ESOP and Average Benefits Test

[AndyH]

[This was originally posted under Cross Tested Plans-received no response]

It seems clear that an ESOP cannot be cross tested for 401(a)(4) purposes, but if you are testing a profit sharing plan and must go to the average benefits test, and an ESOP is included, does anything prohibit determining the employee benefit percentages for the combined allocations on a benefits basis?

I don't see anything prohibiting it, but it seems like a contradiction.

[MWeddell]

IRS officials adamantly say that one can't test ESOP contributions on a benefits basis for average benefit percentage testing. Question 27 from the 1997 Enrolled Actuaries meeting gray book plus conversations with the IRS is my source for this.

Nonetheless, I believe a reasonable interpretation of the regulations is that it is permitted, although I'd advise the client that this is an aggressive position and to confer with legal counsel.

[AndyH]

MWeddell, thank you very much. I could find absolutely nothing addressing this question. Your cite is it.

We're going to take a counter interpretation on the basis that we are not testing the ESOP itself, but the IRS position on the issue is very helpful.

I still can't figure out why the prohibition on cross testing ESOPs exists if you can cross test a K deferrals for ABPT.

[Guest Harry O]

I agree with MWeddell. If you pick your way slowly through the regulations you'll come to the conclusion that you can do ABT testing on a benefits basis even if an ESOP is part of the testing group. ERIC and APPWP submitted comments to the IRS on this issue. You might want to take a look at these because they will give you the citations you need to support this position.

[AndyH]

Thank you. Can you point me in the right direction in terms of where to find such comments?

[Kirk Maldonado]

I'm not sure that this is right, but check out Treasury Regulation Section 54.4975-11(e)(1).

[IRC401]

If you are including a leveraged ESOP in an average benefits percentage test, do you use ESOP contributions or allocations for the test? [There can be a significant difference.]