Application of TAM 9735001

[Guest merlin]

I have a client that sponsors a ps plan that allocates contributions by class of employees pro rata on compensation.The plan only requires 1000 hours to get the allocation,no "last day".The employee classes are currently Class A=Owners(=dr. and wife): and B=All Other Employees.The plan is a calendar year plan,so the 1000 threhold has been passed already for 2002.A preliminary allocation for the year shos that the 5% gateway to the Class Bs will be sufficient to support the maximum allocation to the Class As. Dr. wants to reward long service employees by creating Class C=Employees with 6 or more years of servce and allocating 10% to them, but still maintaining the 5% to the Class Bs,who are now the Employees with

It's my understanding that the IRS Interprets TAM 9735001 to say that any change in allocation basis after a participant has met the allocation is automatically a 411(d)(6) violation, even if the change expands coverage or gives additional allocations without reducing anyone's prior allocation. Is this correct? Is there a cite I can show my client,because he'll never believe it.

Isn't this analogous to a defined benefit plan where the benefit formula is being reduced, but accrued benefits are guaranteed on the old formula through the date of adoption of the amendment?

[KJohnson]

This could just be typing without thinking, but couldn't you just keep Class B as is and then create Class C defined as members of Class B with 6 or more years of service. You could then give 5% to both Class B and Class C with a resulting 10% for members of Class C. You are keeping Class B "as is" in accordance with the TAM.

This TAM has always been a tricky issue in a discretionary profit sharing Plan. There would seem to be so many "end runs" around the TAM such as: Set up a new Plan with the groups as you have stated and make your contributions. Decide not to fund the "old plan" for this year. Merge the Plans next year.

[Guest merlin]

I take it from your answer that you agree with my understanding.I don't know about the validity of any particular approach and yes, I'm sure there are many ways to skin the cat. What I find most disconcerting is the need to skin the cat in the first place when it can clearly demonstrated that no one is suffering any damage. This makes it very hard to explain to a client why he's got to spend extra money for a 2nd plan,and then have the 1st plan disappear a year later. Or why he can't allocate the extra money this year when he's got it, as opposed to next year when he might not.Or that we have to write the amendment in a way that seems to make perfect sense (as per your suggestion),but is in fact an end run around the TAM with the attendant risk to the client. It's through the looking glass. Alice would be pleased.

[KJohnson]

I do agree that you would have to "skin the cat" some way and you cannot redefine Class B after someone has already "accrued" an allocation in that Class. I think the the solution is the multiple allocation formula for Class C discussed in my prior post.

I recall seeing on this Board somewhere that there was a 1994 field directive that adversely affected multiple allocation formulas that was rescinded in 1996 or so. Then a few years later that IRS reiterated that the 1994 directive was withdrawn.

If you do some more research and find these cites, I would appreciate you posting them on the Board so I could stick them in a subject fie.

[Guest merlin]

I'll try. Thanks.

[kocak]

I may be missing the point here, but I was under the impression that you couldn't change the allocation classes, once the benefit had been accrued.

The employer has X dollars to allocate in a plan year, and they allocate some to A and some to B. If I now take those dollars and allocate them to A, B and C (by adding a class), haven't I in effect reduced what I have allocated to B?

michele

[KJohnson]

I think that the problem with that argument is your statement that "the employer has X dollars to allocate in a plan year" If, for some reason, there was a stated rate to each allocation group or an amount stated in the Plan of what the overall contribution will be (i.e. X% of profits) then I could see your argument.

However, this is where you get into the issue of a discretionary profit sharing plan. From Merlin's post, it appears that the employer will not put in any additional amounts for B whether or not he creates class C. Therefore you are not "taking away" anything to Class B members in creating C.

I think the IRS can clearly mandate that once an employee has satisfied the criteria for an allocation to a particular class you cannot take him or her out of that class. However, it does not seem that in a purely discretionary profit sharing plan 411(d)(6) mandates the amount of allocation to that class or your ability to create additional allocation formulas.

I don't think this is an area totally without risk. However, what would you say if the employer creates a totally different plan with three allocation classes and simply decides not to fund the "old plan". If this is an option, isn't this really a quesiton of form over substance.

[kocak]

I would agree that the employer could adopt a second plan, or even amend the plan after the benefits have accrued to increase benefits, and make a minimum contribution under the old formula.

Regarding the profit sharing contribution being "discretionary", I think TAM 9735001 says the participant has a protected benefit, thus the protected benefit rules apply, even if the contribution is discretionary. But I've been wrong before!

michele

[KJohnson]

I haven't gone back to look at it, but I think your right that the TAM says that the mere fact that the profit sharing contribuiton is discretionary does not give you the right to change an existing allocation formula after someone has accrued a benefit under that formula by arguing "Since I don't have to make any contribution in the first instance, I can revise the allocation formula anyway I want."

However, I don't believe that there is anything in the TAM that prevents the addition of a new formula (while keeping the old) or obligates an employer to actually make discretionary contributions under the old formula. .

Of course this logic basically renders the TAM a nullity that you can "paper around" which is what I think got Merlin's goat as well as activated his "risk radar"

I have heard of others getting determ letters on such plans wheere a second formula was added, but I haven't sought one myself.

[Guest merlin]

KJohnson,you're right. The "discretionary contribution" argument doesn't work. We had a client nearly 10 years ago who had an integrated ps plan that they wanted to amend to an age-weighted.The amendment (done by their attorney,not us) was signed after the year-end and submitted for a DL. The service rejected it on the same basis that was later enunciated in 9735001. The only problem for us was that it took more than two years to resolve the issue - tech advice and all that.During that time we had to maintain two sets of account balances - one on the integrated basis,another on the proposed.Ugh.And then the two partners started fighting. One left and wanted to get his distribution but coud only get a partial because we didn't know which balance to pay,and of course he thougt his partner w trying to cheat him with our complicity,etc.Double ugh.

But back to the future. Whether it gets my goat or not I've got to deal with it. Does anyone have anything official or even semi-official (Dickjim Wickerholland said...) to support what we all seem to agree on,i.e. you can't do it,at least not without jumping through a lot of hoops?

[KJohnson]

Merlin,

Just for clarification, was the age weighted formula substituted for the integrated formula (clearly prohibited by the TAM) or was the age weighted formula in addition to the integrated formula and they decided to make no contribution to the integrated formula. (I would think this might work).

I don't know of anything official. I don't even know of anything official where they have "signed off" on even going through the "hoops" (i.e. two formulas) to get it done (other than people reporting that they have received determ letters).

I brought this up on a one to one level with Wickersham after he spoke in the context of an integrated plan with no last day rule who wanted to change to new comparability toward the end of the Plan Year. I raised the issue on whether you could have two formulas for the year and simply not fund one of the formulas. He acknowledged that multiple allocation formulas appeared to be allowed, but said he had not really thought about the implications of not "funding" one of the formulas.

[Guest merlin]

KJohnson,

The age-weighted formula was intended to replace the integrated . As I said, this all took place around 1992,which predates the TAM by several years. In fairness to the attorney nobody was as smart then as we are now ( that mumbling sound you here is my tongue planted firmly in my cheek). The "discretionary contribution" argument made sense at the time.

[Belgarath]

I'd double check your plan language. Some plans, prototypes included, have a provision that distinguishes eligibility from accrual. In other words, nothing is accrued until the last day of the plan year. You may have satisfied the hours for eligibility for an allocation if a contribution is made, but no accrual until last day of plan year. So you could amend the plan as you have suggested with no trouble, in my opinion, if your plan has such language. As long as the amendment is done before the last day of the plan year!