Luke Bailey

Since the employee (assuming the one-time irrevocable election is valid) would not be eligible to defer under the plan, I don't think not providing him or her the sh contribution would invalidate your safe harbor status. At least theoretically, C.B. Zeller, if the excluded employee negotiates with the employer about the class exclusion, you could have a nonqualified cash or deferred election that could blow up the plan. I get it that that would be hard to prove or for IRS to discover on its own, but employees who have done these sorts of things have been known to leave on bad terms later and threaten to blow the whistle on this sort of thing, claiming they were pressured not to participate in 401(k) among other perceived wrongs.

Plan assets must be held in trust, so if they don't establish a trust with a trustee under the plan they are in violation of ERISA.

EBECatty, under the 414(n) ANPRM (Advanced Notice of Proposed Regulations) (from, I don't know, 2012?), you would not have a governmental plan if you had even one nongovernmental employee in it, so if that becomes the law, you would be self-inflicting 5500's, ERISA fiduciary duties, etc.

Gilmore, no. It seems better for the NHCEs, probably always, certainly in the long run. I have seen others criticize this sort of set-up for contributing everything at once for the year for the HCEs, because it makes it harder for them to dollar cost average the investment of their contributions. That is a fiduciary concern, however, not IRS nondiscrimination issue.

BG5150, I think the correct way to interpret the statute (IRC sec. 4979) and the instructions is that the failure here relates to 2019, the year of the failed ADP test. You had until March 15, 2020 to distribute without the 10% excise tax, but having not done that, you were supposed to file the 5330 by March 31, 2020. Note that the form and its instructions seem to me to give the misleading impression that the excise tax is imposed on all your excess contributions and aggregate contributions if you did not distribute all of them by the 2-1/2 months after end of testing failure year deadline. The statute and regs are clear that it is only the offending amounts that are not distributed by the deadline that are subject to the tax.

Good luck does not fall under the definition of a right or feature under 1.401(a)(4)-4(e)(3).

truphao, have you determined that the benefits for the seller's employees (including the seller) can be paid from the plan? Seems to me like Section 415 of the Code is going to limit what you can do.

The plan may, in various instances (terminating participant, participant undergoing divorce or other personal change, plan termination, global pandemic that gets even worse) need a short-term, highly liquid investment, so probably imprudent not to include as an option, but prudence is based on facts and circumstances.

BG150, read all of the posts. Don't just settle for the consensus.

TPApril, where the non-5% owner employee terminates after RBD, the first distribution year is year of termination, so here 2020, but RBD is April 1 of next year, here 2021. Also, the actuarial adjustment required for delayed benefits stayed at 70-1/2; did not move with the RBD to 72.

Right. And something else I thought about a few weeks ago representing a buyer. The seller may want a termination because that probably cuts off its exposure sooner. It will typically indemnify the buyer regarding plan compliance, whether the plan is terminated or merged, and the indemnities may last a couple of years. The seller's exposure on those indemnities will typically cut off, as a practical matter, sooner if the plan is terminated.

MWeddell, while I don't express my opinion to clients quite that strongly, what you describe is typical to what I tell people. They still usually go with the plan termination. I am guessing part of the reason for that is that it's easier to explain to their auditor and to their boss.

EBECatty, thanks for the cite. I don't know. I suspect the bank just let's the employer do everything. There is a legal issue having to do with who actually controls the payment of wages, which is typically the employer, e.g. in a staffing situation. There is an IRS process to appoint someone as a withholding agent, but while that is not complex, and while you could have the employee get 2 W-2's, there would be a lot of complexity, I think, with exchanging payroll data and filing 941's that would make having the bank deposit and report impractical.

EBECatty, another thought. Suppose payment is due and the employer instructs trustee as to gross amount. Trustee transfers funds to employer as its agent, with instructions from trustee accepted by employer to pay the distribution to the employee, subject to withholding and reporting on employer's payroll system. Because the employer is acting as the bank's agent, the bank is paying the funds to the executive. If you vary the facts a little, such that the employer pays a day ahead of getting the funds from the bank, or two days, etc., should that really change the result? As long as the executive is paid, he or she has no complaint, and as long as the IRS gets paid, same.

OK. I see what you mean, EBECatty. I have established many rabbi trusts, but never had to deal with this issue. It seems to me that the best way to do it would be for the trustee to receive from the employer instructions as to what the amount of withholding would be, and then withhold that amount. I would have to review the guidance on payroll agents to determine whether the employer could be the trustee's agent, or vice versa. Peter Gulia's suggesting that flat rate withholding could be applied seems correct, subject to the limitations of that method.

Catch22PGM, take a look at Treas. Reg. 1.415(c)-2(c)(1), last sentence. Even under the general definition of 415(c) comp, deferred comp from an unfunded plan can be comp for qualified plan purposes when it is distributed, if the plan so provides. If the plan uses the W-2 or withholding safe harbor, it probably does so "provide," but you'll need to check the plan document carefully to make sure there is no applicable exclusion. Under Section 414(s), a plan can use a narrower definition than what is permissible under Section 415.

EBECatty, the IRS model trust agreement says the trustee "shall make provision" for reporting and withholding. That provision can be, and in my experience usually is, that the employer will do it. That is also in the IRS form. I think the main thing the IRS is concerned about is to make sure the trustee remains liable if it some how pays the entire benefit and there is no withholding by either employer or trustee. It would be practical for the bank to withhold the appropriate amount from the distribution, as determined by the employer, if the distribution is made from the trust, and remit that amount to the employer for its payroll tax deposit. I guess you could prepare a separate W-2. If the payee is a former employee, it could be practical since it would be the only payment the individual might receive. The bank would have to know what the employer did with FICA while the amount was accrued, and be confident it was correct.

Gilmore, I am addressing this as a hypothetical, since I cannot comment on an individual situation or provide advice in this forum. Deferrals must be withheld. Unlike the tax payment, the employee cannot write a check for the amount. So I don't think that is a possible solution. If the company has set up a cashless exercise program through a broker, it could probably have the broker withhold the elective deferral amount, as its agent, just like the employer may withhold the exercise price and/or FITW and FICA. If the above does not work, it could withhold from future cash payments in a reasonable manner. Those are just suggested answers to your hypothetical. Maybe there are other solutions that will be suggested.

Plan mergers are usually not as bad as some of the above makes them sound. The main reason to merge plans is to make the acquirer's plan bigger which may improve its ability to lower fees with vendors. Also, occasionally the acquirer will not want to improve the target's employees job mobility by giving them access to their 401(k) accounts. Problems that turn up with the target plan post-merger can be fixed in VCP, and the financial cost of fixing could be covered by the seller's warranties. Finally, if from an HR standpoint the acquirer wants the target's employees to feel like they are just continuing in their job, a plan merger is better. Having said that, acquirers almost always end up not merging the plans, but going the pre-signing termination route. Fear of gf the unknown, I guess. As pointed out by Optimatum, plan loans can be handled through rollovers.

If they pay people and report the payments on a W-2, there an employer, and so can have some sort of plan.

I very much agree, Linda. Even if in fact the intent of the parties is that the compensation not be counted, the agreement is not part of the plan document. If you can prove the intent of the parties and the employee is an HCE, you might have a relatively easy time in VCP or audit cap (or the employee could even be over the comp limit for the year without the option spread), but it is still a failure to follow your plan document

Gilmore, one other angle on this. Whenever I review and edit clients' existing stock plans, as well as bonus arrangements, I almost always will see a provision that says that the comp from awards under the plan or arrangement will not be counted as comp for purposes of benefit plans "unless the benefit plan specifically says otherwise." Those provisions are usually pointless, because in almost all cases the benefit plans do specifically say otherwise, just in a nonobvious way.

Gilmore, I guess payroll systems might differ, but the spread at exercise of a nonqualified option (NSO) is current FICA and FITW income for employees, so they must have a system for putting the amount into pay stub and withholding (from other amounts, or through broker if the shares are immediately sold in cashless exercise). If they are using the W-2 or 3401(a) safe harbor definition in their 401(k) plan, which they probably are, then it would be comp for deferral purposes and they would apply the individual's deferral election to, and withhold for deposit into the plan, just as they are withholding for their payroll tax deposit and 941, from whatever they are paying the person from which it is convenient to withhold. Occasionally plans will allow special elections for bonuses, but that's rare.

Someone else had this same question just the other day. Money is money, the taxation won't be different assuming the plan does not permit in-service distributions, and once it is distributed and rolled to an IRA, all the distinctions will go away. But the employer is total unable to amend the plan, e.g. to allow hardships or in-service distributions, so there's a high likelihood it will come back to bite them at some point.

Gilmore, portions of the reg have never made sense to me. Thankfully, most people today use the W-2 or 3401(a) safe harbor, and so, as FORMER ESQ. says above, the W-2 comp that occurs when the option is exercised will be included, because it will be on the individual's W-2 for both reporting and withholding purposes, when exercised. At least the answer will be clear if the optionee exercises while he or she is still employed by the grantor corporation. But even with the W-2 or 3401(a) safe harbors, I am not quite sure how the regs are intended to apply if the exercise of the option occurs after an individual terminates employment. The spread will definitely be on a W-2 for the year of exercise, but what about the timing rules for post-employment compensation in 1.415(c)-2(e)? Is the post-severance spread considered "regular pay after severance from employment" under (e)(3)(ii), like a bonus, since the option could have been exercised before severance in almost all circumstances. That's probably the intended answer. But some might see it as a post-severance payment under (e)(3)(iv. Once you move away from the W-2 and 3401(a) safe harbors, things get more mysterious. Nonqualified option spread is mostly, or perhaps entirely, excluded from 415 comp. First mystery: Why is the general 415(c) definition completely different from the W-2 and 3401(a) safe harbors on this point? Second mystery, why does 1.415(c)(2)(b)(5) tell you to include the value of an option in W-2 comp if it is included in income in the year of grant? Do they mean if the option was vested and the individual exercises in the year of grant? Maybe, but the text here seems pretty clear they are looking at the option itself as being the taxable item in the year of grant, not the spread at exercise, and again as FORMER ESQ states, the option is almost never the taxable item, because even if the stock is publicly traded the compensatory option will have terms different from any traded option on the stock. In fact, I have NEVER seen a compensatory option be includible in income. Moreover, 1.415(c)(2)(c)(2) seems to say you always exclude the spread on exercise of an option, regardless of timing. So my conclusion is that under the general 415 comp definition, nonqualified option spread is never 415(c) comp. And why is income from an 83(b) election included (1.415(c)-2(b)(6)), but not income under Section 83 due to vesting (1.415(c)-2(c)(2))? Probably because they are thinking of restricted stock, not options, and the 83(b) election has to be made within 30 days, so they figure it's really current wage income, just paid in property. The general definition of 415 comp that has these mysteries pre-dates the W-2 and 3401(a) safe harbors by many decades. My guess is that when it was first put into the regs, accounting systems were feeble and there was no internet, so who even knew (in 1964) that if a former employee exercised an option it was reportable on a W-2, or even reportable? And how would you track it? So some of these administrability issues made there way into the regs. Oh for the good old days!