ADP Test for a KSOP

[Guest BrianF]

An individually drafted plan document was amended for 2001 so that all employer stock in the plan is part of the ESOP. This allows the plan to take full advantage of the 404(k) deductibility. When performing the ADP test, the employer stock contributions are seperated from the other investment contributions per Treas Reg 1.401(k)-1(g)(1)(B).

Issue: The plan has been restated for GUST with prior year NHCE percentages being used for ADP testing. Since the plan did not segregate employer contributions that were salary deferrals in 2000, I'm not sure what approach I should take?

The sponsor does not want to amend to current year due to planning considerations with HCEs going forward.

Any suggestions or comments are greatly appreciated.

Thanks

Brian

[QDROphile]

My only comment is not helpful.

This is what we get for jumping on the bandwagon of an IRS mistake in allowing an investment designation to be treated as a plan.

[Mike Preston]

It sounds to me like the employer established a "new" plan in 2001 with respect to stock contributions. You should have the same options you would have had with respect to any new plan established in 2001. That is, if you want to use prior year testing, you use 3% for 2001 and then for 2002 you use the results from 2001. I'd look over 98-1 though, to see if there isn't anything in there that deals with the establishment of a new plan on the heels of one that already exists to see if there aren't some general limitations.

[QDROphile]

Mike Preston:

I may have read between the lines incorrectly, but I think the problem is that the plan has a company stock fund that is a participant directed investment option. The plan now says that anything invested in company stock is the ESOP. Some participants elect to have elective deferrals invested in company stock, some don't. So the question is, which elective deferrals are ESOP contirbutions and which are not? ESOP contributions are disaggreaged from the others for pruposes of the testing. Are all elective deferrals not ESOP contributions because they are made in cash and then later (but not much later) invested in company stock? Or are the contributions directed into company stock ESOP contributions (even though at the end of the year -- or even the next week -- they are transferred to another investment fund)?

[Mike Preston]

I think we were both reading between the lines. It is just that we ended up reading different things. My interpretation was that an ESOP was added and that a participant is given the choice as to how much of their deferral election they wish to make in cash (i.e., to the original plan) and how much of their deferral election they wish to make in stock (i.e., to the newly created ESOP).

Otherwise, they would have stock in two plans and would need to move the stock from the first plan to the second plan just before a dividend is declared in order to allow all of the dividends to be deductible under 404(k).

Since I don't think that is a likely design, I made the assumption that new monies going into the ESOP would be from stock contributions pursuant to deferral elections and not from further transfers.

Maybe Brian can clarify the original post?

[QDROphile]

Your reading is better if the company is not a public company. My reading makes sense only if the company stock is traded, allowing a company stock investment fund.

[Guest BrianF]

Hopefully, I can clear up a few items:

-The stock is publicly traded.

-The ESOP plan was already in existence. The document stated it would be used only for the co match (creating the KSOP). To take full advantage of 404(k) (deducting dividends on all stock contributed to the retirement plan), the sponsor has amended the plan document to read all stock contributions, instead of just for co match.

-QDROphile: You bring up a valid point on 2/16/02 (10:35) in asking about how the deferrals are invested. Although all contributions will be in cash, the cash will be invested in either mutual funds or company stock within T+3. I assumed that the intention of the participant was to contribute the cash into the stock fund (if elected), it should be included in the ESOP. Your comment on interfund transfers clouds the water.

-Mike Preston: In regards to your reply on 02/16/01 (11:21): I believe I am, in essence, dealing with two plans. However, there is co stock in only one plan, the ESOP. The "other" plan includes all of the other investment options.

Mike, thanks for the comment on bulletion 98-1. I am going to look into it.

Any more comments or feedback would be greatly appreciated. Thank you for your time,

Brian

[QDROphile]

The participant does not contribute anything. The Company contributes. The participant merely makes investment decisions. There's the rub.

Perhaps you could look at the issue as one in which the participant chooses in which which plan to participate. But you might get into even more trouble there.

[Guest BrianF]

Just to make sure I understand...

Your first paragraph states that since arrangment is a CODA, the money is never in the possession of the participant. Is this correct? if so, I agree.

I believe your second paragraph is correct. The participant is electing which plan to invest contributions in. I need to separate the plans for ADP testing. Back to the original question on since the plan document states prior year NHCE percentages, how do I complete since the election was not available last year.

I have a couple more leads I am going to attempt. Mostly dealing with mergers or acquistions. I will post my final verdict in a couple days.

Thanks for your help

Brian

[Mike Preston]

I agree with QDROphile. I does appear that somebody, at some level, thought that a participant's investment elections would somehow create two separate deferral elections for the two separate plans. I'd want somebody to look at those participant election forms. Without some clarifying language (it wouldn't have to be very lengthy) it might be that the salary deferrals are all going into the original, non-ESOP portion of the plan. That will be a nasty administrative surprise someday. I'm pretty sure that isn't the intent.

Assuming though, that you can somehow construe the participant elections to be valid with regard to the ESOP contributions, it still looks like the ability to make a salary deferral into the ESOP was first established in 2001.

However, a quick read of IRS Notice 98-1 indicates that the definition of "successor plan" includes the ESOP. Hence, it doesn't appear that you have the ability to use prior-year testing as if the ESOP were the only plan of the employer and as if 2001 were the first year of the plan.

Instead, it looks like the result will be that you end up using the NHCE percentages of 2000 in your 2001 test. I'd want to make sure that 98-1 is read all the way through with the specific facts of these plans being kept in mind, though, before concluding that to be the case.

But if the deferral elections can't be construed as creating a deferral election with respect to the ESOP, the whole discussion is moot anyway.