Padilla Memo

[dmb]

Does anyone have a copy of the "Padilla Memo". The memo issued by Carol Gold on March 13, 1998? Thanks.

[JanetM]

Here you are.

Internal Revenue Service Memorandum

Date: March 13, 1998

To: Robert Padilla, Chief, EP/EO Cincinnati Key District

From: Director, Employee Plans Division, CP:E:EP

Subject: Requirement for definitely determinable allocations

On September 8, 1994, we issued a field directive concerning whether a profit-sharing plan that provided for employer discretion to determine amounts allocated to particular groups of employees satisfied the definite predetermined formula requirement under section 1.401-1(b)(1)(ii) of the Income Tax Regulations. The field directive concluded that this requirement was not satisfied for such a plan.

On July 30, 1996, we issued a second field directive which rescinded the prior field directive and illustrated several plan designs that satisfied the definite predetermined formula requirement.

You have asked whether the first field directive was rescinded in its entirety or was limited to the illustrated plan designs. The first field directive was revoked in its entirety. Consequently, the second field directive should not be interpreted as applying only to the illustrated plan designs, but rather to all plan designs. A plan would not violate the definite predetermined formula requirement if the employer has discretion to determine the amount of the contributions to be allocated to particular groups of employees defined under the plan and the plan specifies the method for allocating these amounts among the employees within each group. The number of people in each group or the number of groups is immaterial provided that each group is identifiable under the plan and the identity of particular employees in each group is not subject to employer discretion. It is also immaterial that the purpose for forming the groups is to satisfy the cross testing requirements under section 1.401(a)(4)-8. For example, a plan with defined groups including a group with one person (i.e. 100% shareholder) would not violate the definite predetermined formula requirement.

Although the plan can provide for employer discretion to determine the amount of employer contributions for each group, the plan must require that the employer notify the trustee, in writing, of the amount of contributions for each group. This requirement does not mean that the plan must provide the specific amount of contributions for each group. Instead, the plan must provide that the trustee be given written notification from the employer as to the amount of the contribution to be allocated to each group.

If you have any further questions regarding this matter, please call Mr. Al Reich of Technical Branch 5 at (202) 622-7976.

Date Published: 03-13-1998

Date Added to File: 05/03/99 09:55 PM EDT

Microfiche Number: Doc 1999-15303 (2 original pages)

[EBECatty]

Bumping this up with follow-up question.

I read this as permitting a plan to have different groups of participants (say groups A and B). The plan must describe groups A and B with enough specificity that the employees in each group can be definitely determined. So group A may be "all employees in the Akron plant" while group B may be "all employees in Duluth corporate headquarters." But the plan can't say a group is "all of the participants the employer assigns to group __ at the end of the plan year." 

The employer also has complete discretion as to the amount of contribution made to each group, and that doesn't need to be in the plan document. The contributions to each group may be different. However, the plan document must specify how each group's contribution is allocated within the group.

So the plan can say "the employer will contribute an amount, if any, in its sole discretion, to each group with respect to a plan year, which amounts need not be the same." But the plan must say definitely how the contribution to each group is allocated (for example "based on ratio of each participant's compensation to the group's compensation"). 

Hopefully none of that is controversial. 

Here's my question: Can you list the groups (and change the groups) in a separate appendix to the plan and change the appendix without a formal plan amendment? For example, if you want to add a new group C of "all employees in California," can you swap in a new appendix without amending the plan, or do you need a formal plan amendment each time?

The guidance above says groups have to be identifiable in "the plan" but I've seen certain aspects get pushed into admin procedures or appendices that are incorporated by reference into the plan document. Would that be pushing it to constitute a definitely determinable formula "in the plan"?

Appreciate any feedback.

[Bill Presson]

43 minutes ago, EBECatty said:

Bumping this up with follow-up question.

I read this as permitting a plan to have different groups of participants (say groups A and B). The plan must describe groups A and B with enough specificity that the employees in each group can be definitely determined. So group A may be "all employees in the Akron plant" while group B may be "all employees in Duluth corporate headquarters." But the plan can't say a group is "all of the participants the employer assigns to group __ at the end of the plan year." 

The employer also has complete discretion as to the amount of contribution made to each group, and that doesn't need to be in the plan document. The contributions to each group may be different. However, the plan document must specify how each group's contribution is allocated within the group.

So the plan can say "the employer will contribute an amount, if any, in its sole discretion, to each group with respect to a plan year, which amounts need not be the same." But the plan must say definitely how the contribution to each group is allocated (for example "based on ratio of each participant's compensation to the group's compensation"). 

Hopefully none of that is controversial. 

Here's my question: Can you list the groups (and change the groups) in a separate appendix to the plan and change the appendix without a formal plan amendment? For example, if you want to add a new group C of "all employees in California," can you swap in a new appendix without amending the plan, or do you need a formal plan amendment each time?

The guidance above says groups have to be identifiable in "the plan" but I've seen certain aspects get pushed into admin procedures or appendices that are incorporated by reference into the plan document. Would that be pushing it to constitute a definitely determinable formula "in the plan"?

Appreciate any feedback.

All of this is generally irrelevant because we now have approved documents that allows for each participant to be in their own group.

[EBECatty]

This would be for an individually designed ESOP, which can only use the comp-to-comp safe harbor or general rate group testing.

If the allocation formula was "every participant gets an allocation as determined in the employer's sole discretion" can you rate group test under (a)(4)? If so, the "groups" can be informally used but officially every participant would be in their own group.

[Bill Presson]

7 minutes ago, EBECatty said:

This would be for an individually designed ESOP, which can only use the comp-to-comp safe harbor or general rate group testing.

If the allocation formula was "every participant gets an allocation as determined in the employer's sole discretion" can you rate group test under (a)(4)? If so, the "groups" can be informally used but officially every participant would be in their own group.

Gotcha. Didn't see that in your first post anywhere. Sorry, ESOPs aren't my thing.

[EBECatty]

If it was a plan vanilla PS plan, could you allocate every participant in their own group in the plan document then test under the (a)(4) general test as rate groups?

[ESOP Guy]

Is this an S Corp ESOP? 

I ask becasue we have a few clients around here that are C Corps and are fine staying that way.  The have started PSPs and done the odd allocations of the ER stock.  They only have stock in them. 

There is strictly speaking nothing in the rules that says a PSP can't have ER stock as its only assets. 

That is how they then do the more creative allocations.  PSPs as you say don't have the limitations on testing an ESOP has.  

Most companies however don't do this as the value of the 100% owned S Corp ESOP benefits are too great. 

Although we have some ESOPs that pass the general test around here and have some pretty creative allocations.  They mostly are looking at adding a service component to reward the long term employee-owners. 

Also, if this is a group of companies and the desire is to only allow some of the companies to be in the ESOP you could set up an ESOP and a PSP and give similar benefit levels and pass coverage with an Average Benefits Test for example.  In these cases parts of the Controlled Group don't adopt the ESOP or PSP as needed.    As long as you think you can pass the combined testing you are good with doing this. 

[EBECatty]

Yes, it's an S corp ESOP so we're somewhat constrained.

The goal is to have different allocation rates for different classes of employees primarily on a project-by-project basis. There could be anywhere from 10-15+ at any given time. 

Getting back to the more basic question, can a plan's allocation methodology say "every participant is their own group" and then rate group test under (a)(4)? I typically associate every participant in a group with new comp testing. 

Or, if not, can you define the groups in an appendix (or something similar) that doesn't require a formal plan amendment every time it changes?