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Plan with no last day of plan year elected


Craig Schiller
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I would be very appreciative of any opinions on this question that I'm sure is not a black and white answer.

Plan has a provision with no minimum hours to get a contribution, and no last day requirement.

Company wishes to make a contribution for 2014 that is 3% for all employees emplolyed on 12/31/2014, and 0% for those who are not employed on that date.

In your opinion, is it violating the terms of the plan to do the above?

On the one hand, one can argue that by not selecting to require employment on the last day of the plan year, it is effectively an election that if you are employed on the last day of the plan year, you will get a contribution if one is made.

On the other hand, one can argue that while it wasn't elected as an automatic factor to deny a contribution, since each person is in their own rate group, nothing prevents an employer in a given year to apply the provision.

Thanks!

Craig Schiller, CPC

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"IF" each person is in their own rate group, then you may provide a zero contribution to those employees who are not employed on the last day. The only thing you would forgo is the safe harbor exclusion of employees who terminated with less than 501 hours. If an employee terminated with less than 501 hours, you don't get to exclude him from your 410(b) analysis because being terminated is not the reason he would fail to get the contribution.

Good Luck!

CPC, QPA, QKA, TGPC, ERPA

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Getting paranoid, Craig? What in heaven's name would make you think that what you described is not allowed? Just because it makes the testing different doesn't in any way mean that it isn't allowed.

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Based on ignorance of the mysteries of testing, I would want to see plan terms with respect to allocation that said that different amounts could be allocated to different rate groups. To me, allocations are one thing and must be specified in the plan. Whether or not those allocations pass testing is another matter.

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Based on ignorance of the mysteries of testing, I would want to see plan terms with respect to allocation that said that different amounts could be allocated to different rate groups. To me, allocations are one thing and must be specified in the plan. Whether or not those allocations pass testing is another matter.

What part of "since each person is in their own rate group" makes you think plan terms don't align with what you would want to see?

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I believe if each person is in their own rate group, you have to pass ratio % for coverage. if there are enough terminees not benefitting you could fail this test.

Yep. No average benefits testing available...

QKA, QPA, CPC, ERPA

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

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MIke Preston: First, the word "IF" and second, the absence of any statement that the separate rate groups are part of the plan document and tied to the allocation provisions. Everyone has become so infatuated with rate group testing as the answer to all impediments to abouse that they sometimes forget the basics.

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Wow Tom, you just blew my mind... Would never have thought of that... The issue here is that you're not using a reasonable business classification to determine who gets a contribution. That's a coverage issue and if you're not using reasonable business classification you can't use Avg Ben for coverage. You can for RG Testing of course.

That's a lot different than some get 3% some get 5% some get 10%.

Austin Powers, CPA, QPA, ERPA

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See paragraph (b) below. Does anyone have a feel for whether the IRS interprets this unfavorably (from the client's point of view) in pre-approved documents that permit each employee in their own group? I understand that this document provision is for nondiscrimination testing of allocations, but does the IRS take the hard line on coverage testing, and consider this as having "substantially the same effect as enumeration by name" - or, is it not something they pursue?

§1.410(b)-4 Nondiscriminatory classification test.

(a) In general. A plan satisfies the nondiscriminatory classification test of this section for a plan year if and only if, for the plan year, the plan benefits the employees who qualify under a classification established by the employer in accordance with paragraph (b) of this section, and the classification of employees is nondiscriminatory under paragraph © of this section.

(b) Reasonable classification established by the employer. A classification is established by the employer in accordance with this paragraph (b) if and only if, based on all the facts and circumstances, the classification is reasonable and is established under objective business criteria that identify the category of employees who benefit under the plan. Reasonable classifications generally include specified job categories, nature of compensation (i.e., salaried or hourly), geographic location, and similar bona fide business criteria. An enumeration of employees by name or other specific criteria having substantially the same effect as an enumeration by name is not considered a reasonable classification.

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MIke Preston: First, the word "IF" and second, the absence of any statement that the separate rate groups are part of the plan document and tied to the allocation provisions. Everyone has become so infatuated with rate group testing as the answer to all impediments to abouse that they sometimes forget the basics.

Boy, and I thought *Craig* was being paranoid.

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First, thanks for the responses. I have a few comments on the comments:

1): Paraniod refers to an irrational level of worry or suspicion. I can make an argument that the IRS has exercised its powers irrationally making concern of the irrational, rational.

2): I disgagree that one cannot call "excluding" those who are not employed on the last day of the plan year" a reasonable classification. It is not naming employees by name, It is a decision that year not to contribute to any employee who terminated prior to the end of the year. I also don't think the fact that each person is in their own rate group has any bearing on it. I think what matters is the classification that is actually applied.

3): I think one can certainly argue with some validity that when the choice made in completing a plan document is "last day is required" or "a minimum # of hours" to receive an allocation, or "no last day or minimum # of hours," selecting the latter is paramount to making the choice that neither a minimum # of hours, nor employment on the last ay will be used as a criteria for an allocation, and that would trump the fact that the employer can choose how much it contributes to each separate allocation group.

What I most wanted, I think i got which was what other practioners did. It seems like most practioners in a plan with separate allocation groups would be comfortable not selecting the requirement that "employees be employed on the last day of the plan year" and still choosing not to allocate to such a group in a plan year. I hope that is what I am reading into the comments,

4): One more thing: I think an IRS agent is looking over my shoulder, Better sign off.

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1) Irrational arguments don't make the paranoid normal.

2) You would be right except for the fact that you are wrong. You have made two comments in this paragraph. The first one has some merit, albeit conventional wisdom is to avoid it because the IRS has said they will fight you on it (using the exclusion of those who are not employed at the end of the year while claiming that doing so means that those who are eligible constitute a reasonable classification). On this issue I personally agree with you but if it is used and your coverage percentage drops below 70%, then expect a fight if audited. The second one has been commented on frequently by the IRS. *IF* everybody is in their own rate group and *IF* somebody (anybody) is excluded from an allocation by virtue of the employer choosing to allocate zero to that person's rate group *THEN* the IRS will treat the plan as if it has the effect of naming employees by name. This is long settled, in the eyes of the IRS. It would take somebody taking the IRS to court and winning to change the IRS' position on this issue.

3) I can't disagree more strongly with your conclusion. If the plan sponsor selects the box that there is no minimum number of hours or last day requirement it does not in any way preclude the plan sponsor from implementing a specific minimum number of hours or a last day requirement as part of its decision making as to how to allocate a given year's allocation. As stated from the beginning, it has an effect on testing, but in no way is it forbidden.

Glad you got what you wanted.

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4): One more thing: I think an IRS agent is looking over my shoulder, Better sign off.

I know the feeling!!

With respect to whether or not a reasonable business classification is someone's employment status, I look to the examples provided. So for example if the definition of business classification is exemplified by things like salaried/hourly, or geographic location, we should look for common threads. Is it a business criteria to treat salaried/hourly people separately? Yes it is (and not just because the regs say so). It is also because the desired benefit structure may well be entirely different for these potentially vastly different audiences. Same w/ California vs Oregon. Perhaps in order to compete in Oregon the benefits need to be greater than those in California. That is a business criteria.

Excluding terminated employees does not satisfy a business need in nearly the same way. To me, it is merely a policy.

At any rate, I have never seen the value of not just including the last/1,000 hour rule if that is what you want to do. Even before I considered the availability of Average Benefits I had already ruled it out merely because of the term with break exclusion.

Here is another good reason to include the last day rule: Johnny gets canned on 12/15/2014 and is expecting his profit sharing. He is mortified when he learns the employer is not giving his 15% of pay contribution. He demands an explanation (he is of course still bitter for being fired), he insists that he be shown where in the document his employment on the last day of the plan year is a pre-condition. What do you tell Johnny? The fact that you are technically correct is rarely a consolation to people.

Austin Powers, CPA, QPA, ERPA

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Dear Johnny,

The plan that you participate in has been approved by the IRS. The plan allows me, the employer, to decide on a person-by-person basis how much, if any, to allocate as profit sharing. The amounts are also tested, as required, for coverage under Internal Revenue Code Section 410(b) and for nondiscrimination under Internal Revenue Code Section 401(a)(4).

In 2014, we decided that you would receive no contribution. Both tests pass, 410(b) and 401(a)(4). You can keep the stapler and the tape dispenser.

Best regards,

Employer

edit: typo

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  • 2 weeks later...

I see how valuable these on-line discussions are, and hope that this year I finally have time to read and follow these on-line discussions regularly. They are tremendously valuable in making sure ones understanding of the rules are correct, and how other practioners are handling things. Since so many rules can be open to so many possible interpretations, knowing how other practioners interpret them helps in understanding the rules, and giving better odds to not veering too far off.

It was very helpful to see the concensus about applying a last day provision even though the plan document didn't "check that box." It was also helput to have Mke Preson's explanation as to why it wasn't okay to consider a last day provision a reasonable classification.

I am concerned about a third thing I wasn't aware of, and suspect I was wrong. I wasn't aware that if a plan has everyone in their own rate group and gives no contribution to even 1 person, it means the plan cannot use the average benefits test. Another words, assume a plan has 20 participants all eligible, and provides a contribution to all except for 8 dental hygienists. Assume the directive states the contribution is to all other than Dental Hygienists I would have had no idea that it precludes the use of the Average Benefits Test. But per Mike Preston, the IRS would consider that naming people if all are in their own rate group.

Does anyone think otherwise? I wouldn't bet against Mike but am hoping he is wrong as I was never aware of this rule.

Thanks,

Craig Schiller

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Hello John -

Thanks for the response. I take it you mean "yes" Mike is correct, and the IRS would automatically not consider it a reasonable classification since everyone is in their own rate group, and one or more rate groups is receiving a $0 allocation (not yes - Mike is wrong - and since not contributing to hygienists is reasonable, it would meet the reasonable classification test)?

Craig Schiller

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I never use the last day/1000 hour; so I don't think it's a consensus. I, too, thought Craig was being a bit paranoid in that you are given total flexibility on how the allocations are made without violating the definitely determinable formula requirement.

When you, then, open the door to how the plan is tested, I think it would be worth mentioning that you have a built in fail-safe for 410(b); and you also get the cherry-pick the employees who will receive the allocation (because each individual is in their own group).

Good Luck!

CPC, QPA, QKA, TGPC, ERPA

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Just to reiterate, I will lead my client in choosing flexibility in most instances. Over my 20 years, I've seen plans with design flaws (i.e. cannot get to the gateway because of accrual requirements) that created nightmares. Because of these experiences, I always attempt to incorporate flexibility whenever possible. When I have a 3% SHNEC, I typically use the wait-and-see; just because.

So, there is no right or wrong; it's just a matter of preference. At the end of the day, I think we can all agree that we're merely making these recommendations to our clients and providing them the best information possible for them to make informed decisions.

Good Luck!

CPC, QPA, QKA, TGPC, ERPA

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Again, this issue is only related to the 410(b) test for coverage.

I am saying that if you have each person in their own rate group, and some folks get zero because the employer chose their rate group to be zero, then your coverage test for the 'plan' must pass using the 70% ratio percent test described in 1.410(b)-2(b)(2).

Further, please note that I am saying that, in my personal opinion, any "reasonable classification" must be accomplished at the plan document level, and a document that says "each in your own class" is not based on any of the objective business criteria that you see listed in Treasury Regulation 1.410(b)-4(b).

Thus, if you have each person in their own rate group, and the employer says "all hygienists get zero", then that still does not make it a reasonable business classification, and thus the ratio percent test is still needed for coverage and the plan cannot use the average benefits test for coverage.

if the plan document listed "hygienists" as excluded from the plan, and if that is a reasonable business classification, then the plan could try to pass coverage using the average benefits test if it needed to do so.

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As far as I can tell, these are the million dollar questions for which there does not appear to be any consensus:

Further, please note that I am saying that, in my personal opinion, any "reasonable classification" must be accomplished at the plan document level, and a document that says "each in your own class" is not based on any of the objective business criteria that you see listed in Treasury Regulation 1.410(b)-4(b).

My thought is I have never seen a requirement that this be delineated in the document to be reasonable, but maybe there is. Has anyone looked more closely at this? It's not mentioned in Belgarath's site.

2): I disgagree that one cannot call "excluding" those who are not employed on the last day of the plan year" a reasonable classification

I actually think this would not be a reasonable business classification. This seems like a perfect question for a Q&A.

The last thing I will say is that what appears to be beyond reproach is either:

  • Include a last day/1,000 hour rule if that is your intention (recall you can always do an -11g to bring in that terminated 25 year old, which has been asked/answered in IRS Q&A's).
  • Make sure coverage passes the 70% ratio percentage test which is almost always a non-issue in these types of plans because generally your using the 3% SHNEC

Because they are so simple and probably will always the desired outcome, why not use one of the two on each plan?

Someone mentioned an inability to provide the gateway which is not accurate as any plan using a non-safe harbor allocation method should already include automatic gateway contributions. Maybe the poster was referring to an IDP where the attorney goofed. But he pre-approved ones should all have that language.

Austin Powers, CPA, QPA, ERPA

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