Doctors' Wives & 401k

[DP]

I have a medical practice with a 3% Safe Harbor PS 401k plan with a 12/31 year end. Currently it has a 1 year/age 21 eligibility with entry on 1/1 and 7/1. Plan is top heavy. They always give a match, plus an additional employer contribution.

There are two shareholder physicians. Their financial advisor told them that they need to pay the wives $14,000 in December and defer the entire amount for 2004. My only problem is that both wives work less than 500 hours a year.

The doctors thought we could open up the 401k to immediate eligibility, but that means all the early entrants would get a 3% Top Heavy contribution if they are still employed at the end of the year.

The plan document says the Safe Harbor contribution will be given to all participants eligible to make elective deferrals and who meet the maximum eligibility requirements under IRC 410(a). I understand this to mean that the early entrants could get the 3% Top Heavy, but not the 3% Safe Harbor since they haven't met the eligibility for the employer contribution or match.

This is also a cross-tested plan, so would the early entrants have to receive the additional Gateway contribution if they haven't met the eligibility for the employer contribution?

Could the plan be amended effective November 1, 2004 to a 3-month eligiblity for the 401k portion with a monthly entry date? Wouldn't this allow anyone who has met the eligibility to enter the 401k portion of the plan on 12/1/04?

My head's spinning! Thanks.

[Blinky the 3-eyed Fish]

Ah, the meddling financial advisor rears his ugly head. He has good intentions but I am sure hasn't considered all the details that you need to.

The doctors thought we could open up the 401k to immediate eligibility, but that means all the early entrants would get a 3% Top Heavy contribution if they are still employed at the end of the year.

Correct.

The plan document says the Safe Harbor contribution will be given to all participants eligible to make elective deferrals and who meet the maximum eligibility requirements under IRC 410(a). I understand this to mean that the early entrants could get the 3% Top Heavy, but not the 3% Safe Harbor since they haven't met the eligibility for the employer contribution or match.

It means that those who haven't met the 21/1 YOS requirement do not get the SHNEC.

This is also a cross-tested plan, so would the early entrants have to receive the additional Gateway contribution if they haven't met the eligibility for the employer contribution?

Not if you use otherwise exludables for the general testing. Also, you will have to make sure in future years that the wives never work enough hours to get out of the otherwise excludable category. Otherwise, if your general test goes to average benefits (like all good general tests should) it will fail miserably if they defer all their compensation.

Could the plan be amended effective November 1, 2004 to a 3-month eligiblity for the 401k portion with a monthly entry date? Wouldn't this allow anyone who has met the eligibility to enter the 401k portion of the plan on 12/1/04?

Sure. It sounds like you want to make this a one-time eligibility provision though.

[GBurns]

If the basis for the wives becoming plan participants is because they are employees, I am curious as to whether these wives will qualify as employees. Where have they ever been reported as being employees, 941, UC, WC etc? How are the hours worked, every week or some other period, or ad hoc? What was the remuneration for the 500 hours? Does it meet FLSA minimum wage requirements for each pay period? How ill the $14,000 be paid? Lump sum or over a few pay periods? Will such an hourly rate or lump sum be acceptable to the IRS as reasonable compensation? How will they account for this huge increase in rate of compensation when there is no change in duties?

Every time I see or hear of a scheme like this getting audited, it fails.

[DP]

Blinky - one other question . . .

The Top Heavy contribution for the early entrants only goes to the participants who make 401k deferrals? If they didn't participate in the 401k, then they have no money in the plan, therefore no Top Heavy minimum??

Thanks.

[Blinky the 3-eyed Fish]

DP, that is not correct. No distinction is made based on a participant's deferrals.

GB, my experience with the IRS has been the opposite of yours regarding paying spouses as long as there is a legitimate employee/employer relationship.

[GBurns]

That is the question, Is there a legitimate employer/employee relationship considering the compensation to hours worked ratio etc? And considering the possible lack of any previous reporting of these wives as being employees.

[DP]

GBurns, Both of these wives received paychecks for several months in the spring of 2004. They were filling in for the Office Manager who was terminated. And they occasionally receive a paycheck throughout the year for filling in. But neither of them work 1000 hours in a plan year.

You have a point as to the $14,000 being earned in the month of December for each wife. That may be hard to justify if audited.

[GBurns]

DP.

You missed the point. It does not only matter that they got a paycheck. The term "paycheck" is too vague to be of value. What were they reported as being on those 941s etc? If any of this was in last year, Did they get a W2 or a 1099 or nothing?

[DP]

The wives get W-2's. All appropriate payroll taxes are being withheld from their pay.