nondiscriminatory classification 1.410(b)-4

[John Feldt ERPA CPC QPA]

I know this has been discussed a few times, but anyway:

Suppose a profit sharing only plan, not top heavy, has the profit sharing allocations with each participant in their own rate class.

Assume 6 NHCEs and 1 HCE - all eligible for the plan. Also assume the plan has a last day requirement in order to receive an allocation.

2 NHCEs quit - both worked over 1000 hours. The document does not show an election to apply any "automatic fix" provisions for a ratio percent coverage test failure.

Running an average benefits percentage test for coverage essentially requires a classification that is reasonable and is established under objective business criteria.

Would this plan be allowed to run the average benefits percentage test for coverage purposes?

Or, must the plan resort to a 1.401(a)(4)-11(g) amendment to make the plan pass the ratio percent test for coverage?

Would the answer be any different if the plan had no allocation condition (no last day requirement)?

[Belgarath]

Depends upon how aggressive you are. If you believe, or more importantly, if you believe that the IRS believes, that everyone in their own group is tantamount to enumerating by name, then no, you can't use the ABT because it would then be, by definition, and unreasonable classification.

If you are more aggressive, you could take the approach that the IRS doesn't believe this, or you are willing to bet that you can win that fight.

Personally, I'd do the 11(g) amendment.

If there is no last day requirement for an allocation, then if your document does not provide for passing coverage via the ratio percentage test, I guess you'd have the bizarre result of amending it to pass coverage when you already have a 100% coverage ratio? I haven't actually thought this part through - it seems too strange to be possible, but...

[BG5150]

I never understood why people draft documents that have everyone in their own group and still an hours requirement or a last day rule. Just allocate to those who didn't reach hours or service milestone zero.

[John Feldt ERPA CPC QPA]

BG150. Yes, I agree. Perhaps a small plan would do it just to remove from testing consideration anyone who quits with under 500 hours (maybe they just apply only a 500 hour requirement though). As you know, you can exclude those terminees from the test count entirely if the sole reason they didn't get an allocation was because they failed to complete a condition, but you can't leave them out if the only reason is because the employer chose not to allocate any to them.

Belgarath. Bizarre, yes. So last fall at the ASPPA annual conference, there's an IRS speaker (Kieffer?) saying that you still have the facts and circumstances as an option to look at even if the plan puts each person in their own class. Saying if the employer has a reasonable business criteria for not providing the allocation, then the plan could still run an average benefits test and not be stuck with the ratio percent test. I immediately cleaned out my ears after hearing that.

[John Feldt ERPA CPC QPA]

Now, suppose the plan is pro-rata or integrated, has a last day requirement, 2 of 6 NHCEs quit, and the document does not have an automatic failsafe. Can the plan run an average benefits percentage test - meaning, does the fact that they terminated put them automatically into a reasonable business classification in that case?

If not, then why have a failsafe option in the plan?

If it does, then why wouldn't that also apply in a plan that allocates to each person in its own rate group?

[Belgarath]

"does the fact that they terminated put them automatically into a reasonable business classification in that case?"

While I absolutely think that this is a reasonable business classification, I don't think it alters the fact that you have to decide, before you ever get to that stage, whether you think you can use the ABT for coverage or not in a plan where everyone is in their own group. If you believe you can, then I don't think it matters. If you believe that you can't (or the IRS position is that you can't) then again, I don't think it matters.

Interesting IRS comment, although I can't figure out what his real position is based on that! By the way, the sound you just heard was my head exploding.

[Tom Poje]

I did at least ask for confirmation as to whether everyone in their own group is reasonable or not reasonable under the new proposed regs, so maybe at least they will commit to something in writing in the preamble. but that of course won't be for another few months.

[Mike Preston]

I think it is clear, Tom, that everyone in their own group followed by an allocation to everyone satisfies the definition of a reasonable class. If the Plan Sponsor declines to allocate at least $0.01 [you may not want to be that aggressive] to somebody then the Plan does not satisfy the reasonable class rule because the IRS takes the position that is effectively the same as naming somebody out of the plan. Of course, if you are in for a penny you are in for a gateway, unless you are otherwise excludable and testing separately.

The IRS has never definitively stated whether the reasonable class definition is satisfied if the only participants that *CAN'T* receive an allocation under plan terms are terminated. Personally, I think a judge would lash the IRS if it tried to enforce a determination that it did not meet the definition, but who wants to fight that battle? Not me.

The issue is gently sidestepped by having everybody in their own group and no allocation requirements. In that case, the terminated participants don't fall into the category of "can't receive an allocation", they fall into the category of "don't" receive an allocation when they otherwise could which, per the above, the IRS treats as effectively the same as naming them out of the plan. So give them a gateway and cure all doubt.

[Tom Poje]

I'd much rather have IRS confirmation one way or the other.

In her comments Ilene Ferenczy makes no mention of 'it is reasonable if everyone receives something' rule you speak of, so maybe it is not as clear to everyone as you

http://www.ferenczylaw.com/Documents/FlashPoint/2_2_16_FlashPoint_The_IRS_Giveth_Yay_and_the_IRS_Taketh_Away_Boo.pdf

[Mike Preston]

Oh, its clear for current rules. The new rules (that are not in place and, with any luck, will never be so) also apply a "who gets the same contribution that determines the contribution for each HCE" rules that adds a requirement.

[John Feldt ERPA CPC QPA]

I will credit these two old IRS responses as having been found by TAGDATA:

From the 2000 Annual ASPPA Conference:

22. Company A has 11 nonexcludable employees; one HCE and 10 NHCEs. Four of ten NHCEs leave employment during year after working more than 500 hours. Plan requires end of year employment for allocation. Coverage ratio is therefore 60%, which meets the non-discriminatory safe harbor at 1.410(b)-4(c )(2). Plan also passes the average benefits percentage test of 1.410(b)-5 (e.g. on a cross-tested basis). Plan still must cover reasonable class per 1.410(b)-4(b) to pass the average benefits test of 410(b)(2).

Question: is “those employed on the last day of the plan year” a “ reasonable classification” for purposes of 1.410(b)-4(b)?

IRS: Yes.


From the 2001 Annual ASPPA Conference:

46. The average benefits test for coverage testing consists of the nondiscriminatory classification test and the average benefits percentage test. To satisfy one part of the nondiscriminatory classification test, it is necessary to determine if the classifications are reasonable based on objective business criteria. Do participants employed at the end of the plan year constitute a “reasonable classification” under Treasury regulation 1.410(b)-4(b)?

IRS: No. Our opinion is that it is not a reasonable classification.

edit: typo

[Mike Preston]

Well, that sure clears things up. :-(

[Tom Poje]

which is why the Q and As carry the note that statements may not reflect an actual Treasury position

which is one of the reasons given for the discontinuance of the Gray Book as people were relying on that as 'fact'

which is the reason why I asked - so they will at least put something in writing even if it is in the preamble to the final regs on this issue.

[AndyH]

which is why you've been composing so many pension songs lately.

[Tom Poje]

hardly Andy. I've been posting old songs. I think I have 14 in all, but it is a matter of finding the words in spot and the music in another, some day I'll get time to post some more