ADP using net compensation

[Guest Dumb & Dumber]

Lets say you have a 401k plan in which you are using net compensation to perform the ADP test. The plan fails the ADP test so you need to calculate returns. Lets put some numbers to this:

NHCE ADP is 3.25%

There is only one HCE with the following info:

$120,000 gross comp

$12,000 in 401k

$1,200 in 125

HCE ADP is 11.24% ($12k / ($120k-$12k-$1,200))

You use the two step leveling to calculate the return.

Is the return $6,393 ($12k - ($106,800*5.25%))?

Or is the return $6,074, which is calculated as follows. If the participant deferred 5.25% of net comp the would have been able to defer......$120k-$5,925-$1,200=$112,875. $112,875*5.25%=$5,925. $12k-$5,925=$6,074

[BG5150]

Have you tried using gross comp?

[Guest Dumb & Dumber]

Assume gross comp yields worse results. The main purpose of the question is how the calculation of the excess is done when you use net comp.

[Tom Poje]

I don't believe there is any rule 'the max would have been able to defer'

if my shrinking brain remembers correctly many moons ago (pre 1997) the basic definition of comp excluded deferrals and no adjustments was ever made to take that into consideration (e.g. that the 415 limit would increase if you refunded some of the deferrals.

[Guest Dumb & Dumber]

OK. But what is the first step in the two step leveling process to calculate returns for a failed test? Isn't the first step to calculate what they theoretically could have deferred to pass the ADO test. The second step is to then take the excess determined under step 1 and allocate that to hce's started with the Hce with the largest dollar amount of 401k.

[BG5150]

I come up with 6,397.32

Testing comp: 106,800

Deferral: 12,000

ADP: 11.24

NHCE ADP: 3.25

To pass test, HCE max: 5.25

Difference, 5.99%

5.99% * 106,800 = 6,397.32

That leaves 5,602.68 in the test. 5602.68/106800 = 0.525

[00hskrgrl]

OK. But what is the first step in the two step leveling process to calculate returns for a failed test? Isn't the first step to calculate what they theoretically could have deferred to pass the ADO test. The second step is to then take the excess determined under step 1 and allocate that to hce's started with the Hce with the largest dollar amount of 401k.

When you have only 1 HCE, the two-step leveling process is moot. All excess will be allocated to one person, so there's really only one step:

(What the HCE deferred - what the ADP limit was for HCE's) * HCE's compensation

I agree with BG5150's calculation.

If this is a sole-proprietor HCE, he might want to consider waiting until year-end to make deferrals. Let his accountant can have the fun of the circular calculation.

[BG5150]

I agree with BG5150's calculation.

Yay. It's been a while since I've done a "manual" calc of an excess.