Correction of Excess Amounts Under TVC and Audit CAP Using the Retenti

[Guest Harvey Carruth]

In part, Rev. Proc. 2000-16 Part III, Section 6.02(4)(B)(ii) states the following:

"Excess Amounts (whether arising from a section 415 failure or a section 403(B)(2) failure), adjusted for earnings through the date of correction, must reduce the participants' exclusion allowances by being treated as amounts previously excludable under section 403(B)(2)(A)(ii) beginning with the year following the year of correction (or the year of correction if the employer so chooses)."

If the Excess Amounts themselves have been left on employer records as non-forfeitable contributions/annual additions during the years they were contributed and continue to be counted as amounts previously excludable under section 403(B)(2)(A)(ii), does the Rev. Proc. statement mean that these same Excess Amounts are to be counted again as amounts previously excludable (amounting to a double-whammy), or should only the earnings through the date of correction be treated as "new" previously excludable amounts?

[Carol V. Calhoun]

We have never interpreted the regulation to require double inclusion. Rather, the normal rule is that amounts "previously excludable under section 403(B)(2)(A)(ii)" must be counted as prior employer contributions. Since the excess contributions were not previously excludible, they would not be includible in prior employer contributions at all, absent the language to which you refer. Thus, the language you cite merely results in adding them once, not twice, to the amount of prior employer contributions.

[Guest Harvey Carruth]

Carol's response is logical and much appreciated. From an administrative perspective the total contribution for an earlier year already resides on the employer or third party administrator (TPA) database, including excess amounts. Hence, a simple and conservative approach would be to continue to consider an excess amount as "an amount previously excludable" in all subsequent years and only treat the earnings at correction as a new amount to be counted as "previously excludable" beginning with the year after correction. However, if the 403(B) exclusion allowance is binding in one or more years between the year after an excess amount was contributed and the year of correction (including the year of correction), adjusting the prior excludable amounts to exclude excess amounts would increase the exclusion allowance accordingly in such years. Hence, it appears that the optimal approach is to include two database fields defined as follows:

"Non-Excludable Contributions" = Contributions that were treated as excludable, but were subsequently determined not to be excludable (Excess Amounts).

"Corrected Excess Amounts" = Excess amounts plus earnings through date of correction.

Then, when an excess amount is discovered and corrected, the excess amount can be entered into the "Non-Excludable Contributions" field for the year in which the excess amount was contributed and the excess amounts plus earnings can be entered into the "Corrected Excess Amounts" field for the year in which the correction occurred. In calculating prior excludable amounts for any year, the usual contributions and DB plan attributions are reduced by the "Non-Excludable Contributions" and increased by "Corrected Excess Amounts" in prior years. Does anyone see problems with this methodology?

[Guest Harvey Carruth]

Further reflection and research on this topic have resulted in the following observations:

Treas. Regs. 1.403(B)-1(d)(3)(v) and 1.415-6(e)(1)(ii) specify that annual additions in excess of the 415©(1) limit must be treated as amounts previously contributed by the employer which were excludable from the employee's gross income, even though these excess amounts were not excludable.

Rev. Proc. 2000-16 Part III, Section 6.02(4)(B)(ii) specifies that when contributions in excess of the 415©(1) limit are retained, then those excess amounts, adjusted for earnings through the date of correction, must reduce participants' exclusion allowance by being treated as amounts previously excludable under section 403(B)(2)(A)(ii) beginning with the year following the year of correction (of for the year of correction if the employer so chooses).

Hence, it would seem that some doubt remains about "double counting" of contributions in excess of the 415©(1) limit as amounts previously excludable under section 403(B)(2)(A)(ii) when they are corrected via retention.

Moreover, Treas. Reg. 1.415-6(B)(1)(i) specifies that contributions in excess of the 415©(1) limit are treated as annual additions during the year the contributions are made, even though they are not excludable from gross income, and Rev. Proc. 2000-16 Part III, Section 6.02(4)(B)(ii) specifies that when contributions in excess of the 415©(1) limit are retained, then those excess amounts, adjusted for earnings through the date of correction, must reduce affected participants' applicable section 415 limit for the year following the year of correction (of for the year of correction if the employer so chooses), and subsequent years, until the excess is eliminated. This is tantamount to counting the excess amounts plus earnings as annual additions during one or more years following the year of correction (or beginning with the year of correction if the employer chooses to begin such counting during the year of correction). Presumably these annual additions should be considered to be nonforfeitable contributions to the 403(B) plan by the employer.

Therefore, a logical argument could be made that the combination of these cites leads to "triple counting" of the original excess 415 contribution as amounts previously excludable beginning with the second year following the year of correction: once during the year the contribution was made; once during the year of correction; and once during the year following the year of correction.

If either the "double counting" or the "triple counting" conclusion is correct, then the "optimal approach" suggested in my previous post to this thread works only for contributions in excess of the 402(g) elective deferral limit and/or the 403(B) exclusion allowance, whereas a different treatment is required for contributions in excess of the 415©(1) limit. Additional thoughts would be welcomed.