For 15% calculation purposes do you subtract deferrals before applying

[R. Butler]

In determining compensation for purporses of calculating the 15% maximum deduction limit do you subtract elective deferrals before the 170,000 limit or after. For example Employee A earns $200,000, defers $10,000, for 15% purposes is his comp. factored in at $170,000 or $160,000? I am fairly confident that you apply the limit after subtracting the deferrals, but I need some confirmation (i.e. in my example 200,000-10,000>170,000, thus comp. 170,000).

[wmyer]

You are correct; you apply the 401(a)(17) limit after subtracting deferrals, so in your example, you would use 170,000 for the 15% limit.

[Richard Anderson]

I may disagree. If you are calculating 15% deductibility on an individual basis, then adding these together for the total deductible amount, then I disagree.

If this person were the only participant in the plan, the deductible limit would not be 25,500 (170,000 x 15%), it would be 24,000 ((170,000 - 10,000) x 15%).

Are you calculating the deductible amount on an individual basis, and the adding these amounts together?

[R. Butler]

This is not a single participant plan. Basically what I do is as follows:

Person A 200,000 10,000 170,000

Person B 175,000 10,000 165,000

Person C 20,000 0 20,000

In calculating the 15% I take (170,000+165,000+20,000)*.15. This is the maximum deductible contribution. Then I would deduct the deferrals and any match off the maximum deductible contribution to get the amount available for profit sharing.

[Richard Anderson]

The deferrals should not be deducted from compensation in the first step. 200,000 gets limited to 170,000. No substarting of deferrals, either before or after the 170,000. 175,000 gets limited to 170,000, no subtracting of deferrals.

Then add total eligible compensation, subtract total deferrals, then multiply by 15%. ((170,000 + 170,000 + 20,000) - 20,000) x .15 = 51,000). Deductible amount is $51,000.

Your method incorrecting determines the deductible amount to be $53,250 ((170,000 + 165,000 + 20,000) x .15)

If you want to calculate this on an individual basis, you can, but you will have to limit compensation to 170,000 first, then subtract deferrals.

200,000 170,000 -10,000 160,000

175,000 170,000 -10,000 160,000

20,000 20,000 0 20,000

Deductible amount is $51,000 ((160,000 + 160,000 + 20,000) x .15)

[wmyer]

I disagree. See Tom Poje's comment at

http://benefitslink.com/boards/index.php?showtopic=6598

Start with compensation, then reduce by deferrals and §125, then cap at 170,000.

[R. Butler]

Richard Anderson,

Thank you for the reply, but I am little unclear. Although you don't explicitly say it both of your examples are the same. It seems to me that your position is that deferrals should be subtracted after applying the limit. Is this the position that you take?

[Richard Anderson]

That is/was my position. I'm checking to see if I can find a basis to defend that position, since others are not agreeing. Are there any examples in the regs. that cover this?

[Richard Anderson]

It appears I'm wrong. I put your example plan in our software and it calculates the maximum deduction as 53,250. Thanks, I learned something today.

[Guest AFRICA6796]

We all seem to be in agreement of the fundamental rule, that is the maximum deductible amount for a taxable year of the employer is 15 percent of the compensation paid during the taxable year to the participants under the plan. [iRC § 404(a)(3)(A)(i)] .

This is based on aggregate compensation, taking into consideration the compensation cap.

For example, for year 2001, assume the following compensation

John $200,000 (only $170,000 would be considered)

Jane $150,000

Jane $180,000 (only $170,000 would be considered)

The maximum deductible amount therefore would be 15% of ($170,000 + 150,000 + 170,000) $490,000

What you have so far not agreed on is if elective contributions treated as employer contributions for purposes of the deduction limit?

The answer to this is yes, refer. [Treas Reg 1.401(k)-1(a)(4)(ii)]

Under section 404, compensation is all compensation paid during the year to eligible employees,

However, compensation does not include contributions made to a 401(k) plan, including elective contributions made at the election of employees. [Treas Reg 1.404(a)-9(B)] The change made by Section 1434 of the Small Business Job Protection Act of 1996 to treat elective contributions as compensation for purposes of Code Section 415 apparently does not apply for purposes of determining the 15 percent limit. Note that the plan's definition of compensation is not relevant in determining the maximum deductible amount. [Rev Rul 80-145, 1980-1 CB 89]

Example. Under a 401(k) plan, participants are not allowed to defer any portion of a bonus, and bonuses are not taken into account in allocating nonelective contributions. Compensation not including bonuses is $1 million; bonuses for the year are $500,000. The maximum deductible amount for the taxable year is $225,000 ($1,500,000 × 15%)

Source- Panel Publishers Pension and Answer Books, by Krass et al. Customer Service Tel #1800-638-8437

[Guest]

Richard (and others):

Just because a software does something does not necessarily mean it is correct. In this case yes, and generally that is a good guideline. However, for example (speaking for the same software), consider top heavy.

Distributions are written into year of distribution. They really should be written into the year of termination.

for example, you would agree you do not consider account balances of terminees who have been gone over 5 years. Now the ee in question finally receives a distribution. The system will start counting that amount for another 5 years!

In regards to 15% deductibility, if my memory serves me correct, the pension bill currently in Congress is seeking to change the rules. One is to eliminate deferrals as being treated as employer contributions.

[Richard Anderson]

Thanks Tom,

We spot check most things calculated by the software, but we manually calculate top heavy; always. Here's a top heavy question for you.

Plan has no owners who are key employees, only officers. Each year the number of officer counted as key employees is limited by the 10% rule. For example, the employer has 38 employees and 6 officers, so the maximum officers counted as key employees will be 4 (38 x 10%, rounded up). But because compensation changes during the current year and 4 preceeding years, these 4 officers are not the same each year.

Let's say employee D is a key employee in 1997, 1998, and 1999; but in 2000 gets bumped because another officer had higher compensation than him. Now the group of 4 officers that are considered key employees no longer includes employee D.

Is employee D now a non-key employee or a former key employee? My guess is he is a former key and is disregarded in the top heavy test.

[Guest]

King Richard:

once key, you are key for current year and next 4 years.

then you become former key and cease to exist for purposes of counting.

at least that would be my understanding of the rules.

ugh, you have ugly plan cuz ees will hop in and out of being key.

[R. Butler]

Richard,

In your example why wouldn't D still be key. A key employee is any employee who during the current or 4 preceding plan years was an officer blah, blah, blah. D was an officer with comp. in excess of 50% of the DB limitation during one of the four preceding plan years.

[Richard Anderson]

Treasury Reg 1.416-1 T-14 specifies that there is a maximum limit to the number of officers that will be counted as key employees. If the employer has less than 30 employees, the maximum number of officers considered to be key employees will be three. If the employer has over 500 employee, the maximum number of officers considered to be key employees will be 50. For employers with 30 - 500 employees the maximum is 10% of employees, rounded up to the next integer.

Tom, the example in T-14 seems to say that only the current maximum will be counted as key. In the example, each year there are 50 officers, but each year they are 50 different officers. The example says to use only 50 as key employees, out of the total 250 officers (50 different key employees each year). This example has a total of 250 key employees for the 5 year period. 50 different officer keys each year. T-14 says "only a total of 50 individuals would be considered to be key employees by virtue of being officers in testing for top-heaviness..." But T-14 does not say what to do with the other 200 who were key employees because they were officers in prior years. In this example, I can't see that the intention is to count the other 200 as key because they were key in a prior year.

Tom, in this example, do you think that there should be 50 keys or 250?

[Guest]

I will go this far to say that my understanding of officer testing was incorrect.

M. Pruit's ASPA talk in 1998 and ERISA Outiline Book both say:

Look at all officers in the 5 year period.

Look at all comp in the 5 year

You take the greatest number of employees in any of the 5 years, not just the current year when determining 10%.

Look at comp in any of the 5 years as well.

thus I conclude had I had the situation arise, I would have performed it incorrectly. oh well, nothing new there! can't stop learning.

[Richard Anderson]

OK, back to my question then.

If, when you look at comp for all 5 years, and now you don't count someone as key (who was a key last year because of being an officer), because now another officer has greater comp in that 5 year period: How do you treat the guy (or gal) that got bumped from being key? Is that person a former key? Non-key? Or still key (not because they are an officer, but because they were key in the prior period)?

Has this been addressed in any of the IRS Q&As?

[Guest]

based on my reading of the regs (which of course are always clear as mud) I would treat the ee as former key.

416(g)(4)(B) again says if ee ceases to be key exclude entirely.

in the case of an owner who sells stuff, well, since he owned stock in one of the last 5 years, he is still key. In other words he hasnt ceased to be key. (yet)

in the case of officers, because of the limitations applied it looks like he got bumped.

but of course, i could be wrong...

[Guest Hans Moleman]

I think the treatment of key employees is the same whether it was due to ownership or being an officer. I would say that in the example that Richard poses the individual would be treated as a key employee in the future. Once the individual is not a key employee within 5 years from the determination date that employee becomes a former key employee and their balance is excluded.

[Guest]

I don't think the treatment of officer is quite the same as owners.

in the current year my key ees are:

owners in the current year or any previous 4 years.

If ee sold his ownership 2 years ago, he still owned stock 3 years, so is key because of that year.

officers on the other hand, says, for all practical purposes, build a cute little excel spreadsheet covering the last 5 years.

take the year with the most employees and take 10% of that.

that is the maximum number of officers. now look at all comp over the last 5 years and see who is key. If someone was key on last years grid, he might get bumped by soeone in the current year.

the officer rule doesn't say 'and include any officer who was considered key 4 years ago as well'