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Profit Sharing, employee vs. employer contribution?


Guest oppy

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I am a salaried physician in a small group practice. After 1 1/2 years of employment I am now eligible to

participate in a Profit Sharing plan. If I were to participate, my monthly check would be reduced (?15%). My employer would contribute by this amount to the plan only at the end of the plan year. There is no "matching".

There is a 7 year vesting schedule.

My employment contract defines my annual "total compensation" as $xx,000 = salary + profit sharing.

Employer (& his accountant) state that despite my salary being reduced, it is an employer contribution, and that ERISA 29 CFR 2510 doesn't apply.

Is this profit sharing plan method allowable?

Is it truly an employer contribution despite my paycheck reduction?

If I participate, am I giving up the right to 15% of my annual compensation - i.e. forfeited were I to terminate

(or be terminated) prior to 100% vesting.

Please help.

Thanks, Oppy.

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Guest EDSAADE

Oppy:

You seem to be describing an arrangement under IRC 414(h)(2),governmental plan sponsor, where a contribution designated as an "employee contribution" under the plan will be treated as an employer contribution.("pick-up" plan)

In order to qualify as a"pick-up" contribution, (i)the employer must specify that the contributions, although designated as employee contributions, are being paid by the employer in lieu of contributions by the employee; and (ii) the employee must "not" be given the option of salary reduction. Pick-up contributions are not taxable to the employee until distributed.

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Guest psalemme

The employer and accountant are wrong. Basically, what you will be participating in is a profit sharing plan with a CODA or cash or deferred arrangement (in other words a 401(k) plan). Under such an arrangement, you can elect to either (i) receive your entire salary in cash, or (ii) defer a portion of your salary. If you defer a portion of your annual salary, your employer will contribnute your "elective deferral" to the plan. For Internal Revenue Code purposes, the elective deferral is considered an employer contribution. However, it is fully vested and nonforfeitable and must be contributed to the plan by the employer within certain time limits prescribed by the U.S. Department of Labor. Under current law, elective contributions must be paid in cash by the employer to the trust maintained under the plan as soon as such contributions can reasonably be segregated from the general assets of the employer but in any event within 15 business days after the end of the month for which the compensation to such elective contributions relate is paid.

The plan probably contains a discretionary profit-sharing contribution feature. If the employer was to make a profit-sharing contribution for a plan year, you would vest in such contribution as outlined in the plan.

To me, the profit sharing referred to in your employment contract relates to profits of the group practice and not what you will receive under the group's qualified retirement plan.

I would obtain a copy of both the Summary Plan Description (SPD) and the profit sharing plan document and read them carefully. The employer is required to make these available to you.

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Oppy,

psalemme's neatly capsulized your probable situation in his/her first paragraph. Contributions you make from your regular paychecks are elective deferrals, and the plan sponsor has no discretion to wait until plan year end to invest them.

Following thru on his/her advice is a good idea, too.

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

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the previous responses assume you have a normal 401(k) profit sharing situation.

As I read your message, you and your employer agreed to a fixed total amount of compensation. Once you became eligible for the profit sharing plan, the employer contribute 15% of your net compensation - (about 13% of your gross) - and you will show the net as your W-2 wages.

This saves both of you some FICA or medicare tax. and the reduced amount is in your profit sharing account where it accumulates on a tax free basis.

However, you are subject to potential forfeiture of "your" contribution (technically it will be an employer contribution - but for practical matters it is yours). Thus, if you should leave before the ned of the seven years, some compensation, which would have been given to you previously in cash, will be distributed among those persons who are staying with the plan.

You should discuss this with your own accountant and ERISA attorney. All the documents, your employment contract and the spd referred to

If, on the other hand, the employer keeps another set of books which reimburses you for the forfeited amount, the plan may not be maintained in a qualified manner and could lead to all sorts of problems for you and the employer.

You should meet with your own accountant and ERISA attorney, bringing with you all the pertinent documents (your employment agreement, the spd and the plan document).

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Thanks to all for your responses,

Larry M, as you elucidated from my question, the key to this tricky plan seems to be the way my employment contract was worded "Total Compensation = salary + profit sharing".

I have discovered a new twist,

One of my co-workers (the only physician currently in the plan except for the boss) has a contract in which her salary wasn't defined by the "total compensation" concept. The contract was signed about 5 years ago (2 years before the profit sharing plan was created) and has a set salary + 5% annual increase with automatic renewal.

For the first two years of the plan this co-worker had 15% taken off of her paycheck and this sum was immediately put into the plan (for which she received a separate statement). Last year, the boss (or his accountant) decided to change to annual contributions to the plan despite coming out of her monthly paycheck.

Note: the SPD I received actually states that the plan will be funded annually. It also states that employee contributions are not allowed (remember, for me it would be an employer contribution).

As you all may guess, I suspect that what he has done for her is illegal since it seems like she is making an employee contribution which isn't being funded immediately.

Now the questions (finally),

1.Is the plan as implemented for her illegal?

2.Does that make the entire plan invalid?

3.If my co-worker continues to participate as-is for fear of rocking the boat, could she be at risk for future loss if she or the boss were to be audited (i.e. IRS decides that the plan was not implemented properly therefore all contributions are taxable retroactively)?

4.What liability could the boss have?

I hope you enjoy this "interesting" puzzle.

Thanks again for your assistance,

Oppy.

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If this plan is legit, I'm at a loss as to the employer's advantage in insisting on some sort of 'per-pay-period' RECOGNITION(?) of the profitsharing allocation, when it's not actually ALLOCATED per pay period, vs a simple year-end (or semiannual, or quarterly) recognition, when the cash contribution--the plan's funding--is actually made.

Are there quarterly tax benefits to the arrangements Oppy describes? Is there some sort of cash flow 'win' re payroll taxes due? Or is it only a misguided attempt to show employees the 'value' of the (I'm assuming mandatory) profitsharing allocation?

Based on Oppy's experience, even if the plan IS ok, the way its been communicated has been bungled--it's value proposition for employees squandered.

My feeling at this stage of the discussion is that this plan may hold some sort of advantages for the employer, but whomever advised the employer to implement it conveniently forgot that for real success the plan needs to provide compensation value to employees.

'Value' depends heavily on participant perceptions of the plan's benefit to them. While I believe I could make a case that such a plan MAY have value for participants, clear explanation of HOW should have been part of the plan's implementation. As Oppy describes it, there was a crude attempt to sum cash compensation and the profitsharing 'promise'. The former is fungible, the latter decidedly less so - and an explanation of the plan should carefully lay out the 'strings attached', in my opinion.

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