Owner opting out of employer contribution. Can he do that?

[Guest EPS]

I have a client (sole-proprietor), who does not want to contribute for his benefit into the profit sharing plan. He wants to make a contribution to all other rank and file (and get tax deduction), but not to himself. Can he do that? He does not necessarily want to do this every year. I cannot find any guidance on this issue.

I know that if the document is non-standardized, one can elect not to participate, but this is irrevocable, therefore he may never participate in this plan or any other plan he maintains. Also, apparently, if he was already participating, he may not elect out. This is only good for new participants. Am I understanding this correctly?

Any ideas out there?

Thanks

[mbozek]

Two things to consider: The nondiscriminaton rules of the IRC only prohibit discrimination against non HCEs. There is no rule that prohibits discrimination against HCE including 5% owners. So if the plan was amended or a resolution adopted the employer could elect not to make a contribution on his own behalf.

second: Under rev. Rul 80-351 a participant can waive participation in a plan. I dont know if the waiver could be revocable but I dont see why not because it would not adversely impact the participant to be allowed to receive contributions again.

[Guest EPS]

I appreciate your reply.

So basically, the section in the document that refers to "elect not to participate" really only applies to rank and file (NHCE).

Even if the document is a standardized prototype, which does not allow for a participant to elect out, the HCE (business owner) can take himself out of the allocation as long as there is a resolution stating that he will not be receiving an allocation for that particular year. Is that what you're saying?

Thanks for your help.

[Tom Poje]

"Even if the document is a standardized prototype"

that might be the kiss of death:

you still have to follow the terms of the document - and I don't think what you want is possible with a standardized prototype.

I think you would be better with a document that allows you to put people into classes...e.g. owners and nonowners, and give the owner zippo if he so desires. Odd, you end up with a cross tested style plan, but instead of maxing the owner and minimzing the others, you get the reverse.

[mbozek]

You need to consult counsel to review the plan document to see if the employer can elect to make a discretionary contribution for all participants except the owner by annual election. This would be possible if the plan permits the employer to elect to make discretionary contributions on an annual basis. Some standardized documents permit discretionary contributions for a class of employees, some do not. Also counsel should review the waiver language to determine if a participant can make a waiver on a temporary basis.

If the current plan document does not allow for a waiver of contribution then consider a individual drafted plan document-- its expensive but it can meet the terms requested by the owner.

[Belgarath]

While I agree generally with the previous comments, it seems to me that there may be an additional problem to consider. There are many different terms to describe it, but yes, you can waive your allocation in many documents. HOWEVER, I haven't seen any that have been recently approved, even Volume Submitter documents where the IRS allows more than in Prototypes, where you can do this if you are self-employed. The IRS put the axe to this years ago, saying that it was an impermissible CODA. I believe that they still follow this line of reasoning.

You may be able to get a custom document as mbozek suggests, but you should probably check with the attorney first to confirm whether you can do it at all with a self-employed. (I've seen newly approved VS documents that allow the waiver of allocation, but specifically prohibit it for unincorporated owners, and I think it is because of the CODA issue.)

[mbozek]

B: I dont understand why opting out by a SE owner is an impermissible coda (and not by a 5% owner of of a corporation?). Many p type plans can be adopted solely for nhces. The plan can always be amended in future years to add a class of participants. There is nothing in the tax law that prevents an owner from opting out of making a contribtion for himself in a plan year, waving participation if the plan permits or adopting a plan in which only non owners participate. None of these acts is discriminatory under IRC 401(a) (4). There may be a need to use a individually designed plan document or a nonstandarized plan but is not illegal to limit participation to NHCEs.

Section 2.08 of the Vanguard Basic DC retirement plan permits any participant in a nonstandardized plan to opt out of participation for one or more years. The employer may not make contributions while the waiver is in effect.

[actuarysmith]

You can do precisely what you want to do in a new-comp plan. Use a non-standardized prototype and put the Sole-Prop into allocation group A. Put all other employees into group B.

Guess what - your testing passes already! (since the Sole-Prop in Group A is an HCE).

I would not fool around with the election not to contribute, etc. My understanding is that this is irrevocable. The only way for the Sole-Prop to contribute for himself under that arrangement would be to terminate the plan and setup a new plan without the election.

Good Luck!

[mbozek]

As Vanguard plan is an IRS approved prototype it is possible to do waivers for selected years.

[Tom Poje]

the Vanguard plan cited was described as a nonstandardized prototype,

while somewhere the original post spoke of a standardized prototype.

A big difference.

[Guest EPS]

Thanks everyone for your input.

What about for a Money Purchase plan? Does it fall under the same rule?

What he did for this plan was to send out a notice to all participants letting them know that compensation recognized for benefit purposes would be January through May 2001 only (calendar year plan). This was done sometime before the plan year began (2001 calendar year). He then signed resolution stating that there would be no contribution allocation for himself at all. The document used for 2001 is a non-standardized document that has participant elect out provision, which can be revoked from year to year.

The Money Purchase Plan, is merged into the Profit Sharing Plan and all assets transferred into PSP. The merge is effective June 1, 2001 while the same non-standardized doc is in effect. Once all assets are transferred into PSP a final 5500 for MPP will be filed.

The GUST restatement is done effective January 1, 2002 for the Profit Sharing Plan only using a Standardized Prototype.

Anyone have any thoughts on this one?

Thanks

[mbozek]

not really - just adopt a nonstandardized plan-- its easier than adopting a new comp plan.

[Belgarath]

This thread is very interesting. Mbozek, the old IRS guidance I was thinking of is IRS Notice 88-127.

Another interesting thing here - when we submitted our prototype for approval, we were told that in a prototype, absolutely no way, nohow, could you waive participation or compensation on a year by year basis, either totally or partially. OK to do it in a volume submitter, but the reviewer told us that the IRS "prototype group" had come up with this guideline. So we couldn't put it in our prototype, but did in our volume submitter.

Amazing what you can do from one IRS document reviewer to another.

But I'm still apprehensive about whether this is allowable for an unincorporated owner. Anybody else have an opinion on this aspect?

[mbozek]

The entire IRS process for approving standard language plans borders on arbritrary and capricious action. One more wacky thing. Hasnt the IRS approved 0% mp plans in which the employer's designated contribution under the formula for all participants is 0. If this is permissible for obtaining a a determination letter why cant the employer provide that a 0 % allocation will be made for any HCE, even one who has not waived particpation?"

[Mike Preston]

You can do all of these things within the confines of the document.

I have a distinct prejudice against waivers of all kinds. I think the IRS, if she (as the tax court refers to it) chooses to do so, can make mincemeat out of any of them. Yes, I've seen them in operation. I've even reviewed some of them and noted that they are sometimes in compliance with various document provisions. But I always recommend, if given the opportunity to do so in advance, that they be avoided like the plague.

All this talk about how to make them work, and in what circumstances they work would be much better spent on how to avoid them and how to ensure that the plan document's provisions are modified so as to provide the same result.

Think of waivers as penguins jumping into the water and the IRS as a leopard seal. Many penguins survive. Unless they run into a leopard seal.

[actuarysmith]

Ahhhhh, Mike Preston must have been to a seminar put on by Larry Duetsch (spelling). He talks about penguins and seals alot.

Or, maybe Larry got the analogy from Mike..............

[Mike Preston]

Mike got it from Larry. Although Larry was fond of thinking that it was a Walrus, not a seal. He has since been disabused of that, but not by me.

[AndyH]

...and the best way to avoid the female leopard seal is to use a document like Tom described. She used to not tolerate those but now gets along fine with them.

[Mike Preston]

Indeed she does.