Nondiscrimination testing - 414(s) compensation - which employees included?

[Belgarath]

I just want to see if I'm off base here.

You have an ERISA 403(b) plan. It includes deferrals, matching, and employer discretionary contributions.

There is "base compensation" and there is "supplemental compensation." Deferrals are allowed for total compesation. Matching contributions and employer contributions are based upon "base compensation" only - the supplemental compensation is excluded for these purposes. Certain employees are excluded for all plan purposes (students who satisfy the requirements under 1.403(b)-5©(4)(ii)((D)) and certain other employees are not eligible for the match purely based upon the exclusion of "supplemental compensation" for matching or other employer contributions.Employer contributions other than the match are allocated under a "new comparability" formula.

So, when you get to doing your 414(s) compensation testing, the question becomes, which employees do you include?

Starting with the employer discretionary contributions, it seems that under 1.414(s)-1(d)(3)(iii)(A), you must take into account all employees who BENEFIT under 1.410((b)-3(a). And this means that if you don't receive an allocation, even though you are included in the rate group testing, you are NOT included for the 414(s) testing. Have I got that right, or am I missing something?

For the consideration of the matching contributions and doing ACP testing under 401(m), it seems a little confusing. If they are excluded due to, say, job classification or insufficient hours, then they would be excluded for 414(s) testing purposes for the ACP test. But, if an employee is excluded from eligibility for the match based purely upon the nature of the compensation, (say they receive supplemental compensation only) then it seems to me that this employee should be INCLUDED when doing the 414(s) testing. Thoughts?

[ETA Consulting LLC]

You several tests working together. I'd look at it like this: When you run your 410(b) test, you'd have a percentage of employees who actually "benefit". This is the population for whom you are running your 414(s) test on.

So, your question is how is this individual reflected on your 410(b) test when they are part of an eligible class but merely fail to earn the type of Compensation that is necessary to receive the particular contribution.

It is confusing; which is why I try to design the plan away from this issue :-) If a person is "eligible" to defer or receive a match for all intents and purposes except for the fact that all his Compensation is "supplemental"; is he benefiting? If you're answer is yes, then he's included in the 414(s) test. If you're answer is no, then he is not. I've seen this both ways, but typically say that he's not benefiting.

Good Luck!

[Belgarath]

Thanks ETK. However, I'd like to explore this a bit more.

"It is confusing; which is why I try to design the plan away from this issue :-) If a person is "eligible" to defer or receive a match for all intents and purposes except for the fact that all his Compensation is "supplemental"; is he benefiting? If you're answer is yes, then he's included in the 414(s) test. If you're answer is no, then he is not. I've seen this both ways, but typically say that he's not benefiting."

To use an extreme example to illustrate why I question this - Let us suppose that most of the NHC employees receive all their compensation as "supplemental" compensation, whereas the HC receive NO supplemental compensation. So the NHC receive no match on this supplemental compensation. Do you think it is reasonable to argue that they are not benefitting, and therefore aren't counted in the 414(s) compensation testing? Granted that this is an absurd example, it illustrates why IMHO they should be included. It sort of seems like "double dipping" to first exclude this compensation, then say, "oh by the way, since you can't receive a match on this, then it isn't included when determining whether the compensation is discriminatory." Seems to me to defeat the purpose of the regulation, although I do see how it could be read this way.

Anyway, I appreciate any additional observations you may have.

[Tom Poje]

Q and A #1 at the 2008 ASPPA Conference

A 401(k) plan disregards commissions as compensation for plan purposes. One employee has only commissions, therefore could not defer. Assuming the compensation definition satisfies 414(s) testing, is this person included in the ADP test as a 0%, or would they be excluded from the test completely since they have no compensation for plan purposes?

If the person is excludable, does the answer change if, for purposes of testing, the plan included all compensation (including the commissions) for ADP testing purposes?

IRS Response

Refer to Treas. Reg. §1.401(k)-2(a)(3)(i), last sentence, which requires that you include all eligible employees in the testing. What is an eligible employee? Per Treas. Reg. §1.401(k)-6, it is someone who is directly or indirectly eligible to make a deferral for the year. Is this guy eligible? Yes, you must include him as 0%..

ASPPA Counter Response

Request was made for further discussion on the issue. Some at ASPPA feel an ee with no comp should not be in the test at all, rather than as a 0.

(And a reminder, any IRS response does not necessarily reflect an actual Treasury position)

[rcline46]

The IRS response is totally opposite of their opining that a partner with no or negative income is NOT in the testing since they were not effectively eligible to make a contribution. Of course the partner is (likely) and HCE and the commission only employee is (likely) a non-HCE. This is known as situational ethics - if it hurts the HCEs, it is good, if it helps the HCEs it is bad, just because.

[Belgarath]

Hi Tom - yeah, it almost seems as if you get into a never-ending loop on some of this stuff. In the absence of something really clear, I guess I make a distinction between eligibility based on not being excluded, and "ineligible" based purely upon the nature of your compensation. So if you have satisfied plan eligibility requirements, but simply don't RECEIVE a match based upon the nature of your compensation, then I'd think you should be included when calculating the 414(s) ratio. I'm just not sure that's right.

I think I'm going to make myself crazy over this, 'cause I can argue both sides...

[BG5150]

FWIW, I had a plan in that exact same situation. Employee received only commissions, and commissions were excluded from comp. AND, he was an HCE, no less.

We included him in the ADP test as a zero. Consequently, the test passed. Without him, it would have failed.

The year in question went thru an IRS audit with no problems. (PY 2008 I think it was.)

[K2retire]

I think I'm going to make myself crazy over this, 'cause I can argue both sides...

But you would be very useful in a debate tournament!

[Belgarath]

In case anyone is interested, I posted the question to TAG - here's their response:

ANSWER

Starting with the employer discretionary contributions, it seems that under 1.414(s)-1(d)(3)(iii)(A), you must take into account all employees who BENEFIT under 1.410((b)-3(a).

I agree.

And this means that if you don't receive an allocation, even though you are included in the rate group testing, you are NOT included for the 414(s) testing. Have I got that right, or am I missing something?

They are not included in the 414(s) testing. They are nonexcludable and not benefiting for purposes of 410(b).

For the consideration of the matching contributions and doing ACP testing under 401(m), it seems a little confusing. If they are excluded due to, say, job classification or insufficient hours, then they would be excluded for 414(s) testing purposes for the ACP test.

Correct.

But, if an employee is excluded from eligibility for the match based purely upon the nature of the compensation, (say they receive supplemental compensation only) then it seems to me that this employee should be INCLUDED when doing the 414(s) testing. ???

Yes, I agree.