Corrective Distributions -- Adjustment for Losses?

[davef]

There have been previous threads talking about what to do when an employee has been permitted to make elective deferrals before meeting the eligibility requirements. The concensus of practitioners seems to say that you distribute the deferrals plus earnings back to the employee. Up until recently, you didn't need to worry about losses. If there are investment losses on the amounts improperly deferred, should you adjust the distribution to take into account losses?

Same question regarding excess 415 contributions. The regs (1.415-6(B)(6)(iv)) only mention distributing excess deferrals and gains. Should deferrals that are distributed in order to satisfy 415© be adjusted for losses? We are getting conflicting opinions from document and software providers.

Any input would be helpful.

[MWeddell]

The IRS has unofficially said that the answer is unclear. This is from the 1996 Enrolled Actuaries meeting gray book:

"QUESTION #20

If the section 415 annual addition rules are violated because of a reasonable error in determining the amount of elective deferrals that are permitted within the constraints of section 415, because of the allocation of forfeitures, because of a reasonable error in estimating a participant's compensation, or under other appropriate factors determined by the IRS, then a number of correction options become available under the section 415 regulations. One of these options is to distribute elective deferrals or after-tax employee contributions to the extent that the distribution would reduce the excess amounts in the participant's account pursuant to Reg. 1.415-6(B)(6)(iv). Prior to December 1994, the regulation stated that gains attributable to returned after-tax employee contributions would be counted as employee contributions if not distributed with the refunded contribution. The regulation did not state that this rule would apply to elective deferrals as well. Amendments to the regulation have now conformed the rule for elective deferrals to the rule for after-tax employee contributions.

The language of the 415 regulation is slightly different from the language of the section 401(k) and (m) regulations relative to corrections of excess contributions and excess aggregate contributions. Those regulations specifically call for the adjustment of the excess to reflect both gains and losses, while the 415 regulation merely mentions "gains". Should refunds made under the auspices of the 415 rules be adjusted for losses?

Also, is there a deadline for making the correction when using the 415 rule?

RESPONSE

It appears that there is no requirement to adjust for losses and it is unclear whether such an adjustment may be made.

There is no regulatory deadline for making the 415 correction. The expectation is that the correction should be made within a reasonable time after it is discovered. For example, the Service would not look favorably on a full year's delay in getting the correction made."