Self-Employed and true-ups

[JustnERPA]

Partnership has a 401(k) plan with match, the match is funded per payroll, but the two partners do not have paychecks, they only have a few "draws" during the year, some have no draw. The document allows the plan administrator to decide whether or not to apply a true-up for the plan year.

The partners' NESE will be determined at year-end and will include their full compensation for the year for determining the match. Does that then require the plan to provide a true-up for the W-2 employees? the plan document does not appear to require that.

[Bird]

I think these document provisions that add so much flexibility are sometimes problematic.  For me, I'd rather know that matches are or are not payroll-based and act accordingly.  (And for a partnership they shouldn't be payroll based - actually just about all of the time I'd prefer that they not be payroll based.)

Having said that, it would appear to me to be discriminatory in operation to give a "full" match to partners and potentially not to others, so I'd do the true ups.  But I'd much prefer that the plan design be that matches are based on full annual comp, and yeah they can go ahead and "pre-fund" for the W-2 employees each pay period but then do an annual calc and do true-ups as needed.

Which circles back to what the plan actually says - you say they are "funding" each pay period but does the plan say they are calculated on a payroll basis?  If not then I'd argue that the language about true-ups being optional is not applicable to this situation (i.e. they are required).

[Luke Bailey]

I agree with Bird that you need to be sensitive to the plan language, but given that the draws are not actually self-employment income, but rather estimates, or in some cases in effect loans, and given the language of 1.401(k)-1(a)(6)(iii) and (iv), I'd be inclined to think that simply calculating a partner's match based on the number that ends up being his/her self-employment income is not really a true-up. I mean, match formulas usually have two components, a rate (e.g. 50 cents on dollar) and a cap (e.g., 3% of compensation). A true-up is usually more important for the rate (e.g.,  participant did $0 deferrals for first 6 months, $2,000 per month for second 6 months), than for the cap. You're not giving the partners a break on the rate part, just the comp part, and that seems arguably OK under the cited reg provisions.

[Bill Presson]

If the match is truly calculated on a "per payroll" basis, I would contend that no match can be done for the partners until their income is determined. A draw isn't a payroll.

If the plan is going to true up the match, then I'm not as concerned.

[Luke Bailey]

On ‎2‎/‎19‎/‎2019 at 12:32 PM, Bill Presson said:

If the match is truly calculated on a "per payroll" basis, I would contend that no match can be done for the partners until their income is determined. A draw isn't a payroll.

Bill, I agree with you in abstract principle, but I've always viewed 1.401(k)-1(a)(6)(iv) as applying to matching contributions as well as elective deferrals, so I don't think IRS would have a problem. Obviously, if it's a really bad year and earned income is less than was reasonably estimated, some of the deferrals and matching, with allocable earnings, must be removed from partner's account.