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3 Qs for IRS - Rev October 9

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I requested information from a "high" friend at Treasury. Their reply, received on 7/26/02, is as follows--

"We talked with the IRS about this [the 3 questions below] and they are not prepared for us to go out with answers on these questions."

[see NOTE at end; Q3 may have been aswered]

Question 1: Integrated SEP -- Code Section 402(h)(2)(B) regarding the exclusion of an employer's SEP contribution provides for a reduction of the $40,000 limit. If, for example, a SEP plan were fully integrated (5.7%) at a $10,000 integration level, would the reduction for an HCE earning $100,000 of W-2 wages be (a) $570 [the integration level $10,000 x .057] or (B) $5,130 [the excess compensation of $90,000 x .057] under Code Section 402(h)(2)(B)? Based on the way integration used to work, $570 would appear to be the correct answer. But the language of IRC 402(h)(2)(B) suggests that the limit is computed separately with respect to each employee "by the amount taken into account with respect to such employee under 408(k)(3)(D)." This seems to suggest that the true benefit of integration is the excess compensation times the spread. Recent LRMs do not address this issue.

Question 2: SARSEP-- Whether compensation used for the 25 percent 402(h) exclusion excludes catch-up elective deferrals?

Assume $100,000 with an elective of $11,000 and a catch-up of $1,000. Is the maximum exclusion based on $88,000 or $89,000?

Under IRC 414(v)(3)(A)(i) and (ii), $89,000 would appear to be the corect answer, otherwise (if $88,000 were used) the employer would not be able to contribute, on an excludable basis, $250 (that is, $89,000 x .25 versus $88,000 x .25). IRC 414(v)(3)(a)(i) specifically references IRC 402(h).

3. Question: SARSEP and 401(k) -- An individual, age 50, earning $13,000. elects to defer $12,000 of this amount into a SARSEP. The employer makes a $2,000 contribution. Although the employer receives a deduction for the full amount under IRC 404(n). In the case of a SARSEP, most of the contribution is includible in the participant's income under IRC 402(h). IRC 402(h) aside, does the $14,000 allocation exceed the 100 percent limit under IRC 415 or any other limit? Same facts, but a 401(k) plan? [see below]

However, on July 30, 2002, the IRS issued and new publication that contains "draft" versions of worksheets that appear in other IRS publications. [Pub 918--Drafts of Worksheets in IRS Publications] In Publication 918, the IRS issued a draft of a worksheet for Publication 560 entitled "Deduction Worksheet for Self-Employed." This "draft" indicates that the sum of the employer contributions and the elective deferrals plus the catch-up contribution ($1,000 for 2002) may exceed the earned income (compensation) of the self-employed individual. Even if true, such a position would not apply to a common-law-employee or nonowner paid on Form W-2--Wage and Tax Statement. Arguably, the 100 percent of EI limit would not be exceeded in a SEP/SARSEP by the catch up amount, but Code Section 401(d) would appear to limit contributions to the amount of EI in the case of a qualified 401(a) plan.

Example. Based on Publication 918, if a self-employed's earned income is $10,000 (after reduction for the 1/2 of the self employment tax deduction), the individual may contribute $2,000 as an employer contribution (25% x ($10,000 - $2,000)) plus defer $8,000 as an elective deferral, plus defer an additional $1,000 if age 50 or older--and still be within the 25 percent deduction limit under Code Section 404(a) (3)(A). This totals $9,000 as an overall contribution with compensation equaling only $8,000. It should be noted that the 25 percent deduction limit is based on the eligible compensation of all plan participants.

Caution: The worksheets are subject to change before they are officially released. It is difficult to imagine the source of contributions that exceed an individual's earned income. As a general rule, an individual may only make elective contributions from amounts they would have otherwise received in cash, had the election not been made. With earned income of $15,000 or more ($16,140.27 before reduction for 1/2 of the self-employment tax deduction ($1,140.27) for 2002) this problem would disappear. In the authors opinion, the worksheet found in Publication 918 is likely to be corrected.

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  • 2 months later...

You might ask that it be submitted in the next Gray Book. Contact Larry Sher or Don Segal. Email addresses available at http://directory.soa.org/CGI-BIN/LANSAWEB?...web3+mdx000+prd

I'm a retirement actuary. Nothing about my comments is intended or should be construed as investment, tax, legal or accounting advice. Occasionally, but not all the time, it might be reasonable to interpret my comments as actuarial or consulting advice.

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  • 1 month later...

Thanks (good idea), hopefully they will answer them in the Grey Book. To date I have not heard of any new developments in this area.

Note: QP-SEP Illustrator software programs for 2002 have been delayed accordingly. SIMPLE Illustrator (v 2002) has already been released. I have not even begun to think about the TSA/MEC software, which I will prepare once IRS worksheets are finalized. For more information, all me at (317) 254-0385 [after 9 a.m. please - that's 10 a.m. if set to NY time]

Note: I have heard that the IRS is standing by their draft worksheets (allowing elective and employer contributions to exceed earned income). The result would seem to conflict with IRC 401(d) in the case of a qualified plan (and, IMO, may result in penalties under IRC 4972). IRC 401(d) is not mentioned in IRC 414(v). Also, the IRS needs to have separate worksheets for Roth IRAs which generally have a $15,000 (not $10,000) spread.

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