“If the test fails, we make corrective distributions to certain Highly Compensated Employees (HCEs) as directed by the correction process (we realize that we can make additional contributions in the form of QMACs to NHCEs to correct the error as well, but the cost of doing that would be prohibitive for our organization).
“My question relates to the timing of our corrective distributions. Our vendor indicates that the deadline for the corrective distributions is March 15 (2 ½ months after the close of the plan year, and we utilize a calendar year as our plan year). However, our adviser states that the deadline for correction is not until 12 months after the close of the plan year, or December 31 in our case. Who is correct?”
Michael A. Webb, vice president, Retirement Practice, Cammack LaRhette Consulting, answers:
Another excellent question! With the wisdom of Solomon, the Experts are pleased to inform you that BOTH your vendor AND your adviser are indeed correct!How is this possible? The reason both answers are correct is a subtle distinction between the statutory deadline for correction and the statutory deadline for penalty-free correction. The statutory deadline for corrective distributions is indeed 12 months after the close of the plan year, or December 31 for calendar-year plans (Treas. Reg. 1.401(k)-2(b)(5)(ii)).
However, Treas. Reg. 1.401(k)-2(b)(5)(i) states, if corrective distributions are not made by 2 ½ months following the close of the plan year (March 15 for calendar-year plans), the employer must pay a penalty in the amount of 10% of the principal amount of the excess. Note that this figure is NOT 10% of the total amount of the distribution, since that amount is adjusted for earnings; it is only 10% of the excess, unadjusted for earnings.
Years ago, it was relatively rare for plans to complete their testing by the March 15 deadline in order to avoid the 10% penalty, for two reasons: a) it was difficult, if not impossible, to collect testing data, perform the test, and make corrective distributions (if applicable) in only 2 ½ months, and b) prior to 2008, corrective distributions issued prior to March 15 were taxed in the year of test failure (i.e. the year PRIOR to distribution), which created difficulties for HCEs who had already filed their prior year tax returns prior to March.
However, with advances in technology, along with regulatory changes (all corrective distributions are now taxable in the year of receipt, negating any prior year filing issues), more and more plan sponsors are now completing ACP testing and any related corrective distributions by March 15. However, if such a timeframe is desired, the time for plan sponsors to work with their vendors is now so the proper data can be collected in the most efficient fashion. Fortunately, many vendors now collect testing data throughout the year, mitigating the need for additional data to be collected after the close of the year.
Finally, though it should be noted that the statutory deadline for completion of corrective distributions is 12 months after the close of the plan year, it is possible to utilize the IRS’ EPCRS program for correction of plan defects to issue corrective distributions after the statutory deadline has passed.
Good luck with your ACP testing!
NOTE: This feature is to provide general information only, does not constitute legal advice, and cannot be used or substituted for legal or tax advice.