Including Owner taking Draw (no W-2) in ADP Testing?

[lcollins300]

We have a 401(k) plan sponsored by a Limited Partnership (Hotel) where one of the 5%+ owners is a working manager taking draws but no W-2 wages.  Would she be included in ADP testing?  Her daughter also works for the hotel but does receive W-2 wages (she owns 2.5%).  Definition of compensation per the plan doc is W-2 (no exclusions).

 

[Lou S.]

Is she a partner with self-employment income on her K-1 subject to self-employment taxes?

Is she eligible for the Plan?

[lcollins300]

Yes as far as K-1.  Plan only excludes Union and Nonresident aliens.

[Lou S.]

Then she sounds like an eligible employee.

[BG5150]

With maybe eligible comp to defer from if they want.

[lcollins300]

This is what we think but the prior recordkeeper (will not name investment firm) did not have her on test.  

 

[K2retire]

19 hours ago, lcollins300 said:

This is what we think but the prior recordkeeper (will not name investment firm) did not have her on test.  

 

They were wrong!

[BG5150]

What if prior comp is less than zero?

 

And what about the daughter?  She should have her K-1 and W2's combined. (Though I don't think partners are supposed to get K-1s and W2's in a partnership.  They do in an S-Corp.)

[Larry Starr]

The working manager would only have a K-1 income; she might have guaranteed payments to recognize her manager status, but she wouldn't have W-2 because she is a partner.  However, she is still an employee under ERISA and her income is determined by net self employment income and the plan almost definitely has the appropriate language covering that issue for self-employed individuals.  As to the daughter, she should NOT have W-2 income at all as she is also a partner and her K-1 should reflect her total compensation from the employer. Again, there could be a guaranteed payment included to recognize her service beyond normal partner involvement.  They are both participants (assuming they met the eligibility) and are included in the tests.  Family attribution will also be a factor with regard to the daughter.  Client might have a cause of action against the prior recordkeeper, but clearly there is a fix needed for the prior incorrect work.  Hate these kinds of takeovers from incompetent firms!

[jpod]

There are plenty of accountants running around who either aren't aware of the IRS position that a partner doesn't get a W-2, or are aware of it and ignore the IRS position.  Or, the accountant has advised that they are handling payroll incorrectly but the client ignores the accountant's advice.  It is quite common to find this situation and in the normal course the IRS isn't going to do anything about it.  

[Larry Starr]

Absolutely correct; but when I find it with my clients, I give the accountant the citation and tell them to correct their approach.  I make sure the client understands that it has to be this way to comply with IRS rules and that they are likely not to have a problem if they were doing it BUT HAVE NOW FIXED IT; that way they feel there's an incentive to do it right from now on!  Just one way to nudge them into the correct method.

[Luke Bailey]

If the plan document really defines compensation for plan purposes as only w-2 employee wages (which question seems to say), I don't see how the 5%+ owner can participate. Would be excluded from coverage. (If the plan really defines comp only as W-2 wages, then presumably also defines "eligible employee" in a way that would exclude self-employeds.) Anyway, 5% owner so HCE, so exclusion would not hurt for minimum coverage.

[Larry Starr]

Luke, there almost definitely is additional language in the plan document that deals with self-employed individuals and their compensation.  I'd bet on it. So, I don't look at the statement as to what the definition of comp is as even dealing with the self-employed issue because there will be additional language in the plan that deals with the self-employed issue regardless of how comp is defined when dealing with a W-2 employee.  It would be nice if the poster of the original message would confirm.

[BG5150]

I'm with Larry.  If this is an Adoption Agreement plan, check the BPD section on comp.

Unless the doc was drafted by an incompetent party, then, undoubtedly SE comp will be in there.

[Luke Bailey]

Larry and BG5150, I agree with you, which is why I prefaced my remark with, "If the plan document really defines compensation for plan purposes as only w-2 employee wages...." Should have added, "big if."