Advance contributions by HCE in participant-directed account plan.

[David MacLennan]

A profit sharing plan has participant-directed investments. The business owner makes his 35K ctb prior to the end of the year to take advantage of tax-deferred investment gain. The employees' contributions are made after the end of the year, when comp, eligibilty, coverage issues, etc. are resolved. Thus, employees don't receive investment gains on contributions to the same extent. Is this practice considered discriminatory?

[rcline46]

Start with failure to follow document. How was contribution allocated to HCE only? Allocation provisions do not permit this. Looks like disqualification to me.

The fact it is discriminatory in a big way is secondary.

[David MacLennan]

The plan document only addresses how the total contribution for the tax year is allocated. It does not specify that in the case of participant directed investments that each individual contribution must be allocated at the time the contribution is made. From a common sense fairness point of view, the document should probably provide for a common trust account to hold advance contributions until they are allocated to individual participants. However, the plan does have a favorable determination letter. The practice does seem discriminatory, even though in a maginal way. An irony is that given this is a doctor plan, and given the investment success of most doctors, the participants would probably be better off without any common trust!

[rcline46]

Contributions are usually allocated in proportion to compensation, defined as annual 415/w-2/etc. There is no way allocating ANY contribution is legal BEFORE compensations are known. You have a failure to follow the document. Also, many documents consider contributions as part of a 'suspense' account until allocated. Allocating an 'advance' contribution to any one person violates the document provisions. Self-direction is irrelevant.

Also, 35K grossly exceeds the 15% deduction limit if it ends up the Dr. has no employees at year end. There are many failures here - mid term allocations not provided for, not allocated according to terms of document, allocated only to HCE, exceeding 404 limits, probably others.

If client will not follow rules, resign with prejudice. We have done so because YOU will be held responsible, read malpractice suit, if the plan is audited.

[AndyH]

I agree it's discriminatory, although off hand I can't think of under what provision-maybe benefits, rights, and features. Or, possibly it could be deemed discriminatory in operation due to unequal timing of deposits.

My company's documents do provide for preliminary allocations based upon preliminary compensation, and for true-up's at the end, so while it may be a document problem, it may not be.

I've handled these (always Doctors!) by creating a holding account, then at the end of the year sweeping contributions and income (plus or minus) to each entitled employee. It is a major hassle, but I think it's the only correct way to handle this, unless the plan does not have a last day provision and a reasonable estimate can be done for each employee at the same time.