415 limits for short initial plan year.

[Jeff Kirtner]

Are 415 limits on annual additions prorated for a short initial plan year? Situation: Employer is on a fiscal year from 4/1-3/31. Employer wants to establish a profit sharing plan with an initial plan year from 1/1/2000-3/31/2000. If the limitation year is defined as the 12-month period ending on 3/31, then is the full 415 limit available for the initial plan year, or are those limits reduced because of the short initial plan year?

[John A]

I believe there are 3 items that would get pro-rated: 1) the 415 limit, 2) the 401(a)(17) maximum compensation limit, and 3) if the plan uses permitted disparity, the social security taxable wage base. However, the regs I'd cite would be more applicable to a change in limitation years rather than a limitation year starting prior to the effective date of the plan and an initial short plan year. The regs I mean are 1.415-2(b)(4) and 1.401(l)-2(d)(5). I'd be curious as to whether others would agree or disagree with what I stated in my first sentence above.

[Jeff Kirtner]

I'm not sure I agree that 415 limits are prorated. Section 415 limits annual additions to $30,000 or 25% of the "participant's compensation", defined (ambiguosly) as "the compensation of the participant from the employer for the year." The regs, however, state that the compensation to be applied for 415 purposes is "[t]he compensation . . . actually paid or made available to an employee within the limitation year." 1.415-2(d)(4). The regs also make clear that the limitation year is a 12-month period. Accordingly, assuming in my case that the limitation year is the 12-month period ending the last day of the initial plan year, then 415 compensation should be based on that entire limitation year, and the 415 limits should not be prorated, even if the initial plan year is a short year and the limitation year predates the beginning of the initial plan year. The regulation you cite relates to a short limitation year resulting from a change to the limitation year, not to a short initial plan year. Is my analysis flawed?

[Guest]

it depends on the document.

The first year of the plan, the plan can provide for the limitation year to be the 12 month month period ending on the last day of the plan year (full 415 limits), or it could define the limiation year to coincide with the plan year, which would then prorate the 415 limits.

[Guest lforesz]

But do we all agree that the 401(a)(17) limit on compensation is prorated for purposes of ADP/ACP testing?

[rcline46]

In general, no. The plan may define compensation as while a participant, so only comp from the effective date of the plan may count. If the limitation year is 12 months then the 401(a)(17) limit does not get changed.

[Richard Anderson]

lforesz,

If the definition of compensation used for allocation purposes is less than 12 months, then the 401a17 is prorated. This would always be the case for a short plan year for the 401(k) part of the plan. If the 1st plan year is 6 months long, the plan could define compensation for the profit sharing contribution to be a 12 month period; in that case no pro-ration would occur for the profit sharing plan.

But for the 401(k) part of the plan, compensation for deferrals is only for the period that the plan is in effect. Therefore, for ADP/ACP testing you would pro-rate for short plan years.