Chapter 3 - Correction of Failed ADP/ACP

Question 1

Leveling Calculation to determine min QNEC

Answer 1

1. Determine avg ADR of HCEs and the NHCEs
2. Use the 1.25 Test or the 2x2 Test to determine the difference between the HCEs and NHCEs
3. Add up the comp of the NCHEs and multiply by the delta

Question 2

Correcting the ADP Test - 4 methods

Answer 2

1. Rechracterization
2. Corrective Distributions
3. QNECs to the NHCEs
4. Shifting

Question 3

Correcting the ACP Test - 3 methods

Answer 3

1. Corrective distribution of the excess aggregate contributions (match or after tax) to the HCEs. Can’t do a recharacterization because after tax is part of ACP anyway.
2. Corrective contributions in the form of QNECs or QMACs to the NHCEs.
3. Shifting

Question 4

Re-characterization

Answer 4

For the ADP Test only, cannot do for the ACP Test because after tax is already there.

• Even though it is in the law it is usually not that helpful. To be able to use this, the plan has to already be allowing after tax contributions. This could also just shift the problem to the ACP Test. Also, once it is in the after tax source, it cannot be withdrawn for hardship.
• Excess contributions assigned to an HCE are re-characterized as after tax employee contributions.
• So these contributions will be taxable to the employee (in the year of the correction/distribution to after tax), but will be able to remain in the plan as after tax.

Question 5

Corrective Distributions for the ACP Test

Answer 5

• If the plan makes the corrections for HCEs and distributes within 2.5 months, there is not a penalty
• If they are <2.5 months to the end of the correction period, which is to the end of the year, they have to pay a 10% excise tax on the employer, only on the excess contributions, not on the earnings.
• If you are EACA, you have 6 months without the excise tax
• You pay the excise tax within 15 months after the end of the plan year. You use form 5330.

Excess for the participant, the excess and the earnings are taxable.

Question 6

QNECs for the ADP Test

Answer 6

• The plan document would have to explain how this money would be allocated to the participants
• The plan cannot limit the QNEC to just those who made an elective deferral (contingent benefit rule)
• The plan can limit it to just NHCEs

Question 7

Shifting for the ADP Test

Answer 7

If you are fixing a failed ADP test, you can shift QMAC (some or all) to the ADP to see if you would pass. QMAC is tested as part of the ACP test. QMACs that are shifted to the ADP test, they are not tested as part of the ACP test.

Plans may shift QMACs to the ADP test regardless if they are needed to pass the ADP test

Question 8

Corrective distributions for the ACP Test

Answer 8

• Can only do a corrective distribution of the excess aggregate contibutions (match or after tax) to correct it
• 2.5 months (6 months if EACA) after the end of the plan year, to make the corrections without the 10% excise tax (only applied to the excess aggregate contributions, not on the earnings).

Question 9

Corrective contribution for the ACP Test

Answer 9

Corrective contribution goes to NHCEs in the form of a QNEC (same QNEC cannot be used for ADP and ACP). Could also do a QMAC.

Question 10

Shifting for the ACP Test

Answer 10

• The plan can shift elective deferrals from the ADP side to test under the ACP side. To pass the ADP test, many times there is a decent margin to pass the ADP test. This extra amount can be shifted to the ACP test.
• The regulation requires that the amount that is the cushion can be shifted. The ADP has to be satisfied before and after the shift to make sure too much was not taken.

Question 11

• 3 methods that are not permissible ways to correct the failed ACP test (see page 57 of the study notes)

Answer 11

• Re-characterization - becuase after tax is part of the ACP anyway
• Not giving a match to HCEs, when the plan calls for it. Disregarding allocation formula.
• Forfeiting vested match

Question 12

Leveling Method

Answer 12

1. Determine how much excess contributions there are:
   *HCEs are reduced in descending order of their deferral percentages, not deferral amounts.
   *Start with the one with the highest percentage and reduce until, A) its low enough to satisfy the test or
   B) the next highest HCE percentage is reached. This process is continued until the test is satisfied. If there are no more HCEs but more percentage to distribute, distribute equally between them.
2. Determine who they belong to:
   * Divide the total correction amount among the HCEs in descending order of their deferral amounts.
   * HCE with the highest amount is reduced until the GBJ is distributed, or to the next highest amount. Repeated until depleted.

Question 13

Form 5330

Answer 13

Form used to pay the excise tax if corrective distributions do not happen within 2.5 months after the close of the plan year.

Due date for payment is the last day of the 15th month following the close of the plan year.

Question 14

Corrective distribution and catch-up contributions

Answer 14

If the plan permits catch-up contributions and an HCE is a catch-up eligible
participant, a portion of the HCE’s corrective distribution must be recharacterized
as a catch-up contribution if the catch-up limit has not yet been reached.