Zero Compensation

I thought there was some guidance that zero compensation employees were not to be included in testing. That's the way I've been handling it for over 20 years working at a number of TPAs.

However, my new employer has a policy to include zero compensation participants in coverage testing (but not in ADP/ACP). We're having a substantial number of plans failing coverage as a result (even safe harbor contributions...). I'm kind of stuck because I have no access to our legal group and don't know whether this interpretation originated with them.

Is there any on-line resource that has some level of definitive guidance on the subject?

Thanks for any help you can provide.

Have you asked them for their justification of including them?  Maybe they have the cite.  

Having a zero compensation employee has been pretty rare in my experience. I've seen it where an owner just doesn't take compensation because of the business economics or when an employee is on some kind of leave of absence. But in that case it would be 12+ months and that's unusual.

What other employees aren't getting paid, especially a "substantial number?"

If you were going to treat them as non-excludable, how would you even correct a testing failure? It seems to me that 415 prevents them from receiving a contribution.

There is an old thread from February 26th, 2003.  I don't know how to insert the connection to the thread but if you search in the following board you'll find it.  Originally referring to the ADP/ACP tests but I think may be relevant to the discussion:

• Retirement Plans
• 401(k) Plans
• ADP test and HCE w/ $0 comp

I'm in the small plan/client market and have some industries where this happens all the time, mostly because the employee doesn't get terminated timely for a variety of reasons.  FWIW - I've been doing this for 32 years and was originally "taught to" and have always excluded them from everything (whether NHCE or HCE), and never had issues on audit.

They're great to include in the testing with an allocation/accrual rate of infinity.  Hard to fail with that kind of math!

21 hours ago, Buckeye said:

However, my new employer has a policy to include zero compensation participants in coverage testing (but not in ADP/ACP).

If you have to perform an average benefit percentage test, you will have a divide by zero condition.  That's not zero and it's not infinity; it is undefined.  

So your employer's policy seemingly is to include someone in the ratio percentage and nondiscriminatory classifications tests that mathematically is impossible to include in the average benefit percentage test.  That seems inconsistent to me.

So, unless it was a partner whose earned income was zero/negative, how can you say such a person was an employee and performed services for the employer during the year? You can't. That the employer may not have "terminated" the person the person in their payroll system is not consistent with the facts and circumstances of the situation. I would say they are terminated as of their last day worked or for which hours were credited. Also, for reasons noted above, like 415, you can't cover/benefit them so why should you need to include them in your testing denominator? Finally, on what basis could you include for coverage but exclude for ADP?

An employee is out on some sort of unpaid leave.  No compensation, but not "officially" terminated.  I would agree that they are not part of testing.  Assume no balance in the plan.  Would you include or not include in the 5500 counts if they have otherwise met the plan's eligibility requirements?

I just met with the owner of a corporation who is taking her compensation to zero beginning in 2023.  She cannot afford to pay herself a salary.  She will still go to work each day and hopefully turn her company around.  If her company survives, and she goes the entire year without compensation, I would count her as an active employee, working more than 1,000 hours, with zero wages.  Her plan is a deferral only plan and there are no other HCEs, so it doesn't matter if she is in or out for testing, but I think this is an example where the plan can count a person without compensation.

On 12/16/2022 at 9:27 AM, MWeddell said:

If you have to perform an average benefit percentage test, you will have a divide by zero condition.  That's not zero and it's not infinity; it is undefined.  

Ding, ding, ding!