ESOP match is based on deferrals to a separate 401(k) - is this OK an

[Guest LMalone]

Employer maintains a 401(k) and an ESOP with identical eligibility requirements. Both plans provide for a discretionary match based on deferrals to the 401(k). Each year the Employer determines the dollar amount it will contribute for the plan year. Then that amount is split in halfbetween the two plans and allocated as a discretionary match based on deferrals to the 401(k). If a

participant has not deferred to the 401(k), he does not share in the contribution in either plan. A

participant in both plans will receive an identical amount in each plan.

Example: Participant defers $5,000 to 401(k). Employer decides to contribute 50% of the amount

deferred. The participant receives $1250 in the 401(k) and $1250 in the ESOP.

Q-1: May the ESOP allocate its matching contribution based on deferrals to another plan?

Q-2: Should the ACP test be run for the combined plans so that the numerator of this individuals’s

ratio is $2500, OR should there be two separate identical ACP tests using $1250 as the numerator

in his ratio?

Any thoughts will be appreciated.

[Guest]

I guess opinions are free, so here goes mine.

the 410(B) coverage rules apply. If you combine the plans for coverage testing, then you HAVE TO combine the ACP tests. no choice in the matter.

likewise, if you do not combine the plans for coverage you cannot combine the ACP test.

from what you said, it sounds like the ESOP is a profit sharing plan with a 401(m) feature and no 401(k) feature.

hadn't thought about something like that but I guess it is possible. some type of KSOP or something.

[IRC401]

There is no rule against making matching contributions to two plans.

I believe that under 410(B) there is mandatory disaggregation of ESOPs. Therefore, you will need to run separate ACP tests. It is not clear how the multiple use rule would work, and if you want to test 401(k) contributions as matching contributions under the ESOP, good luck figuring out the rules.

[Guest]

IRC401 is correct, you do disaggregate the testing for ADP/ACP tests. You only aggregate the ESOP when performing the average benefits percentage test. I wasn't even thinking ESOP when you asked about combining tests. oh well, I've overlooked the obvious before!

Actually, I don't think the regs expected your scenario.

I would go out on a limb and guess that the ESOP disaggregation rule was intended to apply to 401(a) coverage, not an ESOP contribution provided under 401(m) rules. hmmm. after writing that I tried a search of KSOPs and came across the following 'Reish and Luftman ESOP Report 06/96'

mind you, this is just a portion of it...(I would suggest looking at the whole article - interesting reading - and you won't take anything out of context)

"ESOP may not be aggregated. An ESOP may not be considered together with another plan to meet participation, coverage, or nondiscrimination requirements.[Footnote 10] This means that an ESOP, unlike other defined contribution plans, cannot use aggregation to meet the qualification rules. The example in the Guidelines[Footnote 11] involves the use of matching employer contributions to an ESOP to satisfy the nondiscrimination requirements relating to a qualified cash-or-deferred arrangement (CODA).[Footnote 12]

The Guidelines leave the impression that a plan that is both an ESOP and a stock bonus plan with a 401(k) cash-or-deferred feature, commonly known as a KSOP, cannot allocate employer stock as a matching contribution. The Guidelines state as follows: "For example, the use of matching employer contributions to an ESOP to satisfy nondiscrimination requirements relating to qualified cash or deferred arrangements (CODAs) will disqualify the ESOP."[Footnote 13] This misleads the reader because a plan can be both an ESOP and a CODA. For example, it is possible for an ESOP to maintain a portion of the plan that is not subject to the ESOP rules, such as a separate stock bonus plan containing a CODA. If this is done, employer stock can be used to satisfy the match in the stock bonus plan.'

.......

So, based on that, I would say, hopefully, you have an ESOP with a separate stock bonus plan for purposes of the 401(m) test. therefore you combine everything and multiple use is no longer a problem...????

On the other hand some of the footnotes come from Ann 95-33, 1995-19 IRB 14. (Footnotes 11 and 13)Proposed audit guidelines for ESOPs. these cannot be relied on or cited as authority by taxpayers. That is why I suggested looking at the whole article.[Edited by Tom Poje on 08-17-2000 at 08:19 AM]