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Mid-year Discretionary Contribution to 401(k) Plan


KimberlyC
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Employer A is selling (stock sale) a number of subsidiaries to an unrelated buyer. The buyer will assume sponsorship of the 401(k) plan in place for employees of the subsidiaries. Employer A typically makes a discretionary contribution based on a % of compensation for participants who are employed on the last day of the plan year. the plan has a calendar-year plan year. The sale is expected to close on 9/30.

Due to the sale, Employer A would like to amend the Plan prior to the sale to provide the discretionary contribution to participants who are employed as of the closing date of the sale (9/30). The employees are being hired by the Buyer and will continue to participate in the 401(k) plan after the sale. The employer would like to make the contribution based on 100% compensation earned through the first 9 months of the plan year.

Under Treas. Reg. Section 1.401(a)(4)-2(b)(2), employer A can satisfy a safe harbor under an allocation formula that allocates to each participant the same percentage of "plan year compensation". Under Treas.Reg. Section 1.401(a)(4)-2(b)(4)(iv), the allocation formula will not fail to be a safe harbor allocation formula if the allocation formula is limited to a "maximum percentage of plan year compensation."

Question: Can the employer make the contribution based on 100% of compensation for the first 8 months of the plan year? Or must the employer make a contribution based on 75% of compensation for the first 8 months?

The concern is that an employee who terminates right after the closing date would receive an allocation based on 100% of his/her plan year compensation, whereas an employee who works until year-end will only receive an allocation based on 75% of his/her plan year compensation.

Any thoughts are welcome!

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Contributions are tested based on the plan year. An allocated mid-year contribution contribution could fail because of distortions in the remainder of the year, as you have illustrated. You might consider a contribution mid year that is not allocated until the end of the year based on compensationfor the year, but that allocation would not correspond to the employer wish to provide a particular contribution to the employees as of the closing because of the distortions occurring in the year after the closing.

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Thank you all for your comments. This was a case where an agreement was signed and then legal counsel was contacted to make the agreement happen. The buyer and seller don't want to change the agreement in any way (won't even prepare a statement of how to construe the agreement). Yes, I like to see the agreement specify who will do what with adjustments to the purchase price. Based on preliminary analyses, they may have trouble with rate groups and general testing since some employees have already earned compensation above the 401(a)(17) limit. There are many other issues ..... like agreeing to transfer certain employee benefit plan assets before rather than as of the closing date. A couple of hours on the Agreement could have saved many hours after signing. The preamble to the final regulations stated that Treasury planned to issue guidance on special issues that arise in sales and acquisitions, but that has never happened. I had hoped that had formally or informally approved a contribution based on part-year compensation due to a deal. Cleary there is no intent to discriminate (although I suppose I could conjure up fact patterns where it could lead to a discriminatory result),

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