Mike Preston

Katherine, there is nothing that prohibits a $20,0000 allocation to a participant that makes $40,000. The 415 limit these days is the lesser of 415 compensation or $40,000 (in 2003). For somebody that makes $40,000, both parts of that determination are the same dollar amount: $40,000. So, one way that such an allocation might be possible is if the plan divides the participant population into groups for purposes of determining entitlement to employer contributions. If there is a group that the employer wants to provide with an allocation of 50% of compensation, that is certainly ok. The only restrictions are non-discrimination and deductibility. There are many situations where it would not be discriminatory to provide such an allocation.

If what you are talking about is merely recharacterizing a portion of the existing match, then my research tells me that you can't do it unless there are no HCE's that received a matching contribution for the year in question. Essentially, you end up with a benefits, rights and features violation because the regular match that you have left after you move your $400 per capita to QMAC no longer satisfies the definition of a non-discriminatory match.

You need a bracket or two. Try this: Step 1: You run 1 ADP test with the total group. If you pass, STOP. Step 2: If you fail, you test the excludables group and the non-excludables group to see whether each satisfies 410(b). If both groups satisfy 410(b), move to Step 5. Step 3: You only get here if your excludable/non-excludables are such that the excludables group fails 410(b) [in normal situations, it means that somebody became a new owner!]. So you now move all the HCE's in the excludables group to the non-excludables [this is the option referenced at 401(k)(3)(F)]. Test your two groups again under 410(b). Note that the excludables automatically pass since there are no longer any HCE's in that group. Does the non-excludables group fail 410(b)? If so, STOP and correct the Step 1 ADP test. If not, move to Step 4. Step 4: You get here only if your non-excludables, including the HCE's moved into the non-excludable category under 401(k)(3)(F), satisfy 410(b). Run your ADP test on this group. Does it pass? If so, STOP. If not, correct either the Step 1 ADP test or the ADP test you just ran; whichever is best for the Plan Sponsor. Alternatively, you can return to Step 2 and redefine excludables based on a different interpretation of "excludable". There are two interpretations: a) Those that are excludable based on statutory entry dates. b) Those that are excludable based on plan entry dates. Whichever you decided on when you initially performed the analysis in Step 2, do the other one. Step 5: You get here only if your non-excludables and excludables satisfy 410(b) without application of 401(k)(3)(F). Run your ADP on the non-excludables. Do you pass? If so, STOP. If not, correct either the Step 1 ADP test or the ADP test you just ran, whichever is best for the Plan Sponsor. Alternatively, you can follow the same path as the "Alternatively" section under Step 4. The above assumes that there are no ACP amounts that can be tested together with the deferrals under the ADP test. Complicated? Sure. But it really isn't that tough once you have done it a time or two.

Katherine, you make an excellent point, but I don't think I was heading there (except maybe accidentally). I rarely, if ever, have plans where a contribution is made which would intentionally exceed 415. I understand the scenario, though, and agree that it is possible. And I agree that the result is the establishment of a $10,000 suspense account to be allocated in the next limitation year. In most cases, I'm dealing with different percentages between the sole proprietor and the others. So, look at Blinky's example, which starts out fine by providing a different percentage for the Sole Proprietor ($32,466 / $129,864 = 25.00%) than for the others (10%), but increase it even more, to 32.698%. My contention is that the $40,000 allocation doesn't violate 415 and it doesn't, when considered with the contributions for the others, violate 404. Of course, in order to implement this scenario you need some mechanism to allow for different benefit percentages. Either separate plans or a single plan that provides for multiple benefit levels.

Blinky, your example is fine, as far as it goes. To make the point a bit clearer, let's raise the $32,466 to $40,000. The net earnings for the Sole Proprietor are modified to be: $170,000 - $7670 - $40,000 = $122,330. Then the deduction is the sum of $30,000 + $40,000 = $70,000 which is less than 25% of the sum of $300,000 + $122,330, which is $105,582. As I understand mbozek's point, in your example, the Sole Proprietor would be limited to $32,466, because anything higher would result in a deduction FOR THE SOLE PROPRIETOR'S BENEFIT of something in excess of 25% of his/her net earnings. I don't agree with that and that is why I extended your example to make the point clear. (I hope).

Participants become vested in two circumstances: partial termination or plan termination. I don't see either of these here, do you? There is an old ruling that calls for vesting if there is an increased likelihood of reversion, but that hasn't happened, either, has it?

First, I don't agree with the steps you are describing. Second, I think mbozek's example is about "splitting" the deduction such that the amount attributable to the SE person is separately determined. I see no justification for that under 404. He makes a good point that the tax returns seem to be laid out in a manner that leads to his conclusion. I don't disagree with that. But that is just the IRS' desire to see some sort of breakdown. The sum of the two is the actual deductible amount against which the limitations of 404 are measured. You don't do that calculation separately for the SE and for the other folks.

No. But it needs to be tested for coverage. If by "participants" you include 1) everybody in the company (where for this purpose "company" is the controlled group); 2) those who terminate before the end of the year and 3) those that work less than 1000 hours in the year, then it passes coverage automatically, too. If no to any of the three, then it still needs to be tested for coverage.

Thanks, Andy. I, like you, remember it clearly.

Yes, a company can file their tax return without the 5500 being completed. It may not be the best thing to do if the contribution to the plan hasn't been finalized, but there is no "requirement".

That is inconsistent with comments previously made by the IRS. (sigh) Another thing that we have to look up where it came from to debunk a reversal, of sorts, huh? So be it. Don't have time for it today, but I'm confident somebody else will do it. If not, hopefully I can do it next month.

I can't tell whether you are missing something or not, because I can't tell what you think you might be missing.

But you are a lawyer, and one that has been known to read a Code section or two. Where in 404 does it say that the deduction for the SE and the deduction for the employee(s) should be determined separately? It has nothing to do with the 415 limit being increased to 100%, because the same thing could have been done in reverse, before, with the 15% PS limitation: HCE makes $500,000, EE makes $40,000. ER Contributes 15% of all 404(l) pay, which just happens to allocate more to EE than to HCE (don't laugh, I've seen it). Under your theory, the amount attributable to the EE, which would show up on line 19, would have been limited to 15% of the EE's pay. Sorry, it has never worked that way. The amount that shows up on line 19 on the Schedule C is added to the amount that shows up on the 1040 and that total is then treated as the amount deducted under 404 for the sponsoring entity. Whether that amount exceeds the 404 limit is determined by multiplying 404(l) compensation by 25% today (15% in the example above). But, then again, I'm not an accountant.

I agree with everything you have said, but I disagree with the conclusion when there are other participants involved. Take a plan that covers two people: HCE making $500,000 and NHCE making $40,000. It looks like you are saying that the maximum contribution to the plan would be: $40,000 for the HCE and $10,000 for NHCE, for a total of $50,000. But the real limit is 25% * ($200,000 + $40,000) = $60,000. That would have to be allocated as: $40,000 to the HCE and $20,000 to the NHCE. Do you concur with my numbers? If you don't, then I'm still not understanding what you are getting at.

Yes, you can integrate at 5+5 (think of it as 5.7+5.7 but satisfying the 2 for 1 rule. I'm not sure I understand your comment, mbozek, about the 20% limitation. It looks like you are saying that in all circumstances the deductible limit for a self-employed person is $40,000. But the limit is $50,000 (for somebody who makes enough), so I must not be understanding what you wrote. Of course, the limit is only applicable to the max deductible, not the 415 limit, which remains $40,000.

Almost. I'm not sure I agree with the description of those in the DB plan as having to "benefit for the year." 404a7 uses strange language and talks about people being beneficiaries of the trust during the year. That isn't the same language as in 410(b), so the concept of benefiting isn't precisely the same as what is needed for 404a7. I think a participant is a beneficiary of a db plan if they are a participant in said plan, as long as they have a positive accrued benefit at any point in time during the year. Otherwise, frozen plans wouldn't allow for compensation to be included. Also, you have now added "safe harbor match" to the description, so what used to be a PS plan is now a 401(k) plan. Hence, you get to count the salary of those that are eligible for the 401(k), whether they deferred or not (of course, this completely encompasses those that receive a SH match). This was clarified at an ASPA Q&A just after EGTRRA passed. There were some (pessimists?) who thought that in the case of a participant who was eligible for the 401(k) but who didn't defer that said individual's compensation wouldn't count for a7 purposes. At the time, the IRS was quite clear: it counts. But if you expand those two areas, I think you've got it.

You know, that IS what pjm says, isn't it?

I don't think so. The 25% limit is based on compensation paid during the fiscal year, so assuming the same eligible participants, there is no modification to the 25% limit for the CY in question. Am I misunderstanding the question?

Samsam, two points: 1) A PS contribution is a non-elective contribution. That is, the participant shares in the contribution without making any election. The reference is with respect to the EMPLOYEE making an election or not. 401(k) salary deferrals are therefore: elective deferrals. 2) The key to your understanding of this admittedly arcane and difficult subject is the basic definition of a "plan". It is not an easy study, but the place to start is 1.410(b)-7. Once the "plan" is defined, as you correctly point out, the regs say that a participant in such a "plan" must receive a gateway contribution if otherwise benefitting and a gateway contribution is required under 401(a)(4). But for this purpose, if the Plan Administrator decides to disaggregate the statutorily excludable from the rest, you have two, honest-to-goodness, bonifide PLANS as far as the IRS is concerned. Once you view it that way, you can see that the reg you cite is supportive of the ability to NOT provide a gateway contribution to those who are statutorily excludable. And, just in case the language of the reg is too obtuse for a normal human to follow (which I wholeheartedly believe that it is!) the preamble to the reg spells out the effect quite clearly. In other words, you won't get a better cite than what you have already been provided.

Surely Keyshawn was not free to get another job within the same industry, though, was he? He certainly had a valid, continuing contractual relationship that, if he had done the "wrong" thing, cost him some serious money. No, I don't think that is a particularly good example. But I don't disagree with the premise that not being at work is not necessarily indicative of a severed employment relationship. That is a facts and cicrumstances thing, I would presume.

Blinky, I would add just a bit to your post: Be sure that the plan is fully funded if you want to ensure that the 100% owner doesn't merely "take what's left". In any event, the parents get what the plan says they are entitled to, because as you point out, they can't receive less than that under a standard termination.

If he is an NHCE, his benefit wouldn't be capped, would it?

You did. It's gone now. :-)

If the allocation is such that it is pursuant to the integrated formula and the only modifications to that are that HCE's get less than they otherwise would be entitiled to, then it isn't cross-tested, as it satisfies the safe-harbor. People eligible just for 401(k) are counted in 410(b) and 401(a)(4) test but can be restructured into a separate component plan if it works to do so. a4 can't fail if 410(b) doesn't fail if the plan is a safe-harbor. Why would a design that works well for a client be in need of a change?

Without categorization, without doubt, Blinky the 3-eyed Fish.