Reclassifying Salary Deferrals as Employer Contributions

[Guest sacobb]

I have a law firm that is an LLC (taxed as a partnership) and they have a safe harbor 401(k) Plan. Several partners made elections in the beginning of the year to contribute a specific amount of their draw each month as a salary deferral to the 401(k) Plan. One of the partners is contending that these individuals can "reclassify" the salary deferrals as the safe harbor contribution for the year (i.e. a partner contributed $10,000 as salary deferral but now wants $4,800 as safe harbor and balance as salary deferral). I have a problem with this because the partners made written elections to have amounts withheld from their draw and deposited as SALARY DEFERRALS. However, maybe I'm missing something with the treatment of partnership income since its a little different than that paid to the non-partners. Any insight would be appreciated.

[This message has been edited by Dave Baker (edited 12-23-1999).]

[Guest Iwonder]

I can see that this is an old question, but I have a situation like this and wonder if anyone has dealt with a similar situation.

In the case I am looking at: the partners want to reclassify partner contributions to a PSP (used to fund a PSP throughout the year as opposed to lump sum at the end of the year) as employee contributions because a partner is leaving the firm and will not be in the firm on 12/31.

Thank you

[Kimberly S]

It is an old question that continues to be an issue with small employers who often think they can do whatever they want.

If the partner did not end up with sufficient income to support the deferrals deposited, it is not difficult to make the jump to saying the money was actually a deposit of employer money. If the partner had plenty of income and a deferral election on file that matches the amount deposited, it seems to be a riskier leap. This is a good example of why partners and sole proprietors should refrain from making deposits until their income for the year is known.

[Guest Iwonder]

Thank you for your response. You are correct and it would seem that this would be prohibited.

I am having trouble finding information on what I can point to (regulation, etc.) to discourage this practice.

Also I can't find any information on actual adverse consequences that may be faced if a partnership decides to go ahead and continue this practice.

Any discouraging information would be helpful.

[BG5150]

Any discouraging information would be helpful.

For some reason that last sentence made me laugh a little.

[Tom Poje]

about as close to any comments you might find can be found in the preamble to the final 401(k) regulations.

(always print them preambles when available, you can never find them when you need them later!

"One commentator asked for clarification of the interaction between these timing rules and the rule under the regulations that treats a self-employed individual’s earned income as being currently available on the last day of the individual’s taxable year and whether this last day rule precludes a partner from making elective contributions during the year through a reduction in the partner’s draw. The restriction on the timing of contributions is not intended to prevent a partner from deferring amounts that are paid to the partner throughout the year on account of services performed by the partner during the year, and the final regulations have been modified to clarify this point. However, self-employed individuals who take advantage of this opportunity to defer amounts during the year must make sure that the amount contributed during the year will not exceed the limits (such as the limits of section 415) that will apply to the individual, based on the individual’s actual earned income for the relevant period."

[Guest Iwonder]

Your direction is greatly appreciated.

Being discouraging often results in a kill-the-messenger reaction BUT a strategically placed word of caution and the presentation of a nicely drafted piece of regulatory writing will do the trick!!

Thank you.

PS: I printed off the preamble to have available when needed.

[Tom Poje]

if you are not aware of it, one of the best features of this website is the free daily newsletters,

http://benefitslink.com/newsletter/

when, for instance, the final regs for some section are released you receive the notification and a link so you can print out the stuff.

I print the stuff off, because, while I can always look in the regs, I've found it hard at times to find the preamble.

And I've found the preambles to be so valuable - in this particular case I think they addressed your question more so than the regs (in fact I only copied the one paragraph, if you read further they address when the deferral election must be made, etc )