Late correction of ADP deferral failure

Just had an interesting question presented to me - real life case.

401(k) plan with several hundred participants had an ADP failure. Small failure - between $1,000 and $1,500 had to be distributed to 1 HCE. This was done timely in March of 2020 - BUT, 3 days after the deadline, the custodian reversed the distribution - due to some BS paperwork question. They never notified anyone of this, and the distribution was never reprocessed.

Fast forward to now, when it was just discovered.  Of course it can be corrected by a QNEC (prohibitively expensive) or the "one to one" correction method. Problem with one-to-one is that the amounts are so small that it amounts to a QNEC of just a few cents for many eligible NHCE's.

Anyone have brilliant creative thoughts? VCP is prohibitively expensive, and any solution under SCP, while possible, carries no guarantees. Many fixes, while "reasonable" by ordinary standards, might not stand up under audit. However, short of an "approved" fix, then some risk must be assumed.

Thanks for any thoughts.

I would do the prescribed 1 to 1. Small allocations shouldn't be an issue - they may look odd, but my guess is they'll go unnoticed or unquestioned. And there is a de minimis exception for any that might then need to be currently distributed, so you can avoid that hassle. Or, as you note, just process the corrective distribution and roll the dice, and/or bring the custodian into the conversation and discuss how they propose to properly address and fix their error.

3 minutes ago, CuseFan said:

 bring the custodian into the conversation and discuss how they propose to properly address and fix their error.

I would start here. It was their error (assuming your post is accurate) and the liability should be theirs. Start the negotiations with them paying for VCP.

How much would a straight QNEC cost?  Weigh that against the cost of the VCP.  Probably costlier to do the straight QNEC, but worth a look anyway.

Thanks for the responses. 

I realize that Rev. Proc. 2019-19 only includes QNECs as examples of correction, but in this case it sounds like the ADP test was actually correctly run and the distribution was set in motion by the plan administrator, but not made because of administrative error, which I think arguably makes this situation different. You're not correcting an ADP test failure, but rather the custodian's failure to follow the plan administrator's direction. Was supposed to be done March, 2020, so apply SCP and distribute now and pay the 4979 10% excess tax on the excess amount. You asked for creative and brilliant. This is at least creative. 🙂

I agree with Luke.  At least there is a paper trail showing the initial refund.

And in this case, I would include gap earnings in the distribution just because it's been a year since it was supposed to have been distributed.

Thank you. This is actually precisely what we decided on Friday as the "best" course of action, taking into account all factors.