Deferring pay after end of plan year

[Guest Grumpy456]

Can an HCE receive a bonus FOR 2007 that is paid by March 15, 2008 and defer all or a portion of the bonus for purposes of 2007?

The spouse of an HCE is an "employee" of a small business, but was paid no W-2 wage for 2007. Assume the business is an S-corp. The HCE has drawn W-2 pay of $200,000 and there is $100,000 in taxable income left that will otherwise flow-thru to the HCE as S-corp. dividends. The client's TPA has suggested that the HCE pay his spouse $18,000 of the $100,000 as 2007 W-2 pay now (in 2008) and claims that this can be done because the 401(k) rules have been liberalized to permit pay received within 2-1/2 months of the end of a plan year to be treated, at the recipient's election, as pay relating to the prior year. In this case, the TPA claims that if the business bonuses the HCE's spouse $18,000 by March 15, 2008, she can defer up to $15,500 of it to the 401(k) plan FOR 2007. I know the final regulations make an exception for post-severance pay, but this seems almost too good to be true. Is the TPA right? How would such a bonus/deferral be reported? For example, would the spouse's 2007 W-2 include the bonus paid in 2008 as 2007 pay? Would it reflect the deferral made in 2008 as a 2007 deferral? Since the employer is generally obligated to issue a W-2 by January 31, 2008, wouldn't the decision to treat part of the $100,000 as the spouse's pay need to be made before January 31, 2008?

The TPA seemed very confident, even a little cocky, that this was OK so I felt uneasy questioning it too hard in front of the client. It just seems too good to be true, though. Any thoughts would be greatly appreciated.

[WDIK]

See Treasury Reg. § 1.401(k)-2(a)(4).

[QDROphile]

I would really love to see the TPA trace through what I presume are the section 415 regulations to get to the result you describe. For starters, compare sections 1.415( c)-2(e) (2) and (e)(3). Forget about the "employee" fraud for a moment (but only a moment). Did the spouse terminate employment? Somebody has a lot of explaining to do even before you get to the questions relating to 401(k) rules.

[Kimberly S]

Not only will your W-2 be late by March 15, 2008, but the deposit of Social Security and Medicare withholdings will be late and probably subject to penalties as well.

[John Feldt ERPA CPC QPA]

Assume the business is not an S Corp, but say it's a partnership and the spouse is a partner, not a W-2 employee. Now I think your client's TPA is on better footing (perhaps the TPA was misinformed about the entity type and the spouse's 'employee' status). Sure.

[Steelerfan]

I thought that only IRA contributions could be done after end year. I always assumed that 401(k) deferrals had to be amounts that you would otherwise receive during the relevant tax year but for the election. There has to be something in the regs on this or everyone who couldn't max out in 07 would be trying to push their 08 bonuses into the plan (which i'm sure can't be done, but can't prove it at moment)

[WDIK]

For your reference, here is the section (previously cited) on which the assertion made by the TPA mentioned in the original post is likely based.

(4) Elective contributions taken into account under the ADP test--(i) General rule. An

elective contribution is taken into account in determining the ADR for an eligible employee

for a plan year or applicable year only if each of the following requirements is satisfied--

(A) The elective contribution is allocated to the eligible employee’s account under

the plan as of a date within that year. For purposes of this rule, an elective contribution is

considered allocated as of a date within a year only if--

(1) The allocation is not contingent on the employee’s participation in the plan or

performance of services on any date subsequent to that date; and

(2) The elective contribution is actually paid to the trust no later than the end of the

12-month period immediately following the year to which the contribution relates.

(B) The elective contribution relates to compensation that either--

(1) Would have been received by the employee in the year but for the employee’s

election to defer under the arrangement; or

(2) Is attributable to services performed by the employee in the year and, but for the

employee’s election to defer, would have been received by the employee within 2½ months

after the close of the year, but only if the plan provides for elective contributions that relate

to compensation that would have been received after the close of a year to be allocated to

such prior year rather than the year in which the compensation would have been received.

(Sorry about the formatting.)

[masteff]

Two points following WDIK's post...

1) The snag point in that last paragraph (B)(2) is the words "...but only if the plan provides for..." While the law was broadened.... was the plan?

2) The cited section applies to ADP testing but doesn't necessarily extend to W-2 reporting (going back to the original post). My thought is that the comp is deferred until 2008, so not reported on a W-2 until 2008 (in 2009). While the plan contributions might be allocated to 2007, I'd say it happens in 2008 for W-2 purposes.

[QDROphile]

What about the snag point in (B)(1)? It sounds like the employer is thinking in 2008 about compensating the employee for services in 2007. How could the employee have received the compensation in 2007 but for the election, and when was this election?

[Guest Grumpy456]

I'm glad I wasn't missing something obvious. Now I feel obligated at least to ask the TPA for further clarification (and probably legal justification) for their recommendation.

I take away from the discussion that while some 2008 deferrals MIGHT be able to be treated as 2007 deferrals SOLELY FOR ADP TESTING PURPOSES, they cannot be treated as 2007 deferrals for OTHER purposes. Is that the general consensus?

[Steelerfan]

I'm glad I wasn't missing something obvious. Now I feel obligated at least to ask the TPA for further clarification (and probably legal justification) for their recommendation.

I take away from the discussion that while some 2008 deferrals MIGHT be able to be treated as 2007 deferrals SOLELY FOR ADP TESTING PURPOSES, they cannot be treated as 2007 deferrals for OTHER purposes. Is that the general consensus?

I'm going to go out on a limb and say the TPA might be right (but only if the plan provides for it and the election was made in 2007) because we are talking about permissibly deferring compensation, not deductions or immediate inclusion in income. Tax law from secs. 404, 409A and the FICA regs consistently treat amounts paid within 2 1/2 months after the end of a tax year as not deferred compensation. Under section 404, in the direct compensation scenario, the individual on a cash basis of accounting has income the year he receives the bonus, not the year it was earned, and the corporation would get a deduction in the prior year (if the 2.5, etc., rule is met).

But for purposes of deferral of income and those tax concepts, you could argue that the rules mean that the employee is deemed to have been paid in 2007. The IRS recognition of this in the above cited reg is evidence that this is a viable concept. However, to QDROphile's point, it would seem that the election would have had to have been made in 2007 (which does not appear to be the case in OP), so is probably too late even if the plan provided for it.

[Steelerfan]

[Where did your previous post go?]

My responses often have that effect.

Under your facts it looks like 7,500 in 2007, unless I'm missing something. I don't see how you can separate out the 401(k) from the non 401(K) rules and report the amount as wages in 2008. Wouldn't the 2007 W-2 have to relfect the amount of the deferral if it's in the plan, even if its just there for testing purposes in 07? If so, how can you report anything in 2008. I don't know anyone who does this sort of thing, but I'd be surprised if they segregated it for reporting purposes as comp in 08 (except for any portion they don't defer). But I could be off base.

Your examples have me a little confused (not hard to do), especially with the deferral of severance (why would a terminating employee defer severance?)--but using a more traditional example, assuming the regulation referenced above is being relied upon, if a bonus will be paid in March 08 but there is an 07 deferral in effect for that amount, I guess you'd have to issue a W-2C for 2007.

The IRS seems to be saying you can treat the amount as paid to the employee and to the plan in 2007.

[Guest Grumpy456]

Thanks for your response--I was in the middle of revising my last post and my machine locked-up--in the process my last post was apparently deleted.

I see your points--I just wanted to make sure we were covering all of the bases. The 401(k) regs section that I've seen cited as justification for "retroactive" deferral deposit is entitled "Elective contributions taken into account under the ADP test". The title, at least, suggests a limited rule. However, if I understand you right, you're making a consistency argument something like: "since the 401(k) regs permit the 'retroactive' deferral deposit for ADP testing purposes, it would be inconsistent not to treat such a 'retroactive' deferral deposit as an actual deposit in 2007 for W-2 purposes, therefore, the 'retroactive' deferral deposit must be included in the participant's 2007 W-2." I don't mean to create a strawman argument so please don't think I'm doing so. While I understand your argument, I'm just not 100% comfortable with the conclusion yet and, as a result, I'm struggling for more evidence. I do agree, however, that consistency leads to your conclusion. It also, however, doesn't seem crazy or illogical to me for the rules to say if a deferral meets such and such conditions it may be treated, for ADP testing purposes, as a deferral in 2007, and that if it doesn't in must be treated as a deferral in 2008.

Thanks for your help and thoughts.

[Steelerfan]

Point well taken. It just seems too administratively unfeasable for the IRS to expect people to treat the amounts differently. Seems it would be too easy to (1) screw up and accidently include the amount in the ADP test again in 08, or (2) "forget" that in 2007 the amount should not be treated as a contribution. But that could be just that I'm not a plan administrator, it might not be a problem at all.

I agree tho that more evidence is needed

[Kimberly S]

Speaking as a plan administrator, we generally rely on the W-2 as the definitive source of how much was deferred in a particular year. I can't imagine how a TPA or even in-house plan administrator could possibly get it right if deferrals on 2008 salary were supposed to be 2007 contributions.

[masteff]

(A) The elective contribution is allocated to the eligible employee’s account under

the plan as of a date within that year. For purposes of this rule, an elective contribution is

considered allocated as of a date within a year only if--

(1) The allocation is not contingent on the employee’s participation in the plan or

performance of services on any date subsequent to that date; and

(2) The elective contribution is actually paid to the trust no later than the end of the

12-month period immediately following the year to which the contribution relates.

Personally, I'd stick to the argument that it's allocated to 2007 despite it being contributed in 2008. The allocation is an adminstrative/recordkeeping issue. As the wages are paid in 2008 and the contribution actually in 2008 (i.e. "no later than the end of the 12-month period"), then I'd say they go on the 2008 W-2.

[Steelerfan]

Masteff--doesnt your response conflict with what Kim Sheek wrote?

If a contribution paid to the plan (and employee) in 2008 is permitted to be allocated in 2007, shouldn't it be regarded as 2007 wages, thus a W-2C for 2007? Unless I'm mistaken, Kim seems to be saying you can't split the years between different purposes.

[Kimberly S]

That is certainly what I understood -- although it may be the prejudice of my current and former employers rather than an actual rule.

FYI, there is a similar discussion on the ASPPA discussion boards at the moment as well.