ADP Test - HCE Compensation of .01

[PFranckowiak]

In MI - economy and business down.

Owner's son deferred a lot

Owner did not take a paycheck, but worked, Got a W-2 for .01. Yes a penny!!!!!!!!!!!!!!!!!!!!!

If no compensation I know I leave him off the test and it fails big time( Son has to take out more than he put in due to Interest)

If I can use the .01 and have dad in the test, it will help

I am, however, not comfortable with the penny for compensation. I have asked for a copy of the W-2. I cannot believe that they issued it. Got it they did do a W-2 for a penny.

Anyone EVER had anything like this or have any suggestions. What is the minimum compensation that you think someone has to have to be in the test.

I am leaning toward leaving him out.

Thanks for your help.

Pat

[Jim Chad]

Pat:

You have more strange Plans than anyone I know!

I would include it. He is the one who has chosen to follow the letter of the law. I would not want to put myself in the position of deciding whether or not he is following the spirit of the law..

..or even whether he needs to. I understand a penny makes you uncomfortable. How about a dollar? 100 dollars? Where do you draw the line? I would draw it at nothing versus something.:What does everyone else think?

[Guest Sieve]

Jim --

Would you have a problem (in a plan with no service or hours eligibility requirements) using a 100% NHCE deferral percentage if the nephew of the owner (sole HCE) were hired at year-end for one hour and paid $10, all of which is deferred? How about using an HCE deferral percentage of 0% if a teen-age son were hired (or a 10% owner were brought out of retirement) and paid $10 with nothing deferred? I would draw the line at the legitimacy of the hire or, in the case of the owner, the purpose of the determination of the amount paid. There is a legitimate reason to pay an owner nothing...but $0.01?

Wasn't there some kind of generic anti-manipulation discussion/prohibition issued by the IRS 4 or 5 years ago that might apply (I think it dealt with use of part-timers in new comp plans)?--because I don't think Treas. Reg. Sections 1.401(k)-1(b)(3) or 1.401(m)(1)(b)(3) cover it, since they deal with manipulation of plan chenages and testing procedures.

[Jim Chad]

Larry, You raise some very good questions.

These two scenarios actually bother me more because of the question of whether or not there was actually a business reason for hiring them. It looks like these two people were put on the payroll only to save taxes. I would definitely send a letter to the client explaining the grounds the IRS may use to challenge this and ask for an answer in writing to the question of does he really want me to use this?

[Guest Sieve]

Why is your situation any different? The hire wasn't manipulative, but the amount of compensation was.

[PFranckowiak]

I don't know of any discussions regarding using this small compensation. I was surprised when I got the copy of the w-2 in my hands. It makes a huge difference in the ADP test. Is there any problems if we don't count it are require the owners son to take out more money? I was wondering if they wrote him a check for the .01? Definitely probabaly didn't withhold anything.

Thanks for all your help. I appreaciate being able to bounce this stuff off others.

Pat

[austin3515]

From the EOB:

7.a.HCE takes no compensation for plan year. This issue also arises when an HCE, particular one who is an owner of the plan sponsor, does not receive a salary, and does not otherwise receive any compensation for the plan year. This is another one of those situations where there is no clear guidance from IRS, and it may place a plan administrator "between a rock and hard place" to resolve the issue. The more conservative approach would be to treat the HCE as not eligible, based on the discussion in the prior paragraph. Of course, in many cases the employer would like to treat the HCE as eligible, and then calculate the HCE's deferral percentage as 0% for ADP testing and ACP testing purposes. This is probably too aggressive a position. Even if the HCE is treated as eligible, should the deferral percentage actually be 0%? A case could be made that to defer $0 out of zero compensation is actually a 100% deferral. Given these mathematical gyrations, it is probably a sounder approach to treat the HCE as ineligible until formal guidance is issued by IRS. The IRS acknowledged this to be a reasonable approach at the ASPPA 2000 Fall Conference in Washington, D.C., in a "Q&A" session with IRS representatives. In the Q&A Session, the issue dealt with a partner in a partnership whose earned income was negative for a plan year.

Taking nominal salary might be a better approach. This issue, at least where the HCE is a common law employee of the plan sponsor, can be avoided by paying the HCE at least a nominal salary (e.g., $100). So long as some compensation is taken and the HCE does not defer any of that compensation, it is proper to include the HCE in the ADP test at a 0% deferral rate. This won't work in the context of a self-employed individual (e.g., sole proprietor or partner), whose compensation must be based on an earned income calculation. If the earned income is zero or negative, the best approach appears to be to treat the self-employed individual as an ineligible employee.

[Guest Sieve]

I probably would be a little more conservative about a nominal salary for an owner than Sal suggests, and I suspect that the IRS would question it. If you can show some substantial business reason for the compenstion level--e.g., business hardship plus need to keep owner on health care plan--then I'd have less of a problem with it than if it turns out to be just a device to manipulate the ADP test. For example, a big payment of salary shortly after the first of the following year does not help to argue that the nominal salary is a legitimate one.

But, maybe the IRS never questions these things except on a corporate audit. And perhaps it's just my conservative nature speaking . . .

[austin3515]

Personnally, I think it's just wrotten to leave the owner of the ADP test solely because the business was struggling, etc. There should be an exception for someone working 80 hours a week who is not getting paid because he decided to pay his employees instead...

But alas, there is not