Proposed 415 regulations

[Belgarath]

I'm wrestling with a question here. Suppose you have the following scenario:

Plan established 12/31/2006 with a beginning of year valuation date (prior to when the proposed regs become effective) The limitation year is calendar year, so 12-31-2006 valuation is based upon 2006 calendar limitation year. The compensation averaging is based on service. The individual has been in business since January 1, 2000 and their high three year average salary was earned in 2000, 2001 and 2002.

Now, the second year valuation comes up - 12/31/07 and the new regs are effective since we are dealing with the 2007 limitation year. When preparing the 12/31/2007 valuation - the compensation averaging would be based on participation rather than service. Do you:

1. Only use compensation for the limitation year 2007, or,

2. Since 364 days of participation from the first plan year were actually in 2007, do you take into account 2006 compensation as "participation comp" since that is the limitation year that applies to the plan year containing, essentially, a year of participation?

Or something else? Originally I was leaning towards #2, but after discussing with some colleagues and letting it percolate overnight, I'm not sure why I originally thought that, and # 1 makes more sense. But I thought I'd toss it out to see if you agree and to see what discussion it generates. Thanks.

[FAPInJax]

I would lean toward #1 because of the participation clause.

What about adopting the plan and making the entry date 1/1/2006 so that compensation could also be used in the calculations?? Any particular reason for the plan year to be 12/31/2006 to 12/30/2007?

[Belgarath]

Thanks for the response. At this point, I have no idea whatsoever why the plan/fiscal year combination generating the question is being considered. It was just a question that came up.

Trying to think it through, I suppose that if you take the approach that # 1 is correct, and the 2006 compensation (for whatever reason) is quite low but is expected to bounce back, that you might use this method to achieve a higher average? Say 2006 is 50,000, and 2007 is going to be 200,000, then if you have to include 2006 as "participation comp" your average will be dragged down substantially?

May be other reasons as well...

[AndyH]

Couple of comments:

1. I think that any plans that run 12/31 to 12/30 are asking for whatever trouble they encounter. It is done normally only to manipulate the 415 limit or to load a plan with life insurance.

2. I think that any plan that uses pre-participation comp for 415 after the issuance of the proposed regs is asking for trouble. Reminds me of the Clint Eastwood scene, "Do you feel lucky today punk?"

3. Remember the pre participation issue is for 415 only, not comp averaging. You can still base benefits on all comp; you just need to compare it to 415 using post participation comp only (if Clint has bullets left).

4. Foulke needs a couple of injections to his head to match those going to his knees, don't you think?

[Belgarath]

Thanks Andy. Couple of comments.

Re#1, can't argue with that!

Re#2, although I agree in principle, some documents, particularly prototypes, specify comp averaging from date of employment. Since it appears that the proposed regs may not be relied upon currently, that would sort of stick you between a rock and a hard place until 1-1-07.

3. Good point. This is why I'm not a DB person.

4. Probably beyond what injections can cure. After all, even the miracles of medern medicine have their limitations.

[AndyH]

B,

You are without a doubt the most DB-knowledgeable NON-DB-person I know of.

[Belgarath]

Gee, thanks!

But to take this a little further, since I think I'm starting to see the source of some of my confusion:

I think I was mixing the compensation averaging requirements for a 401(a)(4) safe harbor with the 415 limits. So under 1.401(a)(4)-3(e)(2)(i), ignoring the exception in (ii), this averaging must be at least three years, or period of employment if less. So this MUST include pre-participation compensation in the situation I outlined. But under 415, it will soon switch over to participation compensation. So you'll have different compensation for different purposes.

Have I got that right? If so, what a drag. Is there any good reason for this, or is IRS going to change the

(a)(4) safe harbor so that the comps will be the same for both purposes?

[AndyH]

I think you have it right now, although I have been puzzled a couple of times over the years to see a couple of prototype docs that do not have the pre-participation comp inclusion that you reference, but I think that is in error.

The pre-participation 415 exclusion has been the subject of much debate. If David Wells can change his mind .....