Controlled Groups and the Transition Rule

[justatester]

Here is the situation:

Company A & B are part of a controlled group. They performed coverage testing in 2006 (with just the 2 plans). In 2005, Co. B acquired a new company (Co. C). They want to rely on the transition rule for 2005 & 2006. In 2007, Company A&B still want to rely on the 2006 test results and not complete coverage for Company A&B. The demographics of the plan are Co A&B have about 15,000 with 3,000 or so HCEs. Company C has about 100 ees, with 75 HCEs. Obviously, Company C has coverage issues. Company C is to complete coverage including Co A&B as nonexcludable, not benefiting.

Can Company A&B use the2006 Coverage Test still in 2007 since members of the controlled group changed? Any thoughts would be greatly appreciated.

[MWeddell]

There is not a hard and fast rule. The relevant criteria is from Revenue Procedure 93-42, from the section titled "Three Year Testing Cycle."

The guidance recognizes that whether one has to rerun the tests annually or can rely on a prior year's test for an extra year or two depends in part by how narrowly the test passed in the first place.

[justatester]

Ok, so I tried to find a 93-42. Any ideas where I can locate it?

[Laura Harrington]

I have subscription access to www.tagdata.com and was able to locate it there.

Here is the text from Rev. Proc. 93-42 that discussed the 3-year testing cycle.

I do not think you cannot rely on this rule as there has been changes in the employer's workforce (i.e. the addition of another company in the controlled group).

SEC. 5. THREE-YEAR TESTING CYCLE

An employer may rely for the two succeeding plan years on the tests substantiating that a plan complies with the nondiscrimination requirements for a plan year if the employer reasonably concludes that there are no significant changes subsequent to the test (e.g., significant changes in plan provisions, the employer’s workforce, or compensation practices). For this purpose, whether a change is significant depends upon the relative margin by which the plan has satisfied the nondiscrimination requirements in the most recent year in which the plan was tested and the likelihood that the change would eliminate that margin. If there is a significant change in one plan provision, the effect of which can be isolated from the effect of other provisions, the employer may continue to rely on the prior test during the interim two years, provided that the employer can demonstrate that the effect of the amended plan provision is nondiscriminatory. Employers using the three-year testing cycle for purposes of substantiating compliance generally must treat the year in which the final regulations under sections 401(a)(4) and 410(b) of the Code become effective with regard to the plan as a year of significant change requiring actual testing. However, if a plan first complies with these regulations in a year prior to their effective date, then the employer may treat that year, rather than the year in which the regulations are first effective, as a year of significant change for purposes of beginning the three-year testing cycle.

[justatester]

Thanks for the information.

I would tend to agree that the addition to the controlled group would not allow them to rely on the 3 year cycle. However, the client is stating since it is less than 1% change in the population, it was not a significant change.

Any thoughts?

[Laura Harrington]

Thanks for the information.

I would tend to agree that the addition to the controlled group would not allow them to rely on the 3 year cycle. However, the client is stating since it is less than 1% change in the population, it was not a significant change.

Any thoughts?

For some reason I had in my head that the reason they did not want to consider Company C was because it would make the coverage test fail. I don't know why I assumed that. A change of less than 1% probably could be argued to be insignificant, but I don't know of any specific guidance that would support that conclusion.

Do they typically rely on the 3-year testing cycle?

[justatester]

No, this will be the first time they are using it. Originally, when it was just A&B, B always failed coverage. They failed so bad that they did a VCP filing. It took almost 2 year to get an answer, which was basically there is no way to fix the past, just fix it going forward. That covered Co. B through 2007. The VCP Filing did not include the fact that Company C existed.

So I just thought of something...your thoughts would be appreciated.

In 2006, Company A & B were not permissely aggregated. For 2008, Company A & B are permissively aggregated for at least pretax and match....which to me indicates they can not rely on the 2006 coverage results. For the profit sharing, do they need to permissively aggregate since the pretax and match are?

[MWeddell]

In 2006, Company A & B were not permissely aggregated. For 2008, Company A & B are permissively aggregated for at least pretax and match....which to me indicates they can not rely on the 2006 coverage results.

I agree. This is a significant change. 2008 coverage tests are needed for the pretax and the match (although one would think that they would pass the ratio percentage test handily. Also, consider whether there are benefits, rights or features in the aggregated plan that must be tested under Treas. Reg. 1.401(a)(4)-4.

For the profit sharing, do they need to permissively aggregate since the pretax and match are?

No, they are not required to permissively aggregated the profit-sharing portions of the plan just because the 401(k) and 401(m) arrangements are permissively aggregated.

[justatester]

Thanks for the feedback. Now that A&B are together, they now easily pass coverage on the pretax side. However, on the match side, the "otherwise excludable" group does not pass. Company A (the larger group) has a 1yos for match. Company B has immediate. So I have a whole bunch of NHCEs that are now nonexcludable, not benefiting. They also have BRF & General testing issues. Basically, the plan design is a mess.