I just discovered while doing the accounting for the 2002 plan year that the refunds of excess contribution for the 2001 plan year did not occur. I am reading Revenue Proc. 2001-17 and am a little confused about my options. Appendix A.03, OPERATIONAL FAILURES AND CORRECTIONS UNDER VCS says I can correct by allocating a QNEC to bring the ADP up to a passing level. I believe this option is not available to me because the QNEC would have had to have been made 12/31/2001 as the prior testing method was used for 2001. Am I correct?

Next option is the 1 to 1 correction method. The way I read this, I allocate an amount equal to the excess contributions adjusted for investment gains or losses to all nonhighly compensated employees who were eligible to defer during the plan year. (Is this the plan year tested, or the plan year in which the refunds should have occurred?). I also believe these contributions are subject to the vesting requirements.

Am I on the right track?

Spot - just a small suggestion, which may or may not be helpful in your case. (I don't know the answer to your question, and haven't looked it up.) But the Rev. Proc. you reference has been updated - see Rev. Proc. 2003-44. It's possible that the IRS has modified or updated the applicable section(s) that you are looking at. The IRS website has a very handy "redlined" version which specifically shows modifications, so you can scan it pretty quickly to see if anything has changed.