Compensation Limitation Election Available to Certain Participants

Hi, 

I would greatly appreciate any insights etc., on the below. A DC (Money Purchase) Plan (volume submitter) has a provision in the compensation definition section (shown below) that allows the owners to sign a form that states that their compensation for the year of the effective date of the plan and all future years is $0. Their contribution based on this is $0, and only the employees receive an annual contribution. Are there any issues with this? Thank you.

       Compensation Limitation Election Available to Certain Participants.  Except for determining Top Heavy  

              allocation requirements under Section 3.5 or Code §415 limitations of Article 6, any participant who is a

        Key Employee, an Owner-Employee, a Self-Employed Individual, or a Highly Compensated Employee may  

        elect for any Plan Year, on a form prescribed by the Administrator to limit Compensation for all purposes

        under this Plan. 

That sounds a lot like a cash or deferred arrangement to me, although I guess they don't get cash if they don't get a plan contribution, at least not directly.  But basically these employees get to decide whether to get a contribution or not.  

I'd do it another way...like amend it to a profit sharing plan.  We haven't used MP plans for maybe 20 years.

Did that plan get a determination letter?

Thank 

5 hours ago, Bird said:

That sounds a lot like a cash or deferred arrangement to me, although I guess they don't get cash if they don't get a plan contribution, at least not directly.  But basically these employees get to decide whether to get a contribution or not.  

I'd do it another way...like amend it to a profit sharing plan.  We haven't used MP plans for maybe 20 years.

Thank you very much Bird, for your insights and knowledge. I just want to clarify that the provision of limiting the compensation to $0 is only for "any participant who is a Key Employee, an Owner-Employee, a Self-Employed Individual, or a Highly Compensated Employee". Meaning the company is making contributions for the NHCEs and just not making contributions for the shareholders, whom have elected to limit their compensation to $0.

Also, would it be better if the document would have just stated in the eligibility section the following?

  "For purposes of this Plan, all Employees are Eligible Employees except for the following ineligible classes of Employees: (1) Union Employees; (2) Non-Resident Alien Employees; and (3) the shareholders Jack and Jill, and their spouses, and any children of the shareholders."

Thank you again.

3 hours ago, BG5150 said:

Did that plan get a determination letter?

Thank you BG5150. This is a Volume Submitter approved plan.

Was that language a standard part of the plan, or was that added in?

Like Bird said, that setup smacks of a CODA.  What's to say the ER and the EE aren't striking a deal with an HCE to limit her compensation to zero so she can get those funds just paid to her now as salary.  For example, she could have a choice of getting paid $200,000 and $10,000 into the MPP (5%) or just "limit" her MPP comp to zero for the year and get paid $220,000.

I remember this was a common provision in a lot of plans in the 80's. It was a way to manipulate the MP or DB contribution levels from year to year. They largely went away when the CODA concern surfaced.

SSRRS, even restricted to HCEs, you have the nonqualified CODA issue. If you have a nonqualified CODA, it will disqualify the plan. The irrevocable one-time election rule exception to nonqualified CODA treatment is primarily at Treas. Reg. 1.401(k)-1(a)(3)(v); it requires that the election apply to all plans of the employer currently in existence or formed in the future, so is quite restrictive. It's a CODA if the arrangement results in the 0-ed out participant getting additional current pay. If that is not the case (i.e., if it is entirely the employer's decision to give them $0 and there is no corresponding increase in the pay of the person getting $0), then it might not be a CODA, but given that here it appears to be an individual election, I would be concerned that it is.

In the "old days" we used to call this a "waiver of compensation" and it was used a lot. As mentioned above, this largely went away with the CODA concern. I seem to recall, without further research, that this is a real problem - maybe even automatic - for unincorporated partners/sole props, but not necessarily a problem (facts and circumstances) for, say, a corporation. There was some sort of Revenue Ruling/Announcement/whatever back in the 90's on this issue.

Thank you BG5150 and DogHouse.

On 3/5/2021 at 6:38 PM, Luke Bailey said:

SSRRS, even restricted to HCEs, you have the nonqualified CODA issue. If you have a nonqualified CODA, it will disqualify the plan. The irrevocable one-time election rule exception to nonqualified CODA treatment is primarily at Treas. Reg. 1.401(k)-1(a)(3)(v); it requires that the election apply to all plans of the employer currently in existence or formed in the future, so is quite restrictive. It's a CODA if the arrangement results in the 0-ed out participant getting additional current pay. If that is not the case (i.e., if it is entirely the employer's decision to give them $0 and there is no corresponding increase in the pay of the person getting $0), then it might not be a CODA, but given that here it appears to be an individual election, I would be concerned that it is.

Thank you very much Luke Bailey. This particular case was not a case of increasing pay, thru reducing the contribution. Rather , the company simply did not want to include the shareholders and the wives of the shareholders in the annual contribution (HCEs). Would the following provision  in the eligibility section of the document been a better option for them?

  "For purposes of this Plan, all Employees are Eligible Employees except for the following ineligible classes of Employees: (1) Union Employees; (2) Non-Resident Alien Employees; and (3) the shareholders Jack and Jill, and spouses, children or parents of the shareholders."

6 hours ago, Belgarath said:

I seem to recall, without further research, that this is a real problem - maybe even automatic - for unincorporated partners/sole props, but not necessarily a problem (facts and circumstances) for, say, a corporation. There was some sort of Revenue Ruling/Announcement/whatever back in the 90's on this issue.

I don't recall any more guidance on this, Belgarath, other than the regs themselves, and I believe that in both partnerships and corporations its facts and circumstances. But why would anyone ask for less in the company's plan contribution if they're not getting reciprocity in terms of more current comp. I think what you may be thinking of with partnerships is that because most partnerships specially allocate the retirement contribution for the partner to him or her on the K-1, the reciprocity is automatic and transparent. In the case of a corporation, where the reciprocity would be through a raise or bonus, it could be harder to demonstrate the linkage. With a sole proprietor, well, it's impossible that the plan contribution is not linked to the sole proprietor's current comp, so I think the IRS just accepts that, and you really can't apply the nonqualified CODA rule to a sole proprietorship. The nonqualified CODA rules are, on the whole, a little wonky. Congress should have simplified this years ago.

4 hours ago, SSRRS said:

Would the following provision  in the eligibility section of the document been a better option for them?

  "For purposes of this Plan, all Employees are Eligible Employees except for the following ineligible classes of Employees: (1) Union Employees; (2) Non-Resident Alien Employees; and (3) the shareholders Jack and Jill, and spouses, children or parents of the shareholders."

SSRRS, I cannot comment on individual language, but it probably would be. The question is whether the employer's election in the plan document is tantamount to a cash or deferred election by the listed employees. That could be what happened, e.g. in a very closely held setting, but the facts are much more complicated where it is the employer making the decision for a group. As long as the plan provision was not modified frequently in a targeted manner, the facts would look better, for sure.

Hi Luke - I know there was something, but darned if I can find it. Could have been made obsolete by later guidance, etc. The issue is discussed in the IRS audit procedures, but not in great detail.

I tried to see if the EOB has anything on it, and there is an extensive discussion, and there is reference to an an IRS Announcement 94-101, but I can't find that.

At any rate, I agree that it is a thorny issue requiring careful consideration!

16 hours ago, SSRRS said:

Thank you very much Luke Bailey. This particular case was not a case of increasing pay, thru reducing the contribution. Rather , the company simply did not want to include the shareholders and the wives of the shareholders in the annual contribution (HCEs). Would the following provision  in the eligibility section of the document been a better option for them?

  "For purposes of this Plan, all Employees are Eligible Employees except for the following ineligible classes of Employees: (1) Union Employees; (2) Non-Resident Alien Employees; and (3) the shareholders Jack and Jill, and spouses, children or parents of the shareholders."

I don't think anyone would have concerns about the company deciding, through plan terms, that certain participants, especially HCEs, do not get contributions.  That's a completely different ballgame from having the participants themselves decide whether or not they get contributions.  

5 hours ago, Bird said:

I don't think anyone would have concerns about the company deciding, through plan terms, that certain participants, especially HCEs, do not get contributions.  That's a completely different ballgame from having the participants themselves decide whether or not they get contributions.  

Bird, thank you very much, for the clarification. As always your knowledge is appreciated.

18 hours ago, Luke Bailey said:

SSRRS, I cannot comment on individual language, but it probably would be. The question is whether the employer's election in the plan document is tantamount to a cash or deferred election by the listed employees. That could be what happened, e.g. in a very closely held setting, but the facts are much more complicated where it is the employer making the decision for a group. As long as the plan provision was not modified frequently in a targeted manner, the facts would look better, for sure.

Thank you, Luke Bailey, as always, your knowledge and analytical brilliance is much appreciated. 

1 minute ago, SSRRS said:

Thank you, Luke Bailey, as always, your knowledge and analytical brilliance is much appreciated. 

And Bird as well.

12 hours ago, Belgarath said:

Hi Luke - I know there was something, but darned if I can find it. Could have been made obsolete by later guidance, etc. The issue is discussed in the IRS audit procedures, but not in great detail.

I tried to see if the EOB has anything on it, and there is an extensive discussion, and there is reference to an an IRS Announcement 94-101, but I can't find that.

At any rate, I agree that it is a thorny issue requiring careful consideration!

Belgarath, I looked it up. Announcement 94-101 was the finalization of some exam guidelines, including one for qualified and nonqualified CODAs. One of the guidelines, citing Treas. reg. 1.401(k)-1(a)(6) state that any arrangement whereby an individual partner can vary his or her own contribution is automatically a CODA, and that the rule is not automatic for a corporation. So your memory was absolutely correct, and the analysis seems similar to what we described above.

Hi Luke - thanks. By the way, how did you find 94-101? I couldn't find a link to the blasted thing anywhere - obviously looking in the wrong places! 

Belgarath, I used CheckPoint, which is a commercial product we license, otherwise I would have posted a link.😒

Ok, thanks!