If an employee completed an election to withhold 6% of pay into the 401(k) plan but the employer only withheld 3% of pay - is the employer obligated to make a QNEC of 3% to the employee plus allocate lost earnings on the 3%? I could not find this specific example in EPCRS - but I assume the intent of making the employee whole would govern. Is my thought correct.

That's a tough one. Did the employee lose any match or employer contribution because of this? If not, then I'm inclined to think no correction is made. The employee did receive the salary, so if the employer made a corrective contribution plus earnings, the employee would actually be receiving a windfall. The employee should share some responsibility for determining if the payroll deductions are the correct amount.

but the plan still has what I would see as a failure to follow the terms of the document - namely ee wanted to defer 6% but they only took out 3%. the example from EPCRS of course is for someone excluded entirely, not 'sort of'. but again, nothing in this is to be taken as in concrete, there are examples as guidlines, and I think the QNEC sounds reasonable. now, how much? If you are talking 2005, there is still 1 1/2 left. I thought there was some provision in there regarding if an ee was excluded part of the year and had a chance to make up part of it through the rest of the year, then no QNEC was required. but I dont recall where that is. yes, the employee gets a windfall, and I agree, employee should have some responsibility, but I don't know if there is anything in the regs about that.

I heard mention at the ASPPA conference that the service was looking at this "windfall" and contemplating allowing for the employer to contribute half of the missing deferral plus earnings instead of the whole deferral.

I've looked at this issue in the past. The correction principles seemingly conflict - on the one hand, the plan and participants must be restored to the position they would have been in absent the failure, and on the other hand, corrective allocations must come from employer contributions. I've discussed this with the IRS in the past and have taken away the following points.

1. The IRS is aware of the windfall issue resulting from the employer contributing the salary reduction dollars. However, an interesting perspective is that the elective deferrals are employer contributions made as the result of an employee's election to reduce salary in exchange for the employer contribution (notwithstanding the different treatment often mandated for these contributions by the DOL and IRS). From this perspective, there was an underpayment of employer contributions and an overpayment of salary.

2. The IRS generally still wanted the employer to make up the missing elective deferrals. My cases have all involved NHCEs, which may have made a difference.

3. Where the employee has made an election, the election could (should?) be used to determine the employer's corrective contribution.

4. This issue will be addressed in new correction method guidance in the "soon" to be released update of EPRCS, which I understand will look at lost opportunity costs.

As I see it there is a choice between a windfall to the employee and a plan failure by the employer.

As per RTK's post the IRS is well aware of the windfall issue, but it does seem of little concern.

It would seem that the failure to follow the terms of the plan documents is a greater issue, so the correction by the employer seems the onlaction, regardless of the windfall issue. However, it seems quite possible that the correction could be made only up to the actual "loss" so that there is a reduced windfall but a correct account balance/contribution. Sort of a variant on what stephen posted as coming out of the ASPA conference.

I believe you are referring to the "Special Rule for Brief Exclusion from Elective Deferrals" in Appendix B, Section .02(1)(a)(ii)(E) (Don't you just love indexing of governmental documents?)

This is used in connection with corrections for the exclusion of eligible employees (which generally requires a QNEC equal to the ADP% and ACP% of those improperly excluded). The "Brief Exclusion" Rule allows the employer to correct without contributing for the "lost deferral" portion if the employee is able to make deferrals for at least the last 9 months of the year.

Thus, you could exclude someone for the first 3 months of the year, but if you allowed them to participate for the last 9 months, you would only have to put in any lost employer contributions for the first three months (and not have to fund lost deferrals).

Whether this correction applies to the situation above (when only withholding 3% vs. 6% election) is something I'm trying very had to clarify (see my post regarding improper exclusion of bonuses from withholding). It seems like the situations are very similar.

I have calls into the IRS and have been bounced from Cincinnati to Brooklyn and beyond and finally made contact with some people in the Voluntary Correction Group that may clarify the position.

Hopefully RTK is correct, and this issue will be addressed a little clearer in the updated EPCRS guidance.