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Board of directors earn W-2 but work zero hours


Renee H

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I have a cross-tested profit sharing plan whereby the company is owned by 3 siblings who inherited the stock after their father became deceased.  2 of the owners earn W-2 pay but do not work for the company.  The PS formula requires 1000 hours to receive a contribution.  Since they do not work any hours, can they be legally disqualified from receiving a contribution?  This plan does not include a 401k component and is not safe-harbor.

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You have to follow the plan document.  If the allocation conditions say a participant must work 1000 hours to receive an allocation, and there is no other exception to this allocation condition (typically for terminations due to death, disability or retirement), then the participant does not get an allocation.

There are other provisions that may be applicable and again, you have to follow the plan document.  Are they employees?  The definition of participant commonly requires an individual to be an employee to be able to participate.  This likely will impact your cross-testing results.  (This also opens up questions about why the amounts were reported on a W-2 instead of a 1099, and the company's accountant should have an explanation.)

Is this pay included in the definition of plan compensation?  The amounts 2 out of 3 of the owners may not be considered plan compensation for purposes of calculating the contributions, and you have to follow the plan document and exclude it from the contribution calculation.  No plan compensation would result in no contribution.

You may expect that the 2 owners will not be happy if they feel they are not getting a PS contribution and therefore are not benefiting from their inheritance.  There are other strategies to address the situation without involving the PS plan (and possibly triggering compliance issues with the PS plan).

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I agree with Paul I. And would add that you can monkey-do this, i.e. just follow the document and not question it, or you can ask what they would like and either find out that the allocations conditions should be changed (e.g. to 0 hours), or not, or that they are thinking about work and actually do work 1000 hours or could reasonably thought to work 1000 hours. Some of it depends on the size and nature of the workforce.

FWIW we almost use "everyone in their own group" and no hours requirement for cross tested plans (more accurately, general-tested plans). That way you can control exactly who gets what, down to 0 if desired. 

Ed Snyder

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Don't overlook the possible explanation that the W-2 was issued because someone did not know the correct process.  That might be the first problem to solve.

I'm a retirement actuary. Nothing about my comments is intended or should be construed as investment, tax, legal or accounting advice. Occasionally, but not all the time, it might be reasonable to interpret my comments as actuarial or consulting advice.

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4 hours ago, Paul I said:

(This also opens up questions about why the amounts were reported on a W-2 instead of a 1099, and the company's accountant should have an explanation.)

I think this is a big deal and the first question to be answered. Regardless of how they income reported to them or why it's W2, the fact appears to be that they are not providing ANY services to the employer and so even if you can argue it's plan compensation the IRS would say it doesn't matter because they have 415 compensation of zero. If they can substantiate services of some sort that's a different story and maybe it's untracked hours (or salaried hours or some equivalence) instead of zero hours. Otherwise, they're just on the payroll getting a paycheck for nothing, which if I'm the IRS I'm also questioning whether that is a legitimate deductible business expense.

Sorry, seem to be in pessimistic, devil's advocate, argumentative mood this afternoon.

Kenneth M. Prell, CEBS, ERPA

Vice President, BPAS Actuarial & Pension Services

kprell@bpas.com

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There are many possibilities. Just a few of them are:

The data furnished to the TPA did not include a record of hours of service for a worker who in fact had hours of service. For some directors, officers, or professionals, the measure of service might not be obvious. Or, an employer or service recipient might lack records.

An amount reported as wages might have been nonemployee compensation.

For example, if a nonemployee director’s fee is not an employee’s wages, it might be the individual’s self-employment income. A director might be in the business of being a corporation’s director.

If so, that separate business might establish its separate retirement plan. As just one illustration, a 50-year-old director’s fee of $20,000 a month might support a year’s individual-account retirement plan contributions of $76,500 [2024]. But a businessperson considering such a plan needs a practitioner’s advice about many qualified-plan conditions, including coverage and nondiscrimination, especially if the self-employed business might be treated as a part of a § 414 employer that includes the corporation the director serves.

Renee H might face some delicate choices about whether to do the TPA’s work on the data presented, or to invite a conversation about a client’s information and a client’s (and perhaps others’) choices and wishes.

Peter Gulia PC

Fiduciary Guidance Counsel

Philadelphia, Pennsylvania

215-732-1552

Peter@FiduciaryGuidanceCounsel.com

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Thank you everyone for your valuable input.  The compensation in question is for "board of directors" compensation.  They do not provide any other services to the company which is why they have zero hours.  I do not know why it is reported as W-2 pay as opposed to 1099.  It might be in order to cover them on the company's health insurance plan.   I will try to find out. They are the children of the owner who passed away.  You raise a good question about whether they wish NOT to receive a contribution and also about amending the plan to place all participants in their own group (something I have been trying to get them to change).  The plan defines compensation as W-2 pay with no other exclusions.  There is an option to write in a specific exclusion.  Would it be advisable to amend the plan to specifically exclude compensation that is for directors fees?  1000 hours are required to receive an allocation but I am thinking they need to cover more bases.  Thank you again!

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13 hours ago, Renee H said:

Thank you everyone for your valuable input.  The compensation in question is for "board of directors" compensation.  They do not provide any other services to the company which is why they have zero hours.  I do not know why it is reported as W-2 pay as opposed to 1099.  It might be in order to cover them on the company's health insurance plan.   I will try to find out. They are the children of the owner who passed away.  You raise a good question about whether they wish NOT to receive a contribution and also about amending the plan to place all participants in their own group (something I have been trying to get them to change).  The plan defines compensation as W-2 pay with no other exclusions.  There is an option to write in a specific exclusion.  Would it be advisable to amend the plan to specifically exclude compensation that is for directors fees?  1000 hours are required to receive an allocation but I am thinking they need to cover more bases.  Thank you again!

I might be in the minority but it doesn't bother me that they are paid on a W-2. The IRS is collecting payroll and income taxes and I doubt they would quibble. In a tiny company like this, I don't know that "directors' fees" is a significant definition. I know that I wouldn't mess with trying to exclude comp for directors' fees and would control the allocations either through an hours requirement or by using groups. It really requires a talk where everything is out in the open, so you're not being asked later why you are effectively passing judgment on whether these two are, or are not, getting allocations.

Ed Snyder

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It is that simple now that it is clear that the 2 owners in question are not employees, should not have received W2's, and cannot participate in the plan.

The clarification was needed to confirm that they did not have a dual status as being both directors and employees (which is not uncommon).

Now comes the hard part for Renee who has to tell 2 owners that they cannot be in the plan.  They likely will ask why not?  The response is they are not employees and their compensation is being reported incorrectly.  I expect whoever has been preparing the W-2s will push back on being told they are reporting income incorrectly, and I expect the 2 owners in question will push back on not getting a contribution.

Renee, start practicing saying, "you can't handle the truth!".

Good luck!

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But the embarrassment or frustration of whichever person advised or decided the reporting of the nonemployee compensation might fade if it is feasible to design a separate retirement plan for each director, perhaps with annual additions up to the § 415(c) limit or accruals up to the § 415(b) limit (but subject to coverage and nondiscrimination conditions).

Peter Gulia PC

Fiduciary Guidance Counsel

Philadelphia, Pennsylvania

215-732-1552

Peter@FiduciaryGuidanceCounsel.com

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I think you (last three posts) are overreacting. This is apparently a small company, not IBM. As I noted earlier "director's fees" might be a shorthand way of saying "they don't do a whole lot but we want to pay them something." Well, not doing a whole lot isn't necessarily "doing nothing." I don't think it is our job to say "tsk tsk, director's fees are not eligible comp and therefore WE are dictating that it is reported improperly and won't count it, etc. etc." I mean, we don't even know at this point if these folks want or expect a contribution. Let's get the facts nailed down before saying what must be done.

My point is that there needs to be some (more) dialogue before jumping to conclusions and decisions. I'd start by saying "Well, directors' fees are [edit AREN'T (!)] eligible compensation. If these folks aren't expecting a plan contribution(s), then we're good, because they don't work enough hours, so frankly we don't care what you call their comp. If they're expecting a contribution(s), then we have two problems - 1) they don't work enough hours, the way the plan is written right now, and 2) directors' fees aren't really employee compensation." If they come back and say "yeah we really want them to get contributions" then you talk about amending the plan and have them tell you that they misspoke when they said they were directors' fees.

I know that this was supposedly clarified but I don't trust it. Just a sixth sense about such things and I might be wrong. But the thought that maybe this is done to provide health insurance is important - are we (you) going to blow up their health insurance coverage too because you're dictating to them what is or isn't employee compensation?

(edited to add last two paragraphs)

Ed Snyder

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Well, I'll take the other side of the argument. I feel like it is my professional responsibility to refer them to their tax counsel - "Although I can't give you specific tax or legal advice, you might want to discuss this with your tax counsel, as I believe that Revenue Ruling 58-505 covers this issue, and I don't believe true "corporate director's fees" are eligible compensation for plan purposes" or something along those lines. They can take it from there. As you say, they can come back and tell me they misspoke - it is actually W-2, and the census is incorrect, we had "X" hours, or whatever - as long as they are certifying it, not my problem. As to the health insurance, I'm not the one blowing up their health insurance coverage - if their tax counsel tells them it's ok, then it is between them and their tax counsel. It isn't my responsibility to concern myself with other employee benefit issues/problems (about which I'm not qualified to advise them anyway) - I'm hired as a TPA for their qualified plan only, and advise them accordingly. 

Maybe I'm just being a jerk, I dunno...

 

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You can only convey your concern. You are not in their biz nor the CPA. If you are also concerned about how they conduct their biz and possibly think that it may have adverse effects on how you administer the plan, you can refer them to an attorney.

If caring makes you a jerk then I definitely am joining you on being one.

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In many BenefitsLink discussions, we present observations grounded on a set of assumed or possible facts. And we might suggest something based on an inference about a hypothetically assumed or possible fact.

In this discussion, some of us might have drawn different inferences about some ambiguous, inconsistent, or confusing facts described in Renee H’s originating post and follow-up.

As the earlier of my posts said, there are many possibilities. That post expressly recognizes that Renee H’s client might not have accurately or completely described the facts. I imagined at least two possibilities, including that a person described as a nonemployee director might be an employee.

My later post assumed the information and descriptions in Renee H’s follow-up, and suggests one of several possible ways to handle a situation if a person is a nonemployee director, if the person desires a retirement plan, and if it is feasible to design a separate plan.

We recognize that records or other facts furnished to Renee H might include an inaccurate description the client made following its own decision-making without anyone’s advice, or perhaps with another professional’s advice. We know that a business organization, whether small or big, might misdescribe some facts—sometimes unknowingly, sometimes inadvertently, sometimes ill-advisedly, or even for one or more other reasons or causes.

Among the challenges facing a lawyer, accountant, actuary, TPA, or other adviser is that a client might not furnish enough information to get the facts right.

Many BenefitsLink discussions proceed from a commenter’s inferences and guesses about facts to be assumed. An originating post often doesn’t fully describe all relevant facts. Often, that’s because the person seeking information or suggestions doesn’t yet know enough to discern fully which facts might be relevant. Often, it’s because the originating poster doesn’t yet have the facts.

Still, many of us find help in a neighbor’s analysis of, or observation about, even a hypothesized situation. Often, that helps a questioner consider which facts and other assumptions to ask for, or which modes of analysis or advice-giving to pursue.

Peter Gulia PC

Fiduciary Guidance Counsel

Philadelphia, Pennsylvania

215-732-1552

Peter@FiduciaryGuidanceCounsel.com

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5 hours ago, Belgarath said:

Well, I'll take the other side of the argument.

Actually I was trying to say what you said. You have a conversation; you explain the possible problem and work with it. You don't just say "directors' fees - boom; not eligible/end of discussion." It's obvious, or at least it appears, that this is an unsophisticated client and needs to understand the implications of how that comp is paid.

4 hours ago, Peter Gulia said:

In this discussion, some of us might have drawn different inferences about some ambiguous, inconsistent, or confusing facts described in Renee H’s originating post and follow-up.

This is indeed the source of whatever disagreement we are expressing. I don't always express myself well but felt like there was not enough information to be drawing conclusions.

Ed Snyder

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