Client refuses to remove excess contributions; wants to reduce future

[Brenda Wren]

Client refuses to remove excess contributions from the trust. He would rather simply reduce what he remits to the trust for future contributions and pay the distribution to himself from the corp. I'm not really fond of this client and need a good argument as to why this won't fly...something other than "IRS wants to see a paper trail".

[actuarysmith]

Assuming that the problem is excess contributions (meaning that the plan failed ADP - rather than the participant put more than $10,500 in the plan)then the answer really seems rather simple - ask "What part of failed discrimination testing don't you get?" or "What part of plan disqualification don't you get?".

I know that it is easier said than done, but that is the kind of client that you may seriously want to consider firing. (On the basis that they are not following the regs in good faith, and they are disregarding your advice.)

It's the type of client that may be audited later and try to bring you in on the whole mess! (And share in the cost of correction)

Run Forest Run!

[R. Butler]

The IRS is clear that excess contributions must be either be recharacterized within 2 1/2 months after the close of the plan year(assuming the plan allows)or distributed before the end of the plan year following the plan year for which the excess contributions were made. Failure to make the corrective contribution will disqualify the plan for the plan year for which the excess contribution occured and for all subsequent plan years during which the contributions reamin in the plan. (Reg. 1.401(k)-1(f)(6)(ii).

Reducing contributions in a future year is irrelevant to correcting a failed ADP test. The client needs to understand that the plan and the company are separate. The distribution must be made from the plan. A distribution from directly from the corporation is really just a paycheck.

Please remember that if the distribution is not made within 2 1/2 months after the plan year an excise tax is due. Also earnings attribtuable to the excess contribution must be distributed.

[david rigby]

There might be another issue here, depending on what the original question meant by "excess contributions."

If this is referring to failure of 415 or 404, then it may be possible to "divide" a company contribution (made after plan year end) so that a portion applies to the prior year and the balance applies to the current year.

Not trying to complicate, just to clarify the terminology.

[Brenda Wren]

Thanks to all. Appreciate your humor, actuarysmith! Excess contributions were the result of a failed ADP test, but for 12/31/98! Correctable under APRSC?

[John A]

R. Butler, is there a reason you did not mention using QNECs to correct the ADP test as a 3rd way of complying?

Brenda W, I believe failed ADP tests that are not corrected timely can be corrected under APRSC, and I think Rev. Proc. 2000-16 gives decent guidance as to how to correct. How would the client feel about QNECs for the NHCEs as a correction method?

[R. Butler]

John A.

Good question. I didn't mention QNEC's because her question does not ask how to correct the ADP test, but rather what to do with the excess contributions. By definition there are no excess contributions if a QNEC is made. Maybe I shouldn't have, but I assumed that the QNEC option had already been explored and dismissed.

[Brenda Wren]

This guy would never put in a fully vested contribution! I just wanted to see if anyone had ever dealt with this type of reasoning before. I do have lots of clients that will make distributions from the corp to save on commissions, etc. Just never in the case of an excess contribution refund. And then the question regarding APRSC...that was asked just in case I won my argument with this jerk. oops...is my frustration showing???

[MWeddell]

I think the argument is that once the plan year has ended, an ADP test fails, and rerunning the test under various other methods still produces a failing ADP test, one is limited to the correction methods specified in Treas. Reg. 1.401(k)-1(f)(1). Failure to use one of those correction methods fails to remedy the failing test.

A second argument in your case is that the client's proposed correction method (to consider some of the 1998 deferrals to remain in the plan and be reconsidered as future years' deferrals) is specifically listed as an impermissible correction method under Treas. Reg. 1.401(k)-1(f)(1)(iii)(first sentence).

Of course, we're > 12 months past 12/31/1998, so we're looking at the EPCRS, not the regulations themselves, but I don't think you'll find any IRS endorsement that the client's proposed method is a valid correction.

Good luck.

[Kirk Maldonado]

I wholeheartedly concur in the sage advice given by ActuarySmith. If you have any "bad feelings" about a client, fire them immediately. If you don't, you may really be sorry in the long run (pun intended).

[Disco Stu]

I hope I'm not beating a dead horse by mentioning this, but I believe that refunds in this case are not appropriate. Since you are dealing with a failed ADP test that was not corrected within 12 months of the close of the plan year, refunds are not a valid correction of the failure.

The company needs to correct via a QNEC. Regardless of what you think this client will acutally do in the end, I think you are doing both yourself and the client a disservice by recommending anything other than correction via QNEC.

I'm not sure I'd fire a client solely over this issue, but I'd certainly have a CYA letter in my file documenting this issue.