410(b) transition rule and ADP testing

[Guest LMalone]

Does the 410(B)(6)© transition relief also apply to ADP and ACP testing, particularly in a spinoff mid year? May the plan continue to test together for the rest of the current year?

[Alf]

It only applies to 410 and regular 401(a)(4) testing as far as I know. There is no answer from the IRS on how to test either plan in a mid-year acquisition/divestiture situation. "Testing together" may not be defensible if you mean that post-spin off compensation/deferrals are only going to be tested in the pre spin-off plan because that gives the spun-off plan a free pass, doesn't it? We split the deferrals/compensation between the two controlled groups based on the acquisition date. I would just be consistent between the two plans.

[IRC401]

The ADP and ACP tests apply on plan basis (unless you are aggregating plans for a permitted reason).

If part of a plan is spun off, the spun-off part would be tested separately (unless there is a permissible basis for aggregated testing).

The employees who are "spun-off" would count in the ADP/ACP tests based on their periods of eligibility and their compensation and contributions for the periods. Treat the spun-off group as if they had terminated employment (assuming that they are being spun-off to a new ERISA employer).

[MWeddell]

Testing rules in merger & acqusition situations really don't exist, so often there is more than one reasonable way to apply the rules. I would say yes, the plan may continue to be tested as if there were one employer even though there are now two controlled groups due to a corporate spinoff. My main source for this interpretation (not that this is definitive) is this question from the 1998 Enrolled Actuaries meeting gray book:

"QUESTION #23

Nondiscrimination: Testing after Merger/Acquisition

Section 410(B)(6)© provides special transition rules that clearly affect the application of the coverage rules in the event of an acquisition or disposition of a controlled group member. Do these rules also apply to all section 401(a)(4) nondiscrimination purposes? And for the ADP and ACP tests used for demonstrating nondiscrimination and acceptability of income exclusion under section 402(g)?

RESPONSE

The transition period applies throughout the section 401(a)(4) and 401(k) rules to the extent section 410(B) principles are used to apply tests or determine component plans. In the case of the ADP test, for example, the special transition rule would allow ongoing separate testing of separate plans maintained by the separate pre-merger employers. These separate ADP tests would satisfy the ADP test needed for demonstrating nondiscrimination in accordance with the section 402(g)(3) requirement that deferrals be made under a qualified cash-or-deferred arrangement."

[Guest LMalone]

All of these responses are extremely helpful, and I'm still open for more!

[Bob R]

OK - Here's some more for you. First of all, you are dealing with a spin-off of a plan and I'm presuming the transition rule applies because there is a spin-off of the company as well. I was a little confused about the gray book message because it seems to be dealing with a situation where the sponsors of both plans are part of a controlled group. In that situation, if separate plans are maintaind and the 410(B) coverage tests are satisfied w/out aggregation of the plans, then ADP/ACP tests can be run separately. And, due to permissive aggregation, both plans could be combined for testing purposes.

But, that doesn't address the spin-off situation. At other conferences, the response from the IRS has been do what's reasonable. Unfortunately, there isn't anything out there to hang a hat on. Here are 3 alternatives:

1. 1 test is run for the entire year aggregating both plans.

2. 1 test is run through date of spin-off. Then each plan runs a test from date of spin-off through the end of the year.

3. 1 test is run for entire year for the "lead" plan and the spun-off plan runs a test for the short period

Each of these has its plus and minuses (e.g., how do you support aggregation if they are no longer part of a controlled group, or is it fair that an HCE defers the 402(g) max at the beginning of the year and is later in a disaggregated plan so the initial plan doesn't have full year compensation, etc.). In IRS comments that I've been working on, we're asking for all 3 alternatives. The key should be that all deferrals are tested at least once during the year.

And, if this is a spin-off where they are no longer part of controlled group, try to figure out who your HCEs are for this year and next year. That's another area where guidance would be helpful.