Cross Testing again

[pmacduff]

ok - very small plan with cross tested formula; last day rule & 1000 hours for allocation.

There are 7 employees total; 3 HCEs and 4 NHCEs. (One of the HCEs is young and always gums up the non discrim testing.)

One of the NHCEs termed and one retired.

I have to add one of those back in for coverage testing to pass anyway, the retiree was the last out so first back in per plan provisions to fix coverage.

Is there anything that prevents me from adding back in both the retiree and the term for allocation?

The termed NHCE is much younger and would help the EBARs for cross testing thereby allowing less to the NHCEs overall.

thoughts?

[chc93]

ok - very small plan with cross tested formula; last day rule & 1000 hours for allocation.

There are 7 employees total; 3 HCEs and 4 NHCEs. (One of the HCEs is young and always gums up the non discrim testing.)

One of the NHCEs termed and one retired.

I have to add one of those back in for coverage testing to pass anyway, the retiree was the last out so first back in per plan provisions to fix coverage.

Is there anything that prevents me from adding back in both the retiree and the term for allocation?

The termed NHCE is much younger and would help the EBARs for cross testing thereby allowing less to the NHCEs overall.

thoughts?

We recently had a similar situation. If the plan document has specific language for fail-safe (the order of bringing in participants to pass coverage), then we thought you have to stop as soon as you pass coverage, and cannot bring in as many as you want. I think the plan document is what prevents adding back the retiree and term... gotta follow the terms of the plan.

In addition, we're not even sure an 11-g amendment to bring in your terminated participant (in this case) to get a better cross-test result can be done... since there's no failure that needs to trigger an 11-g amendment.

[Tom Poje]

I'd agree, if you have fail safe language you are stuck on who you bring in for coverage. but once that is done you probably fail nondiscrim and then have to correct by bringing in the othe NHCE.

At the 2010 ASPPA Conference the following was asked:(Remembering of course such answers might not reflectan actual position of the IRS)

A company sponsors a discretionary profit sharing plan that has tiered

allocations and utilizes cross testing to show nondiscrimination in amounts.

Owners are allocated a contribution equal to their 415 limit. All other

participants are allocated a contribution equal to 5% of compensation, which

satisfies the gateway minimum. The Plan fails nondiscrimination testing.

The plan could have passed by providing a 6% contribution to all eligible

participants, instead of a 5% contribution. Is the plan sponsor obligated to

correct the failed testing by contributing more to the current participants, or

is it permissible to put in a corrective amendment and permit entry and

provide a 5% contribution to an individual who was previously ineligible

(assuming that would permit the plan to pass nondiscrimination testing

Either proposed correction is possible, but both probably require an amendment to the plan that

satisfies Treas. Reg. § 1.401(a)(4)-11(g), in both form and timeliness. In form, such an

amendment generally either confers additional benefits to existing participants or existing

benefits to additional participants. In either case, the amendment must be both “definitely

determinable” and nondiscriminatory.

of course with a young HCE its possible that you are better off with component plan testing (assuming the young HCE is only receiving the same as another NHCE.

[pmacduff]

This plan does have the fail-safe language for coverage and I concluded as chc93 mentions that you can't add more than you need to pass.

I then went back and read through the language in detail and it appears that the terminee with the greatest number of hours (which is the younger person) should be brought in first as it refers to hours worked and a year of service (as defined in the Plan).

One might assume that normally the last person to term would have the most hours worked but in this case the older person cut back her hours in the last few years preparing for retirement. So...even though she retired after the younger employee termed she had less total hours worked for the plan year.

[BG5150]

but in this case the older person cut back her hours in the last few years preparing for retirement.

I'm sure this was considered, but I'll bring it up anyway: the allocation provisions do not waive service and/or hours conditions for retirees?

[pmacduff]

Yeah - can you believe that...it was one of the first things I checked.

She was actually 65, too, & not retiring "early".

They don't give an allocation for death or disability either.

It's a law firm....nuf said?!?!

[chc93]

Tom, in the 2010 ASPPA Conference question, it appeared to me that the 5% contribution to all others was a discretionary contribution. As such, if given 6% instead, the plan passes nondiscrimination. So, unless the 5% was written into the plan document, I'm not sure how an amendment to bring in an otherwise ineligible participant is justified by 11-g, since the plan can pass nondiscrimination without bringing in another participant and without an amendment to change from 5% to 6%. Thoughts?

[Tom Poje]

I have my leanings towards that answer, but (assuming the IRS understood the question - but the way it was worded seemed clear, but then sometimes questions posted here are misunderstood)

they seemed to indicate otherwise.

Plan allocates max to owner

Plan provides the gateway as required by regulations.

It tests

It fails

It now either corrects by giving more or

bringing someone else in.

plus its an answer by IRS personel and doesn't necessarily represent an official position of the IRS.

not sure if I would be that bold with a discretionary contribution.

[chc93]

Tom, again, thank you very much.

[Tom Poje]

suppose your firm always makes a 5% to the rank and file and maxes out the owner.

even though its discretionary, its done every year that way.

now this particular year you fail.

that's sort of discretionary, but almost fixed in its intent, and perhaps that is the logic behind it.

I'd be only guessing.

[chc93]

suppose your firm always makes a 5% to the rank and file and maxes out the owner.

even though its discretionary, its done every year that way.

now this particular year you fail.

that's sort of discretionary, but almost fixed in its intent, and perhaps that is the logic behind it.

I'd be only guessing.

I understand this point, but generally there will not be a plan provision that governs this, so I really don't see how a failure occurs. Also, my problem is that 1.401(a)(4)-11(g) is titled "Corrective Amendments".

Now, assume that your example plan fails this year, and all employees are eligible and benefiting (no new hires, no terms/retirees). Then, the only way to pass is to reduce the owner or increase the rank and file. And since the contributions are discretionary, no "corrective amendment" is needed. To me, this is the same situation as the original post... change the discretionary contributions, then no failure. Also, if the intent is 5% to the rank and file, and the owner doesn't want to change that, then he's gotta take the hit.

In situations that this occurred for us, we've seen both options selected by different plans... just depends on the owner, I guess.

[Mike Preston]

Warning: This is a rant.

You know how the internet has the "way back" machine? If you don't, you should.

"Way back" when (circa 1993) when the 401(a)(4) regs came out, the IRS and Treasury made it abundantly clear (and I'm sure that ASPPA and other organizations have copies of recordings that confirm what I'm saying) that A FAILURE IS NOT REQUIRED BEFORE YOU CAN UTILIZE 1.401(a)(4)-11(g).

The provisions of 1.401(a)(4)-11(g) list the requirements that one must meet in order to satisfy the rules. You will not find that there be any proof of a failure.

The reason was made abundantly clear by the IRS and Treasury representatives: they thought the cost of running multiple tests was too big of a burden to put on employers in order to take advantage of the rule. So, instead they insisted on the rules that have survived to this day: the amendment must be non-discriminatory, it must be non-discriminatory when considered in combination with the benefits already provided under the plan, etc.

In case this argument doesn't make sense to those of us who have seen less than 20 years of how this is supposed to work, I make this pledge: you send me the raw data on ANY plan and I can run a general test under a set of assumptions and methods that will FAIL. It might take a while. It might cost a bundle. But I've yet to see one that can't be made to FAIL. Actually, it can be trivially easy using component plans, but that isn't really the point to be made here.

If the 401(a)(4) regulations are to be interpreted such that a plan sponsor must provide a test that fails before being able to use a 1.401(a)(4)-11(g) amendment, my business would have been much better these last 20 years merely by offering the ability to demonstrate a failed test. What a waste of time and resources that would have been.

If I never see the "but there wasn't a failure so I don't see how I can use 1.401(a)(4)-11(g) to fix my plan" again, it will be, in the words of that great felon Martha Stewart, a "good thing."

We know that the IRS and Treasury sometimes changes their positions. Sometimes they are long standing positions. I've heard nothing from the IRS or Treasury to indicate that they think what they repeatedly said when the regs came out should be changed.

[Kevin C]

Mike, thanks for the educational rant.

I did some searching and found what you are describing in the preamble published 9/19/1991. It says:

Correction mechanisms

Many commentators stressed that practical problems often prevented data collection and plan testing in sufficient time to correct for failure to satisfy the nondiscrimination requirements. In developing the final regulations two basic alternatives were considered. Use of prior year data, which was suggested by some commentators, is not generally permitted in the final regulations. The primary reason is that use of prior year data could materially undercut the statutory nondiscrimination requirements, unless the old data were required to be modified to reflect certain significant changes (such as significant changes in the composition of the employer's workforce and plan participants). Such an approach would have been difficult for practitioners to apply and the Service to administer.

The other approach suggested by a number of commentators was to permit retroactive correction of the plan for a reasonable period of time after the end of the plan year for purposes of satisfying the nondiscriminatory amounts requirement. This alternative has been adopted in §1.401(a)(4)-11(g) of the final regulations. The retroactive correction period in the final regulations extends through the 15th day of the 10th month after the end of the plan year. This approach, which is similar to that contained in section 401(b) with respect to certain disqualifying provisions, provides the employer with a significant period within which to run any necessary tests and take corrective action.

In order to permit employers to make practical choices based on administrative concerns, use of the retroactive correction period is not conditioned on a demonstration that the plan actually failed to satisfy the nondiscrimination requirements. In addition, the correction is not limited to amendments correcting disqualifying defects. The final regulations do require, however, that any retroactive amendment under this provision be nondiscriminatory standing alone and be consistent with the anti-cutback rules of section 411(d)(6).

From a previous discussion on the subject, the 411(d)(6) requirement may limit the effectiveness of an -11(g) amendment IF your document requires the allocation to satisfy 401(a)(4). I gather that kind of provision is not normally used, but the VS document we use requires that allocations satisfy 401(a)(4).

[Mike Preston]

Thanks, Kevin. Part of the confusion is that the paragraph that so clearly lays out the lack of a need to correct anything was taken out of the preamble to the final regulations, wasn't it?

That brings up additional information from the wayback machine. The first set of regs were about 600 pages long. People complained. So the IRS/Treasury stripped out many things that were "unnecessary". Silly little things like many of the examples intended to clarify how the regulations work. But they had a goal: reduce the length and that they did, by about 50%. So, instead of 600 pages of relatively clear regs we got 300 pages of difficult to slog through and interpret regs. A true victory for government regulators who were deemed to have "responded" to the public's plea for reduced volume.

Again, I'm confident that if ASPPA were to search the tapes, they would find that the government representatives said at the time that the removal of the examples didn't invalidate them (unless there was a true modification of the regulation - which there were some of those, too). As the removal of the preamble information for a4-11(g) didn't institute a failure requirement. A prime example of this is the verbage in 1.401(a)(4)-5(b) dealing with how to measure the 110% liability. The original proposed regs laid out a number of options. The final regs didn't say much. For years the IRS just kept saying: follow one of the examples in the proposed regulations and you will be fine.

Maybe somebody with access to later preambles can find the same language as you found regarding a(4)-11(g) anyway. It has been so long since this issue was "put to bed" as far as I'm concerned that I no longer keep a file on it.

[Kevin C]

I have electronic access to both.

The 1991 preamble says it is for final 401(a)(4) regulations effective for plan years beginning after 12/31/1991.

The 1993 preamble published 9/3/1993 says it is for amendments to the 1991 final regulations initially proposed in January 1993, effective for plan years beginning on or after 1/1/1994. The only -11(g) discussion I see in the 1993 preamble deals with expanding -11(g) to benefits, rights and features issues.

[Mike Preston]

Right. So for plan years beginning 1994 we find the regulations in effect have a published preamble that doesn't include the same language as the earlier version, thereby leading some to believe the thought process had changed. It had not.