Using the average benefits test for COVERAGE

I've understood that the IRS, when it comes to coverage testing interprets 1.410(b)-4(b) such that a plan that has everyone in their own group/classification will be considered to have "substantially the same effect as an enumeration by name" and as such, it is not a "reasonable" classification and the plan must pass the ratio percentage test instead.

That's fine - but is there any written guidance stating this? For some reason I'm unable to locate it if there is. Any unofficial IRS pronouncements to this effect at recent ASPPA conferences, etc? I've seen reference to an indirect interpretation of the issue from back in 2001, but I'd sure like to find something more direct and more recent.

Thanks.

P.S. I know they withdrew the portion of the proposed regulations that would have applied this same interpretation to NONDISCRIMINATION testing, But I'm still trying to track down some documentation/confirmation that this is how the operate n the coverage issue. 

No takers? How about if I change the question a bit - given that the IRS specifically added (and then subsequently removed) in the proposed regs that this requirement would apply to nondiscrimination testing, might you reasonably infer that it does apply to coverage testing?

Since no apparent guidance, just looking for opinions now. Thanks!

I've always taken the approach that coverage only looks at who benefits and nondiscrimination looks at the amount of benefits. That is, for coverage purposes, $1 is as good as $50,000 (ABPT notwithstanding). So even if your plan allocates with each participant in their own group, as long as any non-benefiting groups satisfy some reasonable classification, then I think you can use the ABT to satisfy coverage.

I would like to see this in print also.   Haven't yet; just read some regulars here stating it to be the IRS opinion.

one such IRS comment came from 2001 Q and A  (it was Q and A #3, not #1but when I copied and pasted that is what showed )American Bar Association

1. §401(a) – Definite Allocation Requirement

Would a profit sharing plan be qualified if it were drafted to provide that, each year, the employer's contribution will be declared by written instrument which provides a distinct contribution (dollar amount or percentage of pay) to be allocated to each participant separately? For example, if a plan had 42 participants, the employer's declaration would have to establish 42 separate contribution amounts (or rates), with each one expressly declared to be allocable to a particular participant. For purposes of this question, please assume that:

The plan has routine eligibility requirements (e.g., one year of service and age 21), and that even if the plan had excluded classifications and/or conditions for eligibility to accrue a contribution (e.g., a last day of year employment requirement) that the plan would satisfy coverage requirements under §410(b);

The plan would provide that forfeitures will be allocated in proportion to the individual allocations for that year, and;

The allocations would be subject to the condition precedent that they must satisfy the coverage and non-discrimination requirements.

Given that the IRS has relaxed its position on definite determinability in the declaration of contributions/allocations it seems both reasonable and feasible to operate a plan on this basis. Little could be clearer than to expressly state the amount to be allocated to each participant individually. For example, there would be no question as to whether a participant is in one division or another, because each individual is separately identified, regardless of his or her job classification changes throughout the year.

Unlike the average benefit percentage test for coverage, the non-discrimination regulations do not contain a "reasonable classification" requirement that would prohibit the identification of individual participants, by name, as separate contribution groups.

Proposed Response: It seems conceivable that, if the employer could declare a 0% contribution for any participant, the plan could run afoul of the minimum coverage requirements, because a 0% allocation could have the effect of excluding individuals by name. Therefore, in the case of a plan that would make 0% allocations (and which is not permissibly aggregated with another plan that provides some level of benefit for the participant receiving nothing under the profit sharing plan) the plan would have to satisfy the ratio percentage test in order to satisfy minimum coverage. However, nothing else would seem to limit this approach to plan design.

IRS Response: The IRS agrees with the proposed response.

The proposed regs from 2016 had the following comment (would have required not just coverage but nondiscrimination as well to follow the reasonable classification rule)

IV. Benefit Formulas for Individual Employees or Groups Without a Reasonable Business Purpose; Modifications to the Amounts Testing Rules Under § 1.401(a)(4)-2 and § 1.401(a)(4)-3

The proposed regulations also include changes to address certain arrangements that take advantage of the flexibility in the existing nondiscrimination rules  ^[7] to provide a special benefit formula for selected employees without extending that formula to a classification of employees that is reasonable and is established under objective business criteria. A plan satisfies the minimum coverage requirements of section 410(b) if the plan's ratio percentage is 70% or higher or the plan satisfies the average benefit test. To satisfy the average benefit test, pursuant to § 1.410(b)-4, the group of employees must be determined using a classification that is reasonable and that is established under objective business criteria pursuant to § 1.410(b)-4(b) and must have a ratio percentage that is described in § 1.410(b)-4(c) (which includes safe harbor and unsafe harbor percentages). A classification of employees that is reasonable and is established under objective business criteria is referred to in this preamble as a “reasonable business classification.” To the extent that a plan provides a special benefit formula and can still pass the nondiscrimination requirements, the plan sponsor can use a qualified retirement plan to provide benefits that would otherwise be provided under a nonqualified plan. These arrangements are sometimes referred to as qualified supplemental executive retirement plans (or QSERPs).

Under the general test in the existing regulations, if a plan satisfies the minimum coverage requirements of section 410(b) using the average benefit percentage test, then the rate group for each highly compensated employee is treated as satisfying the minimum coverage requirements if the ratio percentage for the rate group is equal to the midpoint between the safe harbor and the unsafe harbor percentages (or the ratio percentage for the plan as a whole, if less). This rule recognizes that the composition of a rate group may be unpredictable and so the rate group should not be subject to a reasonable business classification standard. However, that same consideration is not relevant if the group of employees to whom the allocation formula under a defined contribution plan (or benefit formula under a defined benefit plan) applies is not a reasonable business classification.

Accordingly, the proposed regulations limit the existing rule under which a rate group with respect to a highly compensated employee is treated as satisfying the average benefit percentage test to those situations in which the allocation formula (or benefit formula) that applies to the highly compensated employee also applies to a reasonable business classification. For example, if a benefit formula applies solely to a highly compensated employee who is identified by name, it does not apply to a reasonable business classification. See § 1.410(b)-4(b). In such a case, the proposed regulations would require that the rate group with respect to that individual satisfy the ratio percentage test.