pro-rating limits -- company established 12/1/02, 401k plan effective

[maverick]

There was an extended discussion of this back in March, but I want to make sure I understand the how pro-rating works.

Situation:

- medical practice established 12/01/02

- owner wants to set up 401(k) plan for 2002

- plan effective date: 1/1/02

- limitation year: calendar year

- deferrals begin 12/1/02

Here's my take on the various limits:

40k 415 limit is not pro-rated

200k comp limit is not pro-rated

402(g) limit is not pro-rated

SSWB is pro-rated (integrated profit sharing formula)

I found something going to the IRS Q&A session (Q 11) at the 1996 APSA conference re: using a full limitation year for a corporation established mid-year, but I'm having trouble accepting that most of the limits are NOT pro-rated for a firm & plan that have only been existence for 1 month.

Comments appreciated. Thanks.

[kocak]

If you don't normally get determination letters, you might want to consider once since the plan is in existence before the employer.

Why would you pro rate the integration level? I thought since you had a full 12 month plan year you didn't pro rate.

mck

[Guest Mike Kimball]

If the employer did not exist until 12/1/02, how could they have a sponsored a plan on 1/1/02? So, first point, plan effective date can't pre-date the creation of the plan sponsor. Having made that point, this will create a short plan year unless you want to run it with an 11/30 plan year end, certainly a possibility.

401(a)(17) regs require the comp limit be pro-rated for a short plan year which would happen here if 12/1/02 was the effective date for a 12/31 plan year end. This would be 1/12 of $200,000 or $16,666.67 maximum comp for allocations. $15 limit would be 100%, therefore, only $16,666.67 could be allocated under 415 in a DC plan.

Tax deductible limit is based on what comp was paid during the fiscal year of employer, so that will depend on the fiscal year and within which plan year the fiscal year ends.

Vesting credits would be affected by the short plan year because the vesting computation period is only 1 month is a short plan year. Need to pro-rate down the 1000 hour amount for vesting credit.

Integration level is pro-rated for a short plan year.

Sort plan year in this situation is not such a favorable thing. For an existing employer, making plan retro to 1/1/02 works fine and gets full limits on everything. A newly created company always has this problem. Is it a corporation that is a continuation of a sole proprietor?

[BFree]

Hours of service for vesting are not normally prorated for a short plan year.

[kocak]

Mike - take a look at the ERISA Outline Book, page 3.149.

Michele Kocak

[maverick]

Thanks for the responses.

I got the idea to start the plan year 1/1/02 from a Q&A in a 1999 issue of one of PPD's periodicals.

"Q: If a calendar year corporation is established mid-year and it establishes a plan on the date of incorporation (e.g., 7/9/99), must the corporation create a short limitation year and prorate the 415 dollar limitation?

A: No. The corporation may designate a full 12 month limitation year ending with the last day of the initial short plan year and avoid proration of the 415 dollar limitation. IRS Q&A session, Q-11, ASPA Conference, October, 1997, IRS Q&A session, Q-84, October 1996."

The way I read that, the plan year will run 12/1/02 to 12/31/02, but the limitation year will run 1/1/02 to 12/31/02.

Mike:

The doc is a member of an existing medical practice (S.C.). He's starting his own practice (no connection to old employer)

[Tom Poje]

Kocak-

when pointing out something from the ERSIA outline book, specify what edition! (If I look at that page in the edition I have, I won't find anything related to this topic)

Based on the comments I have seen, I assume most people are using this resouce[which is great], but might have different editions. If you don't have the book on your shelf, then I will give you credit for knowing a lot more than I ever will!

[kocak]

Sorry Tom - 2002 Edition.

Michele

[Tom Poje]

Thanks Michelle.

I have the 2001 edition, and the book has changed enough I can't find your reference.

In Chapter 15 there is a Table/Checklist dealing with short plan issues.

In the table under Deduction limit, it says that it is based on the employer's taxable year. (And then further adds that if the tax year is short, then the comp dollar limit would apply to calcualte the 15% limit for the short plan taxable year.

I am confused at this point to exactly what is going on, but maybe that will help in the answer. If it is a brand new company, how the heck does anyone have compensation going back to 1/1? It was indicated the doctor was starting his own practice, I assume on 12/1. I would further assume that he would only be able to count compensation for deduction purposes from 12/1 on, so even if the the limitation period might be 12 months, there won't be much comp to use for deduction purposes. Kevin Donavan's talk at the ASPA conference a few years ago did cite the same Q and A 84, but in his section on compensation, he points out that 1.401(a)(17)-1(B)(3)(i) that the annual compensation limit is applied th the compensation for the plan year on which allocations are based. Since the company appears to have started on 12/1, the allocation would appear to be based on comp from 12/1 and therefore a strict reading of this would say you end up prorating the comp limit.

I guess this is different than an initial plan year of an existing company in which you are using someone's full year of comp even though the plan year may have started on 12/1

The best comments I can come up with would be:

Remember that Q & As are opinions expressed by one or more members of the IRS but don't necessarily carry a lot of weight. (Though I am sure we really heavily on them from time to time, don't we?) And some are very reliable!

BFreesaid that hours for vesting are not normally prorated for the short year. Actually, I thought it was required that vesting MUST be a 12 month period. If you want to be more generous and credit someone with less than 1000 hours, obviously, that is something you can do.

oh well, I am rambling....

[BFree]

Yes - I agree, vesting must be based on a 12-month period. My equivocation came as a result of not providing a citation and a lingering question as to whether it is the (a) 12 months ending on the plan year end or the (B) 12 months from the plan year beginning.

[kocak]

Tom - I'm referring to ERISA Outline Book Chapter 3, Part A.4.d.3) What if the employer was not in existence before the effective date of the plan? In the 2001 edition it is page 3.141

Michele

[Tom Poje]

Thanks Michelle!

Interesting reading.

Looks like the big answer is that no one knows for sure.

Guess you follow the book's advice and rely on the determination letter if you get one.

[kocak]

don't mean to beat this to death, but back to my original question to the post, why are we pro-rating the SSWB?

michele

[Tom Poje]

not sure why it was suggested to pro rate integration level.

if a 12 month period is used there is no call to prorate.

If it is indeed a short year (effective date = 12/1, then you prorate at 1/12th)