Using the kids to help test results

[Guest JPIngold]

Just wondering what folks out there think of the following idea ....

I have a husband (dentist) and wife (bookkeeper) who both work in the business. They have three employees. Wife doesn't take much salary (of course enough to max deferrals), so passing the AB % test is VERY tough. We can't restructure into component plans with only 3 NHCE's as we can't cover 70% in each component plan. Therefore, I need my rate groups to cover 70% so I can avoid that test. One of the NHCE's is much older than the two owners. The second is close to their age. So, I am not getting a great bang for my buck with cross-testing unless:

1) They hire a young, part-time employee which opens up better options with cross-testing and restructuring (but involves hiring someone); or

2) The couple has two minor children who clean the office and also are in promotional brochures, ads in the paper, etc. I could eliminate all age and service requirements, exclude HCE's from the safe harbor nonelective contribution, and also exclude keys from top-heavy. Now I have 4 HCE's, 2 of which are deferring nothing and receiving nothing. This helps my rate group testing by giving me a divisor of 4 instead of 2.

Too aggressive??? Anything I am missing??? Anyone had any audit experience with option (2)??? I'm a tax accountant too, and I've had my share of arguments with the IRS about kids on the payroll, but we have pretty good proof that they are working with the brochures, etc.

Thanks.

James

[ETA Consulting LLC]

You know most, if not all, of the issues; and probably are better equipped than most of us to answer your own question. Obviously, you have a solid grasp of the plan design issues with respect to how the plan is tested.

I supposed it would be easy to get beyond the "reasonable compensation" issue with the kids by ensuring they aren't paid too much. It does open the obvious question of the "only" purpose of the kids being on the payroll is to help faciliate passing of the test by artifically creating a "shaft-class" of HCEs. You're argument, of course, it that the kids are hired for purely business purposes.

I can appreciate the complexity of this situation, but generally try to steer clear of these issues; for the same reasons you've pointed out.

Good Luck!

[J Simmons]

Just wondering what folks out there think of the following idea ....

I have a husband (dentist) and wife (bookkeeper) who both work in the business. They have three employees. Wife doesn't take much salary (of course enough to max deferrals), so passing the AB % test is VERY tough. We can't restructure into component plans with only 3 NHCE's as we can't cover 70% in each component plan. Therefore, I need my rate groups to cover 70% so I can avoid that test. One of the NHCE's is much older than the two owners. The second is close to their age. So, I am not getting a great bang for my buck with cross-testing unless:

1) They hire a young, part-time employee which opens up better options with cross-testing and restructuring (but involves hiring someone); or

2) The couple has two minor children who clean the office and also are in promotional brochures, ads in the paper, etc. I could eliminate all age and service requirements, exclude HCE's from the safe harbor nonelective contribution, and also exclude keys from top-heavy. Now I have 4 HCE's, 2 of which are deferring nothing and receiving nothing. This helps my rate group testing by giving me a divisor of 4 instead of 2.

Too aggressive??? Anything I am missing??? Anyone had any audit experience with option (2)??? I'm a tax accountant too, and I've had my share of arguments with the IRS about kids on the payroll, but we have pretty good proof that they are working with the brochures, etc.

Thanks.

James

Like ERISAtoolkit.com, I think you are firing on all cylinders (have a grasp on the issues).

I used this design repeatedly during the GUST II restatements, and submitted for d-letters with Schedule Q and Demos showing how this worked, and that the kids were HCEs. The Service issued the d-letters with no push back on this issue, on any of those applications. (I was pushing the envelope in design on the definitely determinable formula issue then, and had to explain at length the internal IRS memos on that topic to about 6-8 different IRS offices, before they'd back down and issue the d-letters. But never any pushback for relaxed eligibility rules that brought the owners' kids into the plan without accruing anything, benefiting the owner/employees in the testing just the way you are describing.)

I did not submit sample Demos for EGTRRA d-letters, just document requests. But I've not heard anything suggesting a change in attitude by the Service regarding this issue since the GUST II era.

[Guest JPIngold]

Thanks to you both for your input. Always good to make sure I'm not missing anything!!!

[Tom Poje]

of course, the IRS could view any such arrangement as a violation of the intent of the regs, namely using short term employees to benefit a few selected HCEs.

[Guest JPIngold]

of course, the IRS could view any such arrangement as a violation of the intent of the regs, namely using short term employees to benefit a few selected HCEs.

I thought of that too, but the thing I have on my side on this one is the fact the kids have been on the payroll for a few years and we are just adopting this plan for 2012. It is clear the chicken came before the egg in this case as we aren't just putting the kids on the payroll now to help the cause. Further, I feel the Gold memo was intended to keep me from going out and hiring short-term employees (my option 1 in my scenario) and giving them the benefit and not benefitting the full-time employees. In this case, I am simply using what I have and NOT benefitting a couple of HCE's.

Thanks Tom.

[Belgarath]

Dumb question here, but does a regular old integrated plan design produce better results? I'm assuming not, but just thought I'd ask...

[Guest JPIngold]

Dumb question here, but does a regular old integrated plan design produce better results? I'm assuming not, but just thought I'd ask...

Permitted disparity plan - $29,700 to HCE's and $10,500 to NHCE's

Cross-tested --- $38,400 to HCE's and $1,800 to NHCE's

Already giving them 3% SHNEC in addition to above. So, they are receiving 5% contribution in CT plan.

Integrated plan probably wouldn't be enough to entice them away from their current SIMPLE IRA. Have to justify the fees somehow!!!

[J Simmons]

I do not think the Gold memo applies to this issue. It was addressing a plan design that "limit[ed] participation under the plan to highly compensated employees and to rank and file employees with short periods of service (such as periods of a few weeks or even a few days)." It was effectively favoring, among the compensation range of NHCEs, those at the bottom end vis-a-vis those at the top end of the compensation range for NHCEs.

Many plans have no minimum service or age requirements for eligibility, and allow immediate entry. Many of these same plans have no end-of-year-employment requirements or minimum hours in the current plan year for benefit accrual requirements.

I do not think that a plan that uses a cross-testing allocation is required to avoid these liberal eligibility/entry/benefit accrual rules.

The Gold memo, in my opinion, was limited in its reach and indication of the Service's position and thinking about 401(a)(4) to designs that among NHCEs bottom load (either exclude higher earning NHCEs altogether or provide lower rates of company contributions to them as compared to the lower earning NHCEs). Manipulation within the ranks of the NHCEs to leverage further cross-testing results for the HCEs was the focus and import of the Gold memo--not suggesting that you cannot treat all NHCEs similarly because doing so might help the HCEs' accrual levels, and not suggesting that all HCEs that meet the same eligibility/entry/benefit accrual rules also applicable to NHCEs, that such HCEs must accrue a level of benefits or any benefits at all (barring top heavy minimum if an HCE is not also a Key Employee).

I am aware of nothing from the Service, not even informal indications, that the Gold memo would extend or be extended to the situation posited in the OP.