ADP/ACP Failure and Missed Deferrals Discovered Midyear

For the ADP test, the NHCE ADP is 3.9%. The maximum HCE ADP is the greater of 3.9% plus 2 percentage points, or 3.9% times 1.25. The first is 5.9%; the second is 4.875%. The maximum is therefore 5.9%, and the HCE ADP of 6.8% exceeds it by 0.9 percentage points. The plan must reduce HCE deferrals using the leveling method, starting with the HCE with the highest deferral percentage, until the HCE ADP is 5.9%. Excess contributions are distributed with earnings. If any HCE also exceeded the IRC 402(g) limit, the amount may be recharacterized rather than distributed, subject to the plan terms.

For the ACP test, the NHCE ACP is 1.6%. The maximum HCE ACP is the greater of 1.6% plus 2, or 1.6% times 1.25, which is 3.6%. The HCE ACP of 4.2% exceeds the limit by 0.6 percentage points, so excess aggregate contributions must be distributed with earnings. The corrective distribution deadline for a prior-year-tested calendar-year plan is March 15 of the following year to avoid the 10% excise tax under IRC 4979. Because the failure was discovered in June 2024, that deadline has passed, so the 10% excise tax applies to the excess contributions and excess aggregate contributions for 2023. The plan can still correct by December 31, 2024 to preserve qualification, but Form 5330 and the excise tax are required.

The excluded employees missed an opportunity to defer. Under EPCRS, the correction is a qualified nonelective contribution equal to 50% of the missed deferral. The missed deferral is based on the actual deferral percentage the employees would have had, if known, or on the NHCE average if not known. Here the known average is 4.2%, so the QNEC is 50% of 4.2%, or 2.1% of each employee's compensation for 2023, plus earnings from the date the deferrals would have been made to the date of correction. The QNEC is 100% vested and is not counted toward the 402(g) limit.

The employer must also provide the matching contribution the employees would have received on the missed deferral. Because the match is dollar-for-dollar up to 4% of pay, the missed match is 4% of compensation, not 4% of the 2.1% QNEC. The match should be adjusted for the plan's actual matching formula and contributed with earnings. The QNEC itself does not receive a match. The correction should be made under SCP if the plan has established practices and procedures and the failure is not significant. Twelve employees out of 102 NHCEs is about 11.8%, which is a facts-and-circumstances significance question; if the IRS would view it as significant, a VCP submission is safer. The employer should also correct payroll and eligibility controls to prevent recurrence.

The employer should file Form 5330 for the 2023 plan year to report the 10% excise tax on the ADP excess contributions and ACP excess aggregate contributions. For a calendar-year plan, the Form 5330 is generally due by July 31 of the following year, so the 2023 form was due July 31, 2024. Because the failure was discovered in June 2024, the employer should file promptly and pay the excise tax to stop additional penalties. The excise tax is 10% of the excess contributions and excess aggregate contributions, not 10% of the total corrective distributions.

The plan should distribute the excess amounts with earnings by December 31, 2024 to preserve its qualified status for 2023. The distribution should be reported on Form 1099-R, and the plan should issue corrected statements if necessary. The employer should also coordinate the EPCRS correction for the 12 excluded employees with the ADP/ACP correction, because the QNEC and missed match may affect the 2023 testing if they are included in the correction. The employer should document the correction methodology, the earnings calculation, and the date of correction in case of a later IRS review.