Target Benefit and EGTRRA Limits

[mwyatt]

Have a 3-person target benefit plan. The target benefit formula is based on a High 3 Year Compensation for averaging purposes. Situation is the owner, who had established a high average in past years, had his compensation greatly reduced in 2003. The results are as follows:

Owner: Salary of 62,500, TB contribution calculated at $40,000 (new EGTRRA limit)

2 Other participants: Combined salaries of $164,659, combined TB contribution of $18,654. Note that both calculated TB contributions were in excess of the 3% TH minimum.

Problem that arises is the 25% IRC 404 limitation. Here the deductibility limit would be $56,790, while the combined contribution is $58,654, leaving a nondeductible contribution amount of $1,864.

Plan document was timely amended for GUST and EGTRRA using the Relius/Corbel volume submitter document. The document does have the following language present in Section 4.1:

"Formula for Determining Employer Contribution":

Notwithstanding the foregoing, the Employer's contribution for any Fiscal Year will generally not exceed the maximum amount allowable as a deduction to the Employer under the provisions of Code Section 404. However, to the extent necessary to provide the top heavy minimum allocations, the Employer shall make a contribution even if it exceeds the amount which is deductible under Code Section 404.

I'm not sure if this language means anything in this case (from the GUST restatement) as this was clearly drafted prior to the EGTRRA increases in the 415 limits (remember, this wouldn't be an issue pre-EGTRRA since individual contributions were limited to the lesser of the applicable dollar amount and 25% of compensation).

Trying to see if this language would at all support a reduction in the owner's contribution to the amount that would allow the entire contribution to be deductible. Any thoughts on this situation or do we put in the full amount and file the Form 5330 with the 10% penalty on nondeductible contributions?

[AndyH]

sounds like a 5330 situation to me. Ouch! Can you interpret the EGTRRA comp limit as appling just prospectively? Might or might not help but just a thought.

[mwyatt]

Unfortunately, the EGTRRA comp limit isn't really an issue since past salaries were high, but not over the prior $160k limit (the owner is 64). Knew this could be an issue with age-weighted plans, but at least you have an out by pulling back on the overall contribution. At least the excise tax will only be under $200...

Thanks for the input Andy.

[Mike Preston]

What is the year that you are dealing with? PYE 12/31/2003? If so, file tax return on time with contribution of $56,790, then contribute balance after due date of tax return and apply to next year.

[Blinky the 3-eyed Fish]

Mike, can you do that when dealing with a pension plan?

[Mike Preston]

Well, you are precluded from deducting what you didn't contribute as of the date of the tax return due date, so if it isn't on extension it works quite well (or if the fiscal year and the plan year do not coincide).

[mwyatt]

Actually, that's a good suggestion; I imagine that we will be able to bring the 2004 cost down somewhat as the plan year has just started, so that the overage from 2003 could fit under the 2004 25% limit.

[Blinky the 3-eyed Fish]

I see now what you are saying Mike.

[AndyH]

ok, now that I have all you target experts in one room can somebody answer a question I posed a year ago and never got an answer:

Does a safe harbor target have to fund based upon average compensation or can projected average compensation (current comp. for someone not within the averaging period) be used? We thought the former, then ran across a takeover which did the latter.

[mwyatt]

Hey Andy:

Hope I'm not condemning myself, but we've always used projected average compensation for determining the target benefit contribution (of course with no salary scale; although I did run across a takeover where they not only used a salary scale assumption, but also an expense load!).

[Mike Preston]

I think that Example 2 under 1.411(b)-1(b)(3)(iii) makes it clear that Andy's interpretation is the one expected. However, the net effect of using a projection is typically to provide a larger funding amount for those whose use of the rate will increase their targeted benefit the most. That would typically be NHCEs, although I'm sure I could concoct an example where the reverse would be true.

In most cases I suppose the use of projecting the rate rather than the average gives away more to the favored group (i.e., NHCE's) and therefore is non-discriminatory. Hence, the IRS is likely to approve it.

[AndyH]

Well, thanks, Mike P, that cements it for me. I never looked there before. My interpretation was from the repeated use of the term "average compensation" in the examples under 1.401(a)(4)-(8) plus possibly the original LRMs, and an analysis I read way back when.

And Mike W., you are not alone, but Mike P's comments make sense from my experience because I do seem to recall that, to my surprise, the takeover document did seem to support the use of projected average comp.

But then again, it was a law firm's document, so who knows if it was in fact intended to have safe harbor status. This issue could have been easily overlooked by either the drafter or the IRS reviewer. But I would not think that safe harbor status should be granted based upon the language in (a)(4)-(8) which includes Mike P's cross reference.

Thanks for the help. I'm once again comfortable with my interpretation.

[mwyatt]

I asked Relius/Corbel/Sungard/Gigantorcorp for an interpretation of the language I previously quoted and received the following reply this morning:

It's basically as clear as mud and is open to interpretation.

The language really was certainly drafted before EGTRRA. When the 415

limits were increased, a provision was added to IRC 404 stating that a

d/c plan subject to 412 is treated as a p/s plan. So, the net effect is

that there is just an overall 25% limit. What's not clear is what

happens when you exceed it. You are proposing to reduce the owner's

contribution. But, there's nothing stating that the owner should be the

one who gets the reduction, even though his contribution may exceed 25%

of his compensation. I think that would be a reasonable interpretation

of the rule, but I can't point to anything in the plan or the good-faith

EGTRRA amendment that specifically states that.

As I thought, this was pre-EGTRRA language (wherein you had an operating 25% 415 threshold which would keep you out of trouble). Possibly a grey area for the IRS to interpret at a later date. Thanks Mike P. for your deduction suggestion; haven't yet approached the client on this issue before getting advise, and it may turn out that the result may be too much of a good thing, anyway (there probably is a reason that the owner's salary decreased, if you get my drift). At least we have time to scale back the 2004 result...