Failed ADP test

[Cynchbeast]

We have a (calendar yr) client who failed the ADP and ACP tests for 2016.  Unfortunately, we didn't know until we finally received his census on 10/12/17.  It is a small plan with just 6 people; in 2015 the owner deferred a little under 6% and the testing easily passed.  He decided to max out deferrals for 2017 and so deferring at almost 14% both his ADP and ACP tests failed.  WE are trying to figure out if there is some way around the give-back and forfeiting match.

You see the NHCEs deferrals averaged 5.31%, which in our experience is not bad.  But the employer matches a straight 25%, which is almost unheard of.  His argument is that he is being far more generous than most employers, and yet he is penalized for the failed tests.

Can anyone think of a way around this?  QNEC is way too high, and yes, we are discussing SH for 2018.

[Lou S.]

Your options are simple - refund and forfeit the associated match with the associated 10% penalty for not getting it done by March 15 or make a QNEC to pass testing. I don't really see any other options for 2016 and you are probably in the same boat for 2017.

Time to talk to him about a safe harbor plan for 2018.

 

[Cynchbeast]

I was hoping for something creative, but am afraid you are correct.  This is just a unique situation where the employees are deferring at a good rate and the employer is extremely generous with the match  -  and then gets penalized for making full use of deferrals.  It doesn't seem fair, does it.

But then when has the IRS been about being fair?

[Mr Bagwell]

I will bypass the fair comment for now.....

What seems embarrassingly clear is a lack of communication with the employer to structure a plan design to accomplish his wishes: keep his money in the plan.  There are multiple safe harbor designs that would accomplish this.

  

[Tom Poje]

if owner is at max comp, then test use comp less deferrals in testing?

[Lou S.]

Tom his ADP is 14% of pay. I don't see how he's over max comp with a deferral rate that high.

[Tom Poje]

that makes sense

so unless one of the NHCEs is deferring at a great rate comp less deferrals won't help

[Patricia Neal Jensen]

Matching Safe Harbor is an easy and amazing solution to this problem.   

Re owners "generosity"  is irrelevant.  When I was in my first tax course in law school, a student raised his hand and complained, "But Professor Ward, that is not fair!"   Professor Ward drew himself up to his full height and replied, "Son, fairness has nothing to do with the Internal Revenue Code."

Besides, a "straight 25%" match is biased in favor of Highly Compensated people.  It is not particularly fair or generous.

 

[Cynchbeast]

I pretty much told owner the same thing - the IRS is not about being fair.

I have another related question on the same issue - please see new posting re failed ADP/ACP tests

[imchipbrown]

Can some Match be "shifted" into the ADP test?  I saw something about the match being subject to the same "restrictions" as deferrals, but...

From an ASPPA slide presentation: (emphasis mine)

Correcting a Failed Test Through Shifting

• If you pass ADP by a lot and fail ACP; you can shift amounts not needed in ADP to ACP – Testing method only – you do not actually move the funds

– You must pass ADP both before and after shift

– You cannot shift ACP to ADP (unless the ACP amounts are subject to the same withdrawal restrictions as deferrals)

 

[jpod]

Is the employer entity an S corp? If so, how much was the owner's salary, and how much was distributed to him as a dividend? 

[Tom Poje]

imchipbrown - the match would also have to be 100% vested. in effect it is a QMAC,  which of course could always be used in the ADP test anyway, so it really isn't 'shifting'. but it is a possibility that exists if the plan allowed both discretionary and QMACs.