ADEA violation found on IRS audit

[Guest Judy S]

We have a profit sharing plan with a cross-tested formula. The 100% owner is in a group by himself and gets the maximum allocation. His parents are in another group identified by age (key EEs over age 65) and get a much smaller contribution-usually about 7% of pay. The rest of the employees are divided into 2 groups based on age-those under 31 and under and those over 31. The 31/under group got a larger contribution in the audit year (2004) and in the prior year than the over 31 group.

First, if we amend the plan to remove the references to age for 2006, would this fix the ADEA problem? In other words, if we identify the groups by job title for instance, is it then OK to provide less for individuals over 40 if they happen to fall into a category that is getting a smaller contribution? Is the only reason this is a problem is because of the age designations?

Next, we must negotiate a fix for 2003 and 2004 with the IRS. I think it is preferable to avoid audit CAP with its sanction, but the solution proposed by the area coordinator is very expensive. He is proposing that everyone 40 and up be increased to 20%, the percentage of 401(a)(17) pay received by the 100% owner.

The cost for this totals about $619,000 for the 2 years. The employer was planning a 2005 contribution of about $115,000 so the $619,000 would be a real burden.

Does anyone have any experience negotiating settlements with the IRS in this type of situation?

Also, any ideas on alternative arrangements the IRS may accept?

I'm feeling very responsible for accepting the word of a local attorney that this type of allocation is acceptable and want to do the best thing for our client. Any help would be appreciated!

[Blinky the 3-eyed Fish]

Designing allocation groups that split people by age was probably not the best idea. However, giving higher contributions to younger workers in of itself is not an ADEA issue. Otherwise, every single cross-tested plan would be subject to this problem. Businesses have a right to make sound financial business decisions and giving more to a younger worker to pass nondiscrimination testing to save the company some dollars fits into that category.

So, what you have is a semantical (is that a word?) problem. The IRS routinely has approved documents that put each person in their own rate group. You could have easily done that, achieved the same results and not drawn the ire of the auditor.

You need to make this argument and take it to the agent's supervisor if necessary. If you don't get anywhere, then perhaps bring in an experienced party. Reich, Luftman in LA are replete with IRS negiotiation experience.

[Guest Judy S]

Blinky - I agree with you wholeheartedly. In fact, though we haven't done so in the past, I am considering writing the allocation groups so that everyone is in their own. I also don't understand why the same allocation with the "everyone in their own group" language would be OK, but this is being questioned. Thanks for the reply.

[Guest Judy S]

An update to this plan audit and the purported ADEA violation. The auditor told me yesterday that they are just now starting to look at the ADEA issue when reviewing contribution allocations, and that no matter how the formula is stated in the document, the final allocation must be reviewed to be sure that no one 40 or over gets a lesser allocation than someone under 40. We are in the mid-atlantic region and the auditor indicates that there is one coordinator that treats everyone the same and that this is an issue for any plan with a non-safe harbor type allocation. Has anyone else run into this?

[Jim Norman]

The auditor told me yesterday that they are just now starting to look at the ADEA issue when reviewing contribution allocations, and that no matter how the formula is stated in the document, the final allocation must be reviewed to be sure that no one 40 or over gets a lesser allocation than someone under 40.

NO ONE?

Law firm - tiered allocation. Partners get $44K. HCE Associates (some of whom are >40) get 3% TH minimum, NHCE Associates and non-attorney staff (some of whom are <40) get 5% gateway.

So because a 40+ associate got 3% and a 20-something staff person got 5% it is age discriminatory?

[Guest Judy S]

I'm not sure that in your example the plan would be age discriminatory since the top heavy minimum is not the same as the profit sharing contribution. My current understanding based on my discussion with the auditor is that if, under the profit sharing allocation, a participant under 40 gets more than a participant 40 or older, that is considered discriminatory under ADEA. Seems hard to believe, but that is what he told me.

[rcline46]

All I can say is that the auditor had better be wrong! Report this specific case, region and auditor to ASPPA even if you are not a member of ASPPA. This is a very, very serious issue.

[Guest mjb]

Under ERISA and IRC all employees are protected from age discrimination not just employees over 40. See IRC 411(b)(2)- allocation rate may not be reduced on account of attainment of any age. The ADEA does not apply to plans covered under ERISA. See ERISA 204(b)(2)(A). The analysis requires that the employee's lower contribution rate be on account of age not because of some other reasons, e.g., TH requirements that mandate /permit lower contribution rate to persons who are non key employees who can be of any age not just over 40 is not made because of the attainment of any age but b/c of IRC requirement. Mere fact that an older employee receives a lower allocaton than a younger emplyee is not age discriminaton if the lower contributions results for a factor other than age. Under IRS logic HCE over 40 would be required to be allocated same contribution % as younger employee even though plan can discriminate against HCE under IRC. You should ask the auditor for the authority to enforce these provisions since the IRS has not issued any final regs on IRC 411(b)(2) since its enactment 20 yrs ago.

[Guest Judy S]

rcline46-I have reported this situation to ASPPA, but have received no reply to date. FYI

In thinking about this situation over the weekend, I decided that I really have to identify the exact problem the IRS is having with the allocation-it just doesn't seem possible that anyone 40 or over must receive at least as much as anyone under 40. Perhaps the auditor is not sure of the issues since he is taking direction from the area coordinator and the reviewing actuary. I will post again when I have confirmed the IRS position.

mjb-thanks for the analysis. I will review it carefully.