415 Excess Contribution, 401(k) and Safe Harbor Match

Posted elsewhere with no responses.

Safe Harbor 4% Match 401(k) Plan with Integrated Profit-Sharing.  Owner (over 60, HCE) with 5 other employees (one is HCE).  In 2016, Owner maxes 401(k) at $24K, matches $8K and contributes to PS, resulting in his PS allocation being $33,000 per the Plan formula, resulting in him being $6k over 415(c) limit.

I'm reading Rev. Proc. 2016-51, Part III, Section 6.06 (not Notice 2016-60 erroneously cited), which says (emphasis mine):

• (2) Correction of Excess Allocations. In general, an Excess Allocation is corrected in accordance with the Reduction of Account Balance Correction Method set forth in this paragraph. Under this method, the account balance of an employee who received an Excess Allocation is reduced by the Excess Allocation (adjusted for Earnings). If the Excess Allocation would have been allocated to other employees in the year of the failure had the failure not occurred, then that amount (adjusted for Earnings) is reallocated to those employees in accordance with the plan’s allocation formula. If the improperly allocated amount would not have been allocated to other employees absent the failure, that amount (adjusted for Earnings) is placed in a separate account that is not allocated on behalf of any participant or beneficiary (an unallocated account) established for the purpose of holding Excess Allocations, adjusted for Earnings, to be used to reduce employer contributions (other than elective deferrals) in the current year or succeeding year.  While such amounts remain in the unallocated account, the employer is not permitted to make contributions to the plan other than elective deferrals.

Can I calculate 2017 max PS to get owner to $60K (401k, Match and PS) using up the 2016 $6K overage plus whatever else needed?  Anything I'm leaving out?

Your question appears to be asking if you can consider the unallocated account when calculating the allowable contribution.  The amount held in the unallocated account has no relationship to how much the Internal Revenue Code will allow your client to contribute.   When you calculate the contribution the client can make, you do that without regard to the unallocated account. 

Once you decide the discrimination testing will pass and you figure out how much the client can contribute, then you can look to the unallocated account and use the money in that account to pay for the contribution, thus reducing the client's out of pocket cost needed to fund the contribution you calculated.

At least that is what I think you are asking.  

Did he DEPOSIT the PS already?  Otherwise, you just cap his PS at $28,000  (24 + 8 + 28 = 60).

If, the formula give him 33,000 and he deposits that, then I think the 415 excess comes first from deferrals.  In that case you have a 415 violation, not an excess allocation.

What the correction is tell you to do is this:

Say someone was supposed to get a 3% PS, but they got 5%.  You take the excess 2% (+earns) and move it to a suspense account (not the forfeiture account!).  During that time, the ER cannot make any ER (deductible) contributions until the unallocated account is exhausted.  And, yes, you CAN use it to offset Safe Harbor.  (Remember, this isn't forfeiture money)

Thanks Guys for the responses.

To be clear(er),

Owner has max 401k taken out during 2016.  Safe Harbor Match is deposited alongside deferrals during the year.  So by 12/31/16, he has annual additions of  $24k (401k) plus $8k (match) = $32k.  A large PS contribution is made in 2017 for the 2016 year and per the PS allocation formula, he is allocated $33k.  Owner's total AAs are now $65K; $6k over 415.

I think it's an Excess Allocation and $6K goes into a suspense account, to be allocated (again per the PS allocation formula) for 2017.  There will most likely be a new additional PS contribution in 2017, but this time limited to avoid another Excess Allocation to the Owner.

I guess I'm asking if this is the right was to deal with the facts of the situation, ie creating a suspense account.

I still think it is a 415 violation and he gets a refund.

I agree with BG5150... here is what my DC-1 book says on the matter: 

Pages from Chapter 7- Contributions & Allocations from DC-1 Manual (searchable)-6.pdf

Apologies for mis-indentifying the the source of the pasted text above; it's Rev. Proc. 2016-51, Part III, Section 6.06 (it's very dense)

401_noob's link says (and I thank you for the reply):

"the plan may provide" for the distribution of elective deferrals and/or the return of
after-tax employee contributions equal to the excess amount.65

What if my plan doesn't provide for such returns (FT William's doc).

Also, I want to hang my hat (and possibly myself) on the phrasing (continuing on with Rev. Proc. 2016-51, Part III, Section 6.06) :

"Excess Allocations that are attributable to elective deferrals or after-tax employee contributions (adjusted for Earnings) must be distributed to the participant." 

So, if there was no PS contribution, or if it had been less, there would be no excess.  By making a (too large) PS contribution, the excess was created.  So, to my thinking, the excess is attributable to the PS contribution, not the elective deferrals.  A perfect PS contribution would max out the owner, such that allocations to all other participants would have been a lot less.

Chip, I agree with you that it's the PS that is causing the 415 failure.  But the correction states that any deferrals are removed first.  It doesn't make sense.

For a non-owner employee it makes sense -- give back their money and leave the employer's money in the plan. If you gave back the employer contribution, they would lose out.

BG5150 - If it doesn't make sense it must be right.

What would be ideal would be that the owner doesn't take taxable income but instead has a suspense account to spread around in the new year.  He's always made a generous PS contribution.

I'm thinking the distribution would from his FBO account and be coded as "E" in box 7 of the Form 1099-R in 2018. 

Earnings from when?  Beginning of 2017 to date of distribution (or close enough)?

Yes, it looks like the instructions say to use code E for 415 violations. 

Can the return of excess annual additions be part of a RMD?  In other words, if the 2018 RMD is $26,000, does the $6,000  return of the excess annual additions in 2018 reduce the balance to be distributed to $20,000? 

Seriously?

Chip - If you want a citation, see 1.401(a)(9)-5, Q&A-9.

Looks like NO, eh Belgarath?  Just can't catch a break...