10/15/2013

Disclaimer

• The general information in this presentation is not

intended to be nor should it be treated as tax, legal
or accounting advice. Additional issues could exist
that would affect tax treatment of a specific
transaction, and, therefore, taxpayers should seek
advice from an independent tax advisor based on
their particular circumstances before acting on any
information presented. This information is not
intended to be nor can it be used by any taxpayer for
the purpose of avoiding tax penalties.

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 10/15/2013

Agenda
• Correcting Failed Tests by Qualified Contributions
• Timeline for Testing and Corrections
• EPCRS Correction After 12 Months
• Correcting Failed Tests by Refunds and Other Scenarios
• Avoiding Testing Problems
• Merger and Acquisitions
• New EPCRS Issues Affecting Testing
• Compensation
• Employees in the Test
• P t-severance Compensation

ITHE ANNUAL CONFERENCE

NATIONAL HARBOR, MO I OCTOBER 27-30, 2013

Background
• Plan may not favor HCEs on contributions
- HCEs can afford to defer larger%
• Congress developed 2 tests
- Deferrals, ADP
- Matching funds and After Tax, ACP

• Generally, plan covers only NHCEs - no testing

• Generally, plan covers only HCEs - no testing
- Discrimination can only be between HCE and an NHCE
• Sets up unusual patterns when there are only NHCEs

• Any test failures must be completed and corrected

n later than 12 months after plan year end

INAT!ONAl HARBOR. MO I OCTOBER 27-30, 2013

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 10/15/2013

Anti-abuse Provision
401 (k) and (m) Final Regulations
• The 401 (k) and (m) final regulations
include language that indicates that
repeated changes in elections or
procedures used to inflate or improve
testing results will cause the plan to fail
nondiscrimination testing.
• The regulations do not include any
examples of the types of changes that
would constitute abusive practices.

Anti-abuse Provision
401 (k) and (m) Final Regulations
• "The regulations are designed to provide simple, practical rules that
accommodate legitimate plan changes. At the same time, the rules are
intended to be applied by employers in a manner that does not make use
of changes in plan testing procedures, or other plan provisions to inflate
inappropriately the ADP for NHCEs (which is used as a benchmark for
testing the ADP for HCEs) or to otherwise manipulate the
nondiscrimination testing requirements of this paragraph (b). Further, this
paragraph (b) is part of the overall requirement that benefits or
contributions not discriminate infavor of HCEs. Therefore, a plan will not
be treated as satisfying the requirements of this paragraph (b) if there are
repeated changes to plan testing procedures or plan provisions that have
the effect of distorting the ADP so as to increase significantly the
permitted ADP for HCEs, or otherwise manipulate the nondiscrimination
rules of this paragraph, if a principal purpose of the changes was to
achiev such a result. "

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 10/15/2013

Qualified Match or Qualified Nonelective

"Booster Contributions"
• Employer contribution used in testing
- Raises NHCE ADP or ACP so test passes
- Qualified match (QMAC) or Qualified Nonelective
(QNEC)
- Must be fully vested and subject to in-service
withdrawal restrictions
• Final 401 (k) regulations limited the targeted
contributions

INATIONAL HARBOR. MD I OCTOBER 27-30, 2013

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 10/15/2013

QMAC or QNEC "Booster

Contributions" - Prior Year Testing
• Prior year testing method, QNEC must be made by
end of 12 months after prior year: i.e. before testing.

• Example:
- 2013 is testing year for HCEs
- 2012 is prior year for NHCE data
- Booster must be made by Dec. 31, 2013
- Testing starts early 2013.
- NOTE: All NHCEs participants on allocation date receive
booster, even if subsequently terminate

Abusive Use of Targeted Bottom-up

QNECs and QMACs Ended

• Limitation (not elimination) of the

"targeted" or "bQ~_!9rl'"l:l:JJl/ONEC or QMAC

• IRS concerned about abuse and manipulation

- Directed by Congress to limit

• What were they?

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 10/15/2013

QNEC/QMAC
5o/o QNEC/QMAC with No Restrictions
• Can use a QNEC or QMAC of 5% or less in
ADP or ACP testing with no restrictions
- Note that this is 5% QNEC and 5% QMAC for any
one individual
- Thus, one employee may get 10%1

• More than 5% QNEC or QMAC is limited by a

test
• Included in this method are "flat dollar"
ECs or QMACs

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Limitation on More
Than 5°/o QNEC/QMAC
• Test Formula:
- QNEC or QMAC allocation to any one
individual may not be more than twice the
plan's representative rate

• The Plan's Representative Rate is defined as:

- Lowest contribution rate (QNEC and QMAC
divided by compensation) of any eligible NHCE
among a group of NHCEs
• Using Half of all NHCEs in test
-OR
• II of the NHCEs at PYE

INATIONAL HARBOR MD I OCTOBER 27-30, 2013

12

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 10/15/2013

Limitation on > 5% QNEC/QMAC

Example 1
• All NHCEs employed on last day of PY get a
15% QNEC
OK
• Representative rate is 15%

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EXAMPLE NHCE Com pen- ADR QNEC Adjusted

All NHCEs sation ADR
employed on Jimbob $90,000 10% 7% 17%
last day of
Michelle 80,000 8% 7% 15%
Plan Year
receive Jen 70,000 6% 7% 13%
QNEC of Jessica 60,000 6% 7% 13%
same%
Jack 50,000 5% 7% 12%
John 40,000 5% 7% 12%
Joe 35,000 5% 7% 12%
Jeb 30,000 3% 7% 10%
QNEC = $37,100 Janet 25,000 0% 7% 7%
($530,000 x 7%) Jane 20,000 0% 7% 7%
Job 15,000 0% 7% 7%
June 15,000 0% 7% 7%

.
Tr
ADP
K;)l"r"H ::: -"'.~:. [Link]
- 4o/t,
:.~t~
11%
x1.25
NA h..... ""'"'"""' ..... --~""""'""

HCE 6% 13.75%

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 10/15/2013

Limitation on >5°/o QNEC/QMAC

Example 2
• 24 nonhighly employees
• 12 don' t get a QNEC
• 8 get 7°/o
• 4 get 14°/o

Okay because:
1.50°/o of NHCEs got a QNEC
[Link] QNEC rate of 14°/o was no more
han twice the lowest rate of 7o/o

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NHCE Corn pen- ADR QNEC Adjusted

EXAMPLE sation ADR

50% of NHCEs Jim bob $90,000 10% 0% 10%

getQNEC. Michelle 80,000 8% 0% 8%
No one gets Jen 70,000 6% 0% 6%
more than twice Jessica 60,000 6% 0% 6%
anyone else
Jack 50,000 5% 0% 5%
gets.
John 40,000 5% 0% 5%
Joe 35,000 5% 6% 11%
Jeb 30,000 3% 6% 9%
Janet 25,000 0% 6% 6%
QNEC = $10,200 Jane 20,000 0% 6% 6%
Job 15,000 0% 12% 12%
June 15,000 0% 12% 12%
ADP 4% 8%
Tr .. H;,rn~
,... ,......................... un
'" 1..UIU ~Kl:.N!ii~
x 1.25
NA -~ft'"'"' on o
"''
HCE 6% 10%

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 10/15/2013

NHCE Com pen- ADR QNEC Adjusted

EXAMPLE sation ADR
Targeted QNEC Jim bob $90,000 10% 0% 10%
of5% Michelle 80,000 8% 0% 8%
Jen 70,000 6% 0% 6%
Jessica 60,000 6% 0% 6%
Jack 50,000 5% 0% 5%
John 40,000 5% 0% 5%
Joe 35,000 5% 0% 5%
Jeb 30,000 3% 0% 3%
Janet 25,000 0% 0% 0%
QNEC = $2,500 Jane 20,000 0% 5% 5%
Job 15,000 0% 5% 5%
June 15,000 0% 5% 5%

.
lr
ADP .
ll;)l"l"A ""
...
~'"!!.. uunr
4%
..,I\., ~.~[Link]
5.25%
+2
NAIT"'" ounMn lAI\ l\l"Tf'lhl"'nl'l.,

HCE 6% 7.25%

NHCE Compen- ADR QNEC as Adjusted

EXAMPLE sation % of ADR
Comp
Flat Dollar
Jim bob $90,000 10% 0.56% 10.56%
QNEC of $500 to
each NHCE Michelle 80,000 8% 0.63% 8.63%
Is OK because Jen 70,000 6% 0.71% 6.71%
no one receives Jessica 60,000 6% 0.83% 6.83%
a QNEC of more Jack 50,000 5% 1.00% 6.00%
than 5%
John 40,000 5% 1.25% 6.25%
Joe 35,000 5% 1.43% 6.43%
Jeb 30,000 3% 1.67% 4.67%
Janet 25,000 0% 2.00% 2.00%
QNEC = $6,000
Jane 20,000 0% 2.50% 2.50%
3.33% 3.33%
3.33% 3.33%
5.60%
+2
7.60%

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 10/15/2013

Limitation on > 5% QNEC/QMAC

ACP Test

• For ACP test - similar rule

- Plan ' s representative contribution rate is
defined as:
• QNECs, QMACs and all matching
contributions in ACP test

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Limitation on > So/o QNEC/QMAC

• Davis-Bacon exception
- Since these plans make prevailing wage
contributions to certain employees, may use
up to 10% in testing (not 5%)

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 10/15/2013

Returning Excess Amounts

Within 2% Months After Plan Year End

• Testing rush to avoid 10% penalty to

employer on refunds
• Deferral refund taxable to participant in year
distributed rather than year of deferral.
- Earnings taxable in year distributed.
• Excess and excess aggregate can not be
refunded until after the plan year is over
even if you know the ADP and/or ACP test is
· to fail).

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 10/15/2013

Returning Excess Amounts

Within 21/2 Months After Plan Year End
• No mandatory 20% withholding
• Subject to voluntary withholding (10%)
• No 10% penalties or spousal consent applies
- Eligible Automatic Contribution Arrangements that
cover all eligible employees have 6 months to test
and refund

• Prior to plan year 2008, deferrals returned on

First In, First Out (FIFO)
- If the excess is under $100 - taxable in year
· tributed
007 1 taxable in year distributed
ITHE RSPPA ANNUAL CONFERENCE
NATIONAL HARBOR, MD I OCTOBER 27-30, 2013

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Returning Excess Amounts

After 21/2 Months, But Prior to 12 Months

• The same procedures as before 2Yz months

with the following changes.
- Subject to voluntary federal tax withholding. (10%)
- The employer is subject to a 10% excise tax on
the amount being refunded after 2Yz months (or
after 6 months for applicable EACA)
• Note: a QNEC may be made up until 12
months after the end of the year being
tested without a 10% penalty to the
employer.

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 10/15/2013

Returning Excess Amounts

After 12 Months After Plan Year End

• No correction available for after 12 months

after plan year end (PYE)

• Plan is disqualified and must correct under

IRS Employee Plans Compliance Resolution
Systems (EPCRS)

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 10/15/2013

Excess or Excess Aggregate Contribution

After 12 Months After Plan Year End

+ EPCRS has two self-correction procedures

which may be followed within two years of the
end of the testing period.
+For example, if plan year being tested is 2012, the
test is to be run and corrected by end of 2013, self
correct may be made up until end of 2015.
+The two EPCRS methods are:
+One is to provide a QNEC.
other is the one-to-one correction method.

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One-to-one Correction
Overview

• One-to-One correction method would require:

- a refund of the excess, plus earnings
including, if applicable, gap period, to the
HCE(s), (Excess aggregate non-vested
amounts would be forfeited.) AND
- a contribution of the same amount to the
NHCEs.

INATIONAL HARBOR, MD I OCTOBER 27-30, 2013

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 10/15/2013

One-to-one Correction
Form 1099-R Reporting

• The reporting of the excess would be done on

a Form 1099-R for the year of distribution.
- The amount is taxable to the HCE in the
year of distribution.
- Code 8 indicates excess for the year
distributed.

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One-to-one Correction, EPCRS

Appendix 8, Section 2.01 (b)
• ADP/ACP failure correction: one-to-one correction
• Excess contribution determined and (adjusted for
earnings) is either distributed to HCEs or forfeited from
the HCE's' accounts
• That same dollar amount is contributed to the plan and
allocated to NHCEs as provided on next slide

• Under this correction, a plan may not be treated as two

separate plans, one covering otherwise excludable
employees and the other covering all other employees.
- Likewise, restructuring the plan into component plans is
not permitted.

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 10/15/2013

One-to-one Correction
Allocation Methods
• The contribution is allocated to the account balances of
those individuals who were either:
- (I) the eligible employees for the year of the failure who
were NHCEs for that year, or
- (II) the eligible employees for the year of the failure who
were NHCEs for that year and who also are NHCEs for
the year of correction.
- Alternatively, the contribution is allocated to account
balances of eligible employees in (I) or (11), except that
the allocation is made only to the account balances of
those employees who are employees on a date during
e year of the correction that is no later than the date of
ction.

One-to-one Correction
Allocation Methods
• For all the options, eligible employees must receive a
uniform allocation (as a percentage of compensation) of
the contribution.
• The amount allocated is treated as a section 415 annual
addition for "the year of the failure" for the employee for
whom it is allocated.
• Plans using prior year testing method substitute
"the year prior to the year of the failure" for "the
year of the failure."

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 10/15/2013

One-to-one Correction
Example
• On June 30, 2007, Employer A uses the one-to-one
correction method to correct the 2005 ADP test.
• Employer A calculates the dollar amount of the
excess contributions for the two HCEs.
- Employee P Excess is $4,000 (4% of $100,000)
- Employee Q Excess is $2,375 (2% of $118,750)
- For a total of $6,375.
• By leveling the excess contribution is assigned
- Employee P = $3,437.50 + $687 earnings =$4, 124.50
Employee Q =$2,937.50 + $587 earnings =$3,524.50

One-to-One Correction
Example
• On same date, Employer A makes a corrective
contribution to the 401(k) plan equal to $7,649
- the sum of the $4, 124. 50 distributed to Employee P
and the $3,524.50 distributed to Employee Q

• The corrective contribution is allocated to the

account balances of eligible NHCEs for 2005,
pro rata based on their compensation for 2005
(subject to section 415 limit for 2005).

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 10/15/2013

Correcting Failed Tests

Effect of Being Catch-up Eligible
• If HCE is to be refunded an excess contribution but
is 50 or older.
• The refund is required to be recharacterized into a
catch-up contribution (up to the catch-up limit)
provided:
- Plan permits catch-up, and
- Participant has not already used up the catch-up
limit for the year.
• Example
- Refund to an HCE is $6,000 for plan year 2012.
,500 recharacterized as catch-up. $500 refunded

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