404(a)(7)

[Andy the Actuary]

One person-plan.

In 2012, employer makes contribution to profit sharing plan of $50,000 and MRC of $10,000 to defined benefit plan. Employer does not deduct $10,000 db plan contribution. May employer fully deduct $50,000 ps plan contribution? Or, despite employer did not deduct db plan contribution, is employer deduction to ps plan still limited to 6% compensation?

Another way to ask this: Is the application 404(a)(7) driven by the amounts contributed or the amounts deducted?

[shERPA]

From reading the code, 404(a)(7) limits the amount that is deductible, not the amount deducted. The deductible limit is the greater of 25% of comp or the DB MRC. Since the DB is just $10K, presumably the 25% limit is the greater. Then it is really 31% since the first 6% of DC is ignored.

How much comp is there? If it is $193,548 or more, no worries, as 31% = $60K. Deduct $60K, the first 6% of DC is ignored, $11,613, leaving $48,347 which is 25% of comp. If comp is less, then the full amount of the combined contributions is not deductible.

[Andy the Actuary]

Don't quite understand the conclusion. I understand that you conclude it applies to the amount deductible rather than the amount deducted.

However, I don't understand the 31%. Doesn't the individual 25% DC limit, 404(a)(3), still apply as if this were no DB plan? That is, 50,000/193,548 = 25.83% so exceeds the 404(a)(3) limit.

[shERPA]

Yes, the DC 25% limit still applies, I overlooked that backing into a number for your (a)(7) question, sorry 'bout that. Rather than back into numbers, what's the available comp?

Basically the employer doesn't really have the option, whether they include it as a deduction or not, if it is deductible for the 2012 tax year then that's when it is deductible, regardless of whether it is actually deducted on the return. So whatever the combined plan deductible limit is for 2012, that's what he can deduct. Not deducting the DB doesn't make it not "deductible" and doesn't affect the calculation of the deductible limit IMO. The DC plan is not limited to a 6% deduction, it is just that the first 6% of the DC is ignored in looking at 404(a)(7) limit.

[Andy the Actuary]

Thanks for the clarification. So, in summary:

(1) 404(a)(7) applies whether or not employer chooses to deduct contribution. (That was the question)

(2) Employer can contribute MRC to DB and up to 6% to DC (in addition to 401(k) elective deferrals) without penalty even if total of DB and DC contributions > 25% of compensation

(3) Contribution to DC can exceed 6% (without penalty) so long as DC+DB contributions <= 25% of compensation.

[shERPA]

I think (3) should read:

(3) Contribution to DC can exceed 6% (without penalty) so long as DC+DB contributions <= 31% of compensation.

since the first 6% of pay to the DC is disregarded for 404(a)(7). Back this 6% out from 31% and you're at the 25% limit.

[Andy the Actuary]

So, let's say comp=200,000, 31% comp=62,000, MRC DB=1 and DC=61,999.

So, DB+DC <= 31% but DC =~ 31% > 404(a)(3)

This just doesn't sound right

[shERPA]

Well the DC is $50K, which, combined with the DB MRC is $50,001, which is less than 31%, so all is well in your example, right?

Say comp is $200K. DC max (25%) is $50K, assume that's deposited and deducted. The DB deduction could be as much as $12,000, even if the MRC is zero, assuming the DB max with cushion is something more than $12K. So the ER deducts $62K.

The first 6% of pay to the DC plan is disregarded under 404(a)(7), so for this purpose the considered DC deduction is $50,000 - [.06*$200,000] = $38,000. The DB is $12,000, so the combined contribution for 404(a)(7) is $38,000 + $12,000 = $50,000 = 25%*200,000 and the limit is not exceeded, even though the total deduction is $62K.

[Andy the Actuary]

Thank you!

[ubermax]

Andy comments above that he doesn't understand the 31% - after reading 404(a)(7) it's not too hard to understand the confusion - that 31% has become part of many discussions that involve (a)(7) - I believe that (a)(7) itself could do a better job by adding a statement at the end of both (7)©(iii)(I) and maybe even (II) that says something like " the first 6% will fall separately under the provisions of 404(a)(3)(A) " - the current wording of (a)(7) implies that and many if not all practitioners assume that but I still feel that (a)(7) could spell it out more directly - my opinion .

and so you'd have a combined limit of 25% under (a)(7) where only DC contributions over 6% are considered and another 6% under (a)(3)(A) for the 31% - I'm assuming that the 25% is greater than both the MRC and (FT - Assets) .

Most likely at some point in the past practitioners got informal guidance on this at a meeting or conference and now the 31% is part of discussions involving 404(a)(7) .