non-safe harbor 401(k), no HC contributions

[Belgarath]

An odd one here. Employer established a 401(k) plan several years ago. At the time, it was a 1-person corporation. He rolled in some money that first year, specifically to be able to take a participant loan.

Fast-forward to several years later. He now has employees who should have been eligible under the terms of the plan, BUT, he has made no deferrals or contributions of any sort, other than repaying his loan.

When I look at Appendix A of RP 2013-12, the correction under .05 (2)(b) is to correct for the "missed deferral opportunity" based on 50% of the "missed deferral."

Since the "missed deferral is based on the ADP, which in this case is Zero, then it would appear that there is no correction required! An odd result, but that's where I end up. Any other thoughts?

[Griswold]

I agree that it's odd, but I read it the same way. Perhaps, depending on the years, number of employees, etc., this might be egregious and the SCP would not be available.

[Tom Poje]

the corrections methods provided under EPCRS are guidelines, and certainly won't cover every situation, or even imply that they are the only means of correcting a problem, so sometimes you have to make a good faith effort.

If the employees involved were never given an opportunity to defer, I think one could argue when running coverage you have 100% HCEs could defer and no NHCEs could defer and so you have a coverage failure, which then would be one of those nasty items only correctable under VCP. ugh. ok, then let's argue they could have deferred if they had known about so they have missed opportunity. I think at that point you can't really use an average of 0 since there is no average, and as someone pointed out in another post you have a situation of an HCE getting a 'free pass' every year, something not intended. why of why was a 401k established instead of a profit sharing plan with no deferrals? but hindsight is 20-20

I'm not sure what your answer is, but I think the IRS would have a problem with a plan which exists solely for purposes of an HCE being able to take a loan

[Belgarath]

But what "free pass" is the HC getting? And I'm talking strictly in terms of "make-up" contributions? The HC has contributed nothing, has taken no deductions, etc.

The establishment of a plan solely to take a loan is a separate issue, and I understand that. (I intentionally did not address that in the original post) The IRS could disqualify the plan for a nondiscrimination failure (eligible employees were not permitted to roll money into the plan and also take loans) or a coverage failure, but I can't see an argument for a required employer make-up contribution, since under coverage/nondiscrimination testing for employer contributions, you are going to pass automatically if there is no contribution for any HC.

But as I think more about it, I can see your point that the pre-approved fixes are not the only corrections under 2013-12. Possible, for example, that in order to keep the plan qualified if submitting under EPCRS that you might have to propose a correction similar to, for example, what would have been required under a safe harbor plan.

[Tom Poje]

good luck on this one, not quite sure what the correct answer is.

as for EPCRS, as you note, the pre-approved fixes are fine if they = the situation you are in, and of course, are not the only possibilities, merely 'guaranteed' to be permitted.

your post does bring about a point worth following in practice - even if someone doesn't want to defer, have them fill out the form at 0% just so there is protection from someone coming back and saying 'no one told me'.

of course, thinking about it, I'm sure none of these folks ever received the SAR which probably most folks never read anyway, which means they are treated as being not eligible in a way.

my problem with the argument there is no contribution to the HCE-

even though there are no contributions, is the HCE benefiting under 401(k)?

yes, 'cuz he could have deferred.

could the NHCEs defer? not really if not given a chance.

so the HCE had something the NHCEs didn't.

but I'm not even sure how you approach the IRS - oh, I set up this plan so I could take my rollover, avoid paying taxes, and also be able to get a loan and benefit no one else.

but then those are only my ramblings, which may be far off the mark.

[movedon]

How about the exclusive benefit rule?

[Belgarath]

"your post does bring about a point worth following in practice - even if someone doesn't want to defer, have them fill out the form at 0% just so there is protection from someone coming back and saying 'no one told me'."

Agreed. We ALWAYS recommend this, even though employers often don't do it...

And in this case, no employee was ever notified of one darned thing re the 401(k) plan. They did, at least, file 5500 forms, albeit with incorrect participant counts (only showed one participant, rather than counting those that should have been eligible.)

And since it was set up as a "solo" 401(k) plan, pretty good bet that no SPD, etc., was ever done regardless.

I expect they will terminate it, and take their chances on an audit. If plan audited and disqualified, then loan would presumably be a deemed distribution, and client will pay back taxes and penalties, which will likely be less than any make-up amounts for employees that might otherwise be required to retain qualification. But that's up to their tax/legal counsel to figure out.

I really have no idea what I'd submit for a "fix" if employer ultimately decided to attempt to fix this. But I'm betting employer will instead sweep it under the rug and hope for the best.

[masteff]

I'm probably getting out of my depth with this question but what about amending the plan to freeze participation to reflect what has been done in practice for the last several year?