Failed ADP Test

[goldtpa]

A prospect is using a payroll co for the admin of the 401k. HCE contributes $900 in 2009 as 401k contr. No NCHE contributes. No match and No SH match. Same for 2010.

The payroll co said that they give leeway for the ADP test up to 2.8%.

I spoke to the HCE about the failed adp test and failed top heavy test. HCE calls the payroll co. Their solution is to return all of the money in the account to the HCE.

I am wondering whether that would solve the 2009 & 2010 top heavy test?? My gut says no.

[Bill Presson]

The payroll co said that they give leeway for the ADP test up to 2.8%.

This has to be one of my favorite quotes of all time.

No, giving the money back doesn't solve the problem.

[Guest Sieve]

But, wouldn't refunding the HCE deferral as part of the correction for a failed ADP test correct the problem? (Of course, excise taxes may be owed for late return for 2009.)

To answer the OP, I think the minimim contribution for TH is determined AFTER the return to correct ADP, since Treas. Reg. 1.401(k)-2(b)(2)(vii)(B) says that corrective distributions of excess contributions are considered employer contributions for certain purposes but TH (IRC Section 416) is not one of those purposes listed. So, if all HCE deferrals are returned to correct a failed ADP, I think there then is a 0% contribution for the HCE and, thus, if the HCE is the only key employee, there is no required TH minimum contribution.

[austin3515]

Refundng 100% of the deferrals does not eliminate the THM. No cite for you, but did look it up once before when facing the same situation.

[Guest Sieve]

Does anyone have a cite for austin's suggestion that TH minimums are determined before the ADP return? I couldn't find anything in the usual places.

[PensionPro]

The regs say that elective contributions of keys are treated as employer contributions. No exceptions are provided for excess contributions or excess deferrals.

§1.416-1. Questions and answers on top-heavy plans

M-20 Q. May elective contributions be treated as employer contributions for purposes of satisfying the minimum contribution or benefit requirement of section 416©(2)?

A. Elective contributions on behalf of key employees are taken into account in determining the minimum required contribution under section 416©(2). However, elective contributions on behalf of employees other than key employees may not be treated as employer contributions for purposes of the minimum contribution or benefit requirement of section 416. See section 401(k)(4)© and the regulations thereunder. This Question and Answer is effective for plan years beginning after December 31, 1988.

[Guest Sieve]

I saw that reg, but thought that it was trumped by Treas. Reg. Section 1.401(k)-2(b)(vii)(B): "Excess contributions are treated as employer contributions for purposes of Sections 404 and 415 even if distributed from the plan." To me, this means that excess contributions distributed from the plan are not considered employer contributions for purposes of IRC Section 416 (top heavy) because it is not specifically stated in the reg.

Note, for example, that a specific reference to IRC Section 416 is included in the reg. which indicates that distributed excess deferrals (under IRC Section 402(g)) are still treated as employer contributions. (Treas. Reg. Section 1.402(g)-1(e)(ii).)

Nevertheless, I'm not confident in that answer.

[austin3515]

2.b. Are elective deferrals counted if they distributed to the key employee as a corrective distribution? Suppose a key employee is also a highly compensated employee (HCE) and, under the ADP nondiscrimination test applicable to the 401(k) plan, receives a refund of some of his or her elective deferrals. Should the refunded deferrals be counted in calculating the key employee's allocation rate to determine whether the top heavy minimum should be less than 3% of compensation? For example, suppose a key employee's compensation for the plan year is $200,000, and his elective deferrals total $10,000, but his corrective distribution returns $6,000 of those deferrals, leaving only $4,000 of the elective deferrals in the key employee's account. The key employee has no other allocations for the plan year other than investment earnings in his account. For purposes of the rule described in 2. above, is the key employee's allocation rate 5% (i.e., $10,000/$200,000) or 2% ($4,000/$200,000)? According to the IRS, the answer is 5%. See Q&A-29 of the IRS Q&A session held on October 25, 2004, in Washington, D.C. at the ASPPA Annual Conference. This conclusion is consistent with the general treatment that corrective distributions under the ADP test are still annual additions and are otherwise treated as part of an employee's accrued benefit.

(edit: forgot to mention this is from the 2010 EOB)

[Tom Poje]

sometimes you can't see the forest through the trees, so if you get real lucky the individual is catch up eligible. in that particular case, the regs are clear, the catch up does not count toward determining how much the individual received during the year (e.g doesn't count toward 415 either) and so the plan wouldn't have a top heavy due for the year. however, such amounts are considered in determining if the plan is top heavy in future years.

so while noted in a previous post, the regs only mention counting them for 404 and 415, no mention is made of 416.

but the catch up rules do say you don't count them for 415 or top heavy, so in around about way it would seem you would count them for top heavy if not catch up. this would be consistent with opinions expressed by IRS officials as noted in the ErisaOutline Book.