Top Heavy Silliness

The other thread on creative ways to handle a top heavy plan reminded me of something I thought up a while back but never went forward with because I felt it was too aggressive. However I can not find any reason why it would be actually disallowed. I'm hoping someone here can poke a hole in this scheme and teach me something.

This is a 401(k) plan with a single 100% owner who is the only HCE and the only key and is over 50 years old. The only contributions for the plan year are deferrals, although discretionary matching and nonelective contributions are permitted in the document. The plan passes the ADP test for the current year. The plan is top-heavy for the current year. The HCE's deferral contributions are equal to $6,000. Can we do the following:

1. Shift 100% of the NHCEs' deferrals to the ACP test. The ACP test passes because there are no HCEs included in the test.
2. Recharacterize the HCE's $6,000 deferral as catch-up as it now exceeds the limit of the ADP test, when testing on only the un-shifted deferrals. Since all of the NHCE deferrals were shifted, the ADR for the NHCE in this test is 0% and therefore the ADP limit for the HCE is 0%.
3. There is no top heavy minimum for the current year, since the key did not have any contributions other than catch-up contributions, and catch-up contributions for the current year are not taken into account for purposes of section 416.

My thinking is that this falls apart on step 1, that you can not shift deferrals into the ACP test just for fun, that there has to be an actual failure of the ACP test first. Is that actually written somewhere, or just accepted practice?

I thought the regs said you could move deferrals not needed to satisfy the ADP test into the ACP test. So if you pass ADP and have some room left over, you can shift to ACP test. I don't think you can reclassify deferrals into ACP test and purposely create an ADP test failure and trigger reclassification of HCE deferral as catch-up. I believe it all starts with ADP test results and flows from there. This is recollection as i don't do these tests regularly.

I agree with 'Cuse.  The $6,000 is not catchup until after the ADP test fails.

And if you use shifting, you must pass ADP both before AND after.

I won't paste them here, but the relevant reg sections are 1.401(m)-2(a)(6)(ii) which says that you can include elective contributions in the ACP test so long as a) the plan is subject to the ADP test, and b) the plan would satisfy the ADP test including the shifted contributions; and 1.401(k)-2(a)(5)(iv) which says that elective contributions used to satisfy the ACP test are not included in the ADP test, except to the extent necessary to demonstrate satisfaction of the requirement in the (m) reg that the ADP test is satisfied when including those contributions.

The way I'm reading this is that the ADP test including the shifted contributions must pass because the (m) reg says it must pass. The ADP test not including the shifted deferrals must pass because simply every 401(k) plan (exceptions notwithstanding) must pass the ADP test. Therefore all of the usual correction methods that apply to the ADP test, including recharacterization as catch-up, are available for the test performed not including the shifted deferrals.

BG, to address your point, let's say you had a genuine scenario where the ADP test passed with some excess, but the ACP test fails. After shifting enough deferrals to the ACP test to make it pass, the ADP test results in some excess contributions which are eligible for recharacterization as catch-up. Would you say that you can not shift the deferrals in this case?

Here is a quote from the DC-2 Study Guide, 7th ed., which suggests that recharacterization as catch-up is a valid outcome of an ADP test performed after shifting deferrals:

It is possible that excess contributions under the ADP test might be
recharacterized as catch-up contributions, if any of the HCEs who are catch-up eligible participants have not used up the full catch-up limit for the year involved. The plan may not apply the recharacterization rule first, and then determine how it wants to shift elective deferrals to produce different testing results. All testing must be completed, including the  shifting of elective deferrals if desired, before determining whether there
are any remaining excess contributions that would be distributable but are eligible for recharacterization as catch-up contributions.

This paragraph cites the preamble to the final 414(v) regs as a reference, and says see 68 F.R. 40511.