SCP no existing NHCEs

The SCP program suggests for a non safe harbor 401k plan that an acceptable correction for a missed deferral opportunity  is a QNEC equal to 50% of the ADP for that group. If the only two eligible NHCEs were left out in the first year of eligibility then my conclusion is that the ADP% for the group is 0 and the QNEC is 0. Hence, the ADP test is failed and the HCE deferrals must be returned or recharacterized.  Does this seem a reasonable interpretation?

No.  I know the IRS talks in circles sometimes, but I don't think you can apply circular reasoning to compute the correction for the missed opportunity. 

No. Read appendix A of Rev Proc 2018-52

It has language in several places similar to 

"For purposes of this section .05(2), in order to determine whether the plan passed the ADP or ACP test, the plan may rely on a test performed with respect to those eligible employees who were provided with the opportunity to make elective deferrals or after-tax employee contributions and receive an allocation of employer matching contributions, in accordance with the terms of the plan, and may disregard the employees who were improperly excluded. "

So if the NHCE were exlcuded for whole year, the ADP test is done with only the HCEs. It would pass. 

As for the no NHCE group % to use for the QNEC, I have asked informally at conferences both the IRS and other practitioners what to use, and what I usually see is a safe harbor style percentage as a stand in. Something like 4% or 6%, which would result in a 2% or 3% QNEC if going the 50% route. 

I have never received a firm answer, but those rates seemed reasonable to me, depending on the circumstances. 

Couple thoughts...

Maybe like a 0% vested participant terminates, many plan documents specify the this participant was "deemed" to receive his vested distribution on his termination date.

So if the NHCE ADP percentage is zero, then the QNEC correction is 50% of zero, which is zero, and the NHCE's should be "deemed" to receive the 0% QNEC.  (I think this one is out to lunch)

Or, maybe can use the first year prior year ADP test provision which "deems" the prior year NHCE ADP percentage is 3% (apparently good enough for this purpose).  So the NHCE percentage in this case could be 3%, and the 50% QNEC is 1.5%.

the self correction was never intended to give guidelines on how to handle every situation and none is provided if there is no NHCE avg. but there should have been, and if the avg is 0% then you either refund all or treat some of the deferrals as catch up for the HCEs. you can't say "no NHCEs, so plan passes adp test" - otherwise you get a reward for excluding people and I'm going to exclude all NHCEs every year

but then that leads you have a more serious issue if I understand the posting. I have 2 eligible NHCEs that were excluded. you fail coverage. and you have to provide a QNEC and it has to have some value to it. you didn't say what the HCE avg was - given the fact the proposed regs (Family Savings Act) says you can make a 4% SHNEC (instead of 3%) after the end of the year might be a reasonable solution.

plus undoubtedly it would be top heavy, so at the minimum 3% would needed.

I agree with Tom.  Does anyone really think the IRS would let you improperly exclude all of the NHCEs and then claim a $0 QNEC corrects the improper exclusion, ADP/ACP and 410(b)?

I would expect the IRS to make you use a correction like the one described in 1.401(a)(4)-11(g)(3)(vii) to correct the 410(b) failure, so no 50% for the QNEC and the correction must have substance.  I would also look to the correction improper exclusion from a safe harbor 401(k) to determine the amount of missed deferrals. 

The owner/hce is at about a 20% deferral rate..Hard to imagine that a 3% or 4% QNEC is going to let this fly. It would be like saying you can have a safe harbor plan in arrears by using the SCP 50%*0 and then covering 410(b) with a 3% or 4%QNEC. It troubles me that I could get the same result as a safe harbor plan without having a safe harbor document and satisfying the safe harbor notice requirement. The safe harbor nonelective SCP contribution would be 1.5% in this situation yielding a total of 4.5% for the year. I think it should be at least this much.  Thanks for your input on this one.

but if the Family Act Bill passes then the following would apply (assuming it is kept)

(b) Nonelective contributions.—Section 401(k)(12) of such Code is amended by redesignating subparagraph (F) as subparagraph (G), and by inserting after subparagraph (E) the following new subparagraph:

“(F) TIMING OF PLAN AMENDMENT FOR EMPLOYER MAKING NONELECTIVE CONTRIBUTIONS.—

“(i) IN GENERAL.—Except as provided in clause (ii), a plan may be amended after the beginning of a plan year to provide that the requirements of subparagraph (C) shall apply to the arrangement for the plan year, but only if the amendment is adopted—

“(I) at any time before the 30th day before the close of the plan year, or

“(II) at any time before the last day under paragraph (8)(A) for distributing excess contributions for the plan year.

“(ii) EXCEPTION WHERE PLAN PROVIDED FOR MATCHING CONTRIBUTIONS.—Clause (i) shall not apply to any plan year if the plan provided at any time during the plan year that the requirements of subparagraph (B) or paragraph (13)(D)(i)(I) applied to the plan year.

“(iii) 4-PERCENT CONTRIBUTION REQUIREMENT.—Clause (i)(II) shall not apply to an arrangement unless the amount of the contributions described in subparagraph (C) which the employer is required to make under the arrangement for the plan year with respect to any employee is an amount equal to at least 4 percent of the employee's compensation.”.

.........

so this permits plans to wave a magic wand and become safe harbor after the fact as long as the 3% is increased to 4%. I assume that means just for the prior year and then you can go back to 3%.

so if they do pass the  Bill this year then it looks like a way to get out of things!

3 hours ago, draper1 said:

The owner/hce is at about a 20% deferral rate..Hard to imagine that a 3% or 4% QNEC is going to let this fly. It would be like saying you can have a safe harbor plan in arrears by using the SCP 50%*0 and then covering 410(b) with a 3% or 4%QNEC. It troubles me that I could get the same result as a safe harbor plan without having a safe harbor document and satisfying the safe harbor notice requirement. The safe harbor nonelective SCP contribution would be 1.5% in this situation yielding a total of 4.5% for the year. I think it should be at least this much.  Thanks for your input on this one.

It's not like having a retroactive safe harbor plan.  Correcting the improper exclusion is the last step.  Top Heavy and ADP/ACP have to be corrected first.  Rev. Proc. 2018-52 Appendix A .05(2)(g).  With all of the NHCEs improperly excluded, it seems very likely the plan is top heavy.  That's 3%.  Then, ADP/ACP needs to be corrected.  Regardless of what the Rev. Proc. says, I don't think the IRS is going to let you claim ADP/ACP pass because you improperly excluded all the NHCEs.  That means either a salary proportional QNEC/QMAC under Appendix A .03 or one-to-one correction under Appendix B 2.01 (refunds and a QNEC/QMAC of the same amount).  Then, you get to correct the improper exclusion as we have discussed. In other words, each failure is corrected separately.  With a 20% HCE deferral rate, that's going to total significantly more than 4.5% of pay and the HCE may still have a refund.