We have a controlled group of corporations. Two of the Companies have a Simple IRA and one has a 401(k). We would like to terminate the Simples and have all three Companies under the 401(k). However, there are a few participants in the Simples that have not been participants for two years. It is our understanding that any one who has been in the Simple for more than two years can rollover their balance to the 401(k) plan tax free, but the other individuals cannot rollover into the 401(k). Nor can they rollover into a traditional IRA without the 25% penalty. IS this correct? Is there anything we can do to make all rollovers tax free?

You are correct. They can't rollover within the "2 year period." IRS Notice 98-4 gives some additional detail on this. Also note that if one of the exceptions to the normal 10% premature distribution penalty applies, then the 25% penalty doesn't apply either.