"Plan Year Compensation" under 1.401(a)(4)-12 for safe harbor dc plan - inconsistent results

[AndyH]

Issue- how to apply 1.401(a)(4)-12 to dc plan that excludes pre-participation compensation and uses calendar year compensation.

Not an easy question-any help appreciated:

Facts:

Regulations 1.401(a)(4) - 12 Plan Year Compensation Section (5) states that in a situation whereby an "employees' plan year compensation for a plan year is determined based on a 12 month period ending within the plan year under paragraph (3) of this definition, then the plan year compensation of any employees whose date of hire was less than 12 months before the end of that 12 month period must be determined uniformly based on either the plan year or on the employees' periods of participation during the plan year, as provided in paragraphs (2) and (4), respectively, of this definition."

A plan is permitted to exclude compensation prior to participation.

A plan is permitted to use calendar year compensation to define eligible compensation for a plan year.

Assumptions:

9/30/2005 PYE

Eligibility is 1 YOS; Age 21 with entry 10/1/2004 and 4/1/2005

Compensation computation period is defined as calendar year ending in the plan year.

2 new entrants: ("A") hired 12/31/2003 and ("B") hired 1/02/2004; both enter on 4/01/2005

Under these facts, rules and assumptions, in order to rely on a design based safe harbor under Section 401(a)(4), New Entrant A's compensation is determined for the period 01/01/2004 through 12/31/2004 and is $0.00 after excluding pre participation compensation. New Entrant B's compensation is determined for the period 4/01/2005 through 9/30/2005 (due to his date of hire not being 12 months before the end of the 12 month period (12/31/2004)).

Questions: Is this analysis correct? What about year 2 when New Entrant A and New Entrant B's compensation is defined as 4/01/2005 - 12/31/2005? Isn't it true that in the absence of this rule, each would have $0.00 compensation for their first year of participation and compensation from 4/01/2005 - 12/31/2005 for their second year of participation?

In addition, is the $0.00 eligible compensation a potential hidden eligibility under 410(a) even if the Plan satisfies 410(b) ratio?

[Belgarath]

Wow - this is a beauty. I'll go out on a limb and agree with your analysis. I didn't want to, but after wading through the regs and drawing myself little diagrams, I came to the same conclusion.

Seems to me like the 410(a) issue isn't a problem. They ARE eligible to participate - if they don't get an allocation because of an otherwise permissible definition of compensation for plan allocation purposes, I don't think this causes a 410(a) violation.

Did you really encounter this, or is it an academic question from someone trying to stick you?

[AndyH]

Thanks, Belgarath. I am passing along this question after getting stumped myself. This is very real, not hypothetical. And not limited to one plan. Thanks for your and any other comments.