Forfeiture allocation and 404(a)(7) limit

[Guest Rae]

I have tried looking for a similar question in the archives but don't see this situation being addressed:

We are working with an employer who maintains both a DB and profit sharing plan. The minimum contribution to the DB plan is zero, and the maximum is around $200,000 due to unfunded current liability. The 25% limit for compensation is around $150,000.

There are about $500 in forfeitures in the profit sharing plan to be allocated for the plan year.

The question is: Can the employer contributed the $200,000 for the DB, have the forfeitures be allocated in the profit sharing plan (without contributing anything else to that plan), and not be considered to violate the 25% limit due to the forfeiture allocation? I know the answer would be yes if $200,000 were the minimum required contribution in the DB plan, but can't find an answer when this isn't the case.

[WDIK]

Code Section 404(a)(7) addresses deductibility rules.

Forfeitures are annual additions, but not deductible contributions.

[david rigby]

Correct.

Can the ER contribute $200K? Yes.

Can the ER deduct $200K? If the 404(a)(7) limit is $150K, then that is the maximum to deduct.

Does the $500 forfeiture affect the deductible limit? No.

[Effen]

Pax, why are you saying the max ded. is $150,000?

If they are not making a PS contribution, I don't see why 404(a)(7) would even be an issue, unless you believe just having the PS plan makes 404(a)(7) kick in.

[WDIK]

404(a)(7) allows the greater of:

1) 25% of compensation; or

2) the amount necessary to meet the minimum funding standard.

If I'm understanding things correctly, in this case:

1) $150,000;

2) $0.00 (since that is the minimum contribution required for the DB)

So the deduction limit is $150,000.

[JAY21]

Hmmmm......so in essence the emloyer basically is penalized for having multiple plans with common participants benefiting since if it only had the DB plan the company could contribute and deduct up to the unfunded current liability (200k), right ? I guess that's the same result as any other DB-DC combination plan with common participants, but it sure feels weird given these facts. I presume if there were no forfeitures to allocate then there would not be common participants benefiting and the 25% limit wouldn't apply and they could do the 200k.

[Guest Rae]

It sounds like everybody understands the situation. Thanks for the thoughtful replies.

I stumbled across an item in Sal Tripodi's ERISA Outline Book this morning (7.371 in the 2005 edition) that says that 404(a)(7) basically does not apply if the only contributions made to the DC plan are elective deferrals under a 401(k) plan. It references IRC 404(a)(7)©(ii):

404(a)(7)© PARAGRAPH NOT TO APPLY IN CERTAIN CASES. --

404(a)(7)©(i) BENEFICIARY TEST. --This paragraph shall not have the effect of reducing the amount otherwise deductible under paragraphs (1), (2), and (3), if no employee is a beneficiary under more than 1 trust or under a trust and an annuity plan.

404(a)(7)©(ii) ELECTIVE DEFERRALS. --If, in connection with 1 or more defined contribution plans and 1 or more defined benefit plans, no amounts (other than elective deferrals (as defined in section 402(g)(3))) are contributed to any of the defined contribution plans for the taxable year, then subparagraph (A) shall not apply with respect to any of such defined contribution plans and defined benefit plans.

Now I'm leaning toward the full deduction for the $200,000 maximum contribution being allowed since no amounts are in fact being contributed to the PSP (which has no 401(k) feature). Any thoughts? Thanks again.

[Effen]

I agree. I don't think the 404(a)(7) limit comes into play unless they are deducting contributions to both a db and dc plan during the same year. Just having a dc plan doesn't trigger the restriction. I think the full 200K would be deductible.

That said, if you search the board you will find some long threads discussing this.

Ultimately, it's the accountants/clients call.

[WDIK]

I hope no one gets whiplash from my change of direction, but I agree with the $200,000 based on 404(a)(7)( C).

[vebaguru]

I'm glad to see that you have reached consensus.

X company's DB plan has 25 participants with total compensation of $1,000,000 and X's profit sharing plan includes 50 partcipants with total compensation of $1,800,000. How much may X contribute under 404(a)(7)?

The answer cannot be derived from the facts, since we don't know if the 25 DB participants are included among the 50 PS parts. It turns out that 20 of the participants are covered under both plans, with a total compensation of $800,000. Total contributions to BOTH plans on behalf of the 20 participants may not exceed $200,000. Contributions to the DB plan for the other 5 participants and to the PS plan for the other 30 participants are not covered by 404(a)(7). The 404(a)(7) limit only applies with respect to overlapping participants.

[Mike Preston]

Total contributions to BOTH plans on behalf of the 20 participants may not exceed $200,000. Contributions to the DB plan for the other 5 participants and to the PS plan for the other 30 participants are not covered by 404(a)(7). The 404(a)(7) limit only applies with respect to overlapping participants.

I think this is a most novel approach to how 404(a)(7) is to be applied. Not that I dislike it. I'm rather fond of it. But that is just me. I dare say the IRS would be whatever the opposite of fond is. In fact, they may go even further. Not that I would blame them.

By the way, do you have anything, anywhere which supports your novel approach?

I believe that 2.0 * .25 = 5 and therefore $500,000 is your 404(a)(7) limit.

To reword your conclusion slightly: The 404(a)(7) limit only applies if there is at least one overlapping participant.

[vebaguru]

This is to clarify my prior post. I was in too big of a hurry and it was misleading.

Section 404(a)(7) applies if there is at least 1 overlapping participant. How does it apply?

DC alone: The DC plan is subject to the 25% limit anyway under 404(a)(3), so the 404(a)(7) limit is never reached by the DC plan alone.

DB alone: Under 404(a)(1), the tax deduction is he greater of (i) the amount necessary to satisfy the minimum funding standard, (ii) the amount necessary to fund the remaining unfunded cost computed as a level amount (or %) over remaining service years, or (iii) the plan's normal cost plus amortization costs over 10 years.

DB and DC with no overlap: With no overlapping participants, the 404(a)(7) limit does not apply and the deduction limits are as above.

DB and DC with overlap under 404(a)(7): To the extent that a company funds a DB plan, it may deduct the greater of the amount required to meet the minimum funding standard or 25% of compensation. If the DB contribution is > 25%, no DC deduction is permitted. If the DB is < 25%, the DC max deduction = 25% - the DB cont.

I believe that we agree to here, and no "novel" interpretation is required.

Now let us now explore planning opportunities:

Plan 1=DB for dual participants (DB plus DC)

Plan 2=DB for DB only participants

Plan 3=DC for dual participants

Plan 4=DC for DC only participants

Plan 2 is subject to the the DB alone limit.

Plan 4 is subject to the DC alone limit.

Plans 1 and 3 are subject to 404(a)(7) limit on the overlapping payroll.

[Mike Preston]

Do I understand that what you are suggesting is that you can get around 404(a)(7) by establishing 4 plans where previously only 2 existed?

In the case at hand, we already were stretching 401(a)(26) with counts of 25 DB plan participants and 50 DC plan participants. I overlooked that because there may have been some permissive disaggregation which somehow enabled the DB plan to squeek by.

But if you now want to break the DB plan down to 2 plans, one with 20 and the other with 5 (where the 5 are not subject to 404(a)(7)) then unless those 5 are all NHCE's who are approaching retirement age you will either fail a26 or have not a whole heck of a lot going for the deduction.

Hardly seems worth the pain for the gain.

[Guest greybeard]

I'm from the IRS and I am here to help you. I would like to audit the DC/DB combo as described by vebaguru.

[Effen]

When did the IRS start hiring pirates? I think this equal opportunity stuff has gone too far. Can't you guys get a job doing Capital One commercials?