Rev Proc 2008-50 Appendix A QNEC calculation

[Guest CherylWD]

I have a plan that distributed excess contributions for the 2009 plan year. Then when their plan assets were being reconciled during the plan audit process, it was discovered that the plan sponsor made some errors in reporting some of the contributions for a few Non-HCEs. This resulted in additional excesses of small amounts ($48) to two HCEs.

The plan sponsor failed to distribute these excesses in 2010 so we are looking to correct the omission using the Appendix A QNEC of a flat percentage to all eligible NHCEs. The One to One QNEC would be too expensive because the contribution has to include the total excess, not just the portion that was not distributed.

Q1. Isn't the goal of the corrective QNEC to reduce the revised excesses so that the ADP test shows amounts equal to the original excesses that were distributed timely in 2010? With the understanding that the QNEC has to go to all NHCEs, not just those who are not otherwise excludable, couldn't I still calculate the QNEC to achieve the original test results based on disaggregation since Appendix A says you can't use disaggregation to reduce the number of employees eligible to receive QNECs?

Q2. The plan document provides for QNEC calculation of a failed ADP using the Bottoms Up method. When the Appendix A correction method mentions all eligible employees, is that a general reference to eligible employees, or does it need to be according to the terms of who is eligible for the QNEC contribution under the terms of the plan document?

Q3. Appendix A states that contributions must be made on behalf of all eligible nonhighly compensated employees (to the extent permitted under Section 415). I've read articles in the past that state plans would have 415 issues if contributions were made past their tax deduction deadline for the year. In my situation, the contribution falls within the deductible time period for the 2010 plan year instead of 2009. There were some terminated participants in 2009 that have zero compensation in 2010. Does the reference to Section 415 just refer to the individual's limit in 2009 and not a warning regarding terminated employees that have zero compensation in the following plan year?

Any quidance on these questions would be appreciated.

[fiona1]

Here are my thoughts...

1. First, I have a different interpretation of the 1-1 method. To me, the 1-1 QNEC is strictly for refunds that have not been made timely. Therefore, you can issue the $96 in additional refunds - and then the plan sponsor can fund a corrective QNEC equal to $96 (plus earnings). By using the 1-1, the plan sponsor can elect to have the QNEC allocated to only those NHC's who are still active - a huge advantage of the 1-1.

2. In regards to Q2 - the plan document does not come into play at all here. You are using the EPCRS to correct an operational failure - and you follow the correction principles outlined. The QNEC provisions and allocation requirements in the plan are irrelevant here.

3. In regards to Q3 - the corrective QNEC is treated as an annual addition for the year to which the QNEC relates. This goes for both the QNEC method in Appendix A and the 1-1 in Appendix B. But you have to determine what testing method was used on the 2009 test. If the current year method was used, then the QNEC will go to those NHC's on the 2009 test and it's treated as a 2009 annual addition. However, if the 2009 test used the prior year testing method, then the QNEC will go to those NHC's on the 2008 test and it's treated as a 2008 annual addition. I know that Sal discusses the 415 limit related to these corrections in the ERISA Outline book (chapter 15).

4. When I work with this correction, I don't even bother with the QNEC method in Appendix A if some of the refunds have been made timely. I just issue the additional refunds and then have the plan sponsor fund a QNEC equal to the additional refunds only - not the full refunds. Sometimes the QNECs are so small, however, that it just seems pointless. In your situation, for example, - what if you have 500 active/eligible NHCs. Is it really necessary to allocate a $96 QNEC to 500 people? There was an EPCRS forum in August of last year and this question was presented. Here was the answer:

When using the one-to-one correction method can you have situations where the methodology results in the employee's getting de minimis amounts and so really practically you might want to come up with a somewhat different approach to allocate the QNC that's used to correct the ADP test using the one-to-one correction method? The answer is probably you could. You may want to consider the exceptions to full correction provided in Section 6.02 of the revenue procedure, and that includes a provision relating to the delivery of small benefits. That provision might support the rationale you might use in coming up with an approach that the revenue procedure might otherwise consider to be less than full correction.

[Guest CherylWD]

Here are my thoughts...

1. First, I have a different interpretation of the 1-1 method. To me, the 1-1 QNEC is strictly for refunds that have not been made timely. Therefore, you can issue the $96 in additional refunds - and then the plan sponsor can fund a corrective QNEC equal to $96 (plus earnings). By using the 1-1, the plan sponsor can elect to have the QNEC allocated to only those NHC's who are still active - a huge advantage of the 1-1.

2. In regards to Q2 - the plan document does not come into play at all here. You are using the EPCRS to correct an operational failure - and you follow the correction principles outlined. The QNEC provisions and allocation requirements in the plan are irrelevant here.

3. In regards to Q3 - the corrective QNEC is treated as an annual addition for the year to which the QNEC relates. This goes for both the QNEC method in Appendix A and the 1-1 in Appendix B. But you have to determine what testing method was used on the 2009 test. If the current year method was used, then the QNEC will go to those NHC's on the 2009 test and it's treated as a 2009 annual addition. However, if the 2009 test used the prior year testing method, then the QNEC will go to those NHC's on the 2008 test and it's treated as a 2008 annual addition. I know that Sal discusses the 415 limit related to these corrections in the ERISA Outline book (chapter 15).

4. When I work with this correction, I don't even bother with the QNEC method in Appendix A if some of the refunds have been made timely. I just issue the additional refunds and then have the plan sponsor fund a QNEC equal to the additional refunds only - not the full refunds. Sometimes the QNECs are so small, however, that it just seems pointless. In your situation, for example, - what if you have 500 active/eligible NHCs. Is it really necessary to allocate a $96 QNEC to 500 people? There was an EPCRS forum in August of last year and this question was presented. Here was the answer:

When using the one-to-one correction method can you have situations where the methodology results in the employee's getting de minimis amounts and so really practically you might want to come up with a somewhat different approach to allocate the QNC that's used to correct the ADP test using the one-to-one correction method? The answer is probably you could. You may want to consider the exceptions to full correction provided in Section 6.02 of the revenue procedure, and that includes a provision relating to the delivery of small benefits. That provision might support the rationale you might use in coming up with an approach that the revenue procedure might otherwise consider to be less than full correction.

[cpc0506]

I have run into a similiar issue with a fiscal year plan. We discovered that the client never took our advise to remove the matching funds for the failed ACP Test and now they will have to make a QNEC to the plan in the amount of unreturned funds.

My question is: the return considered of vested funds of $2500 and unvested funds of $1000, which were to be moved to the forfeiture account. What is the 1-1 contribuiton needed - just the 2500 or is it the total of vested and unvested funds of 3500?

Thanks for your help

[ETA Consulting LLC]

I have run into a similiar issue with a fiscal year plan. We discovered that the client never took our advise to remove the matching funds for the failed ACP Test and now they will have to make a QNEC to the plan in the amount of unreturned funds.

My question is: the return considered of vested funds of $2500 and unvested funds of $1000, which were to be moved to the forfeiture account. What is the 1-1 contribuiton needed - just the 2500 or is it the total of vested and unvested funds of 3500?

Thanks for your help

This is a good one and subject to a little interpretation. The way I read it is that the one to one is calculated on the "excess contribution amount (adjusted for earnings)". This is clearly the amount of failure. The non-vested portion of the excess contribution amount will be forfeited and used under the terms of the plan.

Good Luck!

[Tom Poje]

I'd say the 1-1 is based on the total correction needed (Appendix B .01(b) does say excess contribution amount is either distributed or forfeited

note, that example 7 under 1.401(m)-2(b)(5) would not even require forfeitures, even though the person is not 100% vested. this gives the HCE to 'vest' as long as they continue to work. you might have a strange looking participant statement for a few years (e.g. end balance = $600. vested % = 60%, but vested balance is not 360 but maybe 200. and then after a few years the person becomes 100% vested and it becomes a good deal for the HCE because they didn't forfeit anything. In exchange, you give up having some forfeitures which could reduce contributions.

......................

Example 7. (i) Employee H is an HCE in Employer X's profit sharing plan, which matches 100% of employee contributions up to 5% of compensation. The matching contribution is vested at the rate of 20% per year. In 2006, Employee H makes $5,000 in employee contributions and receives $5,000 of matching contributions. Employee H is 60% vested in the matching contributions at the end of the 2006 plan year. In February 2007, Employer X determines that Employee H has excess aggregate contributions of $1,000. The plan provides that only matching contributions will be distributed as excess aggregate contributions.

(ii) Employer X has two options available in distributing Employee H's excess aggregate contributions. The first option is to distribute $600 of vested matching contributions and forfeit $400 of nonvested matching contributions. These amounts are in proportion to Employee H's vested and nonvested interests in all matching contributions. The second option is to distribute $1,000 of vested matching contributions, leaving the nonvested matching contributions in the plan.

(iii) If the second option is chosen, the plan must also provide a separate vesting schedule for vesting these nonvested matching contributions. This is necessary because the nonvested matching contributions must vest as rapidly as they would have had no distribution been made. Thus, 50% must vest in each of the next 2 years.

[cpc0506]

Ok, so it appears that I need to provide a 1 to 1 QNEC for the entire amount-vested and unvested.

When does the deposit need to be made and who gets the funds. Right now there are 85 'eligible' participants and only 20 actually participate. Can I give only to those who participate?

They have individual accounts and I would hate to have to tell the client that he will have to set up 65 new accounts due to this failure.

[ETA Consulting LLC]

That is unfortunate, since it is a QNEC and not a QMAC. It must be given to all NHCEs who are eligible. There are some variations of employees with respect to those who were NHCE in the year of failure but are HCEs in the year of correction, and those who have since terminated employment, but in the end the amount is allocated to those NHCEs based on compensation; not deferrals.

You do have the option of filing VCP and seeking permission from the IRS to allow you to allocate to only those NHCEs who actually deferred. In self correction, you have to follow the rule to the letter. In VCP, anything is possible, especially when you explain to the IRS the increase in costs from creating 65 additional small accounts.

Good Luck!

[cpc0506]

Actually, I may have misspoken.

The failure was on the ACP side of the test, NOT the ADP side of the test.

So it does only have to go to participants who received match. RIGHT?

[ETA Consulting LLC]

Unfortunately, the answer does not change. It's still a QNEC, not a QMAC.

But..... I would use shifting (borrowing) to the fullest extent to ensure it did, in fact, fail. It would be nice if the failure actually did not occur when exploring all your testing options.

Good Luck!