414(s) Compensation and 401(k) Plans

[Tom Poje]

Plan fails 414(s), so it is now non safe harbor. There is no 'nondisrim' test by rate groups like for profit sharing contributions. The closest you can come is to run your ADP test using a safe harbor definition of compensation (despite the fact ees weren't able to defer on some comp)

This may cause plan to fail, and therefore require a QNEC /or refund.

Note: according to the ERISA Outline Book, some IRS agents hold that a de minimis standard can be 3% - though even that is stioll a facts and circumstance issue.

possible cite would be 1.414(s)-1(a)(2)

...even though a definition of compensation permitted under 414(s) MUST be used in determining whether the contributions (in your case, deferrals) satisfy a certain applicable provision (in your case ADP test), the plan is not required to use a definition of compensation that satisfies 414(s) in calculating the amount of contributions...

Since you failed 414(s) you are violating the MUST listed above.

[Guest Amy Erlbacher Anderson]

Thank you for the reply. The 414(s) difference is nearly 10% so it can't qualify as de minimus. However, the company passed ADP and ACP using a safe harbor definition and not its plan definition of compensation. Does this make a difference?

[Guest Amy Erlbacher Anderson]

I have been told that if a 401(k) plan passes ADP and ACP, it doesn't matter that its definition of compensation flunks the 414(s) discrimination test and is discriminatory; however, I can't find any proof of this in the Code or Regulations? Is this true and under what?

[Guest Harry O]

No, it makes no difference for ADP/ACP testing purposes. Congratulations! You passed!

But if there are other benefit, rights or features tied to this definition of compensation you may have a problem under the general 401(a)(4) nondiscrimination rules.

[MWeddell]

Let's make sure we agree on the facts: (1) a plan uses a 414(s) definition for compensation and passes ADP / ACP testing, and (2) the plan's definition of compensation used for computing contributions does not meet a 414(s) safe harbor and appears unlikely to pass 414(s) testing.

Whether there's a problem depends on the types of contributions the plan has.

For 401(k) elective deferrals or employee pre-tax contributions, it's highly likely that you don't have a problem. The IRS has said that elective deferrals "are not required to be based on compensation determined under a definition that satisfies

 section 414(s)."  Supplemental Information to the 414(s) regulations comments #7, 54 FR 7659, reprinted in Pension Plan Guid (CCH), para. 23,836F.  IRS officials have publicly stated that they do not intend to develop a test for definitions of compenstion used in this limited fashion.  Unless the compensation definition clearly restricts access to nonhighly compensationed employes, the definition is acceptable.  1992 Enrolled Actuaries Meeting Grey Book, question 40.If this definition is used for computing employee after-tax compensation and employer matching contributions, I still don't think you have a problem.  While technically the ability to make each rate of contributions and the availability of each rate of matching contributions is a benefit, right, or feature subject to testing, using the same logic as presented above for the elective deferrals should convince the IRS not to pursue the issue.  This one's a judgment call, but I think you're quite safe.

If you have employer nonmatching contributions or profit sharing contributions, then you will have an issue with the plan's definition of compensation not meeting 414(s). You won't be able to rely on 401(a)(4) safe harbors and will have to perform general 401(a)(4) testing using a 414(s) definition of compensation.

[Guest Harry O]

I think we all agree on the basic point -- no ADP/ACP problem.

I'm not so sure I'd be comfortable with the issue of whether you are o.k. on the "different rate" of contribution question. For example, I would feel uncomfortable if the plan permitted elective deferrals against annual bonuses (paid exclusively to HCEs) but not against overtime (paid exclusively to NHCEs). Even if the plan somehow passed the ADP test I would be thinking long and hard about the -4 reg! This would be a good issue to fully disclose in your determination letter application. I would definitely indicate that we did not think this definition of compensation created separate BRFs. If the IRS doesn't object I think you are sitting pretty . . .

[Guest Tracy]

We are a partnership and our plan has passed the ADP/ACP tests using the Plan's definition of compensation, however, now we are trying to calculate salary under 414(s). Is there an easy answer on how this should be calculated from the K-1? Should we subtract half of a partner's self-employment tax from the "Guaranteed Payments" line, or the "Net Earnings from self-employment" line?

Should anything else be subtracted besides contributions to a non-qualified plan? (i.e., Profit sharing, Matching contribs, Section 125, Partnership Distribution...)

[Guest Amy Erlbacher Anderson]

Thank you for all of the responses. I am not worried about ADP/ACP; I am worried about the fact that the definition of compensation for elective deferrals and employer matching contribution flunks the 414(s) non-discrimination testing by a wide margin.

The definition is close to a safe harbor but uses base pay - including overtime but excluding bonuses.

[Guest T Hoffman]

Any thoughts on how a determination letter application would be prepared based on the above facts? I know that a demo 3 (benefits, rights, and features) is optional, but a demo 9 is required if the plan bases allocations on a non-safeharbor definition of compensation. Although the above posts all present compelling arguments that the plan at issue should be safe, how would the demo 9 be prepared?

[Guest Amy Erlbacher Anderson]

The Demo 9 is what brought this whole issue up to begin with. I am also interested on any input on Demo 9.

[Wessex]

Under the literal instructions for Demo 9, of course, it is not necessary to complete the demo if a 414(s) definition of compensation is not required. In the past, however, to be sure that the determination letter application would have explicit disclosure on this issue, I have prepared a Demo 9 that says the compensation used for deferrals does not and is not required to meet a 414(s) definition. (This approach may have made more sense under the old 5300 series with the Appendix A attachment required prior to the issuance of the current 5300 series and Schedule Q. If memory serves me correctly, there was an option on the 5300 to check N/A with respect to Demo 9.) My approach generally was to disclose on some schedule or demo anything that one would not want the Service to be able to assert it had not been adequately disclosed and thus was not covered by the determination letter.

As an aside, it's unusual -- although obviously not impossible -- for a compensation definition that includes overtime but excludes bonuses to fail to meet a 414(s) definition.

[This message has been edited by Wessex (edited 06-01-99).]

[AndyH]

This may seem like a blast from the past.

I found this thread as a result of a search. Has anything changed or been clarified with respect to deferrals on compensation which does not pass the 414(s) ratio test?

Is it ok to use non-414(s) comp for deferrals if you satisfy the ADP test using gross wages?

[Richard Anderson]

The compensation definition for deferrals is not required to satisfy 414(s). Of course, the definition for testing (ADP/ACP) must be a definition that satisfies 414(s).

I'm pretty sure that if it is a safe harbor 401(k) (no ADP required) then the definition for both deferrals and match allocations must satisfy 414(s).

[AndyH]

Thanks, Richard. That seems to be the consensus here, but I've had trouble finding that in print except in the gray book cited here where it does say that the IRS does not intend to take issue with this from a 401(a)(4) perspective (benefits, rights and features).

But, if not for that 1992 cite, I'd share Harry O's concern expressed here.

As usual, it would be nice to have something a little more authoritative or official.