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Person with comp but zero ELIGIBLE comp in ADP test?


BG5150
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I have a plan that disregards commissions as compensation for plan purposes.

There is one person who has satisfied the eligibility requirements and continues to earn service under the plan, but gets paid 100% on commission.

Is he in the ADP test with a zero salary? Or not in ADP test at all?

QKA, QPA, CPC, ERPA

Two wrongs don't make a right, but three rights make a left.

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Under a strict reading of the code, he would be included in the test since he has met the eligibility requirements for deferring into the plan. Nonetheless, this is a very poor plan design. Regardless of the definition of compensation for 'employer match and nonelective' to apply such a restrictive definition to compensation allowed for deferrals isn't good planning.

But, under a strict reading of the code, he would be included in the test.

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Some random (very!) thoughts--- (fiona1 & Kevin C, note my item (d)--he's in the ADP test):

(a) What kind of reasonable definition of compensation is it when an NHCE (& I will asume this employee is an NHCE) has all his earnings exempted from a potential deferral? (If he's an HCE, ignore my protestations.)

(b) My foggy recollection from 6th grade math is that any number divided by 0 is infinity. So, if this guy's an NHCE, I want him in my test!! :blink:

© Seems like we discuss this or a closely-related topic every few weeks.

(d) 401(k)-6 reg. definition of "eligible employee" is an employee who "directly or indirectly [is] eligible to make a [deferral] election . . . for all or a portion of the plan year." So, commission-man may not be able to make a deferral (because he has no comp.), but he certainly is able to make an election. So he most definitely should count in ADP.

(e) If (d) doesn't convince you, how about this thought: If he's an NHCE at 0%, take the conservative approach and include him in the test, and worry about it later if the test fails. If he's an HCE at 0%, take the conservative approach & keep him out of the test, again worrying about it only if the test fails.

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1. The following was written in the additional course materials for the SunGard 401(k) Plan Workshop, 4/06, page K-37: “Note: A participant with zero compensation for the plan year is not an eligible employee and is excluded from the ADP test.” © Copyright 2006 SunGard

2. From our good friend Blinky: Jim Holland at the IRS has stated many times, and that same sentiment has been reiterated many times as well on these message boards, "no compensation, not in the test."

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Some random (very!) thoughts--- (fiona1 & Kevin C, note my item (d)--he's in the ADP test):

(a) What kind of reasonable definition of compensation is it when an NHCE (& I will asume this employee is an NHCE) has all his earnings exempted from a potential deferral? (If he's an HCE, ignore my protestations.)

(b) My foggy recollection from 6th grade math is that any number divided by 0 is infinity. So, if this guy's an NHCE, I want him in my test!! :blink:

© Seems like we discuss this or a closely-related topic every few weeks.

(d) 401(k)-6 reg. definition of "eligible employee" is an employee who "directly or indirectly [is] eligible to make a [deferral] election . . . for all or a portion of the plan year." So, commission-man may not be able to make a deferral (because he has no comp.), but he certainly is able to make an election. So he most definitely should count in ADP.

(e) If (d) doesn't convince you, how about this thought: If he's an NHCE at 0%, take the conservative approach and include him in the test, and worry about it later if the test fails. If he's an HCE at 0%, take the conservative approach & keep him out of the test, again worrying about it only if the test fails.

In response to item (b), my possibly even foggier recollection from Number Theory in Grad School is that 0/0 is defined as 1.

Sorry to contradict your old math teacher......

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Can you use this definition of compensation for the ADP test? For testing don't you have to use a definition that is either safe harbor under 414 or passes testing? It seems unlikely to me that this definition would pass testing. So I think you would have to count all of his commissions in the ADP test.

IMNTBHO

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Isn't this the employee's "regular" compensation and doesn't this amount get reported on a W-2 ? Isn't the commission subjected to FICA ?

If so how can this compensation be disregarded ?

I admit that this is not my area, but the issue sticks out especially from a discrimination perspective. But even if that does not matter, there is still the issue of the definiton of compensation for purposes of ADP/ACP testing.

George D. Burns

Cost Reduction Strategies

Burns and Associates, Inc

www.costreductionstrategies.com(under construction)

www.employeebenefitsstrategies.com(under construction)

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Some random (very!) thoughts--- (fiona1 & Kevin C, note my item (d)--he's in the ADP test):

(a) What kind of reasonable definition of compensation is it when an NHCE (& I will asume this employee is an NHCE) has all his earnings exempted from a potential deferral? (If he's an HCE, ignore my protestations.)

(b) My foggy recollection from 6th grade math is that any number divided by 0 is infinity. So, if this guy's an NHCE, I want him in my test!! :blink:

© Seems like we discuss this or a closely-related topic every few weeks.

(d) 401(k)-6 reg. definition of "eligible employee" is an employee who "directly or indirectly [is] eligible to make a [deferral] election . . . for all or a portion of the plan year." So, commission-man may not be able to make a deferral (because he has no comp.), but he certainly is able to make an election. So he most definitely should count in ADP.

(e) If (d) doesn't convince you, how about this thought: If he's an NHCE at 0%, take the conservative approach and include him in the test, and worry about it later if the test fails. If he's an HCE at 0%, take the conservative approach & keep him out of the test, again worrying about it only if the test fails.

In response to item (b), my possibly even foggier recollection from Number Theory in Grad School is that 0/0 is defined as 1.

Sorry to contradict your old math teacher......

The math theory I was taught was that 0/0 is either 0, 1 or infinite. Zero being a focus on the numerator; 1 being a focus on the identical aspect of the numerator and denominator; and infinite being a focus on the denominator.

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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mphs77 -- Obvioulsy my 6th grade math teacher never made it through Number Theory (nor did I). But my infinity determination matches what John learned, if you focus correctly. :blink:

GBurns & Jim -- (Hey, Jim, what's IMNTBHO?) My notion precisely (see my Item #1 in earlier post). Now that it's not so late in a work day, I'll elaborate for all of us. In calculating ADR, the precursor to ADP, compensation is deferral divided by comp (as defined as in 414(s)). (Reg. 1.401(k)-2(a)(3)(i) & -6.) A definition of comp, if not falling within a safe harbor definition, must be "reasonable" (Reg. 1.414(s)-1(d)(1)) and must pass a nondiscrimination test (Reg. 1.414(s)-1(d)(3)). "Reasonable" is defined in the regs (Reg. 1.401(k)-1(d)(2)). How is excluding 100% of an employee's compensation (an NHCE, that is) reasonable under the regs? Even if "rate of compensation" is used and it is $0 (i.e., he/she receives no salary, but only commissions), that $0 rate of compensation cannot be used in ADP determinations (Reg. 1.401(k)-1(e)(2)). However, if this employee is an HCE and only HCEs receive commissions, then 414(s) allows commissions to be excluded (Reg. 1.414(s)-1©(5)).

I believe you can use any definition of comp. to determine the amount of an individual's deferral--which would mean this employee could defer nothing because his/her compensation was $0 for purposes of calculating the deferral made to that individual's account. But ADP must be based on 414(s) comp. So, if this employee is an NHCE, I don't believe the Jim Holland "no comp, not in test" rule applies, since this person has 414(s) compensation.

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Fun, indeed.

0/0 = 19 [= ERISA, according to many]

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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Any number divided by itself is indeed 1, which in ADP test is 100% (that would have quite a dramatic effect in a small population!)

But I thought it was more like any VALUE divided itself is 1, but zero is by definition the lack of any value at all... But admittedly I did not study match in grad school - truth be told I studied nothing at all in grad school (of course if I had gone to grad school I would have studied...).

Austin Powers, CPA, QPA, ERPA

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Aren't we lucky that the regs deal with things much more certain than the quotient of 0/0? :rolleyes: Things like "facts & circumstances", and "no comp, not in the test" and what "is" is, and what definiton of comp to use (& what comp really means when we use it), and how to determine the applicability of the 6-year cycle, and whether a 403(b) plan complying with the new regs is an ERISA plan. How nice it is for us always to know the answer to everyday issues like we do . . . :lol: Actually, this 0/0 stuff looks very much like the 401(a)(4) regs: http://en.wikipedia.org/wiki/Division_by_zero

Notice that in these new 401(a)(4) regs-- :blink: --, it says that "the fallacy is the implicit assumption that dividing by 0 is a legitimate operation with 0 / 0 = 1." And, through that, we can show that 1 = 2. Typical actuary fare, ehh? :o

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While this is fun, it seems that we have gone off-track.

Isn't the problem the definition of compensation that should be used ?

Can the commissions be disregarded?

George D. Burns

Cost Reduction Strategies

Burns and Associates, Inc

www.costreductionstrategies.com(under construction)

www.employeebenefitsstrategies.com(under construction)

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George --

Golly, you put the cabbosh on us just as it was getting interesting . . . :blink: (And I agree with Kevin that, strictly mathematically, you can't include someone in the ADP test if there is no comp. Now I'm sounding like Jim Holland!)

However, when determining ADP, I don't believe commissions can be omitted for a person whose only compensation is from commissions (or when omitting commissions is otherwise unreasonable)--unless(& we don't know), in some circumstances, if the employee is an HCE.

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That definition of compensation can be used for ADP testing IF it is consistent with the plan definition of compensation for testing and IF the definition satisfies 414(s).

We don't have enough information to be able to tell if there is a problem or not. I agree with George that if it has not already been done, then the first step is a 414(s) test to see if the compensation definition passes.

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I am leaning toward INCLUDING him in the test for these reasons:

The definition of an eligible EE for the puposes of the ADP test (1.401(k)-6) is someone who is eligible to defer a portion of his compensation for all or a portion of the year. "Eligible employee —(1) General rule . Eligible employee means an employee who is directly or indirectly eligible to make a cash or deferred election under the plan for all or a portion of the plan year."

The person in question here was elgiible to make a deferral if he had a regular paycheck (instead of a commissions paycheck).

And furthermore, from 1.401(k)-2, the employee's ADR is the employee's elective contribution (plus QNEC's, etc.) "divided by the employee’s compensation taken into account for the year"

So, I think I could use his 414(s) compensation (which includes the commissions) with a zero deferral because it says "compensation taken into account," and not just the compensation that was eligible to be deferred.

Once again, your thoughts are appreciated.

QKA, QPA, CPC, ERPA

Two wrongs don't make a right, but three rights make a left.

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I think you need to do 2 things:

  1. Check the plan document to determine the definition of compensation for purposes of performing the ADP test. That particular definition could possibly include commissions, which would make this person's deferral percentage 0%. Then your task is finished.
  2. If that definition excludes commissions, then you need to determine if that definition, as for the employee group as a whole, is reasonable. It still could be reasonable (although I doubt it if it reduces an NHCE's comp. to $0.) If you determine that the definition is not reasonable, then I think you need to probably use some default definition in the Plan, porbably Section 415.

Then you'd perform the ADP test using the proper definiton of compensation.

Kevin -- So, my 6th grade math teacher was correct (almost!) after all. Although 0/0 is indeterminate, any number (i.e., greater than or less than 0) divided by 0 = infinity.

(Jim Chad -- I like it.)

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Plan says ADP test is done using 414(s) comp. Person IS HCE (so him being in the test helps a lot). Plan passes 414(s) test with exclusion of commissions.

So, to me, it really comes down to this: Regs say he must be eligible to make a deferral election to be in test. He has been with the company for many years and has long satisfied the service and entry date requirements. So, you would think he is eligible. However, since he is a "commission only" employee and will not get any "regular" salary, and it is explained in the SPD that commissions are excluded for deferral purposes, did he have any real case to make a deferral election?

I know it is better to err on the side of caution, especially since he is an HCE, but I want to get this right, because it affects a failing 2006 test and QNECs and/or refunds amounts are on the line, adding up to potentially thousands of dollars. (It affects 2007 testing, too, but just the refunds.)

QKA, QPA, CPC, ERPA

Two wrongs don't make a right, but three rights make a left.

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