Changing P/S contribution amount

[Guest emtee]

An employer calculates a discretionary profit sharing contribution for 2001 after the end of this year and prints participant statements that include this amount. The employer has not yet filed there corp. tax return. They decide that they can not afford the P/S contribution. Can they elect not to make the P/S and change the statements to reflect this since they have not filed their corp tax return? Or would this be taking an accrued benefit away from the participants and they are commited to make this contribution?

[Mike Preston]

Legally, I think they can do it. Employee relations-wise, it is going to create problems. Just because it seems to be legal, doesn't mean that somebody might not challenge it. Once in court, what was legal might become illegal. Such is the nature of going to court and letting a judge decide.

Need it be said that printing statements before the contribution is actually funded is not the best practice? Probably not.

[mbozek]

First: How could Plan Ad. distribute statement prior to date contribution is actually made to plan?

Second What did statement say? Were there any hedges such as that contribution is contingent on sufficient profits or did the statement make a definite statement. If the latter then there could be an estoppel issue, e.g., employee could sue for contribution on the basis that employee only continued to work because such a contribution was promised but this a long shot because estoppel claims for benefits are difficult to prove.

Third: Need to review plan document to see what plan provides as the requirement for making contribution, e.g., board approval, to find a way to state that notice of contribution is invalid because plan terms were not followed.

[Guest Tbrown]

I would be willing to guess that 95% of all statements prepared by the administrator are distributed before the contribution is actually deposited. In many cases, the employer will wait until the very last minute to make the deposit. That could be a long time after the plan year end.

I tend to agree with Mike. Being a profit sharing contribution, I doubt that there is any legal problem with them changing the contribution after distributing statements, but who knows what might happen if a participant sued. I wouldn't want to be the one to find out. Although we have had a couple of clients do it over the years.

[mbozek]

TB: What happens if a particpant terminates after year end but before date for filing the return? Does employer make a special contribution?

[Guest Tbrown]

It depends on the timing of the termination and when the contribution is expected as well as the investment situation. If it is a large, pooled account and we are near the point where the employer will be making the contribution, the participant is paid out what is due them including the accrued contribution. If they have individual directed accounts, then they are paid what they have and then an additional amount is paid after the contribution is deposited. But there could be many different scenarios. We have always taken the position that if we are consistent, we should have no problems (and haven't had up to this point).

Tim

[E as in ERISA]

Mbozek alluded to this.... it's always been my understanding that by the end of the corporate fiscal year, you should always have something setting out the formula or amount of the contribution for the year in writing (plan document, board resolution, authorization by some other party to whom board has delegated responsibility).

[Mike Preston]

Kahterine, that used to be true. But it no longer is a requirement.

[AndyH]

I've always had the same understanding as that expressed by Katherine about having to commit to a contribution by year end. Nobody ever followed this literally, but it was a common understanding. I've never understood why and would welcome any elaboration on it. What changed it? What required it before, if anything?

I remember an IRS auditor on a profit sharing plan that my company administered years ago questioned a Board Resolution which was dated "As of" the end or plan year. He said that it needed to be dated unconditionally by the end of the plan year. I've never understood why.

And, with respect to benefit statements being issued prior to funding, that was a very common occurrence with pooled profit sharing plans in the pre-daily valuation days.

[Mike Preston]

I still say it is bad practice. Yes, I know it was common.

As far as the cite goes, I think it was a very long time ago that the IRS was disuaded from requiring resolutions, so I don't have anything handy. It is sort of like the need to fund $100 by the end of the first plan year end. An urban legend of sorts. Sure does pop up every once in a while.

[mbozek]

Reg. 1.401-1(B)(ii) states that a ps plan must provide for a predetermined formula for determining contributions made to the plan among the participants, e.g., in preportion to compensation of the participants. I have always understood this to require some form of action by the employer by the end of the tax year. Otherwise how does a participant know what the terms of the plan are regarding contributions as required by ERISA: plan terms and amount of er contributions must designated in writing. At what point is the employer obligated to notify the employees of a discretionary contribution to a ps plan so as to obligate the employer to make contribution ?

[Mike Preston]

I know this isn't going to satisfy the intellectually curious, but the answer is that it isn't. A check delivered (or monies wired) seals the deal.

[pmacduff]

The plan must have a stated formula for allocation to participants, but in a discretionary Profit Sharing Plan, the formula for the Profit Share is just that...discretionary.

[AndyH]

So, then, what is the source of the "urban legend" that we were all taught?

[Mike Preston]

The deduction for compensation, taken under Section 162, has long held that a fixed liability must exist as of the end of the fiscal year for same to be deductible. That was naturally extended to 404 as a safe course of action, and of course, it is.

Even that has been backed off from, by the way. If you read RIA's notes on it you see that in closely held corporations where corporate formalities are not typically followed, an informal committment has been upheld even under 162.

Also, part of the confusion results from the general notion that compensation under 162 (for reasonability purposes) includes deferred compensation programs.

If this keeps up long enough, I'm sure somebody will run across a citation that will identify when the "requirement" was "modified".

[mbozek]

Many ps plans, including m & p plans contain a provision requiring board or employer action designating how the allocation of contributions for participants will be made. Mike's response still does not anwer the question of whether the mere allocation of contributions is consistent with ERISA and the SPD requirements. See reg. 2520.102-3(p). If the employer is not required to ratify the amount of the contributions how will a participant ever know whether the amount allocated to his account is the correct amount? The depositing of the contribution by the due date merely permits the employer to take a tax deduction. How would an employer defend against nuisance suits claiming that the allocation was less than what the employee was supposed to get? Making the allocation would be acceptable in a plan for an owner that was exempt from ERISA.