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Change to Allocation Method After Year End


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#1 Alan Stonewall

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Posted 06 January 2003 - 07:44 PM

I have a clear recollection that for a profit sharing plan with a discretionary nonelective contribution provision, it is possible to amend the allocation formula after the end of the year and change how the discretionary contribution is allocated among eligible employees. For example, it would be possible to amend a calendar year profit sharing plan today to change the allocation methodology from an equal percent of pay to a cross tested or age-weighted approach even though that would mean a lesser allocation for some nonkey employees.

I believe the IRS's position is that because the contribution is discretionary, there is no accrued benefit until the contribution is actually made. The employer could decide after year end not to make a contribution. Stated another way, there is nothing wrong with amending a plan after year end to create a second allocation methodology and electing to make a contribution using the new methodology and electing not to make a contribution pursuant to the original methodology.

Does anyone remember when and where the IRS made this pronouncement or alternatively does anyone have a different opinion/recollection? Thanks.

#2 Mike Preston

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Posted 07 January 2003 - 05:04 AM

Hi, Alan, good to see you here.

This is one of my pet peeves. I would like to agree with what you have written, but I can't quite get there. You may be referring to Q&A 20 from the IRS Q&A at the 2002 ABA meeting. Here is the whole thing:

20. §411(d)(6) – Anti-cutback rule

Assume a discretionary profit sharing plan (or a §401(k) plan) does not have a 1,000 hour or last day of the plan year requirement. Is there an anti-cutback problem if the plan is amended midyear to:

• increase the annual compensation limit to $200,000 (contribution allocated on a pro rata basis)

• change the vesting schedule to provide for faster vesting for matching contributions (thereby reducing the amount of forfeitures to be allocated for the year)

• increase the annual compensation limit to $200,000 in a §401(k) plan resulting in the plan passing the ADP test.

Assume a discretionary profit sharing plan has a last day of the plan year requirement but the requirement does not apply to participants who retire, die or become disabled during the plan year. The plan is amended mid year to increase the compensation limit to $200,000. Is there an anti-cutback issue with respect to the participant who retires, dies or becomes disabled prior to the adoption of the amendment?

Proposed response: In a discretionary profit sharing plan there is no anti-cutback issue regardless of whether there is a last day of the plan year requirement. A participant does not accrue a protected benefit until the contribution is actually made to the plan and the participant has met any other requirements imposed by the plan (such as an hour requirement). In TAM 9735001 a discretionary profit sharing plan’s allocation formula was retroactively amended after the end of the plan year and after a contribution had been made to the plan but before the due date of the employer tax return. The IRS concluded that the retroactive amendment of the formula violated §411(d)(6). The facts presented in the TAM are different from the facts outlined above where the plan is being amended mid year (or in any event by the last day of the plan year) and therefore a similar conclusion should not be applied to the above facts. Moreover it is our understanding that:

• this TAM is currently under reconsideration;

• the IRS has orally agreed not to challenge anti-cutback issues regarding changes in a discretionary profit sharing plan formula prior to the reconsideration being complete and the IRS issuing something in writing;

• the IRS will not challenge the §411(d)(6) cutback issue regarding EGTRRA amendments for 2002 and that no amendments (with respect to the compensation limit increase or the faster vesting for matching contributions) needed to be in place by the end of 2001 to be effective for the 2002 plan year.

IRS response: The IRS agrees with the portion of proposed response that it will not challenge the §411(d)(6) cutback issue regarding EGTRRA amendments for 2002 and that no amendments (with respect to the compensation limit increase or the faster vesting for matching contributions) needed to be in place by the end of 2001 to be effective for the 2002 plan year. Rev. Proc. 2001-42 establishes an amendment procedure for plan amendments, but mandatory and discretionary amendments, allowing plan sponsors until the end of the 2002 plan year to adopt good faith amendments. Specific §411(d)(6) relief is provided for top heavy plans in that procedure. The IRS disagrees with the portion of proposed response that the TAM is under reconsideration or that it has orally agreed not challenge anything.


I think that it is very easy for somebody to see the above and assume the "proposed response" is, in fact, a response of the IRS itself. This is because of the language actually used (e.g., "The IRS will not...").

With all that said, the TAM is based on some very bad acts. That is, an attempt to amend an allocation after the end of the year and after the contribution has been made.

Does the TAM actually stand for the proposition that one cannot do what you are asking about? I don't think anybody knows for sure. It might not. Certainly one would think that EGTRRA amendments adopted after the first day of the plan year beginning in 2002 should be subject to the same rationale, absent a specific 411d6 exemption. But the only 411d6 exemption the IRS gave us with respect to EGTRRA amendments has to do with the top-heavy issue. Not the 401a17 issue and not the 415 limit issue. If they are agreeing not to challenge the 401a17 issue and the 415 limit issue for EGTRRA amendments, are they tacitly saying that 97-35001 doesn't apply to amendments made before the end of a year? Or that it doesn't apply to amendments made before a contribution for the year has been made (as you are inquiring about)?

Unless somebody can come up with a citation that is consistent with your recollection, I think the only safe course of action may be to file for an LOD and splash the timing of the amendment and the contribution over the submission to make sure the issue is addressed.

#3 Trumpy!

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Posted 07 January 2003 - 08:19 AM

The ERISA Outline Book addresses this issue in chapter 3, page 230 (2002 edition). It states that the position of the IRS is that participants have a protected allocable share of the employer contribution.

The solution suggested on the following page is to amend the plan to provide an additional contribution under the desired formula. Then, provide a minimal contribution under the original formula and a second contribution under the second formula.

#4 MWeddell

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Posted 07 January 2003 - 08:22 AM

"The conditions for receiving an allocation of contributions or forfeitures for a plan year after such conditions have been satisfied" are a section 411(d)(6) protected benefit that may not be retroactively amended. Treas. Reg. 1.411(d)-4, Q&A-1(d). The way around this restriction is to add a completely new type of contribution to the plan document with its own allocation formula and fund that contribution, not the prior contribution.

#5 MWeddell

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Posted 07 January 2003 - 08:24 AM

Sorry, Trumpy, for repeating a response very similar to yours. I hadn't read yours yet when I drafted my prior post.

#6 KJohnson

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Posted 07 January 2003 - 09:20 AM

The TAM cited above can be found here:

http://www.benefitsl...am9735001.shtml

Does an actual contribution under the old allocation method actually get you anything logically or legally as long as you leave the old allocation method in the Plan (along with your new allocation method). Presumably, the contribution under the allocation method is discretionary. Thus, as long as you have not eliminated the allocaiton method, aren't you still o.k under the TAM if you simply decide not to fund it? It seems like making a minimal contribution would be just for "show."

#7 Mike Preston

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Posted 07 January 2003 - 12:00 PM

KJohnson, you have made my point. If the contribution is discretionary, then the approach of adding a new contribution type and then funding the original contribution type with no dollars is the same as replacing the original allocation formula with a modified version.

It flies in the face of all logic (at least what I learned as logic) to declare that a discretionary contribution plan has some sort of protected benefit before a discretionary contribution is determined. In my opinion, it can be determined in a number of ways: resolution of the plan sponsor, actual funding of a contribution, forfeiture under the rules of the plan. But if there isn't a determined contribution/allocation, there isn't anything to protect. To the extent such a contribution/allocation is determined, it should be protected.

A far more logical approach would have been to mandate that an allocation formula can be replaced as long as the "predetermined" allocation would have resulted in an allocation that is less than or equal to the eventual allocation. This would have allowed a comp-to-comp plan with forfeitures of 1% of pay to be amended to an integrated plan, for example, as long as everybody got at least 1% of pay (highly likely) or to a new comp plan where everybody gets at least 1% of pay (no problem, as the gateway would now push people up to more than that, in all likelihood). Note that it would preclude a new comp plan that attempted to exclude certain participants from the allocation entirely.

It is helpful to look at the cite that MWeddell posted: "The CONDITIONS for receiving an allocation of contributions or forfeitures for a plan year after such CONDITIONS have been satisfied" is a 411d6 protected right. I agree. But that doesn't necessarily identify what the SHARE of those contributions/forfeitures must be. For the conditions to gel into a 411d6 protected share of the allocations, a contribution/forfeiture must be determinable.

I therefore think the allocation language should trump, if you will, the conditions for eligibility.

To show my age, remember when contributions, pre-401(l) being modified to reflect the 2-for-1 rule, could be allocated on a pure excess basis? What was a participant's protected right under such a plan? It was to share in the allocation and if that contribution resulted in an allocation, fine, but if not, so be it. The determining factor was whether the allocation formula satisfied the rules for non-discrimination. An excess-only plan did so at the time. But so would a comp-to-comp allocation, obviously. I can remember many an excess-only plan being amended after the end of the year, but before an allocation was made, to provide for a minimum benefit (this would have been pre-top-heavy), where those amendments were submitted (we were submitting all amendments back then, as I recall) and where LOD's were issued. 411d6 isn't a non-discrimination issue. It applies to both HCE's and NHCE's. If current day logic were to be applied to the amendment I just described, it would be disallowed, because each and every individual with compensation above the excess compensation threshold would be cut back.

As I said, it is one of my pet peeves!

#8 Alan Stonewall

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Posted 07 January 2003 - 12:59 PM

Thanks to everyone for your input. It seems pretty clear to me that the issue revolves around form over substance.

I take as a given that allocation "rights" are an accrued benefit protected by 411d6. What is far from clear is the issue of form over substance, i.e., adding a new allocation formula and ignoring or minimally contributing under the old formula.

Even though an employer has the discretion to designate separate and identifiable contributions to a plan, does contributing minimally (or not at all) using the old formula and designating a large contribution using a new allocation formula amount to a violation in operation of 411d6? Even if it does not technically constitute a violation, will the IRS challenge it?

For my case at hand, I am going to suggest the client add a "Tier 2" allocation formula for which only HCE's are eligible. Therefore, no non-HCE will have the method for allocating his or her contribution changed by amending the plan after year end. All that has been done is to add a Tier 2 cross tested allocation for HCE's. I expect the amount of contribution under the old formula for non-HCE's will be the same as it has for the past several years. The affect of the amendment will be to provide an additional contribution for HCE's.

While this does not make moot the form over substance issue and the IRS can certainly object to anything they want, I do not see how this fact pattern even raises the issue of changing the allocation methodology for non-HCE's.

#9 Mike Preston

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Posted 07 January 2003 - 06:31 PM

Alan, I'm not sure about your method.

Consider the 401(a)(4) regulations that define how amendments are treated. Combine that with the -11g portion which allows for amendments after the end of the year, but mandates that the results attributable to those amendments stand on their own.

Could it be argued that the impact of your amendment must be tested under a4 in some manner that excludes the plan's provisions other than the amendment itself?

And, if what you are suggesting is deemed to fall under -11g, the deductibility of the contributions might be an issue, too.

Something tells me that an amendment after the end of the year is problematic.

I'm not sure I have a solution, though.

#10 Alan Stonewall

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Posted 07 January 2003 - 08:04 PM

Mike,

I was under the impression that -11g applies to corrective amendments. I was proceeding on the basis that the amendment I was suggesting was not a corrective amendment.

Still, I agree that an amendment after year end may be problematic because of the noted possible issues. However, if someone asked me why they shouldn't do the amendment all I could think of to say is maybe there will be challenges from the IRS.

Thanks again for all your input.

#11 Mike Preston

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Posted 07 January 2003 - 09:23 PM

My concern about discrimination issues goes beyond whether the amendment is specifically labeled an -11g amendment.

Check out 1.401(a)(4)-5(a)(1) and (2). I think any amendment which adds a benefit solely for the HCE's is suspect. The way the IRS addressed this issue for -11g amendments was to state, in 1.401(a)(4)-11(g)(3)(v)(A) what the hurdles to overcome are.

My question with respect to a amendment that you admittedly will be making retroactively (although not correctively) is how will the IRS logic be any different?

If the answer is that this is the best section we have to judge the IRS' response, I think there may be an insurmountable problem.

The title of the section doesn't thrill me, either, although I know that titles are not supposed to mean much: "Retroactive benefits must be provided to nondiscriminatory group."

I agree with you, though, that the only thing we know for certain is that the IRS may object.