ADP/ACP Testing Question

Working on a plan where the owners and their spouses in a corporation had no compensation for 2022. Do I still include them in my testing? This is the first time working on this plan but I see that they haven't taken any compensation for a few years now. One year the prior TPA included them and the next year they were excluded. Not sure why hence my asking this question.

The ADP test measures for discrimination the deferrals for everyone eligible to defer.  The lack of compensation made these people ineligible to defer, so I leave them out.

Agree with Bri

That's what I thought. It threw me when the prior TPA included them one year but not the next.

Thank you!

Is not being eligible the same as the amount one can defer being $0? If I were a HCE by 5% ownership but took no comp in a given year would it be unreasonable to count my deferral % as 0% which would improve the ADP% for HCEs? If I paid myself $1 and defer nothing I get to be counted as 0% but not if I pay myself nothing? I don't know..

From what I researched, there is disagreement on this subject, some say yes, some say no.

The "no's" state this person is not an eligible employee, is someone with zero compensation eligible to defer?

The "yes'" refer to Treas. Reg. 1.401(k)-2(a)(3)(i) - "If no elective contributions, qualified nonelective contributions, or qualified matching contributions are taken into account under this section with respect to an eligible employee for the year, the ADR of the employee is zero."

But their deferral rate is not 0% it is undefined as "$0 deferral / $0 414(s) compensation" is not 0. At least not in any math class I took.

6 hours ago, Coleboy1 said:

owners and their spouses in a corporation

How are they complying with the reasonable compensation requirement?

Is that just for Subchapter S,  or could a C-corp. legitimately pay its owners $0 ?

19 minutes ago, Bri said:

Is that just for Subchapter S,  or could a C-corp. legitimately pay its owners $0 ?

I was thinking S corp, but even C corp compensation has to be reasonable. It's more of an issue in the other direction (paying too-high salary) for C corps though, since the idea would be that the corporation could deduct the salary paid to the employee, as opposed to paying them a dividend, which is taxable both to the corporation and to the shareholder.

I don't see how $0 salary could be legitimate. If memory serves me right, Steve Jobs took a $1 salary from Apple for a number of years; if this company wanted to pay their shareholder a token salary I think that would be more reasonable than $0 which essentially makes them a volunteer.

IMO it is not unreasonable to take $0 salary if the company is unprofitable. If it is an S corp and they are taking no salary but getting dividends, yeah that is a big problem. In any event I agree with others that they are not in the test with $0 pay. It probably makes sense to take some nominal pay for plan purposes. This all assumes there are other HCEs, otherwise it shouldn't matter.

What if it's a partnership?  Or sole proprietorship?

If the company has a loss, so do the owners.

Spouses on the other hand...

They are employed HCE's and eligible, but the deferral is 0.  Good for the test results.

What does Sal say?  It's been a while since I read that part of the EOB.

That said, I always thought that owners are not 'employees' and are not 'employed' by the company.  (Can you employ yourself?)

In this case are the spouses also owners?  If not, did they perform services for the company during the year?  If so, why no W2 or 1099?  In absence of a W2 did they even technically work for the company?  If not, then they weren't employees that year and the spouses wouldn't be in the test.

I think most software treats zero comp and zero deferrals as a zero ADP.  At least Relius does.  And if your software doesn't and you want these people in, give the owners $1 comp.

17 hours ago, BG5150 said:

What does Sal say?  It's been a while since I read that part of the EOB.

That said, I always thought that owners are not 'employees' and are not 'employed' by the company.  (Can you employ yourself?)

In this case are the spouses also owners?  If not, did they perform services for the company during the year?  If so, why no W2 or 1099?  In absence of a W2 did they even technically work for the company?  If not, then they weren't employees that year and the spouses wouldn't be in the test.

I think most software treats zero comp and zero deferrals as a zero ADP.  At least Relius does.  And if your software doesn't and you want these people in, give the owners $1 comp.

It seems like you are circling back to the original question - if someone has $0 comp are they in the test at all? As far as I'm concerned, owners (that is, a sole proprietor or a partner) are also employees...but with $0 comp I would not include them in testing. An owner's spouse who is not a partner would have to either get a W-2 income or get nothing, and if they get nothing then I can't see how you would include them in the test. 

As far as software, I think it would short out if they divided 0 by 0, so they program it to = 0. That doesn't mean it is correct.

21 hours ago, BG5150 said:

That said, I always thought that owners are not 'employees' and are not 'employed' by the company.  (Can you employ yourself?)

For a corporation, the corporation is a separate legal "person" from the owner, so it's easy to see how someone could separately be a shareholder and an employee of the corporation.

For a self-employed individual (partner or sole proprietor) you are right that they can not really be their own employee, which is why IRC 401(c) has to explicitly say that the term "employee" includes a self-employed individual.

4 hours ago, Bird said:

As far as software, I think it would short out if they divided 0 by 0, so they program it to = 0. That doesn't mean it is correct.

In Relius, if someone is eligible (or at least the program determines them to be eligible), the show up the the ADP test with zero comp, zero deferrals and an ADP of 0.00%.  

One of the reasons I run my tests sorted in compensation order first.  So I can see all the zero comps at the bottom.

In.  From the eligible employee definition of 1.401(k):  Finally, an employee does not fail to be treated as an eligible employee merely because the employee may receive no additional annual additions because of section 415(c)(1).

17 hours ago, Nate S said:

In.  From the eligible employee definition of 1.401(k):  Finally, an employee does not fail to be treated as an eligible employee merely because the employee may receive no additional annual additions because of section 415(c)(1).

I don't have a dog in the fight here, but not getting an "additional" allocation because you hit a limit doesn't necessarily equate to being eligible with $0 comp. I get that one reason they can't contribute is that 100% of $0 is $0, but they are also ineligible to defer because they have $0 comp. And then you go back to the 0/0 problem.