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Part 4. Examining Process

Chapter 72. Employee Plans Technical Guidelines

Section 2. Cash or Deferred Arrangements (Cont. 1)

4.72.2  Cash or Deferred Arrangements (Cont. 1)

4.72.2.10 
CODA Nondiscrimination

4.72.2.10.1 
ADP Test

4.72.2.10.1.2  (03-01-2002)
Prior Year Testing

  1. Generally, the rules that apply to calculating ADRs and ADPs in current year testing also apply to prior year testing. Prior year testing simplifies plan administration because an employer can determine the percentage of elective contributions that can be made on behalf of HCEs early in the plan year and have more time to plan for correction. Consider the following examples:

    1. Employer X maintains a plan containing a qualified CODA that provides that distribution of excess contributions is the only method under the plan to correct ADP test failures. The plan has a calendar-year plan year and both HCEs and NHCEs make ECs to the plan. In January 1997, Employer X determines that the plan fails the ADP test for 1996, and that a corrective distribution of excess contributions must be made to appropriate HCEs by March 15, 1997, to avoid all penalties.

    2. Same facts as above, except that the testing year is 1997 and the plan is using the prior year testing method. The ADP for the NHCEs for 1996 under the plan can be determined early in 1997 by Employer X because it has obtained the necessary data on prior year NHCE status, contributions and compensation by January 1997. This simplifies plan administration for Employer X.

  2. The eligible employees taken into account in determining the prior year’s ADP for NHCEs are those eligible employees who were NHCEs during the preceding year, without regard to the employee’s status in the testing year. A special rule applies for the first plan year. In the case of the first plan year of any plan (other than a successor plan), the amount taken into account as the ADP for NHCEs for the preceding plan year is deemed to be 3 percent, unless an election is made to use the actual ADP data for the first plan year.

  3. Example:

    Employee A was employed by Employer X and was an NHCE in Year One. Employee A no longer works for Employer X in Year Two. For purposes of determining the prior year’s ADP for Employer X’s section 401(k) plan for the Year Two testing year, Employee A is taken into account. The result would be the same if Employee A were still employed by Employer X but had become a HCE in Year Two.

  4. Notice 97-2 and Notice 98-1 provide guidance on the use of the prior year method and the current year testing method and on changing from one method to the other. In general, Notice 98-1 requires that a plan must specify which of the two testing methods it is using. If the testing method is changed, the plan must be amended to reflect the change. See § IX of Notice 98-1.

4.72.2.10.1.2.1  (03-01-2002)
Use of QNECs and QMACs in Prior Year Testing

  1. To be taken into account for the NHCE ADP for the prior year, a QNEC or QMAC must be allocated as of a date within that prior year, and must actually be paid to the trust by the end of the 12-month period following the end of that prior year. In other words, it must actually be paid to the trust by the end of the testing year; thus, when using prior year testing, an employer cannot use QNECs or QMACs to correct a failed ADP or ACP test because the employer won’t know until after the testing year whether or not the ADP or ACP test is failed and by then the deadline for making corrective QNECs and QMACs has passed. Of course QNECs and QMACs made prior to the deadline can be counted.

  2. Example:

    A plan uses the prior year testing method for the 1999 testing year. QMACs that are allocated to NHCEs’ accounts as of the last day of the 1998 plan year may be taken into account in calculating the ADP only if those QMACs are actually contributed to the plan by the last day of the 1999 plan year.

  3. Note that this 12-month rule does not change the rule under IRC section 415, that employer contributions shall not be deemed credited to a participant’s account for a particular limitation year unless the contributions are actually made no later than 30 days after the end of the IRC section 404(a)(6) period applicable to the taxable year with or within which the particular limitation year ends. See Regs. 1.415-6(b)(7)(ii).

4.72.2.10.1.2.2  (03-01-2002)
First-Year Rule for Prior Year Testing

  1. For the first plan year of a plan (other than a "successor plan," see below) that uses prior year testing, the ADP for NHCEs for the prior year is deemed to be 3%. See IRC section 401(k)(3)(E). Alternatively, if the employer so elects in the plan document, the NHCE ADP is equal to the NHCE ADP for that first plan year (i.e., the current year).

  2. For ADP testing purposes, the "first plan year" is the first year in which the plan provides for elective contributions. A plan does not have a first plan year if for that year it is aggregated under the regulations with any other plan that provided for elective contributions in the prior year.

  3. A plan is a "successor plan" if 50% or more of the eligible employees for the first plan year were eligible employees under another CODA maintained by the employer in the prior year.

4.72.2.10.1.2.3  (03-01-2002)
Changes in the Group of NHCEs in Prior Year Testing

  1. In general, under the prior year testing method, subsequent changes in the group of NHCEs are disregarded. That is, the ADP for NHCEs for the prior year is determined with respect to eligible employees who were NHCEs in that prior year, and without regard to changes in the group of eligible NHCEs in the testing year. This is true even though some NHCEs in the prior year have become HCEs in the testing year, or are no longer eligible employees under the plan. It is also true even though some NHCEs in the testing year were not eligible employees in the prior year.

  2. However, if a plan results from or is affected by a "plan coverage change" that becomes effective during the testing year then the NHCE ADP for the prior year is the weighted average of the ADPs for the prior year subgroups. A "plan coverage change" is a change in the group(s) of eligible employees on account of:

    1. the establishment or amendment of a plan;

    2. a plan merger, consolidation, or spinoff under IRC section 414(l);

    3. a change in the way plans are (or are not) permissively aggregated under Regs. 1.410(b)-7(d); or

    4. any combination of the above.

  3. A "prior year subgroup" is all NHCEs for the prior year who were eligible employees under a specific CODA maintained by the employer, and who would have been eligible employees under the plan being tested if the plan coverage change had been effective as of the first day of the prior year.

  4. The "weighted average of the ADPs for the prior year subgroups" is the sum, for all prior year subgroups of the "adjusted ADPs."

  5. The "adjusted ADP" for each prior year subgroup is the ADP for the prior year for all NHCEs of the specific plan under which the members of the prior year subgroup were eligible employees, multiplied by a fraction, the numerator of which is the number of NHCEs in the prior year subgroup, and the denominator of which is the total number of NHCEs in all prior year subgroups.

  6. An exception to the exception: If there is a plan coverage change, and 90% or more of all NHCEs from all prior year subgroups are from a single prior year subgroup, then the employer may elect to use the prior year ADP for NHCEs of the plan that included that single prior year subgroup. Notice 98-1 contains examples involving plan coverage changes.

4.72.2.10.1.3  (03-01-2002)
Changing Testing Method

  1. A plan that uses the prior year testing method may adopt the current year testing method for any subsequent testing year. Notification to or prior approval of the Service is not required for the election to be valid. However, the employer may wish to apply for a determination letter on the plan amendment needed to implement the change.

  2. A plan that uses current year testing after the 1997 plan year (see Notice 97-2) is permitted to change to prior year testing in four situations only:

    1. The plan is not the result of the aggregation of two or more plans, and current year testing was used for each of the 5 plan years preceding the year of the change (or, if lesser, the number of years the plan has been in existence).

    2. The plan is the result of the aggregation of two or more plans, and for each of the aggregated plans current year testing was used for each of the 5 plan years preceding the year of the change (or, if lesser, the number of years the plan has been in existence).

    3. A transaction occurs that is described in IRC section 410(b)(6)(C)(i) (i.e., the employer becomes or ceases to be a member of an IRC section 414(b), (c), (m) or (o) group), and, as a result, the employer maintains both a plan using prior year testing and a plan using current year testing, and the change occurs within the transition period described in IRC section 410(b)(6)(C)(ii) (i.e., by the last day of the 1st plan year beginning after the transaction).

    4. The change occurs within the plan’s SBJPA remedial amendment period (generally, the last day of the first plan year beginning on or after January 1, 2001; see Rev. Proc. 2000-27, 2000-26 I.R.B. 1272).

4.72.2.10.1.4  (03-01-2002)
Limits on Double Counting of Certain Contributions

  1. When a plan changes from current year testing to prior year testing, contributions on behalf of many, if not all, NHCEs are likely to be double counted. For example, if a plan used current year testing in 1998, and then changed to prior year testing in 1999, elective contributions on behalf of NHCEs for 1998 will be counted twice; once in 1998 in calculating the NHCE ADP under the current year testing method, and again in 1999 in calculating the NHCE ADP under the prior year testing method. To limit double counting, Notice 98-1 provides that the ADP for NHCEs for the prior year is determined taking into account only:

    1. elective contributions for NHCEs that were taken into account for purposes of the ADP test (and not the ACP test) under the current year testing method in the prior year; and

    2. QNECs that were allocated to NHCEs’ accounts for the prior year, but that were not used to satisfy either the ADP test or the ACP test under the current year testing method for the prior year.

  2. Thus, the following contributions made for the prior year are disregarded for the ADP test: QNECs used to satisfy either the ADP or ACP test under the current year testing method for the prior year, elective contributions taken into account for purposes of the ACP test, and all QMACs.

  3. These limitations on double counting do not apply for testing years beginning before January 1, 1999. Thus, for a plan that changes to prior year testing for the first time for the 1998 plan year, the ADP and ACP for NHCEs will be the same as for the 1997 plan year. See Notice 98-1 for examples involving double counting.

4.72.2.10.1.5  (03-01-2002)
Plan Provisions Regarding Testing Method

  1. A plan must specify which of the two testing methods (current year or prior year) it is using. If the employer changes the testing method under a plan, the plan must be amended to reflect the change.

  2. The regulations under IRC section 401(k) and (m) permit a plan to incorporate by reference IRC section 401(k)(3) and (m)(2) (and, if applicable, (m)(9)) and the underlying regulations. A plan that incorporates these provisions by reference may continue to do so, but must specify which of the two testing methods (current year or prior year) it is using. Further, for purposes of the first plan year rule, a plan that incorporates these provisions by reference must specify whether the ADP/ACP for NHCEs is 3% or the current year’s ADP/ACP.

  3. Rev. Proc. 2000-27 extends the remedial amendment period for SBJPA generally to the last day of the first plan year beginning on or after January 1, 2001. Any plan amendments to reflect a choice in testing method are not required to be adopted before the end of this remedial amendment period. However, plans must be operated in accordance with the SBJPA changes as of the statutory effective date (section 1433(c) and (d), which added the prior year testing method, were effective for plan years beginning after December 31, 1996). In addition, any retroactive amendments must reflect the choices made in the operation of the plan for each testing year, including the choice of testing method (and any changes to that method), and must reflect the date(s) on which the plan began to operate in accordance with those choices (and any changes).

4.72.2.10.1.6  (03-01-2002)
Correction of ADP Test

  1. If corrective QNECs or QMACs (for CODAs using current year testing) do not bring the CODA within the ADP limits, the plan must either distribute the excess contributions, along with attributable earnings, or recharacterize them as after-tax employee contributions, according to the terms of the plan. A plan may provide for more than one correction method or may provide for a combination of methods.

  2. If the ADP test is not corrected within the 12-month period following the end of the failed plan year, the CODA is not qualified and the plan may be disqualified. Failure to correct excess contributions will result in the CODA being nonqualified not only for the plan year for which the excess contributions were made but also all subsequent plan years during which the excess contributions remain in the trust.

4.72.2.10.1.6.1  (03-01-2002)
Determination of Excess Contributions

  1. The amount of excess contributions is determined using a leveling method based on HCEs’ ADRs, beginning with the HCE with the highest percentage and continuing in descending order of ADR percentages until the target HCE ADP is reached.

  2. Example:

    There are three HCEs in a section 401(k) plan: HCE1 has compensation of $80,000 and ECs of $8,800 for an ADR of 11%; HCE2 has compensation of $100,000 and ECs of $9,000 for an ADR of 9%; and HCE3 has compensation of $150,000 and ECs of $10,500 for an ADR of 7%. The HCE ADP is 9%. If the HCE ADP needs to be 8% to pass the ADP test, the amount of excess contributions is determined by multiplying one or more HCE’s compensation by the percentage that such HCE’s ADR would have to be reduced, using the percentage leveling method, in order to produce a HCE ADP of 8%. The highest ADR percentage, HCE1's 11%, is reduced to the next highest, HCE2’s 9%, and then both HCE1 and HCE2’s reduced ADRs are further reduced to 8.5%, so that the HCE ADP using these reduced ADRs is 8%. HCE1’s ADR reduction by 2.5% produces excess contributions of $2,000 (2.5% x $80,000) and HCE2’s ADR reduction by 0.5% produces excess contributions of $500 (0.5% x $100,000) for a total amount of excess contributions of $2,500.

4.72.2.10.1.6.2  (03-01-2002)
Distribution of Excess Contributions

  1. For plan years beginning before January 1, 1997, corrective distributions of excess contributions, adjusted for earnings, were made to the HCEs whose ADRs were used to determine the amount of excess contributions and in the same amount. So in the previous example, $2,000 (adjusted for earnings) would be distributed to HCE1 and $500 (adjusted for earnings) to HCE2.

  2. Section 1433(e) of SBJPA amended IRC sections 401(k)(8)(C) and 401(m)(6)(C), effective for plan years beginning after December 31, 1996, to provide that corrective distributions are made based on HCEs’ dollar amount of contributions rather than on their percentages. In other words, excess contributions are distributed to HCEs who have the largest amount of contributions in the numerator of their ADR (a dollar leveling method). The method of determining the amount of excess contributions (and excess aggregate contributions) remains the same. Thus, the HCEs whose ADRs are used to calculate the excess amount may be different from the HCEs who receive a corrective distribution. So in the previous example, the $2,500 of excess contributions would be allocated $1,900 to HCE3 (the HCE with the largest amount of ECs), $400 to HCE2 (the HCE with the next largest amount of ECs) and $200 to HCE1. See Notice 97-2 for a more detailed example involving corrective distributions.

  3. A plan must distribute both the excess contribution and the earnings attributable to the excess contribution. Any reasonable method of determining income or loss otherwise used by the plan may be used to determine income or loss attributable to excess contributions. The regulations do not require the plan to determine or pay out the “gap period” earnings (i.e., the earnings for the period from the end of the plan year to the distribution date). However, if a plan does provide for distribution of gap period earnings, the method used must be consistent for all participants and must be either the method the plan normally uses to allocate income to participants’ accounts or the safe harbor method provided in the regulations.

  4. A failed ADP test can be corrected by distributing excess contributions, adjusted for earnings, to certain HCEs by no later than 12 months after the close of the testing year, regardless of whether the plan is using the prior year or current year testing method.

  5. Note that if these distributions are made, the section 401(k) plan is treated as meeting the ADP test even though the HCE ADP, if recalculated after distributions, would not satisfy the ADP test.

  6. Notice 97-2 provides that after excess contributions and excess aggregate contributions, if any, have been distributed using the method described above, the multiple use test of section 401(m)(9) is applied. For purposes of section 401(m)(9), if a corrective distribution of excess contributions has been made, or a recharacterization has occurred, the ADP for HCEs is deemed to be the largest amount permitted under section 401(k)(3). Similarly, if a corrective distribution of excess aggregate contributions has been made, the ACP for HCEs is deemed to be the largest amount permitted under section 401(m)(2).

  7. Excess contributions distributable to a HCE for a plan year are reduced by the amount of any excess deferrals (amounts over the IRC section 402(g) limit) that have been distributed to the HCE for the HCE’s tax year that ends with or within the plan year.

  8. Distributions of excess contributions and attributable earnings must be reported on Form 1099-R using the appropriate code. Such distributions are taxable distributions under IRC section 72, but are not subject to the consent rules under IRC sections 411(a)(11) and 417 or the early withdrawal tax under IRC section 72(t). The distributions must be immediately subject to income tax, so a "distribution" of the excess contributions into a nonqualified deferred compensation arrangement is not a permissible method of correction.

  9. If the distributions are made within the first 2 1/2 months following the end of the plan year, the distributed amounts are treated (for income tax purposes) as if they were received by the employee as of the earliest date the employee could have received the amount in cash. In most cases, this means the distributions will be taxable in the preceding calendar year. If the distributions are made after the first 21/2months, the distributions are taxable in the year distributed (and the employer is subject to the 10% tax under IRC section 4979 tax). However, under IRC section 4979(f)(2)(B), if the total excess contributions and any excess aggregate contributions are less than $100 (without regard to attributable earnings), the amount is included in gross income in the year distributed even if the distribution is made in the 21/2 month period.

4.72.2.10.1.6.3  (03-01-2002)
Recharacterization of Excess Contributions

  1. Under IRC section 401(k)(8)(A)(ii), a CODA can correct an excess contribution by "recharacterizing" an employee’s excess contributions as an employee after-tax contribution. This is a fiction in which the plan is deemed to have distributed the excess contribution and the HCE is deemed to have contributed this amount to the plan as an after-tax employee contribution.

  2. The total amount of excess contributions and the HCEs to whom they are allocated is determined in the same manner as for distributions of excess contributions, except the amount recharacterized does not include attributable earnings.

  3. Plans may only recharacterize excess contributions within the first 21/2 months after the plan year during which the excess arose, and then only if the plan otherwise allows for employee after-tax contributions.

  4. The employer or plan administrator must notify the HCEs to whom the excess contributions are allocated that the excess contributions are being recharacterized and must inform them of the tax consequences of the recharacterization. The date of the recharacterization (used to determine whether the 21/2 month rule has been satisfied) is the date on which the last affected HCE receives notification.

  5. Excess contributions that are recharacterized are reported and appropriately coded on Form 1099-R and are included in gross income according to the same rules that apply for actual distributions of excess contributions.

  6. Once an amount has been recharacterized, it will be considered an employee contribution subject to the ACP test. However, for all other qualification purposes, such as deductibility under IRC section 404, the recharacterized amount continues to be considered an employer contribution.

  7. The plan may require recharacterization of excess contributions or may allow affected HCEs to choose between recharacterization and distribution.

4.72.2.10.1.7  (03-01-2002)
IRC section 4979 Tax

  1. IRC section 4979 imposes a tax on the employer equal to 10% of any excess contributions not corrected within 21/2 months after the end of the plan year to which they relate. However, the tax does not apply if corrective QNECs or QMACs (current year testing plans only) are made within 12 months after the end of the plan year. If the QNECs or QMACs were insufficient to fully satisfy the ADP test, the tax will apply to the remaining excess contributions.

  2. The plan has 12 months after the end of the plan year being tested to correct excess contributions. The plan can distribute excess contributions any time during the 12-month period, but the employer will still be subject to the 10% tax if the distribution is made after the 21/2-month period.

  3. The tax is reported on Form 5330 and is due 15 months after the end of the plan year. See Reg. 54.4979-1. Any extension of time to pay the tax is not an extension of time to correct the ADP test.

  4. The tax is a one-time tax, meaning, if excess contributions are not timely corrected for a plan year, the tax applies only for that year.

4.72.2.10.1.8  (03-01-2002)
Examination Steps

  1. Review the plan language to identify eligibility requirements and ensure that the plan is operating in accordance with the plan document.

  2. Review plan financial audit reports and corporate minutes for comments relating to eligibility provisions.

  3. Review plan financial audit reports and corporate minutes for comments on ADP testing and correction.

  4. Have the plan administrator explain policy/procedures for ADP/ACP/402(g) testing (including correction). Analyze the testing methodology and results confirming the accuracy of each ADP test.

  5. If the plan used a safe harbor method to satisfy the ADP/ACP tests, review the plan language and verify the employer made matching contributions or nonelective contribution that satisfied the safe harbor requirements. Also verify that the notice requirements were met.

  6. Establish that all employees who are eligible under the plan to make ECs are counted in the ADP test, even if some do not make ECs.

    1. Check the overall group of eligible employees to determine whether those who have satisfied the plan’s age and service requirements are allowed to make deferrals. Also ask if any other benefits are contingent on a contribution to the CODA.

    2. Determine whether employees who are eligible to make a deferral but cannot because they have been suspended from making deferrals (e.g. because of receiving a hardship distribution), and who are allocated no QNECs or QMACs that are treated as ECs, have been included as "eligible" with a deferral percentage of "0" when running the ADP test.

  7. Compare the total number or eligible employees (including those who would be eligible but for a plan provision requiring a ministerial or mechanical act) with the number of employees used to run the ADP test. They should be the same.

  8. Examine payroll records, Forms W-2, time cards and personnel records, to verify employee compensation. If the plan year is not a calendar year, review the plan document to determine which period should be used and verify the operation of those provisions. If the employer limits compensation to the portion of the year in which the employee was eligible, verify that the plan’s terms allow for such limitation and examine employees with such limited compensation. If limited, the amount of compensation should be that earned since participation in the plan.

  9. Verify that all compensation figures are limited in accordance with IRC section 401(a)(17). If the plan is not a safe harbor plan, examine the ADP test to verify that each individual’s ADR is calculated using the properly limited compensation.

    Note:

    Compensation used in the ADP test can either include or exclude elective contributions deferred during the year. The definition of compensation in Reg. 1.414(s)-1 makes reference to IRC section 415(c)(3), which includes elective deferrals in compensation (IRC section 415(c)(3)(D)). However, Reg. 1.414(s)-1(c)(3) contains a safe harbor alternative definition of compensation that satisfies IRC section 414(s) and does not count deferred compensation.

  10. Reconcile the total participant deferral contributions shown on Form 5500, Schedule H or I, to the total deferral amount shown on the ADP test.

  11. Test check whether the highly compensated employee group was properly determined, using payroll and organization data. Verify that an employee was considered an HCE if he or she was a 5% owner during the year or preceding year, or had compensation above $80,000 (indexed) for the preceding year, and if the employer so elected, was in the top-paid group that year.

  12. If a plan is disaggregated under IRC section 410(b), make sure that the ADP test is also run separately on each disaggregated plan. Apply the aggregation and disaggregation rules of Reg. 1.410(b)-7, as modified by Reg. 1.401(k)-1(g)(11), to find the "plan" (or plans) so that the ADP and ACP tests (or safe harbor or SIMPLE rules) can be applied to the proper employees. Ensure only plans with the same PYE are aggregated, if otherwise permitted.

    1. Review the plan document to determine the eligibility requirements for the CODA. If the eligibility requirements are less than 1 year of service and/or less than age 21, the nondiscrimination testing may be applied on a disaggregation basis. Separate tests may be run; one for employees with less than 1 year of service and less than age 21, and one for all other employees.

    2. If the plan is an ESOP, the ESOP portion of the plan must be disaggregated from the CODA in the same plan. This is true even if any HCE participates in the CODA portion of the ESOP and a CODA of another plan maintained by the employer.

    3. Determine if any employees of the employer are covered by a collective bargaining agreement. If so, these employees must be disaggregated from employees not covered by a collective bargaining agreement for purposes of the ADP test. Review any lists, which identify employees covered by a collective bargaining agreement, such as reports prepared for payment of union dues or payroll records showing union dues deductions. Compare these employees to the separate ADP testing for employees under the collective bargaining agreement.

    4. While inspecting the 5500 returns for all plans, determine if any other plan maintained by the employer contains a CODA. If so, the plans may be aggregated for purposes of the ADP testing, but only if they have the same plan year. If two or more plans are aggregated for the ADP test, they must also be aggregated for coverage and discrimination testing. Inquire of the employer which plans were aggregated, if any. Verify from payroll records whether employees counted for the coverage and discrimination testing are the same employees in the ADP test if the plans were aggregated.

  13. Determine if any HCE is participating in more than one plan, which contains a CODA. If yes, the elective contributions for each HCE must be combined for purposes of determining ADRs. This ADR is then used in the ADP test for all CODAs.

  14. Compare ADP calculations to compensation and deferral amounts shown on Forms W-2 (or payroll records if the plan year is a fiscal year). Trace the individual entries to source documents.

  15. Verify that the ADP test for each group (HCE and NHCE) has been properly determined and that the ADP test was satisfied in accordance with the plan provisions describing the testing method (current year or prior year).

  16. For ADP test failures, verify proper and timely correction. Consider:

    1. Whether the correction method was specified in the plan document and whether the method was foflowed; and

    2. Whether the amount of excess contributions was calculated using the correct leveling procedure.

  17. For correction by distribution:

    1. Inspect cancelled checks or trust statements to determine the date of distribution of the excess contributions (plus attributable earnings).

    2. Inspect Form(s) 1099-R issued for distribution of excess contributions. Amounts distributed should include any gains or losses. For distributions made within the 21/2 month period following the plan year end, the distribution is includible in income for the employee’s taxable year in which the excess occurred. Distributions made to an employee after 21/2 months or that are less than $100 (not counting earnings) are includible in income for the employee’s taxable year in which the distribution was made.

    3. If the distribution was made after 21/2 months following the end of the plan year in which the excess arose, the IRC section 4979 tax applies. Inspect or solicit Form 5330 and verify remittance of the excise tax.

  18. If correction was by recharacterization, consider:

    1. Recharacterization must occur within 21/2 months following the end of the plan year in which the excess arose. Inspect recharacterization notices issued to HCEs. Recharacterization is "deemed" to have occurred on the date of the last notice.

    2. Inspect Forms 1099-R to verify that recharacterized amounts were correctly reported. Earnings or losses on recharacterized amounts are not taxable and should not be included in the amount reported on the Form 1099-R.

  19. If correction was by contribution of QNECs and/or QMACs, determine whether the contributions were made within 1 year after PYE by inspecting cancelled checks or trust statements. (Note that this correction method is not available for plans using the prior year testing method.)

4.72.2.11  (03-01-2002)
SIMPLE 401(k) Plans

  1. IRC sections 401(k)(11) and 401(m)(10) were added by section 1422 of SBJPA (as amended by section 1601(d) of TRA) to permit SIMPLE section 401(k) plans beginning in 1997. SIMPLE 401(k) plans must be maintained on a calendar-year basis. A SIMPLE 401(k) plan is deemed to satisfy the ADP and ACP tests and is not subject to the top-heavy requirements. They closely follow the requirements for SIMPLE IRA plans described in IRC section 408(p), but SIMPLE IRA plans are far more popular with employers because the IRA plans are less burdensome to set up and maintain, for example, Form 5500s are not required for SIMPLE IRA plans.

  2. To set up a SIMPLE 401(k) plan, for the prior calendar year, an employer must have had no more than 100 employees making $5,000 or more. Also, no employee covered under the SIMPLE 401(k) plan can be covered under another plan of the employer.

  3. Elective contributions are limited to $6,000 (indexed) per year, and each year the employer must contribute either:

    1. a matching contribution equal to the lesser of the employee’s elective contribution or 3 percent of the employee’s compensation, or

    2. a nonelective contribution equal to 2 percent of each eligible employee’s compensation for the year, but the plan can exclude from this contribution employees who did not earn $5,000 or more for the year.

  4. All contributions to the plan must be fully vested at all times and no contributions other than those described above can be made to the plan.

  5. A special, inclusive definition of compensation applies to SIMPLE 401(k) plans. See IRC section 408(p)(6). Basically, compensation is what is reported on an employee’s Form W-2 for the year, including elective contributions. Also, compensation is limited to the IRC section 401(a)(17) amount ($150,000, as increased for cost of living).

  6. Each eligible employee must be given the opportunity to make or modify a deferral election during the 60-day period prior to each January 1. For the first time an employee becomes eligible, the first 60-day period can be any 60-day period that includes the date he or she becomes eligible or the day before.

  7. Prior to each election period, the employer must notify all eligible employees of their right to make deferral elections and whether the employer will be making a matching or nonelective contribution for the year.

  8. The Service issued guidance on SIMPLE 401(k) plans, including a model amendment, in Revenue Procedure 97-9.

4.72.2.12  (03-01-2002)
Safe Harbor 401(k) Plans

  1. Beginning in 1999, safe harbor 401(k) plans became available to employers. The Service has published two notices on safe harbor plans, Notice 98-52 and Notice 2000-3. These two notices provide guidance on the design-based alternative or "safe harbor" methods under IRC sections 401(k)(12) and 401(m)(11) for satisfying the ADP test and the ACP test under IRC sections 401(k) and 401(m). A safe harbor 401(k) plan is deemed to satisfy the ADP test (and usually the ACP test as well). If a CODA satisfies the rules in IRC section 401(k)(12) and also the rules in IRC section 401(m)(11), the plan is deemed to satisfy both the ADP test and the ACP test. A plan can satisfy the ADP safe harbor without satisfying the ACP safe harbor, but a plan cannot satisfy the ACP safe harbor without satisfying the ADP safe harbor.

  2. A plan that uses the safe harbor methods to satisfy the ADP or ACP test is treated as using the current year testing method for that plan year.

  3. Note that IRC sections 401(k)(12) and 401(m)(11) provide guidance on the contributions required for NHCEs, but a safe harbor plan will provide for uniform contribution formulas that apply to both NHCEs and HCEs.

  4. Notice 2000-3 provides guidance, in the form of 11 questions and answers, on the safe harbor methods. These Q&As are in section Ill of the notice, and they either modify Notice 98-52 or provide additional guidance on the safe harbors. Sections I and II of the notice explain the purpose of the notice, summarize the contents of the notice and provide background information.

4.72.2.12.1  (03-01-2002)
Plan Provisions for Safe Harbor Plans

  1. Generally, an employer that intends to use the safe harbor provisions for a plan year must adopt those provisions before the first day of that plan year. However, for the remedial amendment period, under Section 4 of Rev. Proc. 2000-27, 2000-26 I.R.B. 1272, a section 401(k) plan intending to take advantage of the safe harbor methods for the 1999, 2000 or 2001 plan year must generally be amended no later than the end of the 2001 plan year, retroactive to the first day of the 1999, 2000 or 20001 plan year, to reflect the first use of the safe harbor methods.

  2. Under Q&A-1 of Notice 2000-3, a section 401(k) plan can be amended as late as 30 days prior to the end of a plan year to provide for the use of the safe harbor nonelective contribution method for that plan year, provided that a regular safe harbor notice (with modified content) is given to eligible employees before the beginning of the plan year and a supplemental notice is given no later than 30 days before the end of the plan year.

  3. Under Q&A-11 of Notice 2000-3, a profit-sharing plan that does not contain a CODA generally can be amended as late as 3 months prior to the end of a plan year to provide for the use of the ADP/ACP safe harbor methods for that plan year.

4.72.2.12.2  (03-01-2002)
Special Compensation Definition for Safe Harbor Plans

  1. Generally, the same definitions apply as are used in other CODAs. In the case of "compensation," the same definition applies for purposes of determining employer nonelective contributions, thus, a uniform definition of compensation satisfying Regs. 1.414(s)-1 must be used for the ADP and ACP safe harbors for purposes of the basic and enhanced matching formulas, the nonelective contribution requirement and the matching contribution limitations. For example, a plan could use a definition of compensation that includes all compensation within the meaning of section 415(c)(3) and excludes all other compensation. (This is an IRC section 414(s) safe harbor definition of compensation. See section 1.414(s)-1(c)(2).)

  2. However, with respect to elective contributions under a plan using the ADP safe harbor matching formula, each eligible NHCE may make elective contributions under a “reasonable definition” of compensation as defined under Regs. 1.414(s)-1(d)(2). Such definition is not required to satisfy the nondiscrimination requirement of Regs. 1.414(s)-1(d)(3). However, the plan must permit each eligible NHCE to make elective contributions in an amount that is at least sufficient to receive the maximum amount of matching contributions under the plan for the plan year and the employee must be permitted to elect any lesser amount of elective contributions.

  3. Compensation may not be limited to a specific dollar amount for NHCEs for purposes of the ADP and ACP safe harbors. (The last sentence in section 1.414(s)-1(d)(2)(iii) of the regulations does not apply.) Note that the annual compensation limit under section 401(a)(17) still applies.

  4. A plan can limit an employee’s compensation to the portion of the plan year in which the employee was an eligible employee under the plan, provided that this limit is applied uniformly to all eligible employees.

  5. Example (illustrating compensation): An employer’s section 401(k) plan defines compensation as "all salary, wages, bonuses, and other remuneration not exceeding $75,000." The plan does not satisfy the ADP/ACP test safe harbors because the definition of compensation excludes compensation over $75,000.

  6. Example (illustrating compensation): An employer’s section 401(k) plan allows employees to make elective contributions only from basic compensation, defined as salary, regular time wages, bonuses and commissions, and excluding overtime pay. This is a reasonable definition of compensation within the meaning of Regs. 1.414(s)-1(d)(2), but is not necessarily nondiscriminatory. The plan provides for a required matching contribution equal to 100 percent of each eligible employee’s elective contributions, up to 4 percent of compensation. For purposes of the matching formula, compensation is defined as compensation under IRC section 415(c)(3). Under the plan, each NHCE who is an eligible employee is permitted to make elective contributions equal to at least 4 percent of the employee’s compensation under IRC section 415(c)(3) (that is the amount of elective contributions sufficient to receive the maximum amount of matching contributions available under the plan). This plan's definitions of compensation satisfy the safe harbor rules.

4.72.2.12.3  (03-01-2002)
Requirements for Safe Harbor Matching and Safe Harbor Nonelective Contributions

  1. The plan must specify that the safe harbor matching and nonelective contributions are nonforfeitable when made and subject to the withdrawal restrictions of IRC section 401(k)(2)(B) (that is, such contributions and earnings cannot be distributed earlier than separation from service, death, disability, an event described in IRC section 401(k)(10), or age 591/2 for a profit-sharing or stock bonus plan).

4.72.2.12.4  (03-01-2002)
ADP Test Safe Harbor Requirements

  1. To satisfy the ADP safe harbor, a CODA must satisfy the safe harbor contribution requirement and the notice requirement of IRC section 401(k)(12).

  2. The safe harbor contribution requirement is satisfied for a plan year if the plan satisfies either the matching contribution requirement or the nonelective contribution requirement. Safe harbor matching or safe harbor nonelective contributions, whichever is used, must be made on behalf of all eligible employees under the plan; meaning, for example, that the plan cannot restrict these contributions to employees employed on the last day of the plan year or to employees who have at least 1,000 hours of service in the plan year. The safe harbor contribution requirement must be satisfied without regard to the integration provisions of section 401(l).

  3. A plan may satisfy the matching contribution requirement by providing for either the basic matching formula or an enhanced matching formula.

    1. The basic matching formula provides matching contributions on behalf of each eligible NHCE in an amount equal to 100 percent of the employee’s elective contributions up to 3 percent of the employee’s compensation, and 50 percent of the employee’s elective contributions that exceed 3 percent of the employee’s compensation but do not exceed 5 percent of the employee’s compensation.

    2. An enhanced matching formula provides matching contributions for each eligible NHCE under a formula that provides an aggregate amount of matching contributions at least equal to the aggregate amount that would have been provided under the basic matching formula at any elective contribution rate, and the rate of matching contributions may not increase as an employee’s rate of elective contributions increases.

  4. For example, a plan provides that matching contributions will be made at the following rates: 100 percent of an employee’s elective contributions that do not exceed 2 percent of compensation and 75 percent of the employee's elective contributions that exceed 2 percent but do not exceed 5 percent of compensation. This formula does not satisfy the enhanced matching formula since the aggregate amount that is provided by this formula is not at least equal to the amount that would have been provided under the basic matching formula at all rates of elective contributions. Under the basic matching formula, matching contributions of 100 percent would be made on the amount of the employee's elective contributions that do not exceed 3 percent of compensation. Under the plan’s formula, the amount of matching contributions at 3 percent is less than 100 percent. For additional examples, see the examples in section V.B.3. of Notice 98-52.

  5. Note that a plan that contains a formula that satisfies the ADP test safe harbor. will not fail the ADP test safe harbor because the plan also provides for discretionary matches. See below or section VI.B.4 of Notice 98-52 for the limitations on the amount of discretionary matches under the ACP test safe harbor.

  6. A matching formula does not satisfy the safe harbor if, at any rate of elective contributions, the rate of matching contributions for an eligible HCE is greater than the rate of matching contributions for an eligible NHCE at the same rate of elective contributions. For example, a plan covers Divisions A and B, both of which have NHCEs and HCEs. If the plan provides for a basic matching formula for Division A and an enhanced matching formula for Division B, (such as 100 percent match of each employee’s elective contributions up to 4 percent of a Division B employee’s section 415(c)(3) compensation), the rate of match for a Division B HCE at a rate of elective contributions of 4 percent is greater than the rate of match for a Division A NHCE at the same rate of elective contributions; therefore, the plan would not satisfy the ADP test safe harbor (see example 5 under section V.B.3 of Notice 98-52).

  7. Generally, the matching contribution requirement is not satisfied if elective contributions by NHCEs are restricted. However, the following restrictions on elective contributions are permitted:

    1. certain reasonable limits on the periods during which employees can make or change their deferral elections;

    2. certain limits on the amount of elective contributions that can be made, for example, an employer can require that elective contributions be made in whole percentages of pay or in whole dollar amounts;

    3. certain limits on the types of compensation that may be deferred; and

    4. limits on elective contributions to satisfy IRC section 402(g) or 415 or on account of suspensions due to hardship distributions or withdrawals of employee contributions.

  8. Despite all of the restrictions just described, there are certain conditions that must be satisfied. For example, as discussed earlier, although a plan sponsor may limit the amount of elective contributions, the employer must permit each eligible NHCE to make sufficient elective contributions to receive the maximum amount of matching contributions available under the plan. For an explanation of restrictions on types of compensation that may be deferred, see the definition of compensation above or section V.B.1.c.iii.

  9. Under Q&A-6 of Notice 2000-3, a safe harbor plan using matching contributions to satisfy the safe harbor contribution requirement can be amended during a plan year to prospectively reduce or eliminate matching contributions and instead use the current year testing method, provided certain notice and election requirements are satisfied.

  10. An alternative to the matching contribution requirement, that can also satisfy the safe harbor contribution requirement, is the nonelective contribution requirement. The nonelective contribution requirement is satisfied if, under the terms of the plan, the employer is required to make a safe harbor nonelective contribution on behalf of each eligible NHCE in an amount equal to at least 3 percent of the employee’s compensation.

4.72.2.12.5  (03-01-2002)
Notice Requirement

  1. The second requirement necessary to satisfy the ADP test safe harbor is the notice requirement, which is satisfied if each eligible employee for the plan year is given written notice of the employee’s rights and obligations under the plan and the notice satisfies the content requirement of section V.C.1. of Notice 98-52 and the timing requirement of section V.C.2. of Notice 98-52, both sections as modified by Notice 2000-3.

  2. The content requirement requires that the notice must describe the safe harbor method in use, making elections, any other plans involved, etc. (with 1999 transition relief). See Q&As -7 and -8 of Notice 2000-3 for information on satisfying the content requirement using electronic media and referencing the plan’s summary plan description.

  3. The timing requirement requires that the plan sponsor must provide notice within a reasonable period before each year. This requirement is deemed to be satisfied if the notice is given to each eligible employee at least 30 days and not more than 90 days before the beginning of each plan year (with special rules for employees who become eligible after such 90th day). Transition relief for 1999 and 2000 is provided.

  4. Under Q&A-1 of Notice 2000-3, the content requirement is modified for a section 401(k) plan that wants to reserve the option of using the safe harbor nonelective contribution method to satisfy the ADP/ACP test for a plan year. Under Q&As -1 and -6 of Notice 2000-3, a supplemental notice (with special content requirements) may have to be given during the plan year.

4.72.2.12.6  (03-01-2002)
ACP Test Safe Harbor

  1. To satisfy the ACP test safe harbor with respect to matching contributions, a plan must satisfy the ADP test safe harbor and limit matching contributions in accordance with IRC section 401(m)(11).

  2. There are three ways to satisfy the matching contribution limitations of IRC section 401 (m)(11):

    1. The plan can provide for the "basic matching formula," described above in the ADP test safe harbor, and for no other matching contributions.

    2. The plan can provide for an "enhanced matching formula," described above in the ADP test safe harbor, but under which matching contributions are only made with respect to elective contributions that do not exceed 6 percent of the employee’s compensation, and no other matching contributions are provided under the plan.

    3. In the case of any other plan, the matching contribution limitations satisfy the ACP test safe harbor if matching contributions are not made with respect to elective contributions or employee contributions that in the aggregate exceed 6 percent of the employee’s compensation, the rate of matching contributions does not increase as the rate of employee contributions or elective contributions increases, and for employees at the same rate of elective contributions or employee contributions, the rate of matching contributions for an HCE does not exceed the rate of matching contributions for an NHCE.

  3. The elective contributions or employee contributions that are used for determining the matching contributions may be restricted only as permitted under the rules for the ADP test safe harbor, above.

  4. A plan that provides for discretionary matches (in addition to nondiscretionary matches needed to satisfy the ADP test safe harbor) can satisfy the ACP test safe harbor if the discretionary matches in the aggregate do not exceed a dollar amount equal to 4 percent of the employee’s compensation. This limitation on matching contributions made at the employer’s discretion does not apply to plan years beginning before 1/1/2000.

  5. The ACP test (not the safe harbor) still applies to a plan with respect to employee contributions and matching contributions that fail to satisfy the ACP test safe harbor.

4.72.2.12.7  (03-01-2002)
Multiple CODAs and Multiple Plans

  1. ADP test safe harbor matching contributions or nonelective contributions may be made to the plan that contains the CODA or to another defined contribution plan that satisfies IRC section 401(a) or section 403(a). If safe harbor contributions are made to another defined contribution plan, the safe harbor contribution requirement must be satisfied in the same manner as if the contributions were made to the plan that contains the CODA. Consequently, each employee eligible under the plan containing the CODA must be eligible under the same conditions under the other defined contribution plan (that is, both plans must have identical eligibility/participation requirements).

  2. In order for safe harbor contributions to be made to another defined contribution plan, that plan must have the same plan year as the plan containing the CODA. However, there is an exception for plans containing CODAs in the case of plan years beginning before 1/1/2000 if:

    1. the safe harbor contribution is allocated as of a date within the plan year of the plan containing the CODA, and

    2. the contribution is made no later than 12 months after the close of that plan year.

  3. The plan receiving the safe harbor contributions does not have to be capable of being aggregated with the plan containing the CODA for purposes of section 410(b).

  4. In addition, safe harbor matching or nonelective contributions cannot be used to satisfy the safe harbor contribution requirements with respect to more than one plan. Thus, these contributions can be used only once to satisfy the safe harbor requirement.

  5. The rules for aggregating and disaggregating CODAs and plans also apply for purposes of the ADP/ACP test safe harbor requirements. Thus, all CODAs included in a plan are treated as a single CODA that must satisfy the safe harbor contribution requirement and the notice requirement. Two plans (within the meaning of Regs. 1.410(b)-7(b)) that are treated as a single plan under permissive aggregation are treated as a single plan for purposes of the safe harbor methods. Conversely, a plan (within the meaning of IRC section 414(I)) that includes a CODA covering both collectively bargained employees and noncollectively bargained employees is treated as two separate plans for purposes of IRC section 401(k), and the ADP test safe harbor need not be satisfied with respect to both plans in order for one of the plans to take advantage of the ADP test safe harbor.

  6. If an HCE is simultaneously an eligible employee under two plans maintained by an employer for a plan year, only one of which is intended to satisfy the ADP/ACP test using the safe harbor methods, and the matching contribution formula of the plan that is not using the safe harbor methods provides greater matching contributions than the formula under the plan that is intended to satisfy the ADP/ACP test using the safe harbor methods, the rules prohibiting an HCE from receiving a greater rate of matching contributions than an NHCE could be violated.

4.72.2.13  (03-01-2002)
Contingent Benefits

  1. An employer may not directly or indirectly condition another employer benefit (other than matching contributions) upon an employee’s election to make or not make elective contributions. This includes benefits under a DB plan, nonelective employer contributions to a DC plan, benefits under a nonqualified plan, the right to make employee contributions, the right to health and life insurance, and the right to employment. If the employer has made an employer benefit conditioned upon elective contributions, the CODA is not qualified. This rule is in the statute to prevent employers from encouraging employees to make or not make elective contributions by linking valuable benefits to the contribution or lack of a contribution.

  2. Participation in a nonqualified plan is treated as a contingent benefit only to the extent an employee may receive additional deferred compensation under the nonqualified plan depending on the employee’s making or not making elective contributions. However, participation in a nonqualified plan is not treated as a contingent benefit if an employee’s participation is conditioned on making the maximum deferrals under IRC section 402(g) or the terms of the plan.

4.72.2.13.1  (03-01-2002)
Examination Steps

  1. Ask whether the employer ties any benefits other than matching contributions to elective contributions. In certain circumstances it may be appropriate to request an interview with employees who make or fail to make elective contributions to see if they get any special treatment from the employer.

  2. Determine whether there is a nonqualified plan linked with the CODA. If there is, ensure there are no conditions in the form or in the operation of the nonqualified plan that are dependent on participation, lack of participation, or reduced participation in the CODA.

4.72.2.14  (03-01-2002)
Cafeteria Plans

  1. IRC section 125 permits an employer to maintain a "cafeteria plan." A cafeteria plan allows an employee to select among various types of employer benefits by specifying where an employer contribution should be spent.

  2. Cafeteria plans are permitted to offer a contribution into a qualified CODA as one of the options, but if it does, another option in the cafeteria plan must be a cash payment to the employee equal to the amount contributed to the cafeteria plan.

4.72.2.14.1  (03-01-2002)
Examination Step

  1. Ask whether the employer has a cafeteria plan that allows a contribution to the CODA. Review the options available to the cafeteria plan participants to ensure that receiving cash is one of the listed options.

4.72.2.15  (03-01-2002)
Top-Heavy Rules

  1. CODAs (but not SIMPLE 401(k) plans) are subject to the top-heavy rules in IRC section 416. If a plan containing a CODA is top-heavy, then the plan must:

    1. vest contributions that are not immediately fully vested at a certain minimum rate and

    2. provide each nonkey employee who is employed on the last day of the plan year with a contribution equal to 3 percent of the employee’s compensation for the entire year or, if lesser, the same percentage as the key employee with the highest percentage contribution. Thus, if the highest percentage contribution given to a key employee was 4 percent, then nonkey employees must each receive a 3-percent contribution. But if the key employee with the highest percentage contribution got a 2-percent contribution, then nonkey employees need only be given a 2-percent contribution.

  2. Elective contributions on behalf of key employees must be taken into account in determining the minimum contribution required for nonkey employees, but elective contributions of nonkey employees do not count towards satisfying the minimum contribution. Thus, if the only contributions made to a profit-sharing plan for a year were elective contributions and all participants, keys and nonkeys, made deferrals of 2 percent, then, if the plan was top-heavy, the employer would have to make a 2-percent contribution to the plan for all the nonkeys. See Regs. 1.416-1, M-20.

  3. Similarly, nonkey employee matching contributions used in the ACP test (and QMACs used in the ADP test) are not counted towards satisfying the nonkey minimum contribution. QNECs, however, whether or not used to satisfy the ADP test, can be used to satisfy the nonkey minimum contribution. See Regs. 1.416-1, M-18.

  4. If it is determined that the top-heavy minimums are provided in another plan, and the eligibility requirements are not the same for both plans, then eligible participants in the section 401(k) plan may not be receiving the minimum benefit in the other plan and therefore must receive a minimum benefit in the section 401(k) plan.

4.72.2.15.1  (03-01-2002)
Example

  1. An employer maintains a money purchase pension plan and a profit-sharing plan with a CODA. The money purchase plan requires 1 year of service for eligibility and provides a contribution of 10% of compensation to all eligible participants.

  2. The profit sharing plan also requires 1 year of service for the profit-sharing portion of the plan but requires only 3 months of service for the CODA portion. In this case, those employees who are eligible for the CODA portion of the plan who have not yet met the eligibility requirements of the money purchase pension plan, are entitled to a minimum top-heavy contribution in the CODA plan, if it’s top-heavy.

  3. The minimum contribution required depends on the allocations to key employees in the CODA plan.

4.72.2.15.2  (03-01-2002)
Examination Steps

  1. Inspect the plan document to determine if the vesting schedule meets the requirements of IRC 416 and verify that the plan follows the schedule in operation.

  2. If another plan is maintained, determine which plan provides the top-heavy minimum benefit.

  3. Verify that all nonkey employees eligible to participate in the CODA who are employed on the last day of the plan year are receiving the top-heavy minimum benefit. If this benefit is provided in another plan, compare the allocation schedule to the list of eligible employees used for the ADP testing in the CODA plan. The list should include all employees who meet the eligibility requirements of the CODA including those who do not elect to contribute under the CODA. If discrepancies are noted, request a complete list of all employees employed on the last day of the plan year who met the eligibility requirements of the CODA. Inspect payroll or other employment records to verify information provided.

  4. Verify that all eligible nonkey employees under the plan are receiving an employer contribution of at least 3% of compensation, (or the highest contribution to any key employee, if less than 3%),

  5. If the employer has made QNECs for the plan year, they may be used to satisfy the top-heavy minimum contribution requirements even if they were used to satisfy the ADP test.

  6. QMACs used to satisfy the ADP test or the ACP test may not be used to satisfy the top-heavy minimum contribution requirements. If the QMAC’s are used to satisfy the top-heavy minimum, they may not be counted as a matching contribution.

  7. Elective contributions of nonkey employees may not be counted to satisfy the top-heavy minimum contribution requirements. However, elective contributions made on behalf of key employees are counted to determine the percentage of compensation required under the top-heavy minimum contribution.

4.72.2.16  (03-01-2002)
IRC Section 415 Rules

  1. A plan can use a number of definitions of compensation for determining allocations (but only to the extent the definition is stated in the plan). However, for IRC section 415 purposes, a different definition may be needed.

  2. As previously noted, for limitation years beginning after 1997, IRC section 415(c)(3) was amended to provide that the definition of compensation includes elective contributions, IRC section 132(f)(4) elective amounts and deferrals made under section 125 and section 457 plans. Under IRC section 414(s), a plan can use a definition that excludes all of these types of contributions.

  3. Regs. 1.415-6(b)(6) was amended to provide that elective contributions that constitute excess annual additions may be distributed to an employee if the excess was due to certain errors, such as, a "reasonable error in determining the amount of elective deferrals that may be made with respect to an individual under IRC section 415." Of course, the plan must have such correction language in the plan document. See Rev. Proc. 92-93, 1993-2 C.B. 505, for information on the correction method.

  4. If the plan distributes the elective contributions to correct an IRC section 415 problem, the ADP test may have to be run again for each year involved, since the amounts distributed under Regs. 1.415-6(b)(6)(iv) cannot be used in the ADP test. In addition, if the elective contribution distributed is tied to a matching contribution, the remaining matching contribution may be discriminatory if the employee receiving the distribution is a HCE. There is no mechanism for either forfeiting or distributing this discriminatory matching contribution, but Regs. 1.401(a)(4)-11(g)(3)(vii)(B) provides a method of correcting discriminatory matching contributions (if the problem is discovered and can be corrected within 101/2 months after the end of the plan year).

4.72.2.16.1  (03-01-2002)
Examination Steps:

  1. Review Form 5500, Schedule H or I, Item 2(f), for disclosure of distributions made to correct IRC section 415 excess annual additions.

  2. Review plan financial audit reports and corporate minutes for comments that address section 415 concerns.

  3. Check the W-2 information for IRC section 415 excess amounts.

  4. Determine whether the employer maintains more than one plan. If yes, verify that annual addition calculations reflect contributions made to all defined contribution plans and employee contributions to defined benefit plans maintained by the employer. Ensure that the elective deferrals to all IRC section 401(k) plans and similar arrangements and salary reduction contributions to cafeteria plans are included in compensation for purposes of IRC section 415 testing.

  5. Review the plan document for IRC section 415 limitation language and methods of correction of excess amounts. If there were IRC section 415 excesses during the year, verify that the correction method was proper and complied with the plan document. If the plan corrected an IRC section 415 problem by distributing elective contributions, determine whether the employer met the requirements for such correction (see Regs. 1.415-6(b)(6)), re-ran the ADP test without the distributed amounts, and whether there were any matching contributions tied to those distributed amounts.

  6. Check the plan definition of compensation for allocation or elective contribution purposes. If the definition does not satisfy IRC section 415, and the overall contribution levels or percentages are high, determine whether the 415 limits have been met using the IRC section 415 definition of compensation.

4.72.2.17  (03-01-2002)
Annual Statutory Limits Applicable to CODAs

Year 402(g) 401(a)(17) 414(q) 415(c) TWB
2001 10,500 170,000 85,000 35,000 80,400
2000 10,500 170,000 85,000 30,000 76,200
1999 10,000 160,000 80,000 30,000 72,600
1998 10,000 160,000 80,000 30,000 68,400
1997 9,500 160,000   30,000 65,400
1996 9,500 150,000   30,000 62,700
1995 9,240 150,000   30,000 61,200
1994 9,240 150,000   30,000 60,600
1993 8,994 235,840   30,000 57,600
1992 8,728 228,860   30,000 55,500
1991 8,475 222,220   30,000 53,400
1990 7,979 209,200   30,000 51,300
1989 7,627 200,000   30,000 48,000
1988 7,313 –   30,000 45,000
1987 7,000 –   30,000 43,800

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