Date post: | 05-Jun-2018 |
Category: |
Documents |
Upload: | truonglien |
View: | 214 times |
Download: | 0 times |
2
Uses of Compensation
Compensation is defined for various purposes:
Allocation of contributions/ determining accrued benefit
ADP/ACP Testing
General Non-Discrimination Testing
Safe Harbor Contributions
Maximum Deductions
Section 415 Maximum Allocations/ Benefits
Gateway minimum allocations/ equivalent allocations
Top Heavy minimum allocations/ benefits
Determining HCE Status
Limitations on Cafeteria Plan benefits to HCE’s
Post severance compensation
3
Defining Compensation
Section 415 contains the central definition
See Reg §1.415(c)-2
Applies to
§415 maximum allocations/ benefits- 100% rule
Top heavy minimum allocations/ benefits
Maximum deductions (§404(a)(12))
Determination of HCE’s
Implicitly-determine from what compensation participants
can make salary deferrals and can receive allocations of
contributions/ accruals of benefits
4
Defining Compensation
What’s included?
Wages and all other cash compensation for personal services performed for the employer maintaining the plan
Non-Cash compensation relating to these services
Specifically- Salary, commissions, tips, bonuses, share of profits, etc.
Compensation must be earned as an employee
Amounts that would have been included in income except it was deferred under §§401(k), 403(b), 457(b), 125, 132(f)(4) (bus tokens)
5
Defining Compensation
What’s included?
Taxable fringe benefits
Include the taxable portion of health and disability insurance
Specialty Items
Moving expense reimbursement that is taxable
Taxable non-statutory stock options in the year granted
Deferred compensation taxable under §409A
6
Defining Compensation
What’s Included?
Amounts constructively received (also amounts
included under §83(b))
What’s Excluded?
Non-taxable contributions/ value of benefits under
qualified or non-qualified deferred compensation
plans
Distributions from qualified or non-qualified
deferred compensation plans
Taxable amounts from exercise of non-statutory
options
7
Defining Compensation
What’s Excluded?
Taxable amounts from sale of stock received under a
statutory option
Implicitly, amounts not taxable pursuant to the exercise of
a statutory option
Untaxed fringe benefits that are employer paid (such
as group term life)
Compensation in excess of §401(a)(17) limit is
disregarded. See Reg §1.415(c)-2(f).
Apply 401(a)(17) limit to each year involved
Pre-EGTRRA years (up through 2001) can use $200K if
elected in plan
8
Defining Compensation
What’s Excluded?
Severance Pay
Not permitted to be counted
Distinguish from regular pay, bonuses, commissions
that would have been paid if employment had
continued
9
Defining Compensation
What can the plan choose to exclude?
Amounts received under a non-qualified, unfunded
deferred compensation plan, in the year received
What can the plan choose to include?
Payment of unused sick leave and vacation pay
subject to timing rules
Hypothetical compensation for disabled participant
10
Earned Income
Self-Employed Persons
Proprietorships
Partnerships
Limited Liability Companies
Receive no wages
“Earned income” from performance of services
11
Earned Income
Self-Employed Persons
“Earned income” from performance of services
Refer to Schedule SE of Form 1040
What about Shareholders of S Corps
They should receive wages
Dividend income reported in Form K1
What if some K1 income transferred to Schedule SE
Is this permissible?
Reserve only for damage control
12
Earned Income
Self-Employed Persons
Rules for “Traders”
Stocks and bonds
Ordinarily short term capital gain
Can make election to be treated as a dealer
Then earned income
Full recognition of losses
Commodities and Index Futures
Blended short and long term CG rates
Ordinarily not earned income
Can make election to be treated as a dealer
Must have use of an exchange membership
Do not need to trade “on the floor”
Earned income applies for retirement plan
13
Defining Compensation
Safe Harbor Definitions- Reg §1.415(c)-2(d)
Alternatives to general definition
Must be provided in plan document
Include all cash and non-cash compensation, but exclude
Health and disability insurance contributions paid by employer and taxable
Moving expense
Taxable non-qualified deferred compensation
Non-statutory stock option
Section 83(b) amounts
14
Defining Compensation
Safe Harbor Definitions- Reg §1.415(c)-2(d)
Section 3401 wages
Wages subject to withholding
Include salary deferral amounts
These safe harbors omit items that are harder to measure
Period for measuring §415 Comp
Limitation year for §415 purposes
Calendar year
Plan year
15
Defining Compensation
Period for measuring §415 Comp
Limitation year for §415 purposes
Calendar year
Plan year
16
Defining Compensation
Period for measuring §415 Comp
Limitation year
Calendar year ending within plan year
Plan year
Minor timing differences
Paid in the first few weeks of next year
All participants treated the same
No double counting
Eg. Weekly payroll that staggers the calendar year
17
Defining Compensation
Period for measuring §415 Comp
Payment after severance of employment
Later of: end of limitation year or 2 ½ months after severance
Must count-
All pay, commissions, bonuses, etc. that would have been paid had employment continued
May count (see plan provision-amendment)
Accrued sick, vacation pay
Payments under non-qualified unfunded deferred compensation plan that would have been paid anyways
18
Defining Compensation
Period for measuring §415 Comp May not count severance pay
Some pretend compensation can count
Disabled participants
Total disability
Impute compensation based on prior rate of pay
NHCE’s only or all employees who are totally disabled
will receive contributions for a fixed period
Optional provision
Back pay is compensation for the period to which it
applies
19
Defining Compensation
Participants in active military service
USERRA (§414(u)(8)) and HEART (§414(u)(9)) See Rev Notice 2010-15
Differential wage payments
Can use this as compensation from which deferrals can be made
Optionally, count as compensation for profit sharing allocations
Participants considered “in service” so top heavy minimum applies to top heavy plans and is not optional
For soldiers who die or are disabled in active duty: Match may be contributed based on imputed salary deferrals using previous rate of deferrals
20
Example
“Retiring” president of a small bank leaves at the end of May
He receives a bonus in June and another in January of the following year
He normally receives an end of year bonus
Bank stock is publicly traded
Declaration of bonus is posted on SEC web site
Language makes it clear the payment is in the nature of a severance payment
Payment is being made to “settle” the contract with former president
21
Example- Analysis
Was the payment being made for services performed?
Would the payment have been made anyways had employment continued?
June payment was timely
January payment in following year was not timely regardless of the reason
Posting on SEC web site made it clear this was a severance payment
Former president was not permitted to make salary deferrals from either payment
22
Compensation Limit
Section 401(a)(17) limitations
Applies in determining benefits and
allocations
Applies to non-discrimination testing
Must be stated in plan document
Generally based on plan year
Calendar year limit that is in effect on the first
day of the plan year applies
23
Compensation Limit
Section 401(a)(17) limitations
Section 401(a)(17) limits are prorated for
short plan year. Reg §1.401(a)(17)-
1(b)(3)(iii)(A).
Section 401(a)(17) limits are not prorated for
participation for a partial plan year. Reg
§1.401(a)(17)-1(b)(3)(iii)(B).
Applies per employer in a multi-employer
plan
24
Compensation Limit
Section 401(a)(17) limitations
Special EGTRRA Rule
Must be in plan
Allows use of $200K limit for years prior to 2002
(Rev Notice 2001-57 and EGTRRA §611(c))
VCP Correction (Rev Proc 2008-50)
Reduce account balance of violating HCE
Increase account balance of all others
25
Defining Compensation
Effect of Section 414(s)
Applies to
All non-discrimination testing
See special definition under Reg §1.401(a)(4)-12 (plan year compensation)
Gateway minimum allocations/ minimum equivalent allocations
Safe harbor contributions
Compensation for allocations and benefits need not meet a §414(s) definition (Reg §1.414(s)-1(a)(2) also see Reg §1.401(a)(4)-3(e)(1)).
26
Defining Compensation
Effect of Section 414(s)
Start with §415 definition
May exclude salary deferrals under §§401(k), 403(b), 408(p), 125, and 457
May exclude taxable fringe benefits, expense reimbursements, deferred compensation
May exclude pre-participation compensation
Non-discrimination testing
“Safe harbor” allocations under §1.401(a)(4)-2
May exclude other items if the exclusion is a category of compensation and the exclusion passes non-discrimination testing
27
Defining Compensation
Effect of Section 414(s)
May exclude other items from NHCE
compensation if the exclusion is a category of
compensation and the exclusion passes non-
discrimination testing
Bonuses
Overtime
Commissions
Etc.
May exclude any portion of HCE compensation
28
Defining Compensation
Effect of Section 414(s) Special non-discrimination testing
For each participant calculate a ratio
Numerator is the compensation included
Denominator is total compensation using a §414(s) definition- safe harbor
If some HCE’s have some compensation excluded, then the exclusion must be applied for those HCE’s. However, if all HCE’s have some excluded compensation, then the exclusion can be disregarded.
Separate HCE’s and NHCE’s
Average the ratios for each group
29
Defining Compensation
Effect of Section 414(s)
Discrepancy between inclusion rates cannot favor
HCE’s by more than a minimal amount
Other reasonable methods can be used
Suggest applying to IRS for review
30
Defining Compensation
Effect of Section 414(s)
Might be able to use aggregate compensation of
all employees in a group rather than ratio of
individual averages
This method does give greater weight to higher
earners
Minimal discrepancy is based on facts and
circumstances and can take prior results into
account
31
Defining Compensation
Effect of Section 414(s)
Section 401(a)(4)-12 plan year compensation
Refers to §414(s)
Pre-participation compensation
Can be excluded
Lack of year to year consistency cannot be strategic
Where plan year and compensation year do not
coincide, then special rule for new participants
32
Example
Total
Comp
Partcpt
Comp
Equiv
Ben
EBAR
Gross
EBAR
Partcpt
Topaz 150000 150000 800 0.53% 0.53%
Asher 60000 32000 175 0.29% 0.55%
Huey 70000 70000 180 0.26% 0.26%
Roger 40000 22000 118 0.30% 0.54%
Harry 30000 30000 100 0.33% 0.33%
33
Example- Analysis
Cross-Tested profit sharing plan
Using total plan year compensation lone HCE has greater EBAR than all NHCE’s
For new entrants, compensation earned as a participant is applied for testing only
Now 2 NHCE’s have a higher EBAR than the HCE and the plan passes
Plan definition of compensation may use total compensation for determining allocations
34
Defining Compensation
Effect of Section 414(s)
Self-employed participants
Need to adjust income based on inclusion ratio of
NHCE’s if “safe harbor” is not used
Rate of Compensation Rules
Cannot be used for ADP
Testing definition must parallel definition for
allocations
Must use inclusion ratio test under 414(s)
35
Defining Compensation
Effect of Section 414(s)
Pretend Compensation
Imputed compensation
Prior employer compensation
Only applies for DB plans
Must be used to determine benefits and for testing
Subject to non-discrimination testing
Legitimate business purpose
Consistency requirement
Imputed compensation under §415 still counts
36
Defining Compensation
Other Compensation Measurements
These tend to be rigid so as not to allow for variance in application
Deductions under §404
25% of compensation
Use §415(c)(3) definition (§404(a)(12))
This means total compensation including salary deferrals
HCE determination under §414(q)
Use §415(c)(3) definition (§414(q)(4))
This means total compensation including salary deferrals
37
Compensation Impact
Other Compensation Measurements
HCE Determination cont.
Definition used for applying threshold compensation in
prior year and for ranking of compensation in
determining top paid group
Top heavy minimum allocations/ accruals
Use §415(c)(3) definition (§416(i)(1)(D))
This means total compensation including salary deferrals
Must be based on plan year or calendar year ending within
plan year
Same definition must apply for all top heavy purposes,
such as determining officers and $150K
38
Compensation Period
Measuring period for compensation
Section 415- limitation year
Can be plan year
Calendar year
Some other 12 month period
Section 414(s)- testing, gateway, etc.
Plan year or
Calendar year ending within plan year
Other 12 month periods may be allowed
Compensation as a participant
Top heavy minimum- plan year only
39
Compensation Period
Measuring period for compensation
For 401(k)/(m) safe harbors under Reg
§1.401(k)-3(c)(5)(ii):
Allows for periodic matching
Pay period
Payroll periods within a month
Payroll periods within a quarter
Calculate compensation based on those periods
Must be paid by end of following quarter
Reg 1.401(k)-3(c)(5)(ii)
40
Compensation Period
Measuring period for compensation
Defined benefit plans
Plan year
12 month period ending within plan year
Prospective for BOY valuation
Slight overlap into next plan year
41
Compensation Period
Measuring period for compensation
Average compensation
Section 415 for DB plans uses 3 years of service for
100% of avg comp limit (§1.415(b)-1(a)(5))
Service versus participation
Less years are permitted if period of service is less than 3
years
Must be at least one year
Fractional years (at least one) are used
Periods during a severance of employment disregarded
Implied not all breaks in service disregarded
Section 416 uses 5 year avg (416(c))(1)(D))
42
Compensation Period
Measuring period for compensation
Average compensation
General testing/ cross-testing
Benefits under safe harbor DB formula
See Reg §1.401(a)(4)-3(e)(2)
At least 3 high consecutive years
Any start date
Continuous
End in current year
Various adjustments
Plan year compensation OK for testing if accruals determined over current year
43
Audits
An error discovered on audit that the definition
of compensation in the plan was not followed
could result in
Additional employer contributions
A reallocation of contributions
Earnings adjustment if the error is discovered in a
later year
Plan disqualification
44
Audits
Accountant procedures require that the
compensation definition be reviewed and
compared to the actual contributions
They are likely to question any match that is not
consistent with the formula, or anything not
involving whole numbers
45
Audits
Employers have an obligation to maintain or have access to
records to demonstrate
An error has not occurred
The person changed contribution percentages during the
year
The person entered or left mid year
The person switched to or from a non-eligible status
46
Audits
An IRS audit will include a review of whether the
definition of compensation in the plan document was
followed in operation
Using an incorrect definition of compensation is one of
the top 5 errors the IRS discovers
The IRS is specifically focused on failure to make
contributions on bonuses and taxable fringe benefits
47
Correction
Rev. Proc 2008-50 provides some guidance on
correcting an error in compensation
Acceptable correction methods
Additional employer contributions on any missed
compensation
Reallocation of contributions using the correct
definition
48
Planning Pointers
Practical Considerations- Plan Drafting
Compensation definition in plan
Applies to determination of allocations and benefit accruals
Applies to testing where plan defines a testing procedure
ADP testing
Can use a separate definition of compensation for ADP testing
Conversely, plan can use any 414(s) definition for non-discrimination testing that is not described in the plan
Generally year to year consistency not required
49
Planning Pointers
Practical Considerations- Plan Drafting
Compensation definition in plan
Best practice is not to define compensation for testing
Definition for allocation/accrual can be different than that used for testing
In general the definition for allocation or accrual need not be a 414(s) definition Reg §1.414(s)-1(a)(2)
§414(s) definition applies for ADP/ACP safe harbor contributions Reg § 1.401(k)-3(b)(2) and allocations intended to meet safe harbor formulas under Reg §1.401(a)(4)-12 (plan year compensation definition)
50
Planning Pointers
Practical Considerations- Plan Drafting
Compensation definition in plan
Ease of administration
Consider excluding taxable fringe benefits such as
taxable portion of health insurance and auto
allowance
If definition includes §125 deferrals, make sure
these are obtained
51
Planning Pointers
Practical Considerations- Plan Drafting
Compensation definition in plan
Avoid linking compensation definition to mechanics
of salary deferral elections
Avoid use of the term “compensation” in election
form
OK to refer to limits on deferrals as a % of
compensation in the plan document
The withholding process should be considered
administrative. Plan can acknowledge this.
52
Planning Pointers
Practical Considerations- Strategies
Plan amends definition of compensation to
exclude overtime pay
Only NHCE’s have overtime pay
Therefore, this definition will not pass the 414(s)
discrepancy test
Use total compensation under 414(s) to perform
testing
53
Planning Pointers
Practical Considerations- Strategies
Plan amends definition of compensation to
exclude overtime pay
Only NHCE’s have overtime pay
Therefore, this definition will not pass the 414(s)
discrepancy test
Use total compensation under 414(s) to perform
testing
54
Example
Base
Comp
Over-time ER
Alloc
Acc
Rate
Olio 200000 0 32500 6%
Lynn 75000 2000 6000 3%
Tracey 50000 0 3000 7%
Suzy 25000 3000 1500 8%
55
Example- Analysis
Use base compensation for determining
allocations
Use total compensation for testing
Specifically authorized under 414(s)
Keep in mind
Top heavy minimum allocation based on total
compensation for full year- 3% of comp
Gateway minimum can be based on compensation
earned as a participant and could exclude salary
deferrals- 5% of comp
56
Planning Pointers
Practical Considerations- Strategies
Exclude salary deferrals such as made under
401(k) and 125 plans
If HCE’s have compensation above 401(a)(17)
limit, then testing compensation for HCE’s may
remain at 401(a)(17) limit
Compensation for NHCE’s will reduce
Therefore allocation/ accrual rates for NHCE’s
will increase relative to those of HCE’s
57
Example
Status Total
Comp
Def $ Net
Comp
Gross
Def %
Net
Def %
Abe HCE 300K 16500 245K 6.73% 6.73%
Izzy NHCE 50K 2600 47400 5.20% 5.49%
Jake NHCE 40K 1600 38400 4.0% 4.17%
58
Example- Analysis Using gross compensation NHCE ADP is 4.6%
which is lower than the required 4.73% and a correction is needed
Using net compensation NHCE ADP is 4.83% and no correction is needed
Note 401(a)(17) caps compensation for HCE at $245,000 in both cases
Had the HCE have net compensation less than $245K, the result may have been worse
59
Planning Pointers
Practical Considerations- Strategies
Exclude categories of compensation for certain
non-owner HCE’s
For example, exclude commissions earned by
HCE’s in determining allocations
This will reduce allocation costs for those affected
Testing (if necessary) can be based on total
compensation, or adjusted compensation
60
Example
Base
Comp
Comm Total
Comp
Def SH
Match
Net
SH
Match
Gross
Dan 245K 0 245K 16500 9800 9800
Jon 245K 0 245K 16500 9800 9800
Ashley 50K 100K 150K 10000 2000 6000
Topley 100K 50K 150K 8000 4000 6000
61
Example- Analysis 414(s) allows exclusion of a category of income
Commissions are a category of income
If NHCE’s affected must test
Only HCE’s are affected- specifically authorized
Reduce match cost for non-owner HCE’s from
12K to 6K, a savings of 6K
62
Planning Pointers
Practical Considerations- Strategies
Use compensation for a subset of the year to
calculate and pay safe harbor matching
contributions
Does 415 limit apply to each pay period?
See Reg §1.401(a)(17)-1(b)(3)(iii)(A)
This technique avoids cost of paying and
calculating a “true-up” after year end
63
Example Plan has a safe harbor match
It is calculated and paid based on pay periods falling within the month
Participant receives compensation of $4,000 per month
Participant withholds $120 per month for 401(k)
Participant receives bonus of $2,000 in July and $5,000 in December
Participant withholds an additional $1,000 from each bonus
64
Example- Analysis
Total compensation for the year is $55,000
Total 401(k) deferrals for the year are $3,440
If full year compensation is used, then the match would
be 4% of compensation- $2,200
If match is calculated based on monthly compensation,
then
June compensation is $6,000 and deferrals are $1,120. Match
is $240
December compensation is $9,000 and deferrals are $1,120.
Match is $360
65
Example- Analysis
Compensation other 10 months is $4,000 per month
and deferrals are $120. Match is $120 each month
for a total of $1,200 for the year
Total match for the year is $1,800
Compare to $2,200 using the full year
Compensation must be measured each month (See
Reg §1.401(a)(17)-3(b)(iii))
Does this include taxable fringe benefits? Auto allowance?
Etc.
Are annual items of income pro-rated?
67
You Know You’re in Trouble
When… 10. DOL 408(b)(2) regulations authorize civil
penalties for Indecent Disclosure
9. The US military adopts the DOL’s electronic
5500 signing process as an acceptable method
of interrogation
8. ASPPA lobbies Congress to pass the Annual
Stimulus for Pension Professional Act (ASPPA),
requiring costly plan amendments each year
69
You Know You’re in Trouble
When… 7. You think a PTIN is something you find in an
outhouse
6. Caving in to client pressure, you held a 5500 signing party with open bar, this past Friday night
5. It figures that a Congressman from Texas would spend so much time thinking about cross-testing
4. You hire an ERPA to lead you on your next Himalayan expedition
70
You Know You’re in Trouble
When… 3. You think an AFTAP is something a
professional athlete does to a reporter, then gets in trouble
2. Rather than resort to the same old “double letter” protocol, the IRS devises a whole new alphabet for the sub-section following 414(z)
1. You’ve blown up more safe harbors this year than the Navy SEALS