Forfeiting ER contributions to correct a failed general test?

[Guest AJR]

I have a client that currently provides a 6% profit sharing to all plan participants. They have inquired about adding an additional layer of p/s for just their partners. I've done a preliminary test and it will pass the general test. I've advised them to fund this additional p/s after the close of the plan year once the general test has been completed. They want to fund on a pay period basis and forfeit the p/s from the partners if the general test fails. I know this isn't an acceptable method of correcting a general test but cannot find an authoritative source. Can anyone point me in the right direction?

Thanks!

[AndyH]

It seems to me that you cannot do what you suggest, that if the test fails, you have a couple of choices:

1. Change the contributions that were intended to be made, or

2. Do a corrective amendment under 1.401 (a)(4)11-(g).

In the case of the latter, you need to give something extra, not take something away. So you might be ok if you use that approach.

So it seems to me that you could tell the client that if he pre-funds then he'll have limited himself to needing a corrective amendment.

But, forgetting about testing for a moment, prefunding by itself can cause some problems or concerns not the least of which is whether or not it is consistent with the plan document, plus what problems you might have if the prefunding becomes discriminatory. One or more IRS people raised this issue in the General Session of the recent ASPA national conference.

p.s. and I think the cite is 411(d)(6)

[Guest AJR]

Thanks for your reply.

Just to clarify, the additional p/s piece will be written as a comp to comp allocation formula and will not specify a certain percentage. Thus, corrective language will not be included in the plan doc. It's assumed that plans with new comp formula's are funded on an annual basis. With that said, if these partners fund on a payroll basis, is there anything precluding them from forfeiting the p/s to correct a failed general test?

[rcline46]

Of course there is. What is the event that permits you to take money from ANY participant's account? There is no failed ADP/ACP test, no inservice, no termination, ....

The quesion is NOT what is the cite that prevents it, the question is if there is any cite the PERMITS this action, and there is no cite permitting it.

[Mike Preston]

AJR: Run from this client. They are going to create a situation that will be impossible to untangle.

[Tom Poje]

or, I suppose, put another, does it pass the smell test.

lets see, partners (HCEs) are able to receive an additional contribution on a payroll basis, thereby getting earnings throughout the year.

the NHCEs only receive a one time contribution at the end of the year.

Smells to me like you might have a BRF failure.

[Mike Preston]

'might"?

[Guest AJR]

I agree that BFR would be an issue if only the HCE's were receiving contributions. But in this case, the client is funding the p/s for every participant throughout the year. The problem is that they will also be funding a potentially discriminatory amount for the partners throughout the year.

[GBurns]

Isn't this precisely the problem that creates the BRF failure ..."The problem is that they will also be funding a potentially discriminatory amount for the partners throughout the year. "?

[Mike Preston]

GBurns, not in this context. What was meant is that the amount that would be funded would exceed the amount that ultimately could remain in the HCE's account.

The intent is quite noble, actually.

But it ignores the realities that are associated with testing.