]

1.410(b)-5(d)(5): Determination of employee benefit percentage. The employee benefit percentage for an employee for a testing period is the rate that would be determined for that employee for purposes of applying the general test for nondiscrimination in §§1.401(a)(4)–2, 1.401(a)(4)–3, 1.401(a)(4)–8 or 1.401(a)(4)–9...

Based on soleley on the title it appears clear to me that they are referring to the CALCULATION of the EBAR, not the minimum amount that the EBAR should be. Then you read the manner in which it references (a)(4)-8, and it becomes more clear.