404(a)(7)

[Penman2006]

Regarding the 404(a)(7) 25% of compensation limit, the 2007 Grey Book Q&A 10 says that in a DB/DC situation if a participant is in only the DC plan and their only DC plan contribution is the 401(k) deferral that persons comp is used in determining the 25% limit.

Does that same "logic" apply when determining the 6% PS contribution limit when doing the deduction limit calculations outlined by Notice 2007-28 (6% of comp of DC plan beneficiaries)?

I would have thought so but I was reviewing an outline from a 2008 EA meeting session and the presenter seems to be indicating that a PS contribution is necessary to count the persons comp for the 6% limit. I wasn't at the session, so maybe I'm missing/misinterpreting something. Can someone shed some light on this for me? Thanks.

[Blinky the 3-eyed Fish]

I hadn't read that Grey Book answer and am surprised by it. Everything I have read or heard since 401(k) deferrals no longer applied toward the deduction limit was that the person's compensation would not count. This includes statements from IRS representatives on multiple occasions. This then transcends to the EA presenters take on the matter.

I would be very leery counting compensation if not receiving an ER allocation.

[Penman2006]

FWIW, that same Q&A goes on to say that if that DC plan participant did not defer (or receive any other allocation) then their comp would not be counted in determining the 404(a)(7) limit.

[Guest Dave Peckham]

Blinky, what have you heard or read that changes the "old Mike Preston" rule that compensation **is** counted for 404(a) purposes if the plan is a 401(k) plan and the participant **was eligible and could have made** an elective deferral?

[Mike Preston]

I think that rule went away with the new 404(a)(7) stuff.

[SoCalActuary]

Regarding the 404(a)(7) 25% of compensation limit, the 2007 Grey Book Q&A 10 says that in a DB/DC situation if a participant is in only the DC plan and their only DC plan contribution is the 401(k) deferral that persons comp is used in determining the 25% limit.

Does that same "logic" apply when determining the 6% PS contribution limit when doing the deduction limit calculations outlined by Notice 2007-28 (6% of comp of DC plan beneficiaries)?

I would have thought so but I was reviewing an outline from a 2008 EA meeting session and the presenter seems to be indicating that a PS contribution is necessary to count the persons comp for the 6% limit. I wasn't at the session, so maybe I'm missing/misinterpreting something. Can someone shed some light on this for me? Thanks.

Part of the change from 2007 to 2008 was the Solomon letter last summer. Portions of the 2007-28 rules were clarified and re-interpreted. Go with the 2008 guidance.

[Guest Dave Peckham]

SoCal, I'm afraid I didn't know about the Solomon letter. Could you point me to that?

Mike, if the rule changed with 404(a)(7), does it affect other than a DB/DC combined plan limit? In other words, how about a standalone 401(k) plan? Old rule or new rule?

[Mike Preston]

What rule are you speaking of, specifically?

[Guest Dave Peckham]

Old rule = For purposes of 404(a), count the compensation for all participants in 401(k) plan, as long as a participant was eligible to make a salary deferral, even if no salary deferrals were made and even if no nonelective employer contribution was allocated, due to tiered allocation formula or last day rule, for example. Exclude only compensation from employees who had not yet entered the plan at all during the plan year.

New rule = For purposes of 404(a), count the compensation of only those participants who received a meaningful allocoation of the nonelective employer contribution. Exclude compensation of a participant who made or didn't make salary deferrals, but got no PS allocation.

The above is my "work-in-progress" interpretation, which is what I'm inviting comments on.

[SoCalActuary]

SoCal, I'm afraid I didn't know about the Solomon letter. Could you point me to that?

Mike, if the rule changed with 404(a)(7), does it affect other than a DB/DC combined plan limit? In other words, how about a standalone 401(k) plan? Old rule or new rule?

http://benefitslink.com/boards/index.php?s...&hl=2007-28

This was the link reporting the information, courtesy of ak2ary and of ASPPA.

[Guest Dave Peckham]

Thanks, SoCal, I had read that discussion but did not realize that Eric Solomon was the Treasury official that ak2ary was citing. Unfortunately, the Solomon letter does nothing to clear up, at least in my mind, changes to how we determine which participants' compensation we get to use in calculating the 404(a)(7) limit.

Back to Blinky again, what have you read that is on point?

[Blinky the 3-eyed Fish]

I too don't see that the "Solomon Letter" is relevant to this discussion. I still am unsure why there is a supposed change in thought. I would be hesitant to count someone as benefiting for deduction purposes without receiving an ER allocation.

[SoCalActuary]

Point 1 - I would hesitate to count any participant's compensation toward the DC deduction limits unless they benefit either by employer contribution or forfeitures. This makes sense to me, and is consistent with comments here and on the COPA board.

Point 2 - Solomon letter was not directly on point about deferral-only participants, and my intent was only to mention that there was other clarifying comments made after RN 2007-28, so sorry for the distraction.

[Guest Dave Peckham]

Mike Preston,

The "old rule" that I attributed to you was explained in detail by Sal Tripodi in the ERISA Outline Book. I don't have a more recent edition, but the 2004 Edition stated, in Chapter 7, part B.5.a.1),

"Under Treas. Reg. Sec. 1.410(b)-3, an employee who is **eligible to defer under a section 401(k) arrangement is treated a benefiting** under that arrangement, even if he elects not to defer. Where the employee does not actually receive an allocation of employer contributions, but is treated as benefiting under a portion of the plan for coverage purposes, should the employee's compensation be included in computing the deduction limit? The answer is not clear. Arguably, the definition of benefiting in the coverage regulations modifies Rev. Rul. 65-295 and the compensation of such employees may be counted. A conservative approach would be to count the compensation only of employees who actually make elective deferrals under the 401(k) arrangement or who receive allocations of other employer contributions. But since eligible employees under a 401(k) arrangement are treated as benefiting for coverage, and are also reported as participants on Form 5500, it seems reasonable to include their compensation in determining the employer's deduction limit, **even if they do not receive allocations of other employer contributions (e.g. nonelective contributions).**

Does separate deduction of 401(k) deferrals in post-2001 years hurt this argument? With elective deferrals deducted separately from other contributions in post-2001 taxable years, without being subject to the 25% limit under IRC Sec. 404(a)(3) as described in 3. above, does that mean an employee who benefits **solely** under the 401(k) arrangement should no longer be included in the compensation base to compute the employer's Sec. 404(a)(3) deduction limit, because he is not benefiting from the contributions that **are** subject to the 404(a)(3) limit (i.e. matching contributions and nonelective contributions)? For example, a 401(k) plan might allow immediate entry for elective deferral purposes but require 1 year of service for matching contributions and nonelective contributions. Should an employee who is eligible to defer, but has not met the 1 year of service requirement for other contributions be taken into account in the Sec. 404(a)(3) compensation base? Some practitioners argue that such employees should not be taken into account. However, Sec. 404(a)(3) refers generically to **all** beneficiaries of the trust, not just to those who share in the allocations that are subject to the Sec. 404(a)(3) deduction, so a reasonable argument can be made that the EGTRRA change has no impact on this analysis of who is benefiting under the plan. The Treasury might provide guidance on this issue at some later date. In the meantime, the employer (with the advice of tax counsel, if requested) will need to decide whether to take a conservative approach to calculating its deduction limit (by excluding the employees who are benefiting solely from the 401(k) arrangement) or to continue applying these principles in the same manner as it did in pre-2002 taxable years (i.e., by including such employees)."

So, according to Sal Tripodi, EGTRRA probably did nothing to change the pre-2002 argument that included **all** participants and thus allowed the higher deduction limit. And, now, PPA '06, as far as I've been able to see by arguments in this thread, also does nothing to change the above pre-2002 argument. Does anyone have The ERISA Outline Book in the most recent edition? Would you be willing to see if Sal Tripodi has updated this section? If you have The ERISA Outline Book on CD, the updated section could be highlighted and pasted into this thread. Thanks in advance to anyone willing to do this.

[Guest Dave Peckham]

So no one is yet willing to take a look at the 2008 edition of the ERISA Outline Book? And see if Sal has changed his tune?

[Guest Judy S]

2008 EOB - Ch 7, Section XVI, Part B.5.a.1:

5.a.1)Employees deemed to benefit under 401(k) arrangements. Under Treas. Reg. §1.410(b)-3, an employee who is eligible to defer under a section 401(k) arrangement is treated as benefiting under that arrangement, even if he elects not to defer. Where the employee does not actually receive an allocation of employer contributions, but is treated as benefiting under a portion of the plan for coverage purposes, should the employee's compensation be included in computing the deduction limit? The answer is not clear. Arguably, the definition of benefiting in the coverage regulations modifies Rev. Rul. 65-295 and the compensation of such employees may be counted. A conservative approach would be to count the compensation only of employees who actually make elective deferrals under the 401(k) arrangement or who receive allocations of other employer contributions. But since eligible employees under a 401(k) arrangement are treated as benefiting for coverage, and are also reported as participants on Form 5500, it seems reasonable to include their compensation in determining the employer's deduction limit, even if they do not receive allocations of other employer contributions (e.g., nonelective contributions).

Does separate deduction of 401(k) deferrals in post-2001 years hurt this argument? With elective deferrals deducted separately from other contributions in post-2001 taxable years, without being subject to the 25% limit under IRC §404(a)(3), as described in 3. above, does that mean an employee who benefits solely under the 401(k) arrangement should no longer be included in the compensation base to compute the employer's §404(a)(3) deduction limit, because he is not benefiting from the contributions that are subject to the §404(a)(3) limit (i.e., matching contributions and nonelective contributions)? For example, a 401(k) plan might allow immediate entry for elective deferral purposes but require 1 year of service for matching contributions and nonelective contributions. Should an employee who is eligible to defer, but has not met the 1 year of service requirement for other contributions be taken into account in the §404(a)(3) compensation base? Some practitioners argue that such employees should not be taken into account. However, §404(a)(3) refers generically to all beneficiaries of the trust, not just to those who share in the allocations that are subject to the §404(a)(3) deduction, so a reasonable argument can be made that the EGTRRA change has no impact on this analysis of who is benefiting under the plan. The Treasury might provide guidance on this issue at some later date. In the meantime, the employer (with the advise of tax counsel, if requested) will need to decide whether to take a conservative approach to calculating its deduction limit (by excluding the employees who are benefiting solely from the 401(k) arrangement) or to continue applying these principles in the same manner as it did in pre-2002 taxable years (i.e., by including such employees).

[Guest Dave Peckham]

Thanks a million, Judy S.

So Sal Tripodi has not changed his tune one bit on this issue.

Does this change your position, SoCalActuary and Blinkie, or do you discount Sal's logic? Penman2006, who is the author of the 2008 EA meeting session notes that started this thread? I wonder if we can get his/her email address and get him/her to comment on Sal's position?

[SoCalActuary]

Sal's interpretation is his opinion. Look at the ways that he qualifies his opinion.

2008 EOB - Ch 7, Section XVI, Part B.5.a.1:

5.a.1)Employees deemed to benefit under 401(k) arrangements. Under Treas. Reg. §1.410(b)-3, an employee who is eligible to defer under a section 401(k) arrangement is treated as benefiting under that arrangement, even if he elects not to defer. Where the employee does not actually receive an allocation of employer contributions, but is treated as benefiting under a portion of the plan for coverage purposes, should the employee's compensation be included in computing the deduction limit? The answer is not clear. Arguably, the definition of benefiting in the coverage regulations modifies Rev. Rul. 65-295 and the compensation of such employees may be counted. A conservative approach would be to count the compensation only of employees who actually make elective deferrals under the 401(k) arrangement or who receive allocations of other employer contributions. But since eligible employees under a 401(k) arrangement are treated as benefiting for coverage, and are also reported as participants on Form 5500, it seems reasonable to include their compensation in determining the employer's deduction limit, even if they do not receive allocations of other employer contributions (e.g., nonelective contributions).

Does separate deduction of 401(k) deferrals in post-2001 years hurt this argument? With elective deferrals deducted separately from other contributions in post-2001 taxable years, without being subject to the 25% limit under IRC §404(a)(3), as described in 3. above, does that mean an employee who benefits solely under the 401(k) arrangement should no longer be included in the compensation base to compute the employer's §404(a)(3) deduction limit, because he is not benefiting from the contributions that are subject to the §404(a)(3) limit (i.e., matching contributions and nonelective contributions)? For example, a 401(k) plan might allow immediate entry for elective deferral purposes but require 1 year of service for matching contributions and nonelective contributions. Should an employee who is eligible to defer, but servicehas not met the 1 year of service requirement for other contributions be taken into account in the §404(a)(3) compensation base? Some practitioners argue that such employees should not be taken into account. However, §404(a)(3) refers generically to all beneficiaries of the trust, not just to those who share in the allocations that are subject to the §404(a)(3) deduction, so a reasonable argument can be made that the EGTRRA change has no impact on this analysis of who is benefiting under the plan. The Treasury might provide guidance on this issue at some later date. In the meantime, the employer (with the advise of tax counsel, if requested) will need to decide whether to take a conservative approach to calculating its deduction limit (by excluding the employees who are benefiting solely from the 401(k) arrangement) or to continue applying these principles in the same manner as it did in pre-2002 taxable years (i.e., by including such employees).

Sal is pushing for a particular point of view. If you wish to adopt that POV, then you are comfortable putting your client at risk of a lost deduction. Good luck, and I hope you have a different E/O carrier than I do.

[Blinky the 3-eyed Fish]

These are the same comments Sal has had in past editions. Because of what I have heard from the IRS over and over again, I would be very hesitant to include comp from someone who did not receive ER money. If I did want to include that comp, I would surely run the issue by the client with all the information and let them make the decision. I would then caveat my work in writing.