Code Sec 404(a)(3) Deduction Limit - Can you count Comp of a Participa

[Guest David Danziger]

Code Section 404(a)(3) limits deductibility of contributions to Profit Sharing Plans at 15% of compensation paid to "beneficiaries" under the plan.

IRS rulings indicate that an employer cannot count the compensation of a participant for whom no contribution is made for the year (e.g., due to a last day of year employment requirement). Their logic is that such a participant is not a beneficiary under the plan for that plan year because no money has been contributed to the trust for their benefit.

Is any one aware of a different rule in the case of a participant in a 401(k) plan? That is - if a participant is not eligible for a PS contribution (due to a last day of year employment requirement) AND that participant elected not to make any elective 401(k) deferrals, is there any chance the employer can count the participant's compensation for purposes of the 404(a)(3) 15% limitation?

The supporting logic would be that the participant is considered to be a beneficiary because s/he had the opportunity to make deferrals. (This is similar to the approach for minimum coverage testing under Code Section 410(B); i.e., a participant is "benefitting" under a (k) plan as long as s/he is able to defer - whether or not they actually elect to defer.) Have you heard any pronouncements from IRS that might support this reasoning?

Thank you for any feedback.

[Disco Stu]

My understanding of the rules is that you would not be able to count the compensation of the participant in the scenario you stated. If the participant you mention would have been eligible for a match, had they deferred, then you could count their compensation towards the deductible limit.

If anyone has a cite out there to back this up, I would be appreciative. The only information I have found on this was a article in CCH. They didn't mention any cites.

[Guest David Danziger]

Stu - It just so happens that the plan in my example allows the employer discretion to declare a matching contribution. The employer elected not to declare a matching a contribution for the year in question. Under these circumstances, could the employer count the participant's compensation? Or, must a matching contribution actually be allocated?

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[Tom Poje]

no one knows for sure. the conservative approach is, of course, not to count ees who do not defer.

however, Sal Tripodi in the Erisa Outline Book puts forth the following argument:

ees who are eligible to defer (even though they do not) are treated as benefiting for coverage purposes and are reported as participants on the 5500 as well. It seems reasonable to include their compensation even if they do not receive allocations.

[Disco Stu]

The participant would have had to receive a match if they deferred. So, since no match was given, the participant can't be counted.

To repeat...if anyone can point me toward some authority for this, I would be appreciative. What I have read, I believe to be credible, but there were no authoritative cites.

Thanks for any help.

[Guest ANNEBV]

I don't think I'm adding anything more than the others have so far, but since I have encountered this issue myself, I feel compelled to share my experiences.

To the best of my knowledge, there are NO authoritative cites to support either position. I have a good article from the Journal of Pension Benefits that I could fax to you if you like. It points out that this issue remains "gray". As mentioned above, the conservative approach is to exclude compensation for those who choose not to defer. However, the argument can be made to include compensation for those who choose not to defer, as suggested by Mr. Tripodi. You have to decide how conservative you are or want to be!

That briefly sums up my experience. Let me know if I can be of any further help!

[PLAN MAN]

According to my notes from a seminar by Pension Publications of Denver, Inc., for purposes of applying the 15% deduction limit the employer should determine which employees are participating in the plan by using the rules to determine "benefiting under the plan" in the regulations under Section 410(B). At the seminar we where told an employee who is eligible to make salary deferrals under a 401(k) plan is participating in the plan for purposes of applying the 15% deduction limit, even though the employee does not make a deferral during the plan year. The IRS should update the deduction regulations to make it clear.