Guest Max Power Posted December 3, 2003 Posted December 3, 2003 My client is a sole proprietor, age 40, whose salary is $30,000. He could easily make his salary $200,000, but for income tax purposes he chose frugally. Can he implement a DB plan where the benefit is the 415 maximum of $160,000? The benefit formula is based on the fractional rule. NRA =65 NRB = 530% x $30,000 x 25/25 (the accrued benefit formula assumes that 1/25th of the NRB is earned each year). The NRB = $159,000 . . . close to 415 Is there any prohibition to this sort of benefit formula?
mwyatt Posted December 3, 2003 Posted December 3, 2003 You better pull a heck of a salary scale assumption (remember the 100% High 3 Year Limitation)!
Effen Posted December 3, 2003 Posted December 3, 2003 Also, sole propietor can only deduct up his earned income, so if by "salary" you mean net earnings, than his deduction would be limited to 30K and if he deducts 30K, he wouldn't have any income to base his benefit on. 530% of $0 is $0. It becomes a circular function. The material provided and the opinions expressed in this post are for general informational purposes only and should not be used or relied upon as the basis for any action or inaction. You should obtain appropriate tax, legal, or other professional advice.
David MacLennan Posted December 3, 2003 Posted December 3, 2003 You might want to also look at his prior earned income history, in case it was higher. The Code says for 415 3-yr comp use years of participation, the regs say service, the Examination Guidelines just quote both w/o taking a position. Probably not relevant though due to the aforementioned 404a8C deduction limit, if he is a sole proprietor (but, when you say he could make his salary more than 30K, and use the word "salary", it sounds like he is not a sole proprietor - perhaps you are using that term loosely to describe any 1-person business?).
AndyH Posted December 3, 2003 Posted December 3, 2003 David, thanks for adding that comment about the code versus the regs. Before I read your comment, I just was going to quote an old Billy Preston song "Nothin from nothin means nothin...." in an attempt to make the point about the irrelevance of "salary". Regarding 415 though, I thought the requirement was hi 3 while a participant, which I guess is the code language. How do others interpret this in practice?
Effen Posted December 3, 2003 Posted December 3, 2003 I have often used a High 3 prior to the inception of a plan and have never been questioned about the practice. I think it's pretty safe. The downside for a sole prop. is that if you base the benefit on a previous high 3 and the required contribution exceeds the current years earnings, part of the contribution may be non-deductible so you need to be careful. The material provided and the opinions expressed in this post are for general informational purposes only and should not be used or relied upon as the basis for any action or inaction. You should obtain appropriate tax, legal, or other professional advice.
David MacLennan Posted December 3, 2003 Posted December 3, 2003 Several years ago I spoke with one (prominent) actuary who speaks often at conferences, etc., and he told me that he had no problem funding a plan based on pre-participation compensation. The regs were issued a few years after the Code, and perhaps were intended to correct the Code? - I know the Code is primary source, but it seems you should be able to rely on the Regs. It doesn't seem "fair" to use participation, since comp often goes down when funding a 1-person DB plan, if you think of the old idea of "replacement" income from a pension plan as being the general socioeconomic intent. Also, if in doubt, get a letter on the plan document and make sure the 415 limit language includes pre-participation comp. My DATAIR prototype documents, one of the most widely used, specifically says "all years of service with the employer" are used in determing the Hi-3 years. I wonder what the IRS LRM's say?
AndyH Posted December 3, 2003 Posted December 3, 2003 Well, I just checked our boilerplate volume submitter language, which probably comes from the LRMs and it does clearly say service.
mwyatt Posted December 4, 2003 Posted December 4, 2003 I will chime in that this very point (TRA '86 changes v. final regs) is actually addressed in the recent IRS exam guidelines and firmly comes down on the side of service v. participation for compensation used in the High 3 limit. Kids need to go to bed or I would dig in further in this board as I know the cite has been web-referenced in the last few years here. As far as the Benefit Formula goes, a formula over 100% of comp is fine, as long as you respect the overriding IRC 415 limits in funding. Also, if there are other employees involved in this plan, note that the prior opinion here is that accruals should definitely be determined PRIOR to application of IRC 415 limits.
Guest Max Power Posted December 4, 2003 Posted December 4, 2003 Thank you everyone for your comments.
AndyH Posted December 29, 2003 Posted December 29, 2003 mwyatt, I found the audit guidline that you mentioned and it is conclusive to me, just as you stated. Thank you.
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