Comments to the IRS on the 401(k) Proposed Regulations
Rev. 08/14/03, E-mail Alert 2003-15 Rev. 11/11/08

Richard Hochman of McKay Hochman will be submitting comments to the IRS on the newly proposed 401(k) and 401(m) regulations. He also will be testifying at the public hearing in November. Click here to read about some of the issues he will be addressing. Feel free to send your comments to Rich at rhochman@mhco.com, if there are any issues you would like to see him address.

Below are three areas of concern Update 11/11/08 Note: Rev.Proc 2005-66 Requires discretionary Amendments by end of plan year for which amendment is mod.

Timeframes for amending plans to change ADP/ACP testing related provisions.
There are some practitioners who believe that it is permissible to change the testing method by amending a plan during the 2 ½ months immediately following the close of the plan year (when testing is being done). Some practitioners have expressed the opinion that employers have until the end of the correction period (i.e. 12 months) to change testing methods Depending on who you ask, such retroactive plan amendment may or may not be acceptable. At recent industry conferences, IRS representatives have clearly stated that amendments should not be made after the end of the plan year being tested.

There are two testing rules that might be amended. One is changing from current year to prior year or vice versa, the other is changing the definition of HCE to include the top 20% rule. The challenge is that the need to make these changes is not evident until testing is actually performed, which is not until after the end of the plan year.

Permitted disparity issue
Another issue not addressed is the inconsistent treatment of permitted disparity and cross-tested allocations in safe harbor 401(k) plan rules. The safe harbor 401(k) plan rules do not allow the 3% safe harbor contribution to be used as the base allocation in permitted disparity formulas. Surprisingly, cross-tested allocations work the opposite way. The safe-harbor rules allow the 3% provided as a non-elective contribution to also be used as part of the cross tested allocation.

GAP Income Calculation Update 11/11/08 PPA eliminated GAP income on ADP/ACP tests effective for plan years starting 1/1/08.
The introduction of a requirement to perform GAP income calculations again will be an administrative challenge which will be very difficult to accomplish. Balance forward and even daily valuation plan administrators have already begun to state that this will be a very difficult calculation.
The proposed regulation Gap income calculation is provided below.

1. Safe Harbor method of allocating gap period income.
Income on excess contributions for the gap period is equal to 10% of the income allocable to excess contributions for the plan year*, multiplied by the number of months that have elapsed since the end of the plan year.

*Method of allocating plan year income for this section
“A plan may allocate income to excess contributions for the plan year by multiplying the income for the plan year allocable to elective contributions and other amounts taken into account in this section (including contributions made for the plan year), by a fraction, the numerator of which is the excess contributions for the employee for the plan year, and the denominator of which is the account balance attributable to elective contributions and other contributions taken into account under this section as of the beginning of the plan year (including any additional amount of such contributions made for the plan year).”

2. Alternative method for allocating plan year and gap period income.
"A plan may determine the allocable gain or loss for the aggregate of the plan year and the gap period by applying the alternate method provided by paragraph (b)(2)(iv)(C)* of this section to this aggregate period. This is accomplished by substituting the income for the plan year and the gap period for the income for the plan year and by substituting the contributions taken into account under this section for the plan year and the gap period for the contributions taken account under this section for the plan year in determining the fraction that is multiplied by that income."

*Paragraph (b)(2)(iv)(C) of this section is entitled "Alternative method of allocating plan year income" and states:
"A plan may allocate income to excess contributions for the plan year by multiplying the income for the plan year allocable to the elective contributions and other amounts taken account under this section (including contributions made for the plan year), by a fraction, the numerator of which is the excess contributions for the employee for the plan year, and the denominator of which is the account balance attributable to elective contributions and other contributions taken into account under this section as of the beginning of the plan year (including any additional amount of such contributions made for the plan year).