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IRC 402(h) Exclusion Limit under EGTRRA


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Although the EGTRRA did not make any changes to the rules regarding the participant's exclusion of SEP and SARSEP contributions under Code Section 402(h), technical corrections are likely to be forthcoming. It is unclear to what extent Code Sections 402(h) will be changed, if at all. The practitioner will need to examine any change by taking into account the following:

1. Whether the "percentage limit" (currently 15 percent) on the exclusion of contributions from a participant's income, is increased (i.e., to 25 percent). [iRC § 402(h)(2)(A)]

2. Whether elective contributions (within appropriate limits) are excluded from a participant's income in addition to the percentage limit (up to the $40,000 aggregate limit under Code Section 415).

3. Whether elective contributions continue to be excluded for the purpose of applying the percentage limit, thus requiring that only "includible" (taxable) compensation be considered [iRC § 402(h)(2)(A)]

4. Whether the reduction to the $40,000 (for 2002) limit should continue to apply when the plan is integrated. [iRC § 402(h)(2)(B)] With a projected taxable wage base (TWB) of $84,900 for 2002, the maximum SEP contribution for 2002 would be $35,160.70 ($40,000 - ($84,900 x .057)) in a plan fully integrated at the projected TWB amount. The language of Code Section 402(h)(2)(B) would appear antiquated and inconsistent with current legislative intent.

5. Whether the compensation cap of $200,000 under Code Section 401(a)(17) for 2002 will apply for the purpose of the percentage limit, which in the authors opinion, it has never been subject to, although it does apply to Code Section 415.

6. Whether elective contributions (within appropriate limits) are deductible by the employer in addition to the 25 percent of aggregate compensation deduction limit (but not in excess of the $40,000 per participant limit under Code Section 415). [iRC § 404(n)].

I submitted a comment to Treasury and Senate officials on July 18, 2001, proposing the following changes be made to address these issues:

(a) Amend Code Section 402(h)(2) (dealing with the exclusion from income) as follows:

Limitations on Employer Contributions. - Contributions made by an employer (other than elective deferral contributions made pursuant to an arrangement under section 408(k)(6)) to a simplified employee pension with respect to an employee for any year shall be treated as distributed or made available to such employee and as contributions made by the employee to the extent such contributions exceed the lesser of -

(A) 25 percent of the compensation [Authors Note: Or "includible compensation," see item 3 above] (within the meaning of section 414(s)) from such employer for the year (determined without regard to the employer contributions to the simplified employee pension), or

(B) The limitation in effect under section 415©(1)(A).

(B) Strike the remainder of Code Section 402(h)(2)(B).

© Amend new Code Section 404(n) (dealing with the 100 percent deduction rules for elective deferrals) as follows:

Elective deferrals (as defined in section 402(g)(3)) shall not be subject to any limitation contained in paragraph (3), (7), or (9) of subsection (a), or subparagraph © of subsection (h)(1), and such elective deferrals shall not be taken into account in applying any such limitation to any other contributions.

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