Self-Employed Match Calculation Question

[Laura Harrington]

I know there isn't any statutory answer for this question, so I guess it is more of a WWYD kind of question!

Plan says employer match is based on payroll periods. The match formula is 40% of salary deferral up to 10% of compensation. Plan has 3 partners who receive K-1 and 10 or so common law employees who receive W-2 wages throughout the year. Compensation for common law employee is W-2, compensation for self-employed is earned income.

The partners receive draws or guaranteed payments (not sure which...but I don't think that matters) throughout the year that is paid to them at the same time as the common law employees receive a paycheck. They defer throughout the year based on those draws/guaranteed payments and the client calculates and deposits match, using the amount of the draw/guaranteed payment as compensation.

Typically at year end we just take the preliminary K-1 and calculate what their match should have been for the year based on line 14A. And usually there are no adjustments that need to be made to the match the client calculated because they max out their match.

However, for 2011, the client did not start matching until mid-year. They matched 13 out of 27 payrolls.

If we calculate the match for the self-employed the way we typically would (based on their total deferral for the year and their prelim K-1), they owe $$$$ to the plan for the self-employed individuals. The client does not want to match them for the entire year since they didn't match the common law employees based on the full plan year. And this makes sense to me.....it does seem unfair.

So we are contemplating pro-rating the prelim K-1 number (taking it by 13/27) and only counting the deferral from the time they started matching the common law employees. They will still owe money to the plan for 2 of the partners, but not nearly as much. They are still going to be upset, because as it turns out, no one has ever explained to them (or had to explain to them) that compensation for the partners is earned income; that you just cannot use the draw/guaranteed payment amount to calculate the employer match.

Thoughts? Any concerns? Other solutions?

Thanks!

[PensionPro]

Even though compensation for self-employeds is determined at the end of the year it is treated as having been consistently earned throughout the year. Your approach sounds reasonable to me.

[ETA Consulting LLC]

I am not sure about that. Let's look at the calculation itself. Each partner's earned income is calculated by first deducting company expenses (which includes employer contributions for the common law employees). However, each Partner's income is calculated by reducing the employer contribution for that owner (and this happens after the reduction for self-employment taxes).

How would you propose to actually calculate a per payroll compensation amount when you consider the existence of all these variables. Even the partner defers from a draw (which they are perfectly allowed to do), they run the risk of a 415 excess in the event they end up with zero compensation at year end. Attempting to do mid year calculations "may" create more harm than good.

Just a thought.

Good Luck!

[Jim Chad]

I agree with ERISATOOLKIT and Pensionpro. As ERISATOOKIT says if you try to do mid year calculations, you will go crazy (crazier?). As pensionpro say, once the year has ended you do the one calculation for the year. Then for a part year match, you would take the fraction of the year the match was in place and apply that to the owners comp.

[masteff]

Plan says employer match is based on payroll periods. The match formula is 40% of salary deferral up to 10% of compensation. ... 10 or so common law employees who receive W-2 wages throughout the year. Compensation for common law employee is W-2 ...

... at the same time as the common law employees receive a paycheck. ...

However, for 2011, the client did not start matching until mid-year. They matched 13 out of 27 payrolls.

... since they didn't match the common law employees based on the full plan year. ...

So this must be a discretionary match? Otherwise, by what mechanism did they not match the common law employees for 1/2 the year?

If they made a proper change in the match rates, what did the mid-year change actually say? Arguably, you need to read the exact wording of whatever action was taken to restart the match and interpret from that. You might be able to make the case for only using 1/2 of the K-1 comp. Next time it'd be nice if they'd use unambiguous words like "40% of deferral up to 10% of either: a) for partners, 1/2 of annual comp or b) for common law employees, the comp received after 7/1."