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Is this exclusion of NHCEs for ADP test legitimate?


Guest 410b
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I think the reason that so many hackles have been raised is that your conservative view, while possibly defensible, goes against how most of us in the business do the tests and also how the software used for testing is programmed. The truth of the matter is that many issues that we take for granted could be argued from a slightly different perspective. If the end result gives an acceptable answer that is more favorable than your alternative view, why would you want to pay extra for the less favorable result?

FWIW, I've been following this discussion looking forward to the new posts each day. After 8 years in the business and 2 professional designations, I had never before heard of any question about how to test otherwise excludables.

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Just to add to reference material for the thread,

I have been given a two page document which begins,

Excerpt from ERISA online/Chapter 11 Section VIII., Part B

I can't find this online so I suspect that it may be in some paid access type database. Perhaps some of you can access it in that way.

The discussions relate well to this thread.

Kim,

I don't know, but I have to believe, particularly after looking at the document above coupled with Tom and Mike's comments, that there would be software packages that would handle either approach. If there is software to handle it, then additional testing may not incur a significant additional charge and the going forward costs should be very similar.

Given that the use of the semi-annual statutory dates is a much more standard industry practice than I suspected, I think the issues about potential penalties to the company and potential income tax issues to an HCE become the more material issues than testing company charges in evaluating a redo of the test.

Why would I want to?

These are subjective, personal reasons.

1) Because I believe it is the right way to do it.

2) The concept of taking more out of a container than was put into it really, really bothers me. In my worldview, the process should be fairly simple and look to the plan. If you take the plan as the guideline, there are more otherwise excludable employees when you use the statutory dates than when you use the plan dates. The document I referenced above even talks about being able to have otherwise excludable employees for testing purposes when the plan has a 21/1 requirement for participation. While there are better tax results achieved, mentally I just don't like the processes.

3) I think that taking a "most conservative" approach helps to give a "line of defense" if you are worried about "the appearance" of administration conflict of interest issues in regard to the plan.

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The bottom line is that you are clinging to your position, even in the face of evidence that supports the use of statutory entry dates. Again, as the client, you are entitled to take whatever position you want, as you will be the responsible party should the IRS ever light you up. But I find it particularly arrogant of you to use the phrase:

"Because I believe it is the right way to do it."

That implies strongly that you believe the use of statutory entry dates is the wrong way to do it. Frankly, there are some very talented, and in some cases brilliant, people who have travelled this road long before you have. And for you to reject their years and years of experience and their well respected views and come to your own conclusion is fine for you to apply to your own domain. But please spare us the language that implies your conclusions should supplant those of the people I just mentioned as it applies to others.

After you have written a treatise comparable to the ERISA Outline Book, maybe you could come back and speak with a bit more authority.

I'm not sure of the specific chapter reference you used, as I couldn't find anything in that section of the 2006 version (btw, it is called the ERISA Outline Book, not ERISA online).

Here is a snippet from the 2008 version, Chapter 11 (401(k) and 401(m) Testing), Section XII (Special testing rules), Part D (Otherwise excldable employees):

"Comments made on July 29 and 30, 2003, by IRS and Treasury representatives of (sic) the ASPPA Summer Conference in Irvine, CA, as part of a discussion of these regulations when they were in proposed form, suggest that, unless subsequent guidance provides explicit language regarding the entry date issue, that a reasonable interpretation of the law would include the assumption that either the plan's entry dates or the statutory entry dates under IRC Section 410(a)(4) are relevant to identfying otherwise escludable employees."

And your quote here:

"While there are better tax results achieved, mentally I just don't like the processes."

says a lot about what you want to accomplish. You want to rewrite the rules to meet your own definitions of simple ("In my worldview, the process should be fairly simple and look to the plan.") and easy to understand. I wish you luck with that. This sort of naive approach to understanding the Internal Revenue Code and the regulations which are published thereunder is indicative of somebody who has very little stomach for the real world of benefits administration.

Heaven forbid you should have cause to review Section 401(a)(4) of the Internal Revenue Code and be responsible for implementing its enforcement. It is 18 words long and sets forth one of the requirements to have a qualified plan: "if the contributions or benefits provided under the plan do not discriminate in favor of highly compensated employees."

The IRS has seen fit to publish regulations interpreting what that section means that are hundreds of pages long. As with any document of such length, there are some provisions that are unclear. And there are some provisions which required the IRS to make a judgement as to how best to implement the statutory intent.

In your world, where things should be "fairly simple" you would reject options which are, I guess, "not fairly simple". In short, you would be a lousy consultant, because you would substitute your judgment for the IRS'.

I'm coming to the same conclusion that Blinky already came to.

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Hi Mike,

After I had made my last post, I was finished with the thread.

I was subsequently given the document which I referenced and I thought it was a concise and balanced presention that specifically addressed issues and comments made in this thread. As such, I thought it was an appropriate additional reference. I figured that it must have come from a database that would be accesible to the professionals on this site. The heading on it is as I typed it, so maybe somebody typed that in above excerpted text. I am not sure if it is allowable for me to add it as an attachment to the thread which is why I handled it the way I did.

Your posts have been tremendously helpful to me and I tried to express that in a response that I made above to Blinky. The fact that I cannot "see" as you wish me to does not diminish the quality or quantity of your experience and knowledge. Nor does it diminish the quality of your posts. In fact I specifically told my boss about your background in order to support the substance of your comments when I passed on the information about your concerns about our plan. As I expressed in my response to Kim, avoiding any APPEARANCE of discriminating in favor of HCEs in my "company specific" situation is one of the reasons I would like to see my company using the most conservative testing approach available.

Personally I don't see a lot of difference between this:

"As I said, 410b may be right. Technically. Even though I don't think he is, that means very little in the long run."

Which you have allowed yourself to make as a side comment to another poster, and this:

"These are subjective, personal reasons.

1) Because I believe it is the right way to do it."

Which you are apparently unwilling to allow me to make as a side comment to another poster.

Kim made a post and asked me a specific question. A forum is a place where people can do that.

I was asked a question about why I would do a certain thing. I did not say those are defensible in regards to the code and regulations. I did not say they were answers that I should have made to any previous posts. I did not submit those statements unsolicited to "beat a dead horse" as I was accused of in a previous post. Another forum user asked me a question about why I did something and I answered it. With answers that were not illegal, immoral, or fattening. Period.

Regards.

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Mike,

So you can check it against what you were looking at, here is the heading and 3 sections of what I have. The first section has a bunch of number 2s within it.

Excerpt from ERISA Online/Chapter 11 Section VIII., Part B

How do the plan's entry dates affect the determination of who is an otherwise excludable employee?

Could a plan with 1 year/age 21 eligibility conditions ever have otherwise excludable employees?

Do not have to be consistent from year-to-year.

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Here's another cite:

http://www.asppa.org/archive/gac/2000/irs_q&a.htm

Search for "6-month" and you'll find that as early as 2000, the IRS folks were making it crystal clear that the 6-month rule is perfectly acceptable.

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Is there a page number on it somewhere?

No there isn't.

The only other numbers besides code/reg refs are

2.a.1 Approach #1

2.a.2 Approach #2

2.a.3 Basis for each approach

-------------------Edit--------------------------

Following Mike's title comment, I searched and found a 1998 table of contents online with this information (chapter heading and first two sections:

Chapter 11 - 401(k) and 401(m) Testing

Identifying eligible employees

ADP and ACP tests explained

So I believe that Mike is correct, the material I was looking at was excerpted from the ERISA outline book. There is one thing that was not mentioned that is in my "rationale" for approach 2. Other than that I liked it very much because I thought it was concise and balanced.

-------------------------------------------------------------------------------------------------------------------------------

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And, the other side of the coin, you'll find:

www.abanet.org/jceb/2006/JCEBQAwithIRSfor2006.pdf

where the IRS makes it clear that they no longer have a clear position on the matter.

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as noted throughout this discussion, there is no clear cut answer at this time. similar to ASPPA, the American Bar Association runs a Qand A session each year with the IRS. At their May 2008 Meeting a similar type question was raised. Rather than trying to understand the exact nature of the question, which may be a bit confusing to some, I would focus on the IRS response, which is basically "we are working on how maximum entry dates should be handled". so someday maybe we will all know exactly how to handle otherwise excludables! at past ASPPA conferences I believe the IRS officials have indicated if how you have handled things is reasonable, then they would not retroactively make you change things once they release a decision on how 'otherwise excludables' and entry dates, etc should be handled.

(I tripped across their website a few years ago, so I do check on their latest Q and A's

Question #14 from the American Bar Association Section of Taxation May Meeting 2008 (May 8-10,2008)

(I tripped across their website a few years ago, so I do check on their latest Q and A's)

14. § 401(k) – ADP Testing

An employer maintains a 401(k) plan. The 401(k) plan provides that an employee is immediately eligible to make elective contributions and is eligible for safe harbor matching contributions upon completing one year of eligibility service. The plan may be disaggregated into two parts: one covering employees who have completed less than one year of eligibility service and one covering employees who have completed one year of eligibility service. See 26 C.F.R. § 1.401(k)-1(b)(4)(vi), Ex. 2. There are employees who in one plan year are in both parts of the plan. For example, an employee hired on March 4, 2006 would be in the first part (covering employees who have not completed a year of eligibility service) from January 1, 2007 through March 3, 2007 and in the second part (covering employees who have completed a year of eligibility service) from March 4, 2007 through December 31, 2007. What portion of the employee’s compensation and contributions needs to be counted in performing the ADP test on the portion of the plan for employees who have not completed a year of eligibility service?

Proposed Response: The employee’s compensation and contributions from January 1, 2007 through March 3, 2007 would be counted in performing the ADP test for the 2007 plan year for the part of the plan covering employees who have not completed one year of eligibility service. See 26 C.F.R. § 1.401(k)-6 (providing in the definition of compensation, “The period used to determine an employee’s compensation for a plan year must be either the plan year or the calendar year ending in the plan year. . . . A plan may, however, limit the period taken into account under either method to that portion of the plan year or calendar year in which the employee was an eligible employee . . . .”). See also 26 C.F.R. § 1.401(k)-2(a)(3)(ii)(B) (providing the plan needs to count only the portion of the employee’s compensation earned prior to the employee completing one year of eligibility service).

IRS Response: The Service representative indicated that, in his personal opinion, the proposed response seemed reasonableThe Service representative cautioned that the answer ignores the issue of maximum entry date and whether they can be taken into account. The Service representative noted that the IRS is working on how the maximum entry date is taken into account for the disaggregation rules under § 401(k), § 410(a) and § 410(b) of the Code

as with any comments by IRS officials, the responses reflect unofficial views of the IRS representatives and not necessarily official policy.

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I guess I'm coming back to the underlying reason for the provision: the employer shouldn't be hurt by allowing for age/service/entry earlier than required by law. By allowing for entry dates before the statutory entry dates, the test shouldn't be worse than they would be if the employer kept everybody out as long as possible. With that as the rationale, it makes perfect sense to me that a plan with a 1 year wait, with age 21 as the age requirement, might still have "otherwise excludables" if the plan's entry dates were not as restrictive as they might be.

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By allowing for entry dates before the statutory entry dates, the test shouldn't be worse than they would be if the employer kept everybody out as long as possible. With that as the rationale, it makes perfect sense to me that a plan with a 1 year wait, with age 21 as the age requirement, might still have "otherwise excludables" if the plan's entry dates were not as restrictive as they might be.

This is an example of torturing the law to get a benefit for the HCEs (read money) that goes beyond the contractual intent of the employer as expressed in the terms of the employer's plan document.

...the employer shouldn't be hurt...

Ok. I can agree with that. But they are restored to a position of "unhurt" by relating the maximum age and service requirements allowed in the code to their (the employer's) participation guidelines as expressed in the plan for their company.

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By allowing for entry dates before the statutory entry dates, the test shouldn't be worse than they would be if the employer kept everybody out as long as possible. With that as the rationale, it makes perfect sense to me that a plan with a 1 year wait, with age 21 as the age requirement, might still have "otherwise excludables" if the plan's entry dates were not as restrictive as they might be.

This is an example of torturing the law to get a benefit for the HCEs (read money) that goes beyond the contractual intent of the employer as expressed in the terms of the employer's plan document.

...the employer shouldn't be hurt...

Ok. I can agree with that. But they are restored to a position of "unhurt" by relating the maximum age and service requirements allowed in the code to their (the employer's) participation guidelines as expressed in the plan for their company.

What? 410b your comments make no sense to me whatsoever. I honestly have no clue what you are expressing here. I am quite befuddled. I now officially remove the tracking of this topic. This horse is beaten, shot, stabbed, burned, and the vultures have picked the carcass clean.

"What's in the big salad?"

"Big lettuce, big carrots, tomatoes like volleyballs."

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How about you guys agree to disagree and get on with it . . . or not.

As long as I think there is hope, I'm an "or not". But I certainly understand the sentiment.

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By allowing for entry dates before the statutory entry dates, the test shouldn't be worse than they would be if the employer kept everybody out as long as possible. With that as the rationale, it makes perfect sense to me that a plan with a 1 year wait, with age 21 as the age requirement, might still have "otherwise excludables" if the plan's entry dates were not as restrictive as they might be.

This is an example of torturing the law to get a benefit for the HCEs (read money) that goes beyond the contractual intent of the employer as expressed in the terms of the employer's plan document.

Pardon me for asking, but how do you know the intent of the law? Have you read the Blue Book? Do you really need me to dig it out to see whether the obvious rationale is stated therein? You really don't believe me that the IRS and Treasury reps have repeated that concept at many conferences over the years?

...the employer shouldn't be hurt...

Ok. I can agree with that. But they are restored to a position of "unhurt" by relating the maximum age and service requirements allowed in the code to their (the employer's) participation guidelines as expressed in the plan for their company.

Strangely enough, I actually understand what you are trying to state, here. And, yes, I think we should agree to just disagree. However, with that said, you used the word torturing earlier and, to me, that is what you are trying to do.

Example: Employer A has a plan with 10 HCE's and 80 NHCE's. The plan uses the statutory framework for age/service and participation. The HCE's contribute just enough such that they are not required to receive a refund.

Employer B is identical to Employer A, however, the participation dates are monthly rather than semi-annual. Instead of 80 NHCE's, there are 85 NHCE's. Because this group of 5 additional people has a lower average deferral percentage than the other 80 NHCE's, these 10 HCE's are subject to receiving a refund.

For you to state that Employer B is "is restored to a position of "unhurt" by relating the maximum age and service requirements allowed in the code to their (the employer's) participation guidelines as expressed in the plan for their company." is, in a word, hooey-pooey.

They were more generous than the law allows, and under your philosophy, the HCE's are disadvantaged, plain and simple.

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Guest EricWings

Clearly those that have posted have done their best to communicate to you how they interpret the law, but because this can be grey you should obtain an official counsel opinion for you to rely upon.

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Tom,

Thanks for your comments above too. One of the issues I ran into as I tried to search about the ADP and ACP tests was that complexity in the nature of the questions and the complexity in the nature of different kinds of plans. I could not find any examples that paralleled specifically my plan situation to compare my logic to allowed logic. The closest things I could find generally seemed to be plans with the adjective "safe harbor" and I didn't know if it was safe to extend logic from them into my situation. The post you made kinda tells me it might be, at least in relation to the procedures of creating this otherwise excludable group.

Your comments have been helpful to me and I appreciate them.

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This horse is beaten, shot, stabbed, burned, and the vultures have picked the carcass clean.

Which may be why we have shifted a bit to a philosophical sidelight. Blinky won't see this, but others besides Mike, tune out if you're tired of the thread.

Mike,

I had two goals when I started this thread. Getting some information and preparing for a meeting. I have accomplished both and the meeting is done.

You would not have gotten to the professional position and stature you have today by lying to me or anyone else about what the government folks say.

I am a combination of the "new guy on the block" and not saying what the party line is. I will defer to your judgement on this issue. Considering that you could be answering another thread, taking your wife to dinner, or supporting a client; is there any value in continuing? If there is, I will again tell the others to tune out and do another post or two or three. If not, I'll be finished.

I guess the other question would be what we would accomplish. We seem to agree that we believe the other is "torturing the law" to arrive at their position. What I see is some additional comment/explanation but, I'm not sure that either of us will change the other's position much beyond where we are now.

Regards

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Guest Sieve

I don't think I'd take the bait, Mike--although you did say that, for the time being at least, you were still in the "or not" camp (agree to disagree . . . or not). I'd suggest, however, that the ship sailed long ago . . .

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... I'm not sure that either of us will change the other's position much beyond where we are now.

My goal has been to ensure that the issues were appropriately vetted. I think the arguments are squarely on the table and that people can make up their own minds. So, I'm happy to let it go at this point, as well.

If you get any further input from additional sources, either way, please drop in.

Take care,

mike

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If you are truly uncomfortable with the way the otherwise excludable rules are being applied to the test for your company, you can always instruct your TPA to not use that option in your test. Your HCEs will not like it, but your other worries will be over.

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