Profit sharing plan - can the allocation method be changed for 2020?

[Jakyasar]

Hi

Having a discussion with an agent and attorney for a plan of theirs and I am not in agreement with what they are saying.

Current document's ps provisions are:

-          No last day rule

-          No hour requirement

-          Comp-to-comp allocation

The attorney states that, since no ps contributions were made during 2020, the allocation method can be changed now or by end of year so that, each participant can be their own group. The contribution will be made after the plan year.

Can they? Just want to check others' opinions and see if i am missing something here.

Thank you

[Bill Presson]

No, they can't because they've already "earned" the right to the current allocation method.

What they can do (and I've done before) is to start a brand new PS plan with whatever allocation method they want and then merge it into the existing plan on 12/31. We've done the new document and merger materials simultaneously. Made the receivable deposits after the end of the year to the surviving plan. Do a 5500 for the new plan that is the first, last and only 5500. Show a transfer out on the asset section. Show a transfer in on the surviving plan.

 

WCP

[Jakyasar]

Very good point, thank you for sharing. In this case, would 5310-A filing for merging plans be required?

[Bill Presson]

On 10/9/2020 at 5:33 PM, Jakyasar said:

Very good point, thank you for sharing. In this case, would 5310-A filing for merging plans be required?

Don't need to. Meets this exception:

Plan merger or consolidation or spinoff.

Do not file Form 5310-A if the plan merger or consolidation or the spinoff complies with Regulations section 1.414(l)-1(d), (h), (m), or (n)(2).

Generally, these requirements will be satisfied in the following four situations:

1. Two or more defined contribution plans are merged and all of the following conditions are met:

   1. The sum of the account balances in each plan prior to the merger (including unallocated forfeitures, an unallocated suspense account for excess annual additions, and an unallocated suspense account for an ESOP) equals the fair market value of the entire plan assets.
      Example. Neither plan has an outstanding section 412(d) waiver balance.

   2. The assets of each plan are combined to form the assets of the plan as merged.

   3. Immediately after the merger, each participant in the plan has an account balance equal to the sum of the account balances the participant had in the plans immediately prior to the merger.

[Peter Gulia]

Bill Presson, thank you for always teaching us so much.  I’m hoping you’ll indulge us with one more lesson.

 

Imagine a profit-sharing plan’s sponsor does not seek to change an allocation’s conditions but wants to change from having only one allocation group to providing an allocation group for each participant.

 

If the plan’s sponsor is unwilling (for whatever reason) to use your new-plan method, what constraints affect the timing of an amendment to an allocation group for each participant?

 

If a participant has accrued into the allocation formula for the current year, must one wait for the next year?

 

Is there any other constraint or restraint on the change?

[Bill Presson]

7 minutes ago, Peter Gulia said:

Bill Presson, thank you for always teaching us so much.  I’m hoping you’ll indulge us with one more lesson.

 

Imagine a profit-sharing plan’s sponsor does not seek to change an allocation’s conditions but wants to change from having only one allocation group to providing an allocation group for each participant.

 

If the plan’s sponsor is unwilling (for whatever reason) to use your new-plan method, what constraints affect the timing of an amendment to an allocation group for each participant?

 

If a participant has accrued into the allocation formula for the current year, must one wait for the next year?

 

Is there any other constraint or restraint on the change?

Peter, I have always used the stance that once a participant has satisfied the conditions to receive a contribution under a current allocation method (if one is made) then that allocation method can't be changed. Historically those included a single allocation group (like for a pro rata allocation) or last day employment or 1,000 hours of service. The restrictions on amending safe harbor plans in general has caused me to be a bit more cautious. But I find in most cases if the benefit is significant enough, the new plan for one year method works pretty well.

[FORMER ESQ.]

As an attorney, I am a bit shocked as to what the agent's attorney conveyed to you. Maybe she/he is not an ERISA attorney. Anyway,  given the language in your plan document, such as proposed modification would clearly violate 411(d)(6) for any employee with even 1 hour of service in 2020. 

[Belgarath]

I've always felt uncomfortable with this approach  - that is, the starting a separate plan approach - (I'm a coward at heart when it comes to potential problems with the IRS) in that they might assert a timing problem under 1.401(a) (4)-5. But I can't say I've heard of this happening.

[Jakyasar]

Hi all

I am with Peter on Bill's  contribution of knowledge.

Thank you all for confirming my approach i.e. cannot be changed though I need to think about the 2 plan approach, very creative.

To answer B. Parvarandeh, I am dealing with an ERISA attorney and I am not budging.

Be safe all and have a great week, 3 more days to 10/15.

[Luke Bailey]

Opinions may differ. I believe that the IRS has indicated it believes it would be too late to change now, but that the only thing in writing on this is a TAM. I don't think the answer under the Code and regulations is clear.

[MWeddell]

Based on Treasury Regulation Section 1.411(d)-4, Q&A-1(d)(8), I agree with Bill Presson.  The conditions for receiving an allocation of contributions or forfeitures for a plan year after such conditions have been satisfied are a 411(d)(6) protected benefit.  They cannot be amended retroactively to the beginning of the current plan year.

Having a separate plan merged in is a viable work-around in my view, but it is aggressive enough solution that I would suggest the client check with its legal counsel.

[Luke Bailey]

3 hours ago, MWeddell said:

Based on Treasury Regulation Section 1.411(d)-4, Q&A-1(d)(8), I agree with Bill Presson.  The conditions for receiving an allocation of contributions or forfeitures for a plan year after such conditions have been satisfied are a 411(d)(6) protected benefit.  They cannot be amended retroactively to the beginning of the current plan year.

MWeddell, thanks. That does support Bill Presson's position, and could well be cited by an IRS agent. I don't think it's airtight, however. Intuitively, if the employer has no obligation to contribute at all, what the employees who have fulfilled the existing allocations have as of any date before the employer makes its decision is the right to share in $0, and so arguably can be changed. You have proved that there is a regulation supporting the position, which I must have read several times over the years, but it did not come readily to mind. But wasn't this issue hotly disputed before a TAM dealing even more specifically with it was released by IRS? Did the TAM pre-date the reg? I don't recall offhand. And didn't the TAM say that you couldn't change the allocation method after the year was over? I'm sure there are other Benefitslink devotees who have the cite to the TAM more readily at hand than I do. I have seen it referred to in Benefitslink exchanges many times.

[Bird]

July 2017 discussion

Quoting myself:

---------

I think it is TAM9735001

Key language:  " Under section 1.411(d)-4, A-1(d)(8), the conditions for receiving an allocation of contributions or forfeitures for a plan year are subject to section 411(d)(6) after such conditions have been satisfied. That is, once a participant has satisfied the conditions for receiving an allocation, the participant's right to an allocation becomes section 411(d)(6)-protected, and a plan amendment cannot add further conditions. "

--------

I think the reg is clear enough and not sure whether the TAM predates it or not, and don't see that it matters.  I can't believe there is any dispute about it.

[Luke Bailey]

Bird, thanks. The TAM must post-date the reg, since it cites it, right?

I don't think the TAM really settles the question, though, because the facts are different. In the TAM, the employer sought to change the plan's allocation formula after the end of the plan year. The contribution had even been made in January of the year following the allocation year, before the amendment to the plan's allocation formula, which was in March of the plan year following the allocation plan year. Also, the TAM bases its analysis in part (in addition to the cited reg) on case law that said that a participant's accrued benefit was to be determined as of the date he or she separated from service. Because of the strong "pull" of annual accounting in the qualified plan area and the tax law generally, I think there is a decent case that the allocation formula could be changed under the circumstances described in the OP.

The very regulation you sight says that allocation and contribution dates are not protected benefits. So I add November 1 as an allocation date. Congratulations, the contribution for that allocation rate is determined in my discretion to be $0. At the same time, I change the allocation formula for the next allocation date, December 31. This is essentially the same in spirit as Bill Presson's "two plan" workaround, but within one plan. Just another way to think about it.

This is a close question, both technically and from a policy perspective. Under your conclusion about what the rule is, the rights of the participants who have been working away almost 10 months now with an expectation (though not a right) to an allocation for the year are protected. But the result might be that the employer exercises its discretion to contribute nothing, or a lower amount, than it otherwise would if it were able to change the allocation formula.

[MWeddell]

Thank you, Luke and Bird, for the thought discussion.  I did not recall the TAM.

The TAM largely supports my interpretation of the 411(d)(6) regulations, that the right to share of the allocation (but not any specific dollar amount given that a contribution might not be made) becomes a protected benefit when a participant has satisfied all of the allocation conditions.

The conclusion of the TAM makes clear that the allocable share of the contribution, if any, that was to made became protected on December 31, 1992 given that the plan had a "last day of the plan year" allocation condition.  It did not become a protected benefit on January 7, 1993, when the contribution was made to the trust but not yet allocated.  The facts would have become harder if the plan was amended to add a second allocation method on or after December 31, 1992 but before the contribution had been made, but it seems that the TAM's conclusion would remain unchanged.

I don't (yet?) agree with Luke's observation that it is a close question.  I thought it was clear based on the regulation and even more so with the TAM.

However, I do agree with Luke that an employer may be able to circumvent the regulation.  Besides Bill Presson's two plan workaround, it is possible that there is a work around within one plan.  Given the plan document language, I don't think that adding an allocation date would necessarily work, but having a short plan year might work.  The employer could amend the plan document on or before October 31 to state that the plan year ended October 31 and that another short plan year would exist from November 1 through December 31.  The amendment would also state that the 415 limitation year and the vesting computation period remains on a calendar year basis throughout.  The amendment could also include a different allocation formula for the November 1 - December 31 two-month plan year that uses compensation for the whole plan year.  The employer could then decide to allocate $0 for the 10-month plan year ended October 31 and substantial dollars for the 2-month plan year ended December 31.  The plan year would have an rather interesting 401(a)(4) general test to run for the 2-month plan year and of course there would be an extra Form 5500 / extra audit needed, but I think that might work.

[Bird]

Luke Bailey, my response is that I've read and participated in these discussions many, many times, going back to PIX days and continuing here on BL, am quite sure it has been discussed in ASPPA (maybe ASPA) IRS Q&A sessions, and always the firm conclusion is as Bill Presson described it perfectly.  I know the TAM facts don't line up perfectly but it doesn't take much to take them to the logical conclusion that the right to an allocation under an existing formula  is earned when the conditions to receive an allocation are satisfied.  It's seared in my brain and if the IRS came out with something now that said otherwise, it would take a long time to get it out of my brain.  You can think otherwise but I don't think there is any gray area here.

[Luke Bailey]

2 hours ago, Bird said:

Luke Bailey, my response is that I've read and participated in these discussions many, many times, going back to PIX days and continuing here on BL, am quite sure it has been discussed in ASPPA (maybe ASPA) IRS Q&A sessions, and always the firm conclusion is as Bill Presson described it perfectly.  I know the TAM facts don't line up perfectly but it doesn't take much to take them to the logical conclusion that the right to an allocation under an existing formula  is earned when the conditions to receive an allocation are satisfied.  It's seared in my brain and if the IRS came out with something now that said otherwise, it would take a long time to get it out of my brain.  You can think otherwise but I don't think there is any gray area here.

Bird, as evidence that other practitioners may view the question as open, you and any others interested may want to check out the following article:

https://www.mintz.com/insights-center/viewpoints/2226/2020-04-03-covid-19-considerations-midyear-reductions-or

[Belgarath]

Infinite are the arguments of the mages...

From my perspective, one thing seems very clear. The IRS believes you can't do it. Now, if they challenged it and you went to court, would you win? I leave that the the legal eagles. But who wants to fight the IRS on this? Unless it is a large plan with a great deal of money at stake, the court costs alone will outweigh the potential benefit to the owners, and they could lose anyway. I just couldn't, in good conscience, advise a client to pursue this approach. If their lawyer advises them it is ok, then great - go for it! 

[Luke Bailey]

1 hour ago, Belgarath said:

From my perspective, one thing seems very clear. The IRS believes you can't do it.

Whoa. The only thing that is clear is that the IRS thinks you can't do it after the end of the plan year, or maybe even after (1) the end of the plan year, plus (2) the contribution of the total amount to be allocated was already made. You are inferring that the TAM is broader than that, and I don't think that is justified.

[Belgarath]

We'll agree to disagree. I think the IRS has, over the years, made its position very clear - unofficially. Like Bird, I've been conditioned over the years from IRS comments, etc. - yes, I absolutely concede not official guidance - that once you have earned the right to an allocation under the current formula, that's it. Not saying it can't be challenged - just saying I wouldn't do it, and wouldn't recommend that a client do it, unless so advised by their legal counsel. 

[MWeddell]

Regarding whether the two plan solution works, the IRS declined to express an opinion on it in 2013.  I don't think it changes anyone's mind, but I thought I'd mention it.

See IRS Q&A-16 from the 2013 ASPPA conference at https://www.asppa.org/sites/asppa.org/files/PDFs/GAC/2013 DC QA.pdf

[Luke Bailey]

6 hours ago, Belgarath said:

that once you have earned the right to an allocation under the current formula, that's it.

MWeddell, just to make sure I understand your position, if the plan in question had a last day of the year requirement, would that make a difference to you?

[Jakyasar]

My position is if the plan had last day rule and amended by 12/30 i/o 12/31 (assume calendar plan), the allocation method can be changed without any 411d6 issue. Last day rule is a condition to satisfy eligibility for an allocation.

[Bill Presson]

1 minute ago, Jakyasar said:

My position is if the plan had last day rule and amended by 12/30 i/o 12/31 (assume calendar plan), the allocation method can be changed without any 411d6 issue. Last day rule is a condition to satisfy eligibility for an allocation.

Agreed with the possible exception that I would tread more lightly if the plan was a safe harbor plan.

[Luke Bailey]

11 minutes ago, Bill Presson said:

Agreed with the possible exception that I would tread more lightly if the plan was a safe harbor plan.

OK. I'm glad we had this discussion. I misread the OP (oops). Agree with you that since plan had no ldy provision, it would be aggressive to change the allocation method now. But I would still say the TAM does not completely settle the matter (even assuming that you want to follow the TAM, because don't want to have a battle with IRS), because in the TAM the amendment was both after the end of the plan year and after the money had already been contributed.

[MWeddell]

1 hour ago, Luke Bailey said:

MWeddell, just to make sure I understand your position, if the plan in question had a last day of the year requirement, would that make a difference to you?

Yes, my position is that only once all of the allocation conditions are fulfilled is the allocable share a protected benefit.

1 hour ago, Jakyasar said:

My position is if the plan had last day rule and amended by 12/30 i/o 12/31 (assume calendar plan), the allocation method can be changed without any 411d6 issue. Last day rule is a condition to satisfy eligibility for an allocation.

Agree, but watch out that there often are exceptions to the "last day of the plan year" condition for those who retire, die, become disabled, go on military leave, etc. during the plan year.  It complicates things if the allocable share is a 411(d)(6) protected benefit for some participants.