Allocations Limited by 415

[ac]

We have a profit sharing plan (no 401(k)) that has 1 owner and 1 employee. 

The owner's compensation is $330,000.  The employee's compensation is $200,000.  Total compensation is $530,000.  Maximum deductible contribution is $132,500. 

The Plan provisions state the profit sharing contribution is allocated on a pro-rata basis based on compensation.

The owner wants to provide himself and the employee with the maximum annual addition of $66,000 or a total contribution of $132,000 or 24.90566% of payroll.

In order to provide the employee with a total allocation of $66,000, the pro-rata allocation percentage must be 33% of compensation.  However, providing the owner with an allocation of 33% of compensation or $108,900 will violate 415 for the owner.  Can we limit the owner's allocation to $66,000 and still provide the employee with an allocation of $66,000 or 33% of compensation.  I am concerned the IRS would say the terms of the Plan are not being followed because the ending allocation is not pro-rata based on compensation.

The Plan states the following in the 415 limitation section: 

"If the Employer contribution that would otherwise be contributed or allocated to the Participant's Account would cause the Annual Additions for the Limitation Year to exceed such maximum permissible amount, the amount contributed or allocated will be reduced so that the Annual Additions for the Limitation Year will equal the maximum permissible amount."

This language seems to indicate we can reduce the allocation for the owner to $66,000 and still provide the employee with $66,000. 

Thoughts?    

[C. B. Zeller]

I think you answered your own question. The plan clearly says that the allocation will be reduced so as not to violate 415.

I would recommend changing the formula to individual allocation groups for the next plan year.

[Paul I]

ac, is the owner self-employed?  If yes, be aware of further complications to your calculations when

• the profit sharing contribution allocated to the owner and
• the employer's portion of the owner's payroll taxes

can impact

• the owner's compensation in determining the owner's allocation percentage and
• the deductible amount of the contribution.

Visit https://www.irs.gov/publications/p560 and

these sections in particular:

Table and Worksheets for the Self-Employed

    Rate Table for Self-Employed.
    Rate Worksheet for Self-Employed.
    Figuring your deduction.
    Community property laws.

[rocknrolls2]

Building on Paul I's comment, even if the owner is not self-employed, please note that there is one other limit your example seems to disregard: this is the limit on the employer's tax deduction for its contribution to the plan. For a defined contribution plan, the limit is 25% of the compensation of the participants, disregarding elective deferrals. The deduction limit is also subject to the 415 limit.

While you could allocate an employer contribition of 33% to the non-owner, the total contribution as a percentage of the participants' compensation would be limited to 25%. Perhaps the allocation to the owner would lower the overall percentage of compensation closer to the 25% limit -- otherwise, a lower percentagevwould need to be allocatee to the owner so as to not exceed the tax deduction limit.

[ac]

The employer is a corporation.  The owners gross W-2 compensation is $1,000,000+.  So not worries with the SE income calc.  Thanks for everyone's input.

[ConnieStorer]

I have to disagree with some of the other comments.  According to AC, the document says that the amount contributed or allocated wil be reduced to avoid exceeding the annual additions limit.  The annual additions limit applies to each participant individually, not the entire plan.  I think the wording allows for the reallocation of the excess to other participants.  I do not think that the wording implies that the Employer Contribution must be reduced.

 

"If the Employer contribution that would otherwise be contributed or allocated to the Participant's Account would cause the Annual Additions for the Limitation Year to exceed such maximum permissible amount, the amount contributed or allocated will be reduced so that the Annual Additions for the Limitation Year will equal the maximum permissible amount."