SECTION 3. EARNINGS

ADJUSTMENT METHODS AND EXAMPLES

.01 Earnings Adjustment Methods . (1) In general. (a) Under section 6.02(4)(a) of this revenue procedure, whenever the appropriate correction method for an Operational Failure in a defined contribution plan includes a corrective contribution or allocation that increases one or more employees’ account balances (now

July 22, 2002 165 2002–29 I.R.B.

increasing the account balance of an improperly excluded employee to correct the exclusion of the employee under the reallocation correction method described in section 2.02(2)(a)(iii)(B), this section 3 does not apply in reducing the account balances of other employees under the reallocation correction method. (See section 2.02(2)(a)(iii)(C) for rules that apply to the earnings adjustments for such reductions.) In addition, this section 3 does not apply in determining earnings adjustments under the one-to-one correction method described in section 2.01(1)(b)(iii). (2) Period of the Failure. (a) General Rule. For purposes of this section 3, the “period of the failure” is the period from the date that the failure began through the date of correction. For example, in the case of an improper forfeiture of an employee’s account balance, the beginning of the period of the failure is the date as of which the account balance was improperly reduced.

(b) Rules for Beginning Date for Exclusion of Eligible Employees from Plan. (i) General Rule. In the case of an exclusion of an eligible employee from a plan contribution, the beginning of the period of the failure is the date on which contributions of the same type ( e.g., elective deferrals, matching contributions, or discretionary nonelective employer contributions) were made for other employees for the year of the failure. In the case of an exclusion of an eligible employee from an allocation of a forfeiture, the beginning of the period of the failure is the date on which forfeitures were allocated to other employees for the year of the failure.

(ii) Exclusion from a 401(k) or (m) Plan. For administrative convenience, for purposes of calculating the earnings rate for corrective contributions for a plan year (or the portion of the plan year) during which an employee was improperly excluded from making periodic elective deferrals or employee after-tax contributions, or from receiving periodic matching contributions, the employer may treat the date on which the contributions would have been made as the midpoint of the plan year (or the midpoint of the portion of the plan year) for which the failure occurred. Alternatively, in this case, the employer may treat the date on which the

contributions would have been made as the first date of the plan year (or the portion of the plan year) during which an employee was excluded, provided that the earnings rate used is one half of the earnings rate applicable under section 3.01(3) for the plan year (or the portion of the plan year) for which the failure occurred.

(3) Earnings Rate. (a) General Rule. For purposes of this section 3, the earnings rate generally is based on the investment results that would have applied to the corrective contribution or allocation if the failure had not occurred.

(b) Multiple Investment Funds. If a plan permits employees to direct the investment of account balances into more than one investment fund, the earnings rate is based on the rate applicable to the employee’s investment choices for the period of the failure. For administrative convenience, if most of the employees for whom the corrective contribution or allocation is made are nonhighly compensated employees, the rate of return of the fund with the highest earnings rate under the plan for the period of the failure may be used to determine the earnings rate for all corrective contributions or allocations. If the employee had not made any applicable investment choices, the earnings rate may be based on the earnings rate under the plan as a whole ( i.e., the average of the rates earned by all of the funds in the valuation periods during the period of the failure weighted by the portion of the plan assets invested in the various funds during the period of the failure).

(c) Other Simplifying Assumptions. For administrative convenience, the earnings rate applicable to the corrective contribution or allocation for a valuation period with respect to any investment fund may be assumed to be the actual earnings rate for the plan’s investments in that fund during that valuation period. For example, the earnings rate may be determined without regard to any special investment provisions that vary according to the size of the fund. Further, the earnings rate applicable to the corrective contribution or allocation for a portion of a valuation period may be a pro rata portion of the earnings rate for the entire valuation period, unless the application of this rule would result in either a significant understatement or overstatement of

the actual earnings during that portion of the valuation period.

(4) Allocation Methods. (a) In General. For purposes of this section 3, the earnings amount generally may be allocated in accordance with any of the methods set forth in this paragraph (4). The methods under paragraph (4)(c), (d), and (e) are intended to be particularly helpful where corrective contributions are made at dates between the plan’s valuation dates.

(b) Plan Allocation Method. Under the plan allocation method, the earnings amount is allocated to account balances under the plan in accordance with the plan’s method for allocating earnings as if the failure had not occurred. (See Example 23.)

(c) Specific Employee Allocation Method. Under the specific employee allocation method, the entire earnings amount is allocated solely to the account balance of the employee on whose behalf the corrective contribution or allocation is made (regardless of whether the plan’s allocation method would have allocated the earnings solely to that employee). In determining the allocation of plan earnings for the valuation period during which the corrective contribution or allocation is made, the corrective contribution or allocation (including the earnings amount) is treated in the same manner as any other contribution under the plan on behalf of the employee during that valuation period. Alternatively, where the plan’s allocation method does not allocate plan earnings for a valuation period to a contribution made during that valuation period, plan earnings for the valuation period during which the corrective contribution or allocation is made may be allocated as if that employee’s account balance had been increased as of the last day of the prior valuation period by the corrective contribution or allocation, including only that portion of the earnings amount attributable to earnings through the last day of the prior valuation period. The employee’s account balance is then further increased as of the last day of the valuation period during which the corrective contribution or allocation is made by that portion of the earnings amount attributable to earnings after the last day of the prior valuation period. (See Example 24.)

2002–29 I.R.B. 166 July 22, 2002

(d) Bifurcated Allocation Method. Under the bifurcated allocation method, the entire earnings amount for the valuation periods ending before the date the corrective contribution or allocation is made is allocated solely to the account balance of the employee on whose behalf the corrective contribution or allocation is made. The earnings amount for the valuation period during which the corrective contribution or allocation is made is allocated in accordance with the plan’s method for allocating other earnings for that valuation period in accordance with section 3.01(4)(b). (See Example 25.)

(e) Current Period Allocation Method. Under the current period allocation method, the portion of the earnings amount attributable to the valuation period during which the period of the failure begins (“first partial valuation period”) is allocated in the same manner as earnings for the valuation period during which the corrective contribution or allocation is made in accordance section 3.01(4)(b). The earnings for the subsequent full valuation periods ending before the beginning of the valuation period dur

ing which the corrective contribution or allocation is made are allocated solely to the employee for whom the required contribution should have been made. The earnings amount for the valuation period during which the corrective contribution or allocation is made (“second partial valuation period”) is allocated in accordance with the plan’s method for allocating other earnings for that valuation period in accordance with section 3.01(4)(b). (See Example 26.) .02 Examples.

Example 23 :

Employer L maintains a profit-sharing plan that provides only for nonelective contributions. The plan has a single investment fund. Under the plan, assets are valued annually (the last day of the plan year) and earnings for the year are allocated in proportion to account balances as of the last day of the prior year, after reduction for distributions during the current year but without regard to contributions received during the current year (the “prior year account balance”). Plan contributions for 1997 were made on March 31, 1998. On April 20, 2000, Employer L determines that an operational failure occurred for 1997 because Employee X was improperly excluded from the plan. Employer L decides to correct the failure by using the VCS correction

method for the exclusion of an eligible employee from nonelective contributions in a profit-sharing plan. Under this method, Employer L determines that this failure is corrected by making a contribution on behalf of Employee X of $5,000 (adjusted for earnings). The earnings rate under the plan for 1998 was +20% . The earnings rate under the plan for 1999 was +10% . On May 15, 2000, when Employer L determines that a contribution to correct for the failure will be made on June 1, 2000, a reasonable estimate of the earnings rate under the plan from January 1, 2000, to June 1, 2000 is +12%.

Earnings Adjustment on the Corrective Contri- bution :

The $5,000 corrective contribution on behalf of Employee X is adjusted to reflect an earnings amount based on the earnings rates for the period of the failure (March 31, 1998, through June 1, 2000) and the earnings amount is allocated using the plan allocation method. Employer L determines that a pro rata simplifying assumption may be used to determine the earnings rate for the period from March 31, 1998, to December 31, 1998, because that rate does not significantly understate or overstate the actual earnings for that period. Accordingly, Employer L determines that the earnings rate for that period is 15% (9/12 of the plan’s 20% earnings rate for the year). Thus, applicable earnings rates under the plan during the period of the failure are:

Time Periods Earnings Rate

3/31/98 - 12/31/98 (First Partial Valuation Period) +15%

1/1/99 - 12/31/99 +10%

1/1/00 - 6/1/00 (Second Partial Valuation Period) +12%

If the $5,000 corrective contribution had been contributed for Employee X on March 31, 1998, (1) earnings for 1998 would have been increased by the amount of the earnings on the additional $5,000 contribution from March 31, 1998, through December 31, 1998, and would have been allocated as 1998 earnings in proportion to the prior year (December 31, 1997) account balances, (2) Employee X’s account balance as of December 31, 1998, would have been increased by the additional $5,000 contribution, (3) earnings for 1999 would have been increased by the 1999 earnings on the additional $5,000 contribution (including 1998 earnings thereon) allocated in proportion to the prior year (December 31, 1998) account balances along with other 1999 earnings, and (4) earnings for 2000 would have been increased by the earnings on the additional $5,000 (including 1998 and 1999 earnings thereon) from January 1 to

June 1, 2000, and would be allocated in proportion to the prior year (December 31, 1999) account balances along with other 2000 earnings. Accordingly, the $5,000 corrective contribution is adjusted to reflect an earnings amount of $2,084 ($5,000[(1.15)(1.10)(1.12)–1]) and the earnings amount is allocated to the account balances under the plan allocation method as follows:

(a) Each account balance that shared in the allocation of earnings for 1998 is increased, as of December 31, 1998, by its appropriate share of the earnings amount for 1998, $750 ($5,000(.15)).

(b) Employee X’s account balance is increased, as of December 31, 1998, by $5,000.

(c) The resulting December 31, 1998, account balances will share in the 1999 earnings, including the $575 for 1999 earnings included in the corrective contribution ($5,750(.10)), to determine the

account balances as of December 31, 1999. However, each account balance other than Employee X’s account balance has already shared in the 1999 earnings, excluding the $575. Accordingly, Employee X’s account balance as of December 31, 1999, will include $500 of the 1999 portion of the earnings amount based on the $5,000 corrective contribution allocated to Employee X’s account balance as of December 31, 1998 ($5,000(.10)). Then each account balance that originally shared in the allocation of earnings for 1999 ( i.e., excluding the $5,500 additions to Employee X’s account balance) is increased by its appropriate share of the remaining 1999 portion of the earnings amount, $75.

(d) The resulting December 31, 1999, account balances (including the $5,500 additions to Employee X’s account balance) will share in the 2000 portion of the earnings amount based on the estimated

July 22, 2002 167 2002–29 I.R.B.

January 1, 2000, to June 1, 2000, earnings included in the corrective contribution equal to $759 ($6,325 (.12)). (See Table 1.)

TABLE 1 CALCULATION AND ALLOCATION OF THE CORRECTIVE AMOUNT ADJUSTED FOR EARNINGS

Earnings Rate Amount Allocated to: Corrective Contribution $5,000 Employee X First Partial Valuation Period 15% 750 ¹ All 12/31/1997, Account Earnings Balances ⁴

1999 Earnings 10% 575 ² Employee X ($500)/ All 12/31/1998, Account Balances ($75) ⁴

Second Partial Valuation Period

Earnings

12% 759 ³ All 12/31/1999, Account

Balances (including Employee

X’s $5,500) ⁴

Total Amount Contributed $7,084

1 $5,000 x 15% 2 $5,750 ($5,000 +750) x 10%

3 $6,325 ($5,000 +750 +575) x 12%

4 After reduction for distributions during the year for which earning are being determined but without regard to contributions received during the year for which

earnings are being determined.

Example 24 :

The facts are the same as in Example 23.

Earnings Adjustment on the Corrective Contribu- tion :

The earnings amount on the corrective contribution is the same as in Example 23, but the earnings amount is allocated using the specific

employee allocation method. Thus, the entire earnings amount for all periods through June 1, 2000 ( i.e., $750 for March 31, 1998, to December 31, 1998, $575 for 1999, and $759 for January 1, 2000, to June 1, 2000) is allocated to Employee X. Accordingly, Employer L makes a contribution on June 1, 2000, to the plan of $7,084 ($5,000(1.15)(1.10)(1.12)). Employee X’s account balance as of December 31, 2000, is

TABLE 2

CALCULATION AND ALLOCATION OF THE

CORRECTIVE AMOUNT ADJUSTED FOR EARNINGS

increased by $7,084. Alternatively, Employee X’s account balance as of December 31, 1999, is increased by $6,325 ($5,000(1.15)(1.10)), which shares in the allocation of earnings for 2000, and Employee X’s account balance as of December 31, 2000, is increased by the remaining $759. (See Table 2.)

Earnings Rate Amount Allocated to: Corrective Contribution $5,000 Employee X

First Partial Valuation Period Earnings

15% 750 ¹ Employee X

1999 Earnings 10% 575 ² Employee X Second Partial Valuation Period 12% 759 ³ Employee X Earnings

Total Amount Contributed $7,084

1 $5,000 x 15%

2 $5,750 ($5,000 +750) x 10%

3 $6,325 ($5,000 +750 +575) x 12%

2002–29 I.R.B. 168 July 22, 2002

Example 25 :

The facts are the same as in Example 23. Earnings Adjustment on the Corrective Contribu- tion :

The earnings amount on the corrective contribution is the same as in Example 23, but the earnings amount is allocated using the bifurcated

allocation method. Thus, the earnings for the first partial valuation period (March 31, 1998, to December 31, 1998) and the earnings for 1999 are allocated to Employee X. Accordingly, Employer L makes a contribution on June 1, 2000, to the plan of $7,084 ($5,000(1.15)(1.10)(1.12)). Employee X’s account balance as of December 31, 1999, is

TABLE 3 CALCULATION AND ALLOCATION OF THE CORRECTIVE AMOUNT ADJUSTED FOR EARNINGS

increased by $6,325 ($5,000(1.15)(1.10)); and the December 31, 1999, account balances of employees (including Employee X’s increased account balance) will share in estimated January 1, 2000, to June 1, 2000, earnings on the corrective contribution equal to $759 ($6,325(.12)). (See Table 3.)

Earnings Rate Amount Allocated to: Corrective Contribution $5,000 Employee X First Partial Valuation Period 15% 750 ¹ Employee X Earnings

1999 Earnings 10% 575 ² Employee X Second Partial Valuation Period 12% 759 ³ 12/31/99, Account Balances

Earnings

Total Amount Contributed $7,084

(including Employee X’s

$6,325) ⁴

1 $5,000 x 15% 2 $5,750 ($5,000 +750) x 10%

3 $6,325 ($5,000 +750 +575) x 12%

4 After reduction for distributions during the 2000 year but without regard to contributions received during the 2000 year.

2000, earnings on the corrective contribution equal to $759 ($6,325(.12)) are treated in the same manner as 2000 earnings by allocating these amounts to the December 31, 2000, account balances of employees in proportion to account balances as of December 31, 1999 (including Employee X’s increased account balance). (See Table 4.) Thus, Employee X is allocated the earnings for the full valuation period during the period of the failure.

Example 26 :

The facts are the same as in Example 23. Earnings Adjustment on the Corrective Contribu- tion :

The earnings amount on the corrective contribution is the same as in Example 23, but the earnings amount is allocated using the current period allocation method. Thus, the earnings for the first partial valuation period (March 31, 1998, to December 31, 1998) are allocated as 2000 earn

ings. Accordingly, Employer L makes a contribution on June 1, 2000, to the plan of $7,084 ($5,000 (1.15)(1.10)(1.12)). Employee X’s account balance as of December 31, 1999, is increased by the sum of $5,500 ($5,000(1.10)) and the remaining 1999 earnings on the corrective contribution equal to $75 ($5,000(.15)(.10)). Further, both (1) the estimated March 31, 1998, to December 31, 1998, earnings on the corrective contribution equal to $750 ($5,000(.15)) and (2) the estimated January 1, 2000, to June 1,

TABLE 4

CALCULATION AND ALLOCATION OF THE CORRECTIVE AMOUNT ADJUSTED FOR EARNINGS

Earnings Rate Amount Allocated to: Corrective Contribution $5,000 Employee X First Partial Valuation Period 15% 750 ¹ 12/31/99, Account Balances

Earnings

(including Employee X’s $5,575) ⁴

1999 Earnings 10% 575 ² Employee X Second Partial Valuation Period 12% 759 ³ 12/31/99, Account Balances

Earnings

Total Amount Contributed $7,084

(including Employee X’s $5,575) ⁴

1 $5,000 x 15% 2 $5,750 ($5,000 +750) x 10%

3 $6,325 ($5,000 +750 +575) x 12%

4 After reduction for distributions during the year for which earnings are being determined but without regard to contributions received during the year for which earnings are being determined.

July 22, 2002 169 2002–29 I.R.B.

APPENDIX C

VCP CHECKLIST IS YOUR SUBMISSION COMPLETE?

INSTRUCTIONS

The Service will be able to respond more quickly to your VCP request if it is carefully prepared and complete. To ensure that your request is in order, use this checklist. Answer each question in the checklist by inserting yes, no, or N/A, as appropriate, in the blank next to the item. Sign and date the checklist ( as taxpayer or authorized representative) and place it on top of your request .

You must submit a completed copy of this checklist with your request. If a completed checklist is not submitted with your request, substantive consideration of your submission will be deferred until a completed checklist is received.

TAXPAYER’S NAME

TAXPAYER’S I.D. NO.

PLAN NAME & NO.

ATTORNEY/P.O.A.

The following items relate to all submissions:

1. Have you included a complete description of the failure(s) and the years in which the failure(s) occurred (including the years for which the statutory period has expired)? (See section 11.02(1) of Rev. Proc. 2002–47.) (Hereafter, all section references are to Rev. Proc. 2002–47.)

2. Have you included an explanation of how and why the failure(s) arose, including a description of the administrative procedures for the plan in effect at the time the failure(s) occurred? (See section 11.02(2) and (3).)

3. Have you included a detailed description of the method for correcting the failure(s) identified in your submission? This description must include, for example, the number of employees affected and the expected cost of correction (both of which may be approximated if the exact number cannot be determined at the time of the request), the years involved, and calculations or assumptions the Plan Sponsor used to determine the amounts needed for correction. In lieu of providing correction calculations with respect to each employee affected by a failure, you may submit calculations with respect to a representative sample of affected employees. However, the representative sample calculations must be sufficient to demonstrate each aspect of the correction method proposed. Note that each step of the correction method must be described in narrative form. (See section 11.02(4).)

4. Have you described the earnings or interest methodology (indicating computation period and basis for determining earnings or interest rates) that will be used to calculate earnings or interest on any corrective contributions or distributions? (As a general rule, the interest rate (or rates) earned by the plan during the applicable period(s) should be used in determining the earnings for corrective contributions or distributions.) (See section 11.02(5).)

If you inserted “N/A” for item 4, enter explanation:

5. Have you submitted specific calculations for each affected employee or a representative sample of affected employees? (See section 11.02(6).)

6. Have you described the method that will be used to locate and notify former employees or, if there are no former employees affected by the failure(s) or the correction(s), provided an affirmative statement to that effect? (See section 11.02(7).)

7. Have you provided a description of the administrative measures that have been or will be implemented to ensure that the same failure(s) do not recur? (See section 11.02(8).)

8. Have you included a statement that, to the best of the Plan Sponsor’s knowledge, the plan is not currently under an Employee Plans examination? (See section 11.02(9).)

2002–29 I.R.B. 170 July 22, 2002

9. Have you included a statement that, to the best of the Plan Sponsor’s knowledge, the Plan Sponsor is not under an Exempt Organizations examination? (See section 11.02(9).)

10. If the submission includes a failure related to Transferred Assets, have you included a description of the related employer transaction, including the date of the employer transaction and the date the assets were transferred to the plan?

11. Have you included a copy of the portions of the plan document (and adoption agreement, if applicable) relevant to the failure(s) and method(s) of correction? (See section 11.04(2).)

12. Have you included a copy of the plan’s most recent Favorable Letter and/or the required applicable document(s)? (See section 11.04(4).)

13. Have you included the appropriate voluntary compliance fee due with the submission? (See section 11.06.)

14. Have you included the original signature of the sponsor or the sponsor’s authorized representative? (See section 11.07.)

15. Have you included a Power of Attorney (Form 2848)? Note: representation under VCP is limited to attorneys, certified public accountants, enrolled agents, and enrolled actuaries; unenrolled return preparers are not eligible to act as representatives under VCP. (See section 11.08.)

16. Have you included a Penalty of Perjury Statement signed (original signature only) and dated by the Plan Sponsor? (See section 11.09.)

17. Have you designated your submission as a VCP, VCO, VCS, VCT, VCSEP, VCGroup, or Anonymous Submission Procedure, as appropriate? (See section 11.11.)

18. If you are requesting a waiver of the excise tax under § 4974 of the Code, have you included the request, and, if applicable, an explanation supporting the request for any affected owner-employee or 10 percent owner? (See section 6.07(3).)

19. Have you submitted an application for a determination letter? (See section 10.06.)

20. If the plan is currently being considered in a determination letter application, have you included a statement to that effect? (See section 11.03(1).)

The following items relate only to submissions under VCO (including VCS):

21. Have you included a copy of the first page, the page containing employee census information (currently line 7f of the 1998 Form 5500), and the information relating to plan assets (currently line 31f of the 1998 Form 5500) of the most recently filed Form 5500 series return? Note: If a Form 5500 is not applicable, insert N/A and furnish the name of the plan, and the census information required of Form 5500 series filers. (See section 11.04(1)(b).)

22. Have you proposed a time period of correction that is limited to 150 days (240 days for VCGroup) from the date the compliance statement is issued? (See sections 10.06(8) and 10.14(3)(b).)

The following items relate only to submissions under VCS:

23. Are each of the failures you have identified eligible for correction under VCS? (See Appendix A and Appendix B.)

24. Have you identified no more than two VCS failures? (If more than two failures were identified, VCS is not available, but you may make a submission under VCO.) (See section 10.11(3).)

25. Have you proposed to correct the failure(s) identified in your request using the permitted correction method(s) set forth in Appendix A or Appendix B? (See Appendix A and Appendix B.)

The following item relates only to submissions under VCGroup:

26. Have you submitted a certified or cashier’s check for the initial fee of ten thousand dollars ($10,000) made payable to the U.S. Treasury?

July 22, 2002 171 2002–29 I.R.B.

The following item relates only to submissions under the general procedures of VCP:

27. Have you included a copy of the most recently filed Form 5500? (See section 11.04(1)(b).)

Signature Date

Title or Authority

Typed or printed name of person signing checklist

(2) authorizes the utility to apply for, and authorizes the public utility commission or other appropriate State agency to issue, a financing order determining the amount of transition costs the utility will be allowed to recover;

(3) provides that pursuant to the financing order, the utility acquires an intangible property right to charge, collect, and receive charges in a fixed amount necessary to provide for the full recovery of the transition costs determined to be recoverable, and assures that the charges are non-bypassable and will be paid by customers within the utility’s traditional service territory who receive electricity through the utility’s transmission and distribution system, even if those customers elect to purchase electricity from a third-party generator;

(4) guarantees that neither the State nor any agency thereof has the authority to rescind or amend the financing order, to revise the amount of transition costs, or in any way to reduce or impair the value of the intangible property right, except as may be contemplated by periodic adjustments authorized by the transition legislation;

(5) provides procedures assuring that the sale, assignment or other transfer of the intangible property right from the utility to a financing entity will be perfected under State law as an absolute transfer of the utility’s right, title and interest in the property; and

(6) authorizes the securitization of the intangible property right to recover

26 CFR 601.105: Examination of returns and claims for refund, credit, or abatement; determination of correct tax liability. (Also Part I, §§ 61, 451, 1001)

Rev. Proc. 2002–49