Facts
Every couple of years, our 401(k) plan fails the ADP/ACP test by a small margin. Since we don’t always fail the test, gathering our year-end census information to send to our TPA sometimes isn’t as high a priority as some of the other projects necessary to close out the year.
Question
Is there a timing deadline to run the tests each year and to make any corrections if there is a failure?
Answer
Let’s start with a quick recap of what the ADP and ACP tests are. They are nondiscrimination tests that limit the benefits that highly compensated employees can receive based on the benefits provided to non-HCEs. The ADP test reviews employee salary deferrals, and the ACP test reviews company matching contribution.
If the test results fall outside the allowable range, there are generally three options for correction:
- Refund contributions to HCEs,
- Make additional contributions to non-HCEs, or
- A combination of refunds and additional contributions.
There are three different timeframes that come into play when thinking about deadlines for correction.
December 31 of the Following Year
The regulatory deadline to correct a failed ADP/ACP test is within 12 months following the close of the plan year of the failure. So, for a calendar year plan that fails the ADP test for 2017, the deadline to complete the correction is December 31, 2018. Easy enough, right? Well, sort of…
March 15 of the Following Year
Even though the correction deadline is not until December 31, 2018, the company must pay an excise tax to the IRS for any corrective refunds that are not paid within two and a half months following the year of the failure—March 15, 2018 for our calendar year plan. The excise tax is equal to 10% of the amount being refunded. It is important to note, however, that if the company is correcting the ADP/ACP failure via additional contributions to non-HCEs, the excise tax does not apply even if those contributions are made after March 15.
After December 31 of the Following Year
If the test failure is not corrected by the regulatory deadline, all is not lost. Correction can still be made, but the IRS imposes some additional obligations and restrictions as further penalty for not being timely. For starters, if a failed test is not corrected by the following December 31, the plan is not allowed to take advantage of certain testing alternatives that can improve the results. That means if the plan failed the ADP/ACP using one of those alternative testing methods, the tests must be re-run without those special methods, and correction must be made based on the more negative results.
Secondly, making correction only via refunds to HCEs is not available. In other words, any correction made after December 31 of the following year requires some level of additional contributions to the non-HCEs. The IRS correction program provides two basic avenues:
- Make additional contributions to non-HCEs, or
- Make corrective refunds to the HCEs and contribute an equal amount to the plan to be allocated among the non-HCEs.
So, the good news is that no matter how long it has been since your plan failed the ADP/ACP test, it is not too late to correct. The bad news, however, is that the longer you wait, the fewer options you have and the more expensive the correction may turn out to be. If you wait too long and the IRS catches the uncorrected failure before you do, things could rapidly go from bad to worse.
If you are facing test failures, give us a call. Not only are we able to help you correct past failures, but we can also help review your plan’s design to minimize or prevent such failures from occurring the future.
For more information on nondiscrimination testing, please visit our Knowledge Center here and here. For more on qualified plan compliance, visit here.
