Cross-Tested Profit Sharing

[John Feldt ERPA CPC QPA]

Reviewing a single DC plan (not a combo) that has each person is their own class.

The plan covers everyone (it passes 410(b) using the ratio percentage test: over 70% covered).

The valuation shows the owners maxing out (20%). The NHCEs look like this:

2 NHCEs get 9% of pay profit sharing

another NHCE gets 49% of pay profit sharing

all other NHCEs get the 5% gateway

The 401(a)(4) test reveals a result of 70.01% (thanks mainly to the one NHCE whose ebar makes up more than half of the sum of the NHCE ebars). Each of the general test percentages are above the safe harbor percentage, except one class: which is above the midpoint, but below the safe harbor percentage.

The one NHCE getting 49% is the youngest and this was their first year in the plan. They are not the very lowest paid of all eligibles (third lowest), but no one else in the plan has less service than they do. The average NHCE in the plan has seven years. Is it a problem that the this one NHCE employee is getting a 49% of pay allocation?

[J Simmons]

I'm aware of bottom loading being a problem for QNEC allocation to correct initial ADP failure, but I'm not aware of bottom loading being challenged for cross-testing purposes.

[Tom Poje]

If it was a prototype then you could only have 2 groups for the NHCEs, but otherwise the formula does work (ignoring the possible reprucussions when the youngest NHCE tells the other NHCEs he received 49% of pay!!)

suppose the plan had simply given all NHCEs 5%. it would have failed testing and could have put in a corrective amendment producing the same results.

[John Feldt ERPA CPC QPA]

Okay, that's what I suspected. Now I'm convinced. As for prototype, we plan to only use volume submitter documents going forward (with EGTRRA documents), there's no longer any advantages for using prototypes anymore (as far as I know).

[Mike Preston]

This is generally referred to as the "BIL" design. Where BIL stands for Brother-in-Law. It works just as well for a girlfriend (or boyfriend) of the owner. 49%, huh? Seems low. Remember, 415 is 100%. Maybe that was all that was needed to pass!

[buckaroo]

Tom,

I saw your reply and I am not clear as to why the NHCEs would be restricted to two allocation groups in this case. My undersanding is that the number of allocation groups is based on the number of eligible NHCEs. I did not see that number provided. Do I not understand the rule or did I just miss something in the post?

As always, thanks for your reply.

[Tom Poje]

its in the LRM pertaining to the prototypes.

I'll post it again

[buckaroo]

Tom,

I have re-read the LRM again and I do not understand. I see and have seen in the LRM that the number of NCHE allocation groups is limited based on the number of eligible NHCEs in the plan. The problem is that I do not see the number of eligible NHCEs detailed in the post.

1) Is there something more I am missing in the LRM?

or

2) Is there something more I am missing in the post?

or

3) Am I correct?

[John Feldt ERPA CPC QPA]

You're right, I did not exactly state exactly how many total HCEs and NHCEs exist. However, I indicated that all of the owners are getting 20% of pay.

[Tom Poje]

then my mis-read. I thought it was indicated there were 4 nhces

[J Simmons]

J4FKBC,

In regard to your OP, you might want to take a look as Carol Gold's October 22, 2004 Memorandum for Director, EP Exams Director, EP Determinations Redesign. There, loading up short-term, low paid NHCEs vis-a-vis other NHCEs (while a beefy contribution is made for thw owner-employee) was assailed as an unreasonable interpretation of the -8 cross-testing regs aimed at preventing discrimination in favor of the HCE, as required by -1©(2).

Your situation does not look as stark or blatant as the straw-man example used in the Gold memo. But you might want to compare your situation closely.

[John Feldt ERPA CPC QPA]

Thanks, that memo is actually the reason for posting this question. This situation appears to be okay, based on the specifics for this client.