Coverage Failure

[jpod]

This is a weird situation. Controlled Group with two employers. Employer X has a non-safe harbor plan. For 2015 (calendar), there was one eligible HCE and about 50 eligible NHCEs. Easily passes 410(b). Employer Y, which is Employer's X's parent holding company that is essentially winding down out of existence, has a safe harbor match plan. One eligible HCE, zero eligible NHCEs. It doesn't pass coverage under any of the available tests. As I understand it permissive aggregation is not allowed because one plan is safe harbor and one is not.

Here's the catch. The one eligible employee - who was an HCE - did not contribute anything or receive any employer contribution. So, technically it flunks coverage because he was eligible, but is any corrective action required to avoid disqualification? In looking at the -11(g) rules, we can amend to make enough employees of the other controlled group member, Employer X, retroactively eligible for Employer Y's plan to satisfy 410(b), and then make QNECs for them. However, the QNECs for them only have to be equal to the ADP and ACP of the otherwise eligible NHCEs, but THERE WEREN'T ANY OTHERWISE ELIGIBLE NHCES!

I know that -11(g) says that the amendment must have substance, but when you read -11(g)(5) it only describes certain instances where there is no substance, and this isn't one of them.

Any thoughts? Am I missing forest through the trees?

[austin3515]

No 410(b)(6)© transition period I take it?

It would seem to me that you would use the ADP for the non-SH Plan. Seems hard to argue with that approach. Probably a candidate for VCP.

[jpod]

No; no 410(b)(6). Austin, I don't think I am any less conservative than you, but I am not following your line of thinking. I don't see how the activity under the other plan is of any relevance here where we are not aggregating for testing purposes. Also, why go to VCP if -11(g) provides a solution? I am reading -11(g) to say that all we have to do is go through the motion of amending the plan to retroactively admit the 6 or 7 additional NHCEs to the safe harbor plan, then say that they will get a QNEC equal to the ADP of the otherwise eligible NHCEs, which happens to be 0%! Granted this seems odd, but I don't know how to read -11(g) any other way.

[austin3515]

I do not recommend an -11g amendment to correct an egregious coverage failure with the stroke of a pen and nothing more. "My plan fails coverage because I left out 100% of the NHCE's, so the NHCE deferrals are zero, so no correction" just doesn't seem reasonable. Does it follow the letter of the law? Sure, I suppose, but we are still left with a plan that benefitted 50% of the HCE's and zero NHCE's. I think there needs to be some pain here.

[Mike Preston]

Maybe it wasn't a safe harbor plan after all? Check the Notice.... was it timely? was it deficient? If the Notice was invalid that means what? Is it then not a SH plan which can be aggregated for coverage. It would seem that the aggregated plan would have to satisfy ADP if the effect of aggregation is to add a zero % HCE to the mix. Or maybe, if that doesn't satisfy the paranoid amongst us, at the least it offers a EPCRS submission with the suggested cure being the aggregation of the plans for coverage and non-discrimination.

[jpod]

Mike, good idea about the SH notice, but I am pretty certain it was distributed, and I would not want to go down that road in any event. I guess I get back to my original question: Does -11(g) apply in this context the way it appears to apply? Let's get rid of the controlled group and 2-plan facts because they confuse the issue. Say you had one plan that covered only the CEO-HCE, and all 50 NHCEs were excluded. The CEO contributed and received zero. Technically, there is a coverage problem. So, can you do a -11(g) amendment to make 35 NHCEs eligible (70%) and give them QNECs equal to the NHCE ADP, which was 0%? P.s., in my case the disqualification risk is a real concern because there is still a lot of money in the plan for deferred vesteds and if the plan is disqualified the trust becomes taxable and the participants taking distributions won't be able to do tax-deferred rollovers.

[Kevin C]

EPCRS has a correction method for safe harbor match plans that improperly exclude people. With a retroactive amendment to add NHCEs, they end up needing a deferral correction. The missed deferrals in this situation are based on the SH match formula, not what the other NHCEs do. I don't think claiming the missed deferrals were 0% will work.

[jpod]

My situation is not one where people were improperly excluded in that sense. Come on now.

[Kevin C]

When you amend to make them retroactively eligible to defer to correct the 410(b) failure, they retroactively become improperly excluded because they were not allowed to defer. You were already looking at it that way or you would not have asked about a QNEC based on the NHCE ADP. But, as I said, you are looking at the wrong correction method, there is one specifically for SH match plans. If you want certainty, you can either use one of the EPCRS pre-approved correction methods, or file under VCP.

[jpod]

Well, I guess I misspoke. The -11(g) amendment would not be an amendment to make them retroactively eligible, which of course is impossible. You are amending to provide for QNECs equal to the ADP of the otherwise eligible NHCEs, which is 0%.

[jpod]

Let's not lose sight of what's going on here. While there is a coverage failure, no HCE contributed or received an employer contribution for the plan year. Doesn't it make sense that this is a qualification problem that deserves a painless solution? IRS may not have contemplated this situation, but if you read -11(g) it seems to clearly fit. Let's change my facts slightly. Let's say there was one NHCE who was eligible and he contributed 0.5%, but you still have a coverage problem because one eligible NHCE was not enough. Could I solve the problem with an -11(g) amendment providing for QNECs of 0.5% of compensation? If you think I can, then why can't I solve it using my real facts with QNECs of 0%? Your thinking somehow may be influenced by the fact that this is a SH plan, but I don't see the relevance of that in working through the -11(g) rules.

[Kevin C]

Sorry, but I don't agree that your proposed solution fits -11(g). And, if you are not making NHCE's retroactively eligible to defer and receive the match, you are not correcting the 410(b) failure. The definition of benefiting for the 401(k) and 401(m) portions of the plan in 1.410(b)-3(a)(2)(i) has nothing to do with whether or not someone defers. It's about being eligible to defer or eligible to receive a match if you defer. The QNEC doesn't make someone benefit under the 401(k) or 401(m) portion of the plan. The QNEC is part of the correction of the retroactive operational failure created by retroactively making them eligible.

The plan's SH status doesn't affect the -11(g) amendment. However, it does affect the correction for the operational failure your -11(g) amendment retroactively creates. -11(g)(1) and (3) both require that the corrective amendment be effective as if it had been in place on the first day of the plan year. You are wanting to count them as benefiting for 410(b) but not treat them as being eligible for deferrals or match.

Stick a fork in me, I'm done.

[jpod]

I might be persuaded by your argument if you can cite some authority for it and also explain why that argument trumps the very specific rule in -11(g) for how you are supposed to fix a coverage problem for a 401(k) plan or a 401(m) plan.

[Kevin C]

The 401(a)(4) regs you reference were published in 1993. Safe Harbor plans were introduced by SBJPA 96 effective for years starting in 1999. Old regulations only stay in effect to the extent they are consistent with law changes. With Rev.Proc. 2013-12 using a different correction method for SH plans than the one first included in the -11(g) regs for 401(k)s, I take that as the IRS is saying the NHCE ADP based correction is not appropriate for SH plans. That's as close as I can get to a cite.

Regardless, I still don't believe that you can say no corrective deposit is needed because no NHCEs were eligible. Otherwise, we could all do SH match plans that exclude all NHCEs, then do an -11(g) amendment each year to bring some NHCEs in for only that year, but not give them anything and have a SH plan where only the owner gets contributions.

[jpod]

Your second paragraph makes a very fair and perceptive point. However, the fact is in the case I am looking at the only HCE made no contributions and received none. Perhaps the answer is that this could be a slam dunk in VCP but there's no correction absent VCP (because demographic failures cannot be self-corrected).