Who is Key? Company sold mid-year

[ldr]

Hi to all,

I am researching the elements that went into a top heavy test for a client for calendar 2018.

Two doctors, A and B, owned Happy Feet PA up until 08/12/2018, and maintained the Happy Feet PA 401(k) Plan.  They sold their practice in an asset sale to Better Feet, P.A. owned entirely by Dr. C.  Doctors A and B continue to be employed by Better Feet for the remainder of 2018.  Better Feet took over as the plan sponsor on the sale date, the plan was re-named Better Feet, P.A. 401(k) Plan, and Dr. C became the Trustee of the plan.

Because Better Feet already had a SIMPLE plan in 2018 for the Better Feet employees, with the advice of a local ERISA attorney, we amended and restated the Happy Feet plan such that only the former employees of the Happy Feet PA were eligible to participate in the Better Feet, P.A. 401(k) plan for the remainder of 2018.  At 01/01/2019, all of the employees of Better Feet, whether they used to be employed by Happy Feet or not, became eligible to participate in the plan and the SIMPLE plan was terminated.

So now, as to the Top Heavy test for 2018:  I am understanding what I read to say that because Dr. A and Dr. B were owners of the (previous)  plan sponsor "at any time during the relevant plan year" (2018), they are Key employees for purposes of the 2018 test.  We had initially hoped that perhaps they could somehow be considered non-Key because by the end of the year, they were not owners, the plan sponsor had changed, their company had been completely bought out by the new owner, etc.  

The reason it matters:  Running the Top Heavy test for 2018 with Drs. A and B as the Key employees results in the plan being Top Heavy for 2019.  This puts Dr. C in the unhappy position of now sponsoring a plan that is considered to be Top Heavy for 2019 even though he had nothing to do with it getting to be Top Heavy.  He and his own employees were not even eligible to participate in 2018.  That may be irrelevant.  This just may be a risk he was assumed to be taking when he agreed to sponsor and continue the Happy Feet 401(k) Plan when he bought out Happy Feet PA.

Am I missing anything that would change the test results?

Thank you as always.

[Lou S.]

I don't think you've missed anything.

[Luke Bailey]

ldr and Lou S I don't think the answer is clear under the Code or addressed in the regs. Certainly, your analysis makes some sense, but to get there you, ldr, have to insert "(previous)", and Lou S you are turning "the employer" into "an employer." The application of the top-heavy rules in mergers and acquisitions is not covered directly in the Code or addressed in the regulations.

[Lou S.]

I've asked several questions about top-heavy to the IRS over the years in mergers and acquisitions rarely if every got a satisfactory response.

that said the plan is continuing as an ongoing concern so for the Plan Year the participants were Key-Employees for part of the year. I think their ownership ends on the date they sell but I believe they are key-employees in  the year sold and the year following then former key employees in future years.

I think the result is different if the Plan of the old company was terminated and the new company started a new 401(k) plan.

That said Luke, you are right the regs on TH as it relates to mergers and acquisitions in essentially non exhisitant. So I admit the IRS position could be different.

[Luke Bailey]

Lou S., I think the IRS would say they are keys for 2019, and plan top-heavy. I'm just saying that the IRS's position might arguably not be dictated by Code, and since not spelled out in regulations, not entitled to deference. I think the issue is who is the "employer" that the individuals have to be 1%, 5%, etc. owners of for purposes of 416(I)(1). Just not clear under Code or regs.

[ldr]

We are taking the position that the old owners were Keys for 2018, the plan is top heavy, and the bottom line is that we told the new owner that if he defers to the plan in 2019, he has to be prepared to make a contribution on behalf of the rank and file employees.  As we understand it, if he defers something less than 3% of his pay - say 2% for the sake of argument - then he has to put in a 2% TH minimum for the rank and file.  If he defers 3% or more of his pay, he has to make a 3% TH minimum contribution.  None of the owners, neither the old nor the new, wants to make any contributions for the employees in any year under any circumstances.

What they really want is to defer all they want and ignore the employees.  Not happening.  They aren't happy with us but that's too bad.

Thank you all for chiming in.

 

 

[ldr]

2019 is really my year for complicated, messy plans that just get messier instead of better!  I am running projections for 2019 for this plan for an upcoming meeting.

In this particular case:  Doctors A and B who sold their practice are continuing to be employed by the company who purchased them, Better Feet, P.A. and plan to be there all of 2019 and plan to defer $25,000 each at the end of the year.  Meanwhile, Doctor C did not disclose to us that he is NOT the sole owner of Better Feet, P.A.  In fact he has 75% ownership and Doctor D has 25%.  YTD, Doctors A, B and C have not made any salary deferrals.  However, Dr. D has deferred what appears to be about 2.07% of pay.

To the best of my knowledge, all of Doctors A through D are Key employees in 2019.  If any one of them makes deferrals, then a Top Heavy minimum contribution will be due for 2019.  Right this minute, if Doctors A, B and C do not defer at all, they owe a 2.07% of pay TH minimum because of Doctor D's deferral YTD.  And that's if he stops immediately.

To make it more fun, Doctors A and B will be livid if they can't make deferrals at the end if the year as they have always done in the past, and Doctor C is seriously pouting right now because he thinks he can't put in his $19,000.

Bear in mind that they were told in advance very clearly that they should be doing a Safe Harbor 3% non-elective to cover all the problems.  They do not want to give the employees anything at all and would not commit to a Safe Harbor contribution.

If all Doctors defer what they want to, the ADP test will not pass either, and Doctors A, B and C will have to take back about $4,500 each.  

I want to just double check one more time that Doctors A & B who sold their practice to Doctor C in 2018 are still considered Key in 2019.  They won't be, in 2020, but for 2019, they still are.  At least that's what I understood to be the conservative approach to declaring who is Key.  Do you agree?

 

 

 

 

 

 

 

[Tom Poje]

while not quite the same (this is somewhat a reverse of the question), here is an IRS response from a Q and A years ago. (of course  such response don't necessarily reflect an actual Treasury position)

Margaret became a participant in a 401(k) plan in the 2010 plan year, which ends December 31, 2010. For 2010, Margaret did not satisfy any of the key employee tests. The plan is top heavy for 2011 because the top heavy ratio exceeds 60%. The top heavy ratio is computed as of 12/31/2010, which is the determination date for the 2011 plan year. For that calculation, Margaret's account balance as of 12/31/2010 is treated as a non-key employee account balance. During the 2011 plan year, Margaret marries the majority owner of the company. This makes her a more-than-5% owner of the company by attribution. Does Margaret receive a top heavy minimum contribution for the 2011 plan year? Should she have received a top heavy contribution for the 2010 plan year even though the employer didn't fund the contribution until 2011 after Margaret already had married the owner?

 

IRS response. There is no guidance directly on point, but the most reasonable interpretation is that Margaret receives a top-heavy minimum contribution for 2011. For top-heavy purposes, a single determination date is prescribed by IRC § 416(g)(4) for determining both whether the plan is top-heavy and whether an employee is a key or non-key employee. While it would be intuitive to adjust this determination based on events occurring within the year after the determination date, this interpolates a condition that is not in the statute. Note that the House Report (H.R. Rep. No. 107-51) and Conference Committee Report (H.R. Conf. Rep. No. 107-84) accompanying EGTRRA § 613 both provide that the determination date is used for identifying who is a key employee in the following year.

2011 ASPPA Conference #47

[ldr]

Thanks, Tom.  It can't hurt anything to take the conservative approach and assume that Drs. A and B are still Key during 2019 and don't fall off that roster until 2020.  No auditor can quarrel with that. So that's what we are doing.

Drs. A-D are all Key in 2019; the plan is Top Heavy based on results from 12/31/2018; at the moment they will owe something as a TH minimum for 2019 due to Dr. D's deferrals. It might be 3% of pay for all participants or it might be less.  If Dr. D stops deferring now and if Dr. D earns at least as much as he did last year, or more, they could owe less than 3%.  Putting in the TH minimum will still not allow them to "do as they please" because the ADP test will fail.  There will be refunds at the end of the year.  Done.  Don't like it?  Sign up for one of the Safe Harbors we recommended in the first place, for 2020.  That's the message we have to deliver (kinder and more gently of course).