Parsonage Vandenack Williams LLC
Attorneys at Law Licensed in Nebraska, Iowa, Michigan,
South Dakota, Texas, Arizona, and Colorado

As published in Steve Leimberg's Employee Benefits and Retirement Planning Newsletter on April 25, 2016.

Reproduced courtesy of Leimberg Information Services, Inc. (LISI) at

http://www.leimbergservices.com.

“The Internal Revenue Service recently announced the withdrawal of specific provisions of proposed regulations that were issued in January, 2016, related to the non-discrimination rules applicable to qualified retirement plans. The proposed regulations would have limited the existing rules under which a rate group with respect to an HCE could satisfy the average benefit test to rate groups that had a reasonable business classification.  

A rate group without a reasonable business classification would have been required to satisfy the ratio percentage test. Withdrawal of this regulation simplifies the ability for qualified plans to comply with the non-discrimination rules. The withdrawal particularly helps with cross-tested new comparability plans.”

In Employee Benefits and Retirement Planning Newsletter #657 (April 25, 2016), Mary Vandenack reports on the withdrawal of proposed regulations that should make it easier for cross-tested and new comparability plans to comply with the non-discrimination rules applicable to qualified retirement plans. 

Mary E. Vandenack is founding and managing partner of Vandenack Weaver LLC in Omaha, Nebraska. Mary is a highly regarded practitioner in the areas of tax, high net worth estate planning, executive compensation, benefits, asset protection planning, business succession planning, tax dispute resolution, and tax-exempt entities.  Mary’s practice serves businesses and business owners, executives, real estate developers and investors, health care providers and tax exempt organizations. Mary is a member of the American Bar Association Real Property Trust and Estate Section where she serves as Vice Chair of Technology and Economics of Practice Committee and serves on several other committees. Mary is also a member of  the Taxation and Business sections. Mary serves on the American Bar Association Commission on the Future of Legal Services and is Vice Chair of the Law Practice Division Futures Initiative. Mary is a frequent writer and speaker on tax, executive compensation, benefits,  asset protection planning, and estate planning topics as well as practice management issues including improving delivery of legal services, marketing, and increased access to the under-served.

Before we get to her commentary, members should note that a new 60 Second Planner by Bob Keebler was recently posted to the LISI homepage. In his commentary Bob reports on CCA 201614036, where the IRS Chief Counsel opined that a taxpayer's understatement of a prior year gift does not extend the assessment statute expiration date (ASED) for the current year. The text of the ruling can be found at https://www.irs.gov/pub/irs-wd/201614036.pdf. Click this link to listen to Bob’s podcast Now, here is Mary Vandenack’s commentary:

EXECUTIVE SUMMARY: 

The Internal Revenue Service has announced the withdrawal of specific provisions of proposed regulations that were issued in January, 2016, related to the non-discrimination rules applicable to qualified retirement plans.[i] The provisions being withdrawn would have modified §§1.401(a)(4)-2(c) and 1.401(a)(4)-3(c).

FACTS:

  • 401(a)(4) of the Internal Revenue Code provides that the contributions or benefits under qualified retirement plans cannot discriminate in favor of highly compensated employees ("HCE’s"). §414(q) provides that a highly compensated employee includes any employee who is a five percent owner (during current or prior plan year) or received compensation in excess of a specified amount ($120,000 in 2016). A plan (defined contribution or defined benefit) can satisfy the non-discrimination requirements by establishing either that the contributions are not discriminatory or that the benefits are not discriminatory.

For a defined contribution plan to establish that the plan is not discriminatory on the basis of benefits, the allocations to the plan for employees are converted to a projected benefit at retirement.  After such conversion, the benefits are tested to ensure the plan doesn’t discriminate in favor of HCE’s. This type of testing is referred to as cross-testing.

After regulations were finalized regarding cross-testing, age weighted and new comparability defined contribution plans became popular. Age weighted plans divide employees into groups based strictly on age. New comparability plans divide employees into different groups or categories other than just age. The non-discrimination testing for such cross-tested plans involves the employer defining classes of employees and making varying contributions to each class. Often, a cross-tested plan has the effect of allowing more contributions to be made on behalf of older employees or HCE’s.

The regulations provide basic approaches for a plan to establish that the plan is non-discriminatory. A plan can satisfy a design based safe harbor specified in §1.401(a)(4).  Such a plan is designed for non-discrimination certainty. Alternately, the plan can use a non-design based safe harbor allocation or accrual formula, which requires testing under the general nondiscrimination rules (rate group testing).

A plan being tested under the general non-discrimination rules involves the following steps: (1) determining the accrual rate for each participant; (2) dividing the participants into rate groups; (3) verifying that each rate group passes either the average benefits test or the ratio percentage test of §410(b).

In January, 2016, the Internal Revenue Service issued proposed regulations modifying the nondiscrimination requirements applicable to qualified retirement plans.[ii]

  • 1.401(a)(4)-2(c)(3)(ii) currently provides:

(ii) Application of nondiscriminatory classification test. – A rate group satisfies the nondiscriminatory classification test of §1.410(b)-4 if and only -

(A)The formula that is used to determine the allocation for the HCE with respect to whom the rate group is established applies to a group of employees that satisfies the reasonable classification requirement of §1.410(b)-4(b); and

(B) The ratio percentage of the plan.

The proposed regulation that is being withdrawn provided:

(ii) Application of nondiscriminatory classification test. – A rate group satisfies the nondiscriminatory classification test of §1.410(b)-4 (including the reasonable classification requirement of §1.410(b)-4(b)) if and only if the ratio percentage of the rate group is greater than or equal to the lesser of-

(A)The midpoint between the safe and unsafe harbor percentages applicable to the plan; and

(B) The ratio percentage the rate group is greater than or equal to the midpoint between the safe and unsafe harbor percentages applicable to the plan (or the ratio percentage of the plan, if that percentage is less.

  • 1.401(a)(4)-3(c)(2) currently provides:

(2) Satisfaction of section 410(b) by a rate group.—For purposes of determining whether a rate group satisfies section 410(b), the same rules apply as in § 1.401(a)(4)-2(c)(3). See paragraph (c)(4) of this section and § 1.401(a)(4)-2(c)(4), Example 3 through Example 5, for examples of this rule.

The proposed regulation that is being withdrawn provided:

(2) Satisfaction of section 410(b) by a rate group.—For purposes of determining whether a rate group satisfies section 410(b), the rules of §1.401(a)(4)-2(c)(3) apply except that §1.401(a)(4)-2(c)(3)(ii)(A) is applied by substituting "benefit formula" for "formula that is used to determine the allocation." See paragraph (c)(4) of this section and §1.401(a)(4)-2(c)(4), Example 3 through Example 6, for examples of this rule. See §1.401(a)(4)-13(a)(4) for rules on the effective/applicability date of this paragraph (c)(2).

COMMENT: 

The Proposed Regulations would have limited the existing rules under which a rate group with respect to an HCE could satisfy the average benefit test to rate groups that had a reasonable business classification.  A rate group without a reasonable business classification would have been required to satisfy the ratio percentage test.

Withdrawal of this regulation simplifies the ability for qualified plans to comply with the non-discrimination rules. The withdrawal particularly helps with cross-tested new comparability plans.

HOPE THIS HELPS YOU HELP OTHERS MAKE A POSITIVE DIFFERENCE! 

Mary Vandenack 

LISI Employee Benefits & Retirement Planning Newsletter #657 (April 25, 2016) at http://www.leimbergservices.com  Copyright 2016 Leimberg Information Services, Inc. (LISI). Reproduction in Any Form or Forwarding to Any Person Prohibited – Without Express Permission.

CITATIONS:

[i] Announcement 2016-16, 2016 FED ¶46,311 (April 15, 2016).

[ii] Standard Federal Tax Reporter (2016), Proposed Amendments of Regulations (REG-125761-14), NPRM REG-125761-14, Internal Revenue Service, (Jan 29, 2016).

 

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