Correction
Rev. 04/30/10; E-mail Alert 2010-7

Correction for the exclusion of an eligible employee from a 401(k) plan. The correction method under the IRS’ Employee Plans Compliance Resolution System (EPCRS) originally called for qualified nonelective employer contributions (QNECs) equal to the average of the actual deferral percentage (ADP) for either the nonhighly compensated employees (NHCEs) or of the Highly Compensated Employees (HCEs) depending on which group the employee was a member of during the time the employee was incorrectly excluded from the plan. Since the Rev. Proc. 2006-27 version of EPCRS, the correction method requires a QNEC equal to only 50% of the applicable ADP average  during the exclusion period; since the employee continued to get their full compensation during the period they were erroneously excluded.  The 50% is called the missed opportunity amount. They also have to receive the full (not 50%) match and earnings that would have been otherwise received.

Correction for the exclusion of an eligible employee from a safe harbor 401(k) plan

EPCRS has special rules for the exclusion of an eligible employee from a safe harbor 401(k) plan. A safe harbor plan with a nonelective contribution (NEC) has different correction rules then a safe harbor matching contribution plan. The 50% of the group average method is not used.  

Correction under a safe harbor 401(k) nonelective contribution plan
If the safe harbor is a 3% NEC, the amount of the missed deferral is deemed to be 3%, regardless of the group average. The amount the employer must make-up is 50% of the 3% deferral and all of the 3% safe harbor nonelective contribution.

Example 1
Plan is a safe harbor 401(k) with a 3% NEC and no other employer contributions. The employee should have entered the plan on January 1, 2009. The employee never had the opportunity to elect to defer. This is discovered in January 2010. The individual’s compensation for 2009 was $30,000. The correction is made on the missed deferral opportunity of 50% of 3%. The employer must also contribute the safe harbor 3% nonelective. In addition, the earnings must be calculated and added to this corrective contribution.  For simplicity, we will assume the correction time period was exactly one year. The correction would be $450 (50% of 3% x $30,000) of missed opportunity and $900 (3% x $30,000) for the safe harbor nonelective, plus earnings.

Correction under a safe harbor 401(k) basic matching contribution plan
If the safe harbor plan uses the safe harbor basic matching formula, the correction is based on 50% of the estimate of the missed deferral. The missed deferral is based on the amount of match that is provided at a 100% rate. In the basic match the first 3% are provided a 100% match. So the missed deferral would be 3%, and the missed deferral opportunity would be 50% of that. The safe harbor match on the 3% missed opportunity would also be provided.

Example 2
We will use the same facts as example 1, except that this is now a safe harbor basic matching contribution plan. The missed deferral opportunity is 50% of 3%. The missed safe harbor matching opportunity would be 100% of 3% and the amount would be adjusted for earnings.

Correction under a safe harbor 401(k) enhanced matching contribution plan
If the plan is offering a 100% match on more then 3%, the missed deferral opportunity would be based on the higher match percentage that is being provided at 100%.

Example 3
Plan is a safe harbor 401(k) with an enhanced safe harbor match formula of 100% match on the first 5% deferred. There are no other employer contributions. The employee should have entered the plan on January 1, 2009. The employee never had the opportunity to elect to defer. This is discovered in January 2010. The individual’s compensation for 2009 was $30,000. The missed deferral opportunity cost would be 50% of 5% of $30,000, equaling $750. The missed safe harbor enhanced matching 100% of 5% of $30,000, equaling $1,500. The total corrective contribution would be $2,250 plus earnings.

Note: If a plan has other employer contributions, such as a discretionary match, hard-coded match formula (or a nonelective contribution), the employer would have to make the employee whole for those amounts using the full match that would have been earned on the missed deferral, plus earnings.

Caveat for controlled groups: A potential follow-up issue is who has to get the safe-harbor amounts. The eligible group may be larger than the employer realized.  If the employer sponsoring the plan is part of a controlled group and coverage could not be passed without including the employees of the other company within the controlled group, all those employees who must be made eligible retroactively to pass coverage testing must be treated as if they also were wrongfully excluded and must receive the corrective contributions.

For Reference, below is RP 2008-50, Appendix A, Section .05(2)(d)

"(d) If the employee was not provided the opportunity to elect and make elective deferrals (other than designated Roth contributions) to a safe harbor §401(k) plan that uses a rate of matching contributions to satisfy the safe harbor requirements of §401(k)(12), then the missed deferral is deemed equal to the greater of 3% of compensation or the maximum deferral percentage for which the employer provides a matching contribution rate that is at least as favorable as 100% of the elective deferral made by the employee. This estimate of the missed deferral replaces the estimate based on the ADP test in a traditional § 401(k) plan. The required QNEC on behalf of the excluded employee is equal to (i) the missed deferral opportunity, which is an amount equal to 50% of the missed deferral, plus (ii) the matching contribution that would apply based on the missed deferral. If an employee was not provided the opportunity to elect and make elective deferrals to a safe harbor §401(k) plan that uses nonelective contributions to satisfy the safe harbor requirements of §401(k)(12), then the missed deferral is deemed equal to 3% of  compensation. The required QNEC on behalf of the excluded employee is equal to (i) 50% of the missed deferral, plus (ii) the nonelective contribution required to be made on behalf of the employee. The QNEC required to replace the employee’s missed deferral opportunity and the corresponding matching or nonelective contribution is adjusted for earnings to the date the corrective QNEC is made on behalf of the affected employee."

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