Allocation Conditions and Profit Sharing

I have a client that wants to declare a profit sharing allocation.  The Document currently has a last day/1000 hours.  However, they want to have the allocation condition be "you must be an employee on the day it is declared."   

The plans sponsor declared the PS contribution effective 2/13/2023 based on 2022 plan year compensation.  Would this be permissible?  Would the contribution be a 2022 or 2023 plan year contribution?

If everyone was in their own rate group, maybe you could construct a PS contribution for 2022 based on those still employed when you declare it in 2023 and still pass testing. Seems a very aggressive position to me though. But if it is simply 1000 hours, employed on the last day of the year, I don't see how you get around that.

Take a look at IRS Technical Advice Memorandum 9735001 where the analysis notes "the accrued benefit includes amounts to which the participant is entitled under the terms of the plan, even though the bookkeeping process of crediting those amounts to the participant's account has not actually occurred".  Essentially, you cannot take away a benefit after it was accrued under the plan.  It also considers whether contribution is discretionary.

Interestingly, the 415 regulations 1.415(c)-1(b)(6)(i)(A) notes that "However, if the allocation of an annual addition is dependent upon the satisfaction of a condition (such as continued employment or the occurrence of an event) that has not been satisfied by the date as of which the annual addition is allocated under the terms of the plan, then the annual addition is considered allocated for purposes of this paragraph (b) as of the date the condition is satisfied" which acknowledges that there can be allocation conditions like continued employment up to the date the contribution is allocated.  If so, then the annual addition counts in the year the allocation is made.  (I believe this provision is intended to address contributions that are made very late or made under certain correction methods.)

If there is a path forward for this client, it would be to not lock in the benefit accrual as of the end of the plan year.  Lou is right that simply having the 1000 hour/last day allocation condition would not accomplish this.  You may be able to add the continued employment requirement.  The benefit would become an annual addition in the year it is funded to the plan.  (This likely shifts the year of deduction.)  In other words, this year's calculation of an accrued benefit is based on last year's hours, compensation, last day of employment and this year's active status on the funding date. 

The plan likely will have to test for non-discrimination since the allocation formula would not be among the safe harbors.  The non-discrimination test would be done for the year in which the contribution is made as opposed to the prior year information used to calculate the benefit amount.

Any required contributions such as top heavy, gateways, and similar contributions that have a mandated contributions would still have to be made.

What is the client's motivation?  Do they feel giving a contribution to a terminated employee is rewarding disloyalty?  This is not worth the effort just to be spiteful.

Are the annoyed because a terminated participant took a distribution and closed out their account which then is re-opened to accept the new contribution?  The recordkeeping industry routinely handles this situation.

Something else?

I'm sure there are more technicalities to trying to do this.  This is one of those times when "just say no" feels like the best choice.

Thank you for the information!  Some additional information since original post.

The plan is on a volume submitter document.  They added to the appendix that they must be employed on the day it is declared.  Does that make them an individually designed plan?  

I was leaning towards it would be a 2023 allocation since that is the date the final conditions were met.

Given the short time-frame between year-end and the declaration date, I smell sour grapes.  No need for fancy gymnastics, tell them ERISA and the Plan must be blind to outside malfeasance, even where there is civil/criminal activity, the allocation would first have to be made, then you can try to recover it.

Otherwise, have the employer resolve to make a discriminatory allocation, as long as it meets safe-harbor and/or top heavy minimum.  Then correct with 11g to avoid the undesired employee as much as possible. 

It sounds like the horse is out of the barn.  When was this addition to the appendix made to the document?  If it was executed after 12/31/2022, it will not be applicable to 2022 (see the TAM).

Read the VS document, basic plan document and the IRS approval letter very carefully.  They all limit the types of modifications that can be made in "Describe" entries and Appendixes to core plan provisions like eligibility, vesting and allocation conditions.  Crossing the line can rescind reliance on the IRS approval letter.  You may want to talk to the document provider to confirm your understanding after reading everything.  I would be surprised if the provider says this provision is permissible in their document.

The fact that they adopted a provision like this without asking you about it in advance makes me feel this will be a toxic client for you - do stuff without telling you, wanting you to fix it when it is screwed up, and probably not wanting to pay for all of the extra effort.  Hope not.  Good luck.

Such a modification likely does not make it an individually designed plan but is very likely the kind of modification that would require submission to IRS for an individual determination letter and which could not rely on the IRS pre-approved opinion letter for its determination letter.

I agree with Lou that using the individual allocation groups is the best way to accomplish this, subject to satisfying coverage, nondiscrimination, et al, without annual additions year disconnect issue to monitor. That could be an issue if someone terminated early in the year immediately after declaration/entitlement with little current compensation - and people do stick around until they get their bonus (or profit sharing in this case) and then bolt, happens all the time.