There is little formal guidance for this type of correction. The formal guidance that exists is in EPCRS (see option 1). The EPCRS process may not always be desired by the employer. Therefore, many plan documents now provide a procedure that IRS has approved to be followed. Below listed are the most commonly used correction procedures.

Option number 2 and 3 are to be adopted by the employer and were included in the GUST prototype documents.

IMPORTANT 2008 CHART UPDATE:
Options 2 and 3 have not been approved as part of the EGTRRA prototype documents.

Thus, for employer's adopting the EGTRRA prototype defined contribution plan document, these two options will no longer be available as a plan document provision.

1. EPCRS procedure* to retroactively amend the plan to include such an employee.
2. Distribute the elective deferrals and the associated earnings to the individual who made them in the plan year in which the discovery is made. This option should only be used if the document provides for it.
3. Forfeit from the ineligible employee's account. Allocate the forfeiture as stated in the plan document. Reimburse the employee and adjust for earnings.
   
   

Excess and earnings should be taxed in year returned to employee.

Participant’s W-2 had been reduced by the elective deferral and the refund of the elective deferral is reported on a 1099R.

If not corrected within 12 months of the contribution, file under VCP or self-correct under SCP.

1099R issued for affected participant(s).

If the ineligible participant's deferrals had been included in the ADP test, the test would have to be done over without those deferrals.

Option 1, EPCRS revenue procedure 2008-50 rules for retroactively amending the plan (from Appendix B, Section 2.07(3))
"Inclusion of Ineligible Employee Failure. (a) Plan Amendment Correction Method. The Operational Failure of including an ineligible employee in the plan who either (i) has not completed the plan's minimum age or service requirements, or (ii) has completed the plan's minimum age or service requirements but became a participant in the plan on a date earlier than the applicable entry date, may be corrected by using the plan amendment correction method set forth in this paragraph. The plan is amended retroactively to change the eligibility or entry date provisions to provide for the inclusion of the ineligible employee to reflect the plan's actual operations. The amendment may change the eligibility or entry date provisions with respect to only those ineligible employees that were wrongly included, and only to those ineligible employees, provided (i) the amendment satisfies §401(a) at the time it is adopted, (ii) the amendment would have satisfied §401(a) had the amendment been adopted at the earlier time when it is effective, and (iii) the employees affected by the amendment are predominantly nonhighly compensated employees.

(b) Example

Example 25

Employer L maintains a 401(k) plan applicable to all its employees who have at least six months of service. The plan is a calendar year plan. The plan provides that Employer L will make matching contributions based upon an employee's salary reduction contributions. In 2001, it is discovered that all four employees who were hired by Employer L in 2000 were permitted to make salary reduction contributions to the plan effective with the first weekly paycheck after they were employed. Three of the four employees are nonhighly compensated. Employer L matched these employees' salary reduction contributions in accordance with the plan's matching contribution formula. Employer L calculates the ADP and ACP tests for 2000 (taking into account the salary reduction and matching contributions that were made for these employees) and determines that the tests were satisfied.

Correction:

Employer L corrects the failure under SCP by adopting a plan amendment, effective for employees hired on or after January 1, 2000, to provide that there is no service eligibility requirement under the plan and submitting the amendment to the Service for a determination letter.