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Note - Any federal tax advice contained in this transcript is intended to apply to the specific situation described and should not be considered official guidance independent of the presentation. The tax advice and statements contained herein should not be relied upon for retirement planning purposes without first consulting a tax or retirement planning professional. This transcript has been edited for technical accuracy and may differ slightly from the audio recording of the 401(k) Plan Mistakes phone forum. This information is current as of September 7, 2012. Since changes may have occurred, no guarantees are made concerning the technical accuracy after that date.

NOTE: Rev. Proc. 2013-12 supersedes Rev. Proc. 2008-50 (discussed in this program). Please see the EPCRS phone forum held on Feb. 21, 2013 for the Rev. Proc. 2013-12 presentation.

Brenda:  Hi everyone! I'm Brenda Smith-Custer with IRS Employee Plans Customer Education and Outreach. Welcome to our Correction of 401(k) Plan Mistakes phone forum. We'll be hearing from two of our experts in this area, Avaneesh Bhagat and Sherri Morris, who will discuss how to correct common mistakes in 401(k) plans.

Before we start, I'd like to point out a couple of things. Everyone who registered for this forum will receive a Certification of Completion by email in about a week as long as you would attend the entire live forum. Enrolled agents, enrolled retirement plan agents, and enrolled actuaries are entitled continuing education credit for this session. Other types of tax professionals should consult their licensing organization to see if today's session qualifies for continuing education credit.

As with all of our presentations, the comments expressed by our speakers should not be construed as formal guidance from the IRS. For more information on correcting common mistakes in 401(k) plans, please visit our retirement plans website at and select "Correcting Plan Errors" in the left navigation bar.

Now, let's hear from Sherri Morris.

Sherri:  Thanks, Brenda. Due to the short amount of time we have this morning and because we want to address as many of the questions we received as possible, I'll just touch on some of the points contained in the handout before turning the platform over to Avaneesh who will address as many of the questions we received as time permits.

Before getting started, I want to mention that because we can't address everything in the handout and because you may want to use it as a resource to refer back to, on page two of the handout, you'll find what I hope is a useful Table of Contents showing you where different topics are addressed.

With that, let me begin by reviewing the basic correction principles found in Section 6 of Revenue Procedure 2008-50, or what I'll call simply 2008-50. These principles underscore all correction methods for document, operational, and demographic failures including the specific 401(k) failures we're addressing today. You'll find these correction principles listed on pages three to five of your handout.

The first correction principle is that full correction includes all taxable years whether or not such years are closed. Next, the correction method should restore the plan and its participants to the position they would have been in had the failure not occurred. Third, the correction should be reasonable and appropriate for the failure. The correction methods found in Appendix A and Appendix B of 2008-50 are deemed reasonable. Although other methods may be acceptable particularly when they're consistent with the Internal Revenue Code, which includes the plan requirements in Code Section 401-8 when they provide benefits to non-highly compensated employees and when they keep assets in the plan.

2008-50 provides some exceptions to the requirement of full correction, which you'll find detailed on page five of the handout. The one I want to particularly draw your attention to this morning concerns locating lost participants. As you may have heard, with the issuance of new Revenue Procedure 2012-35, once again, that's Rev. Proc. 2012-35 issued on August 31st, the services letter-forwarding program to assist in locating lost participants is no longer available. The impact of this is two-fold.

If you're preparing future submissions for the Voluntary Correction Program, or VCP for short, you shouldn't include the IRS letter-forwarding program as a method to locate lost participants. Also, if you have a current submission, which includes the use of the program particularly if no alternative methods of locating participants have been proposed, you may be asked by the agent or tax law specialist working that submission to revise that portion of your proposed correction method.

Okay, let's see how the correction principles I've just mentioned play out in the context of some specific 401(k) failures starting with the exclusion of eligible employees. You'll find this described beginning on page eight of your handout. Let's assume the exclusion of an eligible employee has occurred in a non-safe harbor plan. Because the employee was excluded, we don't know what he or she will have deferred. So we use the information we do have which is the actual deferral percentage that other participants in the excluded participants, HCE or NHCE, category deferred multiplied by the excluded participant's compensation for the period of exclusion. We call this the missed deferral. The plan sponsor is required to contribute 50% of this amount on behalf of the excluded participant, what we call the missed deferral opportunity.

The form of contribution the employer must make is called a Qualified Non-Elective Contribution or QNEC. The QNEC have to be adjusted for earnings. Also, if the plan provides matching contributions, the employer also has to make a corrective contribution for the excluded employee equal to whatever the match would have been on the missed deferral amount.

Let's do an example. Assume an employer has Non-Safe Harbor 401(k) Plan that doesn't include any matching contributions and let's assume that Marlena who was in NHCE was excluded for an entire plan year during which she had $80,000 of plan compensation. The ADP for NHCEs in this plan during the year Marlena was excluded was, let's say, 8%. Here, we compute the missed deferral as 8% times Marlena's $80,000 plan compensation, which works out to be $6,400 and the missed deferral opportunity is half this amount or $3,200. The employer is going to have to contribute this $3,200 to the plan as a QNEC on Marlena's behalf together with earnings.

Starting on page eight in the handout, you'll find more information about what happens if in this example Marlena had been only excluded for part of the year, how to compute the corrective matching contribution if the plan offers such match, and what the correction would be if instead of a non-safe harbor plan, Marlena had been excluded from a safe harbor plan. A Safe Harbor Plan, just to clarify, is one in which the employer makes a specified safe harbor matching contribution or non-elective contribution on behalf of NHCE, and by doing so is deemed to pass the ADP test, which we'll talk about in a few minutes.

Speaking of Safe Harbors or Safe Harbor Plans, a failure we sometimes see in VCP is the failure to provide the required annual safe harbor notice. This is a notice that contains details about the plan and its features. The failure to give a notice could result in an employee not being able to make deferrals because they either didn't know about the plan or know how to make their deferral elections. In that case, the missed deferral is deemed to be equal to the greater of 3% of compensation or the maximum deferral percentage for which the employer provides a 100% match on the deferred amount.

Again, the corrective contribution for this failure must include earnings and any required matching contribution. What happens if the employer failed to give the safe harbor notice yet the employee was able to make an informed timely deferral election and all required matching contributions and non-elective contributions were made on such deferral? Here, the employer doesn't really seem to have been harmed. It could be the employee doesn't really seem to have been harmed by the failure to have received the notice. Therefore, an appropriate correction in this case might, depending on all the facts, be simply to amend the employer's administrative procedures going forward to ensure all participants receive the required safe harbor notice.

An increasingly popular option for plans is to adopt an automatic enrollment feature whereby participants automatically have a pre-designated percentage of their compensation deferred unless they specifically elect a different percentage. There are two kinds of failures I'll address with respect to automatic contribution arrangements. The first is a situation is where even though the plan provides for an automatic contribution, the plan sponsor fails to implement it and the employee has not made an overriding election.

In that case, the net effect is that no deferral is made for such employee. Although there's no specific correction outlined in 2008-50 for this, it may be reasonable to treat the plan sponsor as having failed to implement an employee deferral election and apply the correction for that kind of failure. That would result in a missed deferral being the automatic enrollment deferral percentage multiplied by the employees plan compensation and the required corrective contribution would be 50% of this amount.

What if instead the employee never received the enrollment material and therefore never had an opportunity to make a meaningful decision about whether or not to accept the automatic deferral percentage? In that case, the employee is treated as an excluded participant and we look to the ADP for the employee's NHCE or HCE group, multiply this by the employee's plan compensation, and a corrective contribution equal to 50% of this amount must be made by the plan sponsor.

Another plan feature that's been around since 2006 is the right of plan sponsors to amend their 401(k) plans to allow employees to make their 401(k) contributions to a designated Roth account. This is different, of course, than a Roth IRA. Here, the participant makes their deferral to the 401(k), but for each dollar deferred the participant gets to select whether that dollar will go into a tax deferred 401(k) account or whether that's all it will be taxed currently but contributed to a Roth 401(k) account. A participant's combined elective deferrals whether to a traditional 401(k) or Roth 401(k) or to both, can't exceed the annual 402(g) limit, taking into account any permitted catch-up contributions. Thus, every dollar contributed to a Roth 401(k) account counts against the employees annual 402(g) limit on contributions.

I want to give you a bit of additional background about Roth 401(k)'s. First, a later withdrawal of contributions and earnings from a Roth 401(k) isn't taxed if it's a qualified distribution. Qualified distribution means that the account has been held for at least five years and that the distribution is made because of a disability, after death, or after attainment of age 59 ½. However, matching contributions on designated Roth contributions do not receive the favorable tax-free on distribution, Roth tax treatment.

I also want to kind of take a minute here and just contrast such Roth 401(k) contributions with after-tax employee contributions. After-tax employee contributions are contributions from compensation other than Roth contributions that an employee has to include in income on his or her current tax return. At the time of distribution, the employee pays no tax on the portion of the distribution attributed to the after-tax contribution he or she made but unlike in a Roth account, does have to pay tax on any gains.

Okay, so let's go back to Roth 401(k)'s. There are primarily three types of failures we see in VCP. The first is really just an offshoot of what happens if an employee has been wrongfully excluded from the plan but the plan happens to allow Roth 401(k) contributions. There, we just have our normal excluded employee correction, which is the QNEC based on the missed deferral opportunity which is computed using the ADP for the employee's NHCE or HCE category, but one thing to keep in mind is that the corrective contribution can't be treated as a designated Roth contribution. That means it can't be included in the employee's gross income and can't be contributed or allocated to a designated Roth account.

The second of the common failures involving Roth 401(k)'s that we see involves an employer who withholds and deposits pre-tax deferrals for a participant who actually had elected after-tax Roth deferrals. There's no standard correction for this in 2008-50, but if you look on page 35 of your handout, you'll see some suggested possibilities for handling this kind of failure. The third failure is absolutely just the reverse problem, which is when a plan withholds and deposits Roth deferrals for a participant who elected pre-tax deferrals. Again, there's no identified correction in 2008-50 but you'll see a possible way of correcting this failure on page 36 of the handout.

Okay, let's leave Roth 401(k) failures and turn now to the issue of compensation and really to one of the more common kinds of failures we see in VCP, which involves failing to apply a participant's deferral election to an element of compensation such as overtime or bonuses or, conversely, applying the deferral election to something that isn't part of compensation under the plan's definition of compensation.

Let's start with missed deferrals attributable to excluded elements of compensation. In that case, the employee's elected percentage of compensation is used to determine the amount the employee would have deferred from the excluded elements. The corrective contribution for the missed deferral opportunity equals 50% of the missed deferral, and of course, is adjusted for earnings. If the plan calls for matching contributions or the employer makes profit sharing contributions to the plan, a corrective contribution has to be made equal to the full matching contribution or profit sharing contribution that the employee would have received had the deferral election been applied properly to all elements of compensation.

For example, let's say a plan document provides that bonuses are included in the definition of compensation. Allen receives a $20,000 bonus in 2010 but the employer failed to apply Allen's 5% deferral election to that bonus. Let's also say that the employer decided to make a discretionary profit sharing contribution equal to 6% of compensation on behalf of each employee, but in operation, the contribution was calculated without regard to Allen's bonus. The missed deferral for Allen is $1,000 which is Allen's 5% deferral election applied to the $20,000 element of compensation on which the employer failed to apply that deferral percentage. The employer must contribute 50% of this amount, $500, plus earnings to Allen's account. But Allen should also receive a $1,200 contribution for the discretionary profit sharing contribution, which is the 6% discretionary profit sharing contribution applied to the $20,000 bonus.

Let's take a look at the converse situation where an employer applies a participant's deferral election to items that weren't included in the plan's definition of compensation. Here, the employer generally is required to make a distribution of the excess elective deferrals plus earnings to the participant. Any discretionary profit sharing contribution or matching contribution made with respect to such excess is forfeited and either re-allocated to other participants or used to offset future employer contributions depending on the terms of the plan. Unlike the situation where the employer fails to apply the participant's deferral election to an item that is compensation under the plan so that the participant has been shortchanged of making their full deferral; here, the employer had applied the election to something that would have been eligible to be included in the plan's definition of compensation, but wasn't.

Therefore, it may be natural to want to fix such failure by simply retroactively amending the plan to include the additional element of compensation. In appropriate cases, this indeed might be an alternative to distributing the excess elective deferral but would only be an acceptable correction if there was no discriminatory impact under Code Section 401(a)(4) or cutback under Code Section 411(d)(6). You'll find this discussed on page 41 of the handout.

That leads us to the next kind of failure I want to touch on this morning and that involves ADP and ACP testing failures. Just to give you a bit of background, testing is designed to ensure that the amount of contributions made by and for rank-and-file employees will be called the NHCEs, are proportional to the contributions made for owners and managers, the HCEs. Let's focus on the ADP test, although your handout contains materials about both ADP and ACP testing.

The ADP test is met if the ADP for the eligible HCEs doesn't exceed the greater of 125% of the ADP for the group of NHCEs or the lesser of 200% of the ADP for the group of NHCEs or the ADP for the group of NHCEs plus 2%. I know that that's a mouthful, but you'll find this on page 43 of your handout. In most cases, you look at the ADP for the HCEs and there's a problem if it exceeds the ADP of the NHCEs by more than two percentage points. If the score is greater than two percentage points, one correction method is to determine the amount necessary to raise the ADP of the NHCEs to the percentage needed to pass the test and the plan sponsor makes a QNEC for the NHCEs in such amount.

The contribution generally has to be the same percentage for each participant and you'll find this discussed also on page 43 of the handout. An alternative to making a QNEC for the NHCEs is to use what's called the one-to-one correction method. This involves making a distribution of the excess contribution amounts to the HCEs and contributing the same dollar amount in the form of the QNEC to the plan allocating a pro rata based on compensation to all eligible NHCEs. In some cases, this may be less costly to the employer than the cost of just increasing the ADP of the NHCEs.

There is something I want to highlight this morning about QNECs just so that we're clear. A QNEC has to be a contribution that's fully vested at all times. This means forfeitures can't be used to fund QNECs made to correct failed ADP and ACP tests because forfeitures typically represent the non-vested portion of terminated participant's accounts. Basically, QNECs have to be new money contributed to the plan. Let's take a minute to illustrate what we just talked about concerning failed ADP testing using a simple example.

This example is a bit of a variation of what you'll find in your handout. Let's assume an employer discovers that due to mistakes made in ADP testing a couple of plan years ago, let's say 2010, the HCEs actually had an ADP of 7%, the NHCEs had an ADP of 4%. Therefore, the plan failed ADP testing because the spread was greater than two percentages points. Here, the maximum passing percentage ADP for the HCE group is 6%. Let's assume there were only two HCEs and that they each deferred 7% of their $200,000 plan compensation. To keep this simple, let's also assume there were no matching or other employee contributions for the 2010 plan year. If the employer comes into VCP with a failure, it can make a QNEC on behalf of the NHCEs in the amount necessary to raise the ADP to a percentage that would enable the plan to pass the test.

In this example, each NHCE would receive a QNEC equal to 1% of the employee's compensation bringing the NHCEs up to within 2% of the HCE group. As an alternative, if the employer instead chooses to use a one-to-one correction method, it would first make a distribution to the NHCE and contribute a like amount on behalf of the NHCE. Here, in order to bring the HCE down to within two percentage points of the NHCE, the ADP for the HCE will have to be 6% instead of 7%. That means the employer would have to distribute an amount equal to 1% of the deferral on $200,000 or $2,000 to each of the two HCEs for a total of $4,000 plus any earnings on such amounts and then will have to contribute $4,000 to the plan as a QNEC on behalf of the NHCEs.

In connection with ADP and ACP testing failures, in VCP we often see failures involving using the wrong year to run the ADP or ACP test. For example, an employer who previously elected to use the current year testing method in running the ADP test uses prior year testing in operation; or conversely, an employer who elected prior year testing uses current year testing in operation. If an employer elected prior year testing but in operation used current year testing to run his ADP test, VCP may be able to permit a retroactive amendment reflecting such practice if the plan sponsor provides sufficient evidence of employer intent and employee expectation.

However, if the employer elected current year testing but in operation used prior year testing, then in addition to such analysis, the employer must demonstrate that it falls within one of the enumerated situations that are described in Treasury Regulation 1.401(k)-2(c)(1), and these are described beginning on page 48 of your handout.

I want to use my remaining time this morning to focus on three topics. The first two of which involve hardship distributions and plan loans, with respect to hardship distribution, in VCP we often address situations where elective deferrals weren't suspended following financial hardship withdrawal as required by the plan terms.

On page 52 of the handout, you'll see a specific reference to the Treasury Regulation that provides that either the plan itself or another legally enforceable agreement must prohibit an employee from deferring or making employee contributions for at least six months after receipt of a hardship distribution. The correction for this failure is generally to make a taxable distribution of the six months worth of improper deferrals that should have been suspended adjusted for earnings. The employee generally also forfeits any matching contributions associated with such deferrals. In appropriate circumstances, however, where the employee is still a participant of the plan and is currently making deferrals, an alternative correction that might be acceptable is to make a current suspension of six months worth of deferrals in lieu of making the taxable distribution of the improper deferrals.

To do this, you need to apply caution because there are potential pitfalls with doing a current suspension. For example, the matching contribution formula might have changed or the participant might undergo a separation from service during the current six months of suspension resulting in full correction not being achieved. Another relatively common failure involves a plan either making a hardship distribution or a plan loan to a participant but the plan document doesn't actually provide for such distribution or loan. In that instance, an acceptable correction might be to amend the plan retroactively to permit such hardship distribution or loan. The amendment generally is effective on the first date of the plan year in which a plan loan or hardship distribution is made, and the amendment has to satisfy the qualification requirements of Code Section 401(a) as of such effective date.

While we're on the subject of plan loans, I want to clarify a bit what VCP can do to address loan failures. This requires a brief background about plan loans. In order for a plan loan to not be considered a taxable distribution to the participant, it has to satisfy the requirements of Code Section 72(p)(2)(A) which relates to the maximum amount of the loan, Code Section 72(p)(2)(B) which generally requires the loan be repayable within five years although there's an exception for certain home loans; and Code Section 72(p)(2)(C) which requires level amortization in not less than quarterly payments of the loan.

If a plan loan fails to satisfy any of these three requirements but is properly corrected within the five-year maximum repayment period, then the employer is able to request relief from VCP from reporting such loans as a deemed distribution which obviously is a significant tax benefit to the participant. The handout explains beginning on page 55 how each of these three requirements is addressed in order to have a plan loan not be treated as a taxable distribution. But if correction can't be completed before the expiration of the five-year period, then the only relief available through VCP is the ability to report the loan as a deemed distribution in the year of correction rather than the year of the failure.

Let me point out that often Appendix F, Schedule 5 can be used to report the failure and request relief as described above. However, if the affected participant is either a key employee which you'll find defined in Code Section 416(i)(1) or an owner employee as defined in Code Section 401(c)(3), then Appendix F, Schedule 5 can only be used to request reporting the loan as a deemed distribution in the year of correction instead of the year of the failure. A request for relief from reporting a loan to such individuals as a deemed distribution in both the year of the failure and the year of correction even if it's corrected within the maximum five-year repayment period can be presented using Appendix D, not Appendix F.

I'll finish up my portion of the presentation this morning pointing out something about late remittances of deferrals. This is where an employer fails to remit participant's elective deferrals by the earliest date the employer can reasonably segregate the deferral deposits from general assets. It's important to note that this may not be a failure for VCP purposes if the plan does not have language relating to the timing of the contributions being deposited. It will, however, be a prohibited transaction for DOL purposes and therefore would need to be corrected using the DOL's Voluntary Fiduciary Correction Program.

If, however, the plan does include such language then there may be a qualification failure for failing to follow the terms of the plan. The correction would be for the employer to make the contributions with earnings up the date of correction. The change in procedures as described in the submission should include new safeguards to ensure that the deposits are made by the earliest date the employer can reasonably segregate the deferral deposits from general assets.

Now that we'd have a brief tour for different kinds of 401(k) failures and their corrections, Avaneesh will focus on specific questions we received from all of you.

Avaneesh:  Thank you very much, Sherri. What I'm trying to do is, and we got a lot of questions and some of them were pretty long narratives that really don't fit the format of the teleconference that has a shorter time frame. In some cases, what you'll hear is a shortened version of a narrative of the questions. We'll get some done here and to the extent that I don't finish, what I'll try and do is get you all individual email responses to the questions that weren't addressed. Hopefully, that should cover us.

Now, the first question, a controlled group consisting of two employers both adopted a Simple 401(k) plan in 2009 with almost identical provisions. The proposed fix is, I quote, "We think that a VCP application is in order where the employer proposes to merge the two plans and that the application, if there's any plan differences in the VCP applications?" My response to that would be that we would consider that proposal under VCP. Your proposal addresses the basic issue that the employer can have only one Simple 401(k) plan since the code requires that the Simple 401(k) plan be the exclusive plan sponsored by the employer and the employer for this purpose includes all members of the controlled group.

Okay. The second question wants me to address when exactly a determination letter is required under VCP? It had various scenarios and different things. I'm going to kind of attempt to summarize that and basically say the following. A determination letter application is not required if correction is achieved by adopting an IRS approved model amendment or the adoption of a prototype or volume submitter plan or if the plan sponsor adopts a prototype or volume submitter plan with the current opinion or advisory letter. If you're using that (preapproved plan document) to correct the problem, you don't need to submit a determination letter application.

The question is when is a submission required? Submission will be required where correction is being done through an individually designed amendments or plan document. Given that framework, if your plan hasn't been amended for any legislation such as GUST or one of the plan cycles such as Cycle A or B, and if you are solving the problem through the adoption of an individually designed plan to address those non-amender issue, in that case you would need to make a determination letter application and submit that along with your VCP application package.

In other situations where you are correcting a failure to operate the plan in accordance with plan terms, if your submission which includes the corrective plan amendment falls within the plans on cycle year, under that scenario, you would be expected to submit a determination letter application along with it because the theory is that you will be expected to make your determination letter application in an on-cycle year anyway and you're also correcting an operational failure in the same year, you might as well roll all of that into one application and submit to us along with your VCP application.

Alright? Those are the two main situations where a submission would be required. Again, this comes into play where you are using an individually designed plan framework to resolve this. Another piece of it (that was also addressed by the question) is what if the corrective amendment that you're adopting to correct, say an operational failure, is being made to a defined contribution prototype or volume submitter plan? What's the consequence and what are the requirements of that? If the amendment is approved as correction for the failure, the compliance statement will provide you reliance on the corrective amendment.

The next piece of it is can you still rely on the opinion letter or advisory letter issued with respect to the pre-approved prototype or volume submitter plan? The answer to that would be that the employer may continue to rely on the opinion or advisory letter if:

One-  no other provision of the plan document or adoption agreement has been modified in a way that would cause the employer to lose reliance on the plan's opinion or advisory letter. That is, the corrective amendment under VCP, should be our only change to the plan document.

Secondly, the amendment correcting the failure should be acceptable under pre-approved plan rules. Let's say you are adopting an amendment that may or may not fit within the parameters of your plan document but would otherwise normally be approved within the parameters of the pre-approved plan program that determinations administers- that could be a situation where we would accept that amendment and you would have continued reliance on the opinion or advisory letter. In both situations where you have that continued reliance on the opinion or advisory letter, no new determination letter application is required. You're still on that pre-approved program and you could proceed forward. Okay?

Next question: If an individual is employed by a firm and contributes the maximum to the firm's 401(k), can the individual also contribute to a SEP plan established by his 100% owned S-Corporation? Are the combined contributions limited to $50,000 for tax year 2012? One comment, SEPs typically don't allow for elective deferrals. Prior to 1997, a SEP could have a SARSEP feature where the plan could provide for elective deferrals. But if you set up the SEP today, basically it would consist of employer contributions only. The S-Corp could potentially set up a SEP providing for employer contributions that are allocated to the individual. The next question would be whether the dollar limitation would apply, and if the firm that the individual works for and the S-Corporation are members of the same controlled group or affiliated service group, then a single 415 limitation applies and you would use the cap of lesser 100% of comp or $50,000 for figuring out what this individual is limited to in terms of allocations for the 2012 tax year.

Okay. Next question: Plan provides for mandatory distributions in cases where a terminated employee has a vested account balance of less than a thousand dollars. Is there any notice required to be issued to the participants for closing their accounts for vested balances below a thousand dollars? Yes. Notice requirements of Section 402(f) of the Internal Revenue Code must still be satisfied. The Section 402(f) notice relates to eligible rollover distributions and explains the rules relating to such distributions. Among other things, the notice will inform the employee that the distribution may be directly transferred to an eligible retirement plan.

Alternatively, the tax will be withheld from the distribution if the amount of money is not directly transferred to an eligible retirement plan. If the person receives such a distribution, then the notice could provide potentially that the participant could still avoid tax consequences if the received amounts are rolled over within 60 days after the date that person receives the distribution. Those would be typical elements in a 402(f) notice.

The next part of the same questions says "After mailing the checks, the checks come back undelivered. How do we handle them?" One very good resource that one could look at is from the Department of Labor side, you can take a look at the Department of Labor's Field Assistance Bulletin 2004-02. There are basically two parts to that bulletin. One talks about the search process because a reasonable effort should be made to locate those participants if the checks come back undelivered. The search process will include tools such as the use of certified mail, checking other employer records, contacting the designated plan beneficiary in the file, using search tools such as the Social Security's Letter-Forwarding Program, commercial locator services, internet searches, credit reporting agencies.

Since it was issued in 2004, it also refers to the IRS' Letter-Forwarding Program. However, we know now that it's no longer an option with the issuance of Revenue Procedure 2012-35. The IRS Letter-Forwarding Program no longer exists as an option effective August 31 of 2012, that kind of talks about the search process. If despite those steps the participant cannot be located and at the same time if the plan is being terminated, the bulletin also provides for different distribution options such as implementing rollovers to IRAs established on behalf of those non-locatable participants or the establishment of federally insured bank accounts or escheats to state unclaimed property funds. You can look at that bulletin and check that framework. It has a lot of good information on that issue.

Next question: If a participant takes out a loan and loan payments are withheld from the employee's paychecks but the employer does not remit the loan payments to the plan, should the participant's loan be defaulted if the cure period passes? What should the remedy be in this situation? Broadly, if the loan installment is not remitted by the end of the cure period, then the loan would be in default. If the loan is in default, then VCP could be used as a vehicle to correct that loan by either making a catch-up payments or re-amortizing that loan going forward so that it is fully paid off by the end of the maximum period permitted under 72(p), typically five years measured from the original date of the loan.

In addition, the employer may also consider using the Department of Labor's Voluntary Fiduciary Correction Program to correct this problem and avoid the imposition of fiduciary penalties. Also, under certain conditions such as if the repayments were transmitted within 180 calendar days from the date the amounts were received by the employer, then the employer may also be able to by using that program, avoid the late remittance's treatment as a prohibited transaction for purposes of the excise tax and the Section 4975 of the Internal Revenue Code.

Take a look where if you go to DOL's website,, you can find information on the Voluntary Fiduciary Correction Program and also Prohibited Transactions Exemptions, PTE. For that, look at PTE 2002-51 and there's an update to that called the Amendment to PTE 2002-51. That's the framework that you would be operating under in the situation described.

Next question: What is the recommended request for abatement of the 50% excise tax for failing to timely make the required minimum distribution for greater than 5% owner? The filing of the 5329 by the owner or VCP by the plan, and are there any repercussions for the plan? In general, you would probably need to consider what your goals are. If the goal is to both preserve the qualified status of the plan because your plan's not complying with Section 401(a)(9) and also get request the waiver of the excise tax under Section 4974, the 50% excise tax, then VCP application is the way to go because the VCP route is the only way that you can also get relief from the potential consequences of plan disqualification as a result of the plan not complying with Section 401(a)(9). If that's your goal, then of the two alternatives, VCP would be the recommended way to go. That application would be filed by the employer instead of the individual.

The 5329 is an attachment to the 1040 and that's something that the individual files. It's the employer that would make the application and request both that a compliance statement that would approve the correction for the 401(a)(9) violation as well as the waiver from the excise tax. Most situations, the request for the waiver of the excise tax is pretty automatic. However, for individuals who are at least 10% owners, the Revenue Procedure does require that the applicant provide an explanation in support of that request and that explanation is evaluated before a determination is made on whether the excise tax should be waived.

If you go the 5329 route as talked about earlier, the 5329 filing is made by the individual, not the employer and it can only deal with the issue of the waiver of the excise tax. It does not deal with the qualified status of the plan as a whole. In that situation, if the individual goes that route and turns to filing the 5329, the individual has to show that the shortfall and the amount distributed during any taxable year was due to a reasonable error and that reasonable steps are being taken to remedy the shortfall. That's straight out of Section 4974(d) of the Internal Revenue Code. That's the standard that service center would probably use to evaluate whether a waiver is appropriate.

Next question: If excess 415 employer contributions are removed from a participant's account and placed to an unallocated account and then reallocated in lieu of employer contributions to employees other than the employee in excess, is the amount of the excess received by the participant or allocated to the participant taxable to that participant? If you make that correction, then generally no, that excess amount would not be taxable to the participant. However, I would contrast that with the situation where the employee actually receives a distribution of that amount. Here, you're solving the problem within the plan and so with that reallocation and assuming it's done within the framework of the correction program would not result in a tax consequence to the participant who initially received an allocation in excess of the 415 limitations.

Okay. The next question basically deals with plan corrections involving late or missed deferrals and or actually late remittance of deferrals and the use of the IRS programs and the DOL programs and the coordination of the rules and things like that. Basically, I guess, it's worthwhile to draw out what your objectives are. The purpose of making an application to the IRS would be to basically correct the problem and preserve the plan's qualified status and the favorable tax treatment that results from that. The reason why you would make an application to the DOL's voluntary program would be to avoid penalties associated with fiduciary violations. Your objectives in both cases are going to be different. The question is which program should you use or should you use one, should you use both, and again, it all depends on what your objectives are. If your objectives are two-fold, both preserving the qualified status of the plan and to avoid penalties associated with fiduciary violations, you could potentially be using both programs. It all depends on what your objective is.

Let's get back to the late remittance issue. Here, basically it is a fiduciary violation so that is eligible for correction under the Department of Labor's Voluntary Fiduciary Correction Program. They could use that to avoid fiduciary violation-related penalty. In addition to that, if certain conditions are met such as if the repayments were transmitted within 180 calendar days from the date the amounts was received by the employer, very similar to what we talked about in the late remittance of loan withholdings before, then the employer may also be able to avoid late remittance treatment as a prohibited transaction for purposes of the excise tax under Section 4975 of the Internal Revenue Code.

The DOL piece is going to be a probable consequence of fixing a late remittance of an employee's elective deferrals. If you are able to meet the requirements of the Prohibited Transaction Exemptions, then you don't have to file the 1530 return, but if you don't meet those requirements for that exemption, then you would file a 5330 return and be liable for the excise taxes under Section 4975. That's the DOL piece.

Now in terms of the IRS side of it, where it might rise to the level of being a qualification problem is if your plan has provisions in it that talk about the timeframes within which those deferrals should be remitted. It might even say something general like the remittance should be done within a reasonable timeframe and you conclude that it wasn't then potentially you have a violation of plan term. It could probably potentially rise to other Code Section violations if the problem exists to an extreme where it's concluded that there has been an assignment or alienation of benefits which could impact 401(a)(13) of the Internal Revenue Code, or if you arrive at the conclusion that the way this is being done, the plan is no longer set up for the exclusive benefit of employees or their beneficiaries which would potentially impact 401(a)(2) of the Internal Revenue Code or the introductory language in 401(a) itself.

In those cases where you think that this would rise to the level of a qualification problem either because of the violation of plan terms or the implications under the Internal Revenue Code, then in those situations, you might want to consider filing a VCP application.

Now, then the next part of it is- what's the correction? Obviously, we'd want to restore the plan and participants to the position they would have been in had the error not occurred. The employer would want to contribute those remitted amounts that were withheld from the employee's paychecks to the plan. In addition to that, to the extent that there were lost earnings associated with it, the employer would need to make an earnings adjustment.  In the DOL's program, you can use the Department of Labor's online calculator for purposes of making that adjustment.

Under the IRS program, if the amounts are small, you may be able to take advantage of the Revenue Procedure's provisions for using reasonable estimates and then the Department of Labor's online calculator becomes an option there as well. In that case, your correction under both scenarios assuming you are using both programs is one and the same. You could have situations where if the amounts are significant, and the IRS generally requires the use of actual earnings, you might want to basically consider contributing the greater of the two to satisfy both sets of rules if you are submitting applications under both VFCP and VCP. That kind of deals with the coordination issues with respect to that.

Okay. Next question: In the case of where a short plan year ending in December 31, 2011 where the previous plan year ended on June 30th, 2011, how do you calculate whether there were excess employee deferrals or not? For instance, do you take the limitation and divide it into half? What do you do and how do you apply the $16,500 deferral limitation? The $16,500 deferral limitation, assuming we're using the 2011 year, is an individual based limitation and it applies to the individual's taxable year which typically is the calendar year. So regardless of what the plan year might be, for purposes of figuring out whether an employee deferred within the 402(g) limit, you would use the calendar year and measure the employee's elective deferrals to all plans. It could be elective deferrals to all plans sponsored by any employer and the total of all those elective deferrals for the period from January 1, 2011 to December 31, 2011 can't exceed $16,500. Okay.

Eddie:  Pardon. Avaneesh, this is Eddie. I just want to give you a reminder that five minutes will top the hour. 

Avaneesh:  Okay. I think I'll just take maybe one more, or maybe two more. Okay. This one deals with the question of how do you address severance pay for plan allocations and 401(k) deferrals? The first part would be to determine whether that severance pay that you're talking about is includable in compensation and you would look at the terms of the plan and also applicable regulations of Section 415 to see if that fits. By way of a quick example, payments that the individual would not have otherwise received if he or she was still employed by the employer would generally not be includable in compensation.

If your severance pay falls into that category, it would not be includable in compensation. So then to the extent that you have a situation where deferrals and/or employer contributions are made with respect to amounts that are not includable in compensation, you would have to correct that. To the extent that you have excess elective deferrals, that amount will be returned to the employee. The elective deferral amounts will be returned to the employee and of course, would not receive any favorable tax treatment or entitled to any favorable tax treatment. The employer contribution piece or an employer contribution attributable to that portion of pay will be forfeited and generally allocated in accordance with plan provisions which would mean either reallocation to other plan participants or transfer to an unallocated account that is used to reduce future employer contributions.

Okay. Let's see. We'll just keep going until you tell me no, and we're almost done. Okay. The next question deals with the situation where a person got a compliance statement two years ago where correction was a retroactive amendment. That amendment may have been signed but consequently the plan sponsor can't find that amendment. Then the question is what do you do? Now since you don't really have any evidence of the fact that the correction was achieved within typically 150 days of the issuance of the compliance statement- there is no longer has any protection under the compliance statement because the period by which you had to complete correction (which was a condition of the compliance statement) has not been met.

The compliance statement was issued two years ago so I guess the only possible option would be that the employer considers making a brand new application for that issue assuming that the plan is not under examination yet and have that issue addressed again. This time hopefully, the employer finds the amendment and you are able to keep it in a spot where that amendment is not lost so that you could show proof of correction if it was required at any point.

Okay. Next question: How do we handle excess loan payments that were deposited into the plan? One option might be to apply the excess payments towards reducing the outstanding principal of the loan. In that case, the consequence would be that the loan might be paid off faster than originally scheduled and there's no problem with that. Alternatively, if the loan is already fully-paid off and you still have excess payments after that's done, then probably those excess payments should be returned to the participants. Since those excess payments are likely made with after-tax dollars, the participants would have basis in those returned amounts.

Let's see. Here we have a question on whether self-correction might be possible for loan corrections and whether the new Revenue Procedure would provide any new leeway on this. Generally, we're not really expecting any changes in terms of the framework for correcting loans. Basically let's just talk about this framework for a second. If the objective of the employer is to seek relief from any income tax or excise tax provided for in the Revenue Procedure, self-correction wouldn't be an option.

For that you would have to make a VCP filing in order to get that relief. Self-correction is only available where you're correcting a failure to operate in accordance with plan terms and that's it, and trying to preserve the qualified status of the plan. But you can't get any other income tax or excise tax relief in association with that. You can potentially have a situation where you don't necessarily want any of that relief under 72(p). Maybe you're willing to absorb the taxes associated with that. Now, the only thing you want to address is the correction of the qualification failure. If that's the case, then you could, for that sole purpose, you could look at the parameters of the self-correction program and fix that.

I think with that, my time is done. All I'll say here is for other questions we've got, I'll try to get you responses by email. We really enjoyed doing this presentation. I hope you all enjoyed it as well.