Short-term HCE to Sway ADP Test

[austin3515]

https://www.irs.gov/pub/irs-tege/directive.pdf

Does anyone think this "Carol Gold" memo about abuses involving short-term employees would apply to the owner's spouse working a "few days" solely to have her included in the ADP test as a zero?

I'm trying to find a reason why it is wrong because it just doesn't feel right. They would be the only two HCE's so it effectively doubles what the HCE can contribute.

[Mr Bagwell]

Austin,

I would not use this memo for proof text for owner's spouse scenario you asked.

The ADP scenario you mention is a manipulation so the HCE's can effectively keep and defer a little more into the plan. The NHCE's are not getting worked over to hold down potential benefits.

I would use the spouse's zero to benefit the ADP test. I don't think it smells as bad as the floor I work on:)

[austin3515]

So the wife comes in for the afternoon to answer the phones and instead of contributing $5,000 hubby contributes $10,000? It just seems rough...

Hey it's a great answer if it works, but I'd be sweating it a little on audit...

[Mr Bagwell]

I understand your concern. I just don't see it as egregious.

[Bird]

I don't have a problem with it, as long as the related parameters are legit - like meeting eligibility. I don't even care so much about the working part as the getting paid part. If eligibility is 1 YOS and the spouse is paid $1000, that's probably fugazy.

[austin3515]

She used to work their full-time so is legitimately eligible.

[RatherBeGolfing]

I just had this conversation with a CPA client of mine, and he wanted something to back up my opinion that it was ok to include the HCE wife with a $0 deferral. Assuming (like your example) that this person is legitimately eligible to participate, a nominal salary with no deferral can be used as a $0 deferral in the ADP test.

EOB - Chapter 11 - Section VI - Part B - Item 7a

7.a. HCE takes no compensation for plan year. This issue also arises when an HCE, particular one who is an owner of the plan sponsor, does not receive a salary, and does not otherwise receive any compensation for the plan year. This is another one of those situations where there is no clear guidance from IRS, and it may place a plan administrator “between a rock and hard place” to resolve the issue. The more conservative approach would be to treat the HCE as not eligible, based on the discussion in the prior paragraph. Of course, in many cases the employer would like to treat the HCE as eligible, and then calculate the HCE’s deferral percentage as 0% for ADP testing and ACP testing purposes. This is probably too aggressive a position. Even if the HCE is treated as eligible, should the deferral percentage actually be 0%? A case could be made that to defer $0 out of zero compensation is actually a 100% deferral. Given these mathematical gyrations, it is probably a sounder approach to treat the HCE as ineligible until formal guidance is issued by IRS. The IRS acknowledged this to be a reasonable approach at the ASPPA 2000 Fall Conference in Washington, D.C., in a “Q&A” session with IRS representatives. In the Q&A Session, the issue dealt with a partner in a partnership whose earned income was negative for a plan year.

Taking nominal salary might be a better approach. This issue, at least where the HCE is a common law employee of the plan sponsor, can be avoided by paying the HCE at least a nominal salary (e.g., $100). So long as some compensation is taken and the HCE does not defer any of that compensation, it is proper to include the HCE in the ADP test at a 0% deferral rate. This won’t work in the context of a self-employed individual (e.g., sole proprietor or partner), whose compensation must be based on an earned income calculation. If the earned income is zero or negative, the best approach appears to be to treat the self-employed individual as an ineligible employee.

[Kevin C]

We have clients that have that situation occur each year. For some of them, the spouse fills in for people who are out sick. As long as the spouse actually performs services for the compensation received, I don't see a problem. Of course, the reasonable compensation issue is really the client's issue, not ours.

If the spouse is a participant and has compensation, the regs are clear that he/she is in the ADP/ACP test.

[ratherbereading]

I wonder if my scenario fits this. I have a plan whose owner puts his 2 daughters on his payroll and maxes out their 401k contribution each year. They get the PS and the safe harbor contributions They don't work there ever. Not even for 5 minutes...

[Belgarath]

Well, that's tax fraud. But that's the client's problem, not the TPA's.