What is the primary consequence of not correcting an ADP violation timely?

The primary consequence of not correcting an ADP (Actual Deferral Percentage) violation in a timely manner is taxation of employee contributions. When a plan fails the ADP test, it indicates that highly compensated employees (HCEs) are contributing at a disproportionately higher rate than non-highly compensated employees (NHCEs). If this violation is not addressed promptly, the excess contributions made by HCEs become subject to taxation. This generally leads to the requirement for the employer to notify affected employees, who will then face tax ramifications on contributions that exceed the allowable limits set forth under the testing criteria.

Timely correction of an ADP violation is crucial because if not corrected, it not only affects the tax status of the contributions but may also lead to additional compliance issues for the plan. Correcting the violation restores the plan's compliance and avoids unwanted tax consequences for participants.

While other consequences, such as plan disqualification or additional employer contributions, may also arise from compliance failures, they are not the immediate or primary issue stemming from an unmet ADP obligation. Understanding the nuances of ADP testing and the importance of timely corrections is essential for maintaining the qualified status of a 401(k) plan and ensuring the continued tax advantages for plan participants.