Correction of Ineligible Employee Deferrals (Posted February 22, 2003) Technical Tip 91: The following question and answer were from the IRS Q&A Session at the 2001 ASPPA Annual Conference: A 401(k) plan mistakenly allows an employee to defer before he is actually eligible. Under VCP, the plan refunds the ineligible deferrals plus earnings. Response: We don’t believe VCP allows for a refund. We would suggest you amend the eligibility to make the contribution "good." The next two parts of the question are moot. Is the corrective distribution subject to the additional tax imposed by Code Section 72? Is the corrective distribution counted as a distribution for purposes of determining whether the plan is top heavy? Comment by RL&R ERISA Attorneys: Other possible approach to correction, which would follow the principle that the correction should restore the plan to the position it would have been in had the failure not occurred (see Rev. Proc. 2002-47, Section 6.02.), would be to: (1) move the deferrals (and related earnings) from the ineligible employee's account to a suspense account in the plan to be used to offset future employer contributions, if any; or (2) notwithstanding the IRS response that this is not permitted under EPCRS, to return the deferrals (and related earnings) to the participant (and issue the appropriate Form 1099). Either of these approaches would require IRS approval through the VCO program. Presumably, if the former approach were used, the employer would need to restore the lost deferrals to the employee outside the plan. View all Tips © 2012 Reish Luftman Reicher & Cohen, a Professional Corporation Important notice: Answers are provided as general guidance on the subjects covered in the question and are not provided as legal advice to the questioner's situation. Any legal issues should be reviewed by your legal counsel to apply the law to the particular facts of your situation.