Is a partner's plan compensation for a 401(k) computed without regard to deferrals or is it net of deferrals?

[Guest mjn]

I have a partnership client - a physicians' group - that has sponsored a profit sharing plan for years. In computing the partners' plan compensation I use a spreadsheet to do a circular calculation, deducting one-half of the SE tax and the amount of the "employer" contribution to arrive at plan comp for each partner. In 2003 they restated to a 401(k) safe harbor plan with a 3% NEC and a discretionary profit sharing option. When I compute plan comp, do I deduct all contributions to the plan for the partners (including deferrals) or just the QNEC and profit sharing contributions?

[Mike Preston]

You do what the plan says. Most likely, though, it says that deferrals do not reduce plan comp.

[E as in ERISA]

The 404 deduction limits no longer exclude elective deferrals.

[Guest mjn]

Does that mean I compute "earned income" for a partner without taking his deferrals into consideration? In that case, allocations of match or profit sharing will be based on higher plan comp because I haven't reduced it by the amount of his deferrals. An associate of mine says a partner's earned income is reduced by all contributions made to the plan on his behalf, and so plan comp would be lower by the amount of the deferrals.

[Harwood]

Chapter 1 of The ERISA Outline Book has several pages on Earned Income

The Pension Answer Book has several items on the self-employed and/or earned income.

[Mike Preston]

Your associate is wrong, unless the plan defines it that way. What part of "you do what the plan says" leads you to believe that further general questions will eliminate any confusion you have?

As Katherine says, though, notwithstanding whether the plan instructs you to include or exclude deferrals from the definition of plan compensation, the maximum deductible rules of IRC Section 404 mandate that deferrals do not reduce compensation solely for the purpose of the 25% multiplier.

Post the plan's provisions with respect to the determination of plan compensation if they are not clear.