ADP Test

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I have an HCE (by ownership) that works for his company just like a regular employee. He does not take a salary from the company therefore he does not make any deferrals. Is he included in the ADP test?

[jpod]

Is the Company an S corporation? An unincorporated sole proprietorship?

Tell us more: how does he get money out of the Company's business?

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Yes, it is an S corporation and he gets money out by doing the ol' "distribution of profits" trick.

[jaemmons]

Is he receiving these "profit" distributions annually or periodically throughout the year?

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I don't know for sure but I would guess that they are periodic so he will have something to live off.

[jpod]

So, his compensation is $0, yet he is an employee in all other respects(?).

I don't think the 401(k) regs. contemplate that an "eligible participant" could have compensation of $0.

It seems to me that he has to be ignored, even if "0" divided by "0" is 0%.

This is kind of off point, but he should understand that the IRS has a longstanding position that a Sub S owner cannot avoid Social Security taxes by merely taking distributions of profits in lieu of W-2 wages. If he or the corporation is audited, the IRS is likely to recharacterize some/all of the distributions as W-2 wages. Nevertheless, I don't think you can assume that will happen for plan testing purposes.

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I have found out the IRS has actually not issued any guidance on this issue as I am sure it does come up often. However, at the 2000 ASPA conference in D.C. during a Q&A session the IRS did acknowledge that treating this HCE as ineligible would be a reasonable approach.

Jpod, just to further your point, the IRS has recently raised employment tax audits to a top enforcement priority. Being a CPA I have seen many people do this but I would not advise it anyone with similar circumstances.

[Guest David M. Lipkin]

Jpod - I agree = he s/b omitted from the ADP test. One should never have anyone in the test with $0 comp.

David