reasonable business classification

[imchipbrown]

FT William document with  "New Comparability - One Group per Participant" selected as the Allocation Method.  The are only three participants; owner, owner's daughter and job-cost estimator, all earning roughly $100k this year.

Estimator quit after year end.  Owner wants to skew contributions in favor of himself and daughter, if possible.  He's also considering no contribution. 

Limited reading sees to indicate that I could at least limit the estimator to 70% of what owner and daughter (owner by attribution) get - say 17.5% of pay vs 25% of pay.  But I get the sinking feeling that I have to look at the "reasonable business classification" portion of the Average Benefit Test to do so.

So, is Owner/Non-Owner a reasonable business classification?  All I find are "great debates" from ASPPA and limited examples in the regs.

 

[Tom Poje]

In my tradition of being long winded, instead of simply answering 'yes' or 'no'...

I have the following notes that "magically" appeared from somewhere (they must have, since I don't have the cite which I usually include as well) probably come from a few years ago when the IRS talked about requiring passing ratio percentage test for nondiscrim if everyone was in their own group, then backed off on the issue.. but basically, at the moment, reasonable classification applies to 410b (coverage) (and indirectly to nondiscrim testing (401(a)(4).

The second set of comments is the actually withdrawal of the IRS proposal.

 

There is a potential problem for COVERAGE using the Average Benefits Test, due to the requirements of 1.410(b)-4(b), and whether the IRS believes that having each person in their own group is tantamount to “enumerating by name.” If they believe this, then the ratio test must be passed, because the average benefits test for COVERAGE requires a “reasonable classification” – and enumerating by name or having the same effect is by definition not a reasonable classification.

When we are talking about the nondiscrimination testing under 1.401(a)(4) for rate group testing, there is a crucial difference.

To satisfy nondiscrimination testing using rate group testing, each rate group must satisfy either the ratio percentage test (70%) OR the average benefits test.

When determining if the average benefits test passes for a rate group for NONDISCRIMINATION purposes under 1.401(a)(4), it is a two part test:

A. The nondiscriminatory classification test, and
B. The average benefits percentage test.

To pass the nondiscriminatory classification test, the coverage ratio must be at least equal to the midpoint between the applicable safe harbor percentage and the unsafe harbor percentage. The “reasonable classification test” does NOT apply – under 1.401(a)(4)-2(c)(3)(ii), the nondiscriminatory classification test including the reasonable classification test is deemed satisfied if the ratio percentage test for the rate group satisfies the midpoint test. So the 1.410(b)-4(b) problem never enters into the nondiscrimination testing, ‘cause when you pass the midpoint, it is deemed satisfied.

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Announcement 2016-16 (released mid April (I assume 2016 since that is the announcement number))

Withdrawal of Proposed Nondiscrimination Rules Applicable to Certain Qualified Retirement Plan Benefit Formulas

The Department of the Treasury (Treasury Department) and the Internal Revenue Service (IRS) announce that they will withdraw certain provisions of proposed regulations published on January 29, 2016 (81 FR 4976) (“Proposed Regulations”) relating to nondiscrimination requirements applicable to qualified retirement plans under § 401(a)(4). The provisions of the Proposed Regulations that will be withdrawn are the provisions that would modify §§ 1.401(a)(4)-2(c) and 1.401(a)(4)-3(c).

 

 Following publication of the Proposed Regulations, the Treasury Department and the IRS have given additional consideration to the potential effects of the provisions that would modify §§ 1.401(a)(4)-2(c) and 1.401(a)(4)-3(c) on the adoption and continued maintenance of qualified retirement plans with a variety of designs and have concluded that further consideration will be needed with respect to issues relating to those provisions. Accordingly, the Treasury Department and the IRS will withdraw the provisions of the Proposed Regulations that would modify §§ 1.401(a)(4)-2(c) and 1.401(a)(4)-3(c)..

Some examples of changes the proposed regulations intended are described below. Exactly what will get changed in the future remains to be seen.

 

On January 29, 2016 the IRS issued proposed regulations that would require each rate group to pass the ratio percentage test if the plan did not satisfy the reasonable classification test. At this time the reasonable classification test only applies to coverage testing and not nondiscrimination testing.  Plans that have grouped employees by name fail the reasonable classification test, and most likely plans that treat everyone in their own group would also be treated as an unreasonable classification.

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I can only assume the estimator must really young if their is a daughter in the plan and you can pass rate group testing, avg ben % test etc. and provide 25% to owner and daughter.