401(a)(17) Limit for Participant Going from Employee to Partner Mid-Year

[401 Chaos]

Any thoughts or advice on this issue welcomed. Parternship has cross-tested 401(k) / profit sharing plan which has all partners in a higher contribution rate group than other rate group. Partnership has last day of plan year requirement in order to receive discretionary contribution. Partnership has individual that has been an employee through the end of this month but will become a partner effective September 1st. Individual has already earned in excess of $255,000 as an employee. How should profit sharing contribution for this individual be calculated? Should the plan just use the lower percentage for the employee rate group taking into account "the first $255,000 earned" or instead try to maximize the higher contribution percentage possible from partner earnings for the period from September through December and then only fill in with employee earnings (at the lower percentage contribution) to the extent the partnership income does not reach $255,000 or instead do some pro rata apportionment based on the percentage of overall income earned as an employee versus earned income as a partner with the thought that no contribution is due and earned until the individual has satisfied the last day requirement and the partnership declared a profit sharing contribution for the year thus the partnership can look at the individual's overall earnings across the entire year?

[rcline46]

The first question is how are the groups defined - each in their own group, or by category. If each is in their own group, then the emplooyer sets the contribution by person and you do not have a problem other than testing. If not, then does the document specify what happens in this situation? Maybe by probably not.

Since you have a year end requirement, sounds like its time to modify the plan to what your client wants.

[401 Chaos]

Many thanks. The groups are defined by category with all partners in a single category. The plan document does not specify what is to happen in this situation. (Situation is one of first impression. Changes in status normally coinicide with calendar / plan year starts but this is a unique case.) Am sure the client would welcome the chance to specify as they wish it to be but just wondering if there are any issues in doing that or particular considerations to pay attention to (e.g., would there be a typical default or preferred way of handling that they should know about even if the rules would permit flexibility?) Thanks.

[rcline46]

I recall the IRS opining at one of the conferences that maybe it should be pro-rata if the document is silent. OTOH, my opinion is whatever group the person is in at allocation time.

You can really mess this up with a change from an eligible group to ineligible group mid year, which I think is the underlying basis for the IRS position.

The client should clearly see now the utility of 'each in their own group' design, since they can then change their mind on how to handle the situation each time it may arise.

[401 Chaos]

Rcline,

Thanks very much. Would you happen to recall which conference the IRS may have opined on that or if there was any record of their thinking on that?

I hear you on the each in their own group design but seems that approach may carry its own issues / disadvantages as well? So far they've made it several years without this or similar issues coming up and I think may prefer to set the rule rather than possibly open things up on a person by person basis if this comes up in the future.

[Tom Poje]

see PDF page 132 (actual page 129) of the LRM (Listing of Required Modification)

this was released 10/2011 so probably the most up date.

About the closest I can find on the issue.

lrm.pdf

[401 Chaos]

thanks

[chc93]

I recall the IRS opining at one of the conferences that maybe it should be pro-rata if the document is silent. OTOH, my opinion is whatever group the person is in at allocation time.

You can really mess this up with a change from an eligible group to ineligible group mid year, which I think is the underlying basis for the IRS position.

The client should clearly see now the utility of 'each in their own group' design, since they can then change their mind on how to handle the situation each time it may arise.

We had a similar situation. In our case, a participant transferred from non-union (eligible class) to union (excluded class) during the plan year. The plan provides for profit sharing contributions with 1000 hours and last day of employment. The participant had 1000 hours as non-union, and was "employed" on the last day of the plan year. The ERISA attorney for the plan told us that since he wasn't employed on the last day of the plan year in an eligible class (non-union) so was not eligible for the contribution. So, as underlined in RCline's post above, it ended up to be the class the participant was at "allocation time". FWIW

[401 Chaos]

CHC93,

Thanks very much for your response. Sounds like you have not had the reverse situation (transferring from Union to Non-Union) but assume then the person would be eligible to participate? Wonder in that case whether you would count just the comp for the portion of the year they were in the eligible class as sort of an extension of the guidance Tom Poje provided?

[chc93]

We actually had a situation going from union to non-union (same plan, turns out). If I recall correctly, participant was eligible for a contribution, and we only used non-union comp, again based on plan attorney. Also appears to be in line with Tom's post.