Chapter 5 Profit-Sharing Plans

at least one third of the allocation rate of the HCE with the highest allocation rate. at least five percent of the NHCE's compensation.

"minimum allocation gateways." The general rule is that a plan satisfies the minimum allocation gateway if each NHCE has an allocation rate that is ... The second gateway provides that a plan is deemed to satisfy the minimum allocation gateway if each NHCE receives an allocation of ....

the allocation is nondiscriminatory and the contribution to each employee's account is not more than the maximum permitted for the year ($61,000 for 2022).

Conceptually, the deduction limit simply creates a big bucket of money, which must then be distributed among the participating employees in a nondiscriminatory manner. There is not a requirement that all employees who receive the same salary receive the same contribution to their individual account so long as (2 requirements):

"Substantial and recurring." Contributions can be in the form of employer stock, but proxy voting rights remain with the plan trustee. A plan that does not make any contributions for an extended period of time risks disqualification.

Contributions to profit-sharing plans are generally discretionary but funding must be what 2 things?

The due date of the company's tax return (including extensions) for the year for which the employer will be contributing to the plan to be treated as having been established as of the last day of the taxable year. Contributions can be made to the plan as late as the due date of the company income tax return (including extensions).

For tax years beginning after December 31, 2019 the SECURE (Setting Every Community Up for Retirement Enhancement) Act created additional flexibility for plan sponsors wishing to adopt a new qualified plan by allowing a plan established by when?

5.4 percent 4.3 percent remains at 5.7 percent.

If the integration level is less than the Social Security wage base, but more than 80 percent of the wage base, then the 5.7 percent is reduced to __________. If the integration level is less than or equal to 80 percent of the wage base and greater than 20 percent of the wage base, then the 5.7 percent is reduced to _________. At 20 percent or less, the rate is __________.

-the 15th day of the third month following the end of the tax year and can be extended by six months by properly filing for the extension by the due date of the tax return. -the 15th day of the 4th month following the end of the tax year, and can be extended for up to six months by properly filing for the extension by the due date of the tax return.

Tax returns for partnerships and S-corporations are due by: C corporation tax returns are due by:

True

True or False A catch-up contribution can allow an eligible employee to defer more than the annual additions limit of $61,000 for 2022.

False - In addition to the normal distribution options, 401(k) participants may also take distributions for hardships.

True or False A distribution from a 401(k) plan is not available until the plan participant either retires or dies.

True

True or False A hardship distribution can be taken from a 401(k) plan for an amount equal to the employee's total elective contribution, QNECs [Qualified Non-Elective Contributions], QMCs [Qualified Matching Contributions], and earnings on these amounts, less the value of any previous hardship distributions.

False - A negative election requires an employee to proactively opt-out of the plan.

True or False A negative election is an election the employee can make that states that they want to participate in the plan.

False - A pension plan may not invest more than 10% of its assets in employer securities.

True or False A pension plan can be funded using 100% employer securities.

Base compensation ($) compensation up to the integration level Excess compensation ($) compensation above the integration level Base contribution ($) contribution for compensation up to the integration level Excess contribution ($) contribution for compensation above the integration level and below the covered compensation limit.

- represents compensation up to the integration level, $147,000 for 2022. - represents compensation above the integration level, (over $147,000 for 2022) but below the covered compensation limit ($305,000 for 2022). - represents the contribution for compensation up to the integration level. - represents the contribution for compensation above the integration level and below the covered compensation limit.

contributory

A cash or deferred arrangement (CODA), generally referred to as a 401(k) plan, is a feature that attaches to certain types of qualified plans to create a __________ component to the plan.

respective classification in the company as defined by the plan sponsor (employer). The contributions for the "owner" category classification will always be higher than the contributions for other employee classifications.

A new comparability plan is a profit-sharing plan in which contributions are made to an employee's account based on their what?

A fixed number of years, the attainment of a stated age, or upon the prior occurrence of some event such as layoff, illness, disability, retirement, death, or severance of employment. A formula for allocating the contributions among the participants is definite if, for example, it provides for an allocation in proportion to the basic compensation of each participant.

A profit-sharing plan is a plan established and maintained by an employer to provide for the participation in profits by employees or their beneficiaries. The plan must provide a definite predetermined formula for allocating the contributions made to the plan among the participants and for distributing the funds accumulated under the plan based on what criteria?

The correct answer is d. Matching contributions cannot be contributed to a Roth account. Balances in 401(k) plans can be rolled over to a Roth account in the form of an in-plan Roth rollover. Roth account balances remaining in a qualified retirement plan are subject to minimum distributions beginning at age 72 (70½). Roth accounts do not have income limitations like Roth IRAs.

Acme Inc., is establishing a retirement plan and they want a plan that includes a Roth account. Which of the following statements is correct about Roth accounts? a. Matching contributions can be contributed to Roth account. b. Amounts in a traditional 401(k) plan cannot be rolled over to a Roth account. c. Roth accounts do not require minimum distributions until after the death of the participant. d. Roth accounts permit access for taxpayers who may otherwise not be able to contribute to a Roth IRA.

age-based profit-sharing plans, integrated plans, and new comparability plans The use of such plans is permitted by the IRS because they are within the anti-discrimination permissible limits.

Although contributions must be made on a nondiscriminatory basis, there are types of profit-sharing plans available that provide for larger allocations of contributions to shareholders, officers, and highly compensated employees. Among these types of plans are: (3) types

reduced to allow for larger amounts of income to be subject to the higher excess rate. However, as the integration level is reduced, so is the maximum difference between the base rate and the excess rate.

Although the integration level is generally equal to the Social Security wage base, it can be what?

older than most or all other employees and the company wants to tilt the contribution toward those older employees. The concept of using an age-weighting formula in the allocation of benefits is based on a theory of comparable benefits for employees at normal age retirement (usually 65). Age-based profit-sharing plans use both age and compensation as the basis for allocating contributions to an employee's account.

An age-based plan is chosen when the employee census is such that the owner or key employee is...

A 10% excise tax on the portion of the contribution that exceeds 25 percent of covered compensation for the current year.

An employer may contribute more than the permitted 25 percent employer contribution limit to a profit sharing plan. In such a case, the employer will currently deduct the 25 percent (on the tax return) and may carry forward the contribution amount in excess of the 25 percent limit and deduct this amount in a future year. However, the amount carried forward when added to the contribution made for the future year cannot exceed 25 percent. Additionally, the employer is required to pay what tax for overpaying?

$5,000 (10% x $50,000) $23,021 [10% x $147,000 plus 15.7% x ($200,000 - $147,000), rounded to the nearest dollar] It is important to understand that integration has increased Mike's contribution by $3,021 ($23,021 - $20,000) over a straight 10 percent plan. This higher contribution is a result of the higher excess contribution rate for compensation above the integration level.

Assume that Tantalus Inc. sponsors an integrated profit-sharing plan that provides for a 10 percent base contribution percentage and an excess contribution percentage of 15.7 percent. If Dave earns $50,000, he would receive a contribution of ____________ If Mike earned $200,000 and the Social Security wage base was $147,000, then Mike would receive a contribution of __________

The correct answer is b. Compensation is limited to $305,000 for 2022. He is limited by the 415(c) limit, which is $61,000 for 2022. An 18% contribution limits his deferral to $6,100 ($61,000 - (305,000 x 18%)).

Dustin, who is 48 years old, works for Pinnacle Inc., with a salary of $320,000, a car allowance, and a very nice expense account. Pinnacle is a Fortune 1,000 company that sponsors a defined benefit plan that pays two percent times years of participation times the average of the three final years of compensation. In addition, Pinnacle sponsors a 401(k) / profit-sharing plan and contributes 18% of employees salary to the profit-sharing plan. There is no additional match. If the ADP of the NHCEs is 3%, what is the maximum that Dustin can defer this year (2022)? a. $400. b. $6,100. c. $14,250. d. $19,500.

To reduce future contributions to the plan since the owner cannot personally benefit from forfeitures. Alternatively, a forfeiture policy of reallocation can be combined with integration or an age-based approach to assist the owner in receiving the maximum contribution allowed.

Forfeitures cannot be reallocated to participants' accounts that have already reached their annual additions limit for the year. Therefore, an owner who has managed to have current contributions of $61,000 for 2022 made to their account will likely consider having forfeitures used for what?

reduce future plan contributions or be reallocated to the remaining participants' accounts. However, any such reallocation of the forfeiture amounts must not be discriminatory in favor of highly compensated employees, owners, or officers. Reducing future plan contributions is best for those who have maxed out their contributions.

Forfeitures in a profit-sharing plan may either be used to do either of what two things?

fulfilled two years of participation in the plan.

Generally, profit-sharing plans do not permit employees to receive distributions from the plan except upon termination, hardship, disability, or retirement. However, profit-sharing plans may permit in-service withdrawals after the participant has...

The correct answer is d. Cole is highly compensated through family attribution. The ADP of the NHCEs is 5% and not 6.67%. Option c is not correct as QMC would only go to NHCEs.

Jack and Jill own a successful engineering company, which sponsors a 401(k) plan that requires standard eligibility. Cole, Beau, and Mary are the only other employees, who are between the ages of 25 and 29 and have been with the company for a couple of years. Jack and Jill each have salaries of $200,000, while their employees have salaries ranging between $28,000 and $30,000. Jack and Jill both defer $10,000 each. Cole, who is Jack and Jill's son, earns $30,000 and defers $6,000 into the 401(k) plan. Beau, who makes $28,000, defers $2,800, while Mary does not defer anything into the 401(k) plan. Which of the following statements is correct? a. The ADP for the NHC employees is 6.67%. b. Jack and Jill are the only highly compensated employees. c. If the plan failed the ADP test, then the issue could be solved by providing a qualified matching contribution to all five employees. d. If the company hired a new employee, it would not increase the amount that Jack and Jill can defer during the first year of the employee's employment?

The correct answer is d. Vesting is based on years of service with the employer. Larissa keeps the entire deferral of $20k. The cash balance plan uses a 3-year cliff, which means that she keeps all of the $40k. The matching contributions will vest over a 2-to-6-year graded schedule, which means that she keeps 40% of the $10k, for a total of $64k.

Larissa, who is age 45, has just resigned from her current job. She worked for Ace, which sponsors a cash balance plan and a standard 401(k) plan. Each of the plans uses the longest permitted vesting schedule and both plans are top heavy. Larissa has a balance of $40,000 in the cash balance plan, has deferred $20,000 into the 401(k) plan and has employer matching contributions of $10,000. If she has been employed for three years, but only participating in the plans for the last two years, how much does she keep if she leaves today? a. $20,000. b. $30,000. c. $60,000. d. $64,000.

Age 21 and one year of service will generally apply to profit-sharing plans. As discussed before, plan sponsors may always relax the eligibility requirements. Profit-sharing plans may also require a two-year waiting period before an employee is eligible; however, all employer contributions must then be 100 percent vested. The two-year eligibility rule is not a common choice for most businesses due to the 100 percent vesting requirement.

Profit-sharing plans are subject to standard eligibility rules of other qualified plans. Therefore, the standard eligibility of apply, what are the standard eligibility?

25% of covered compensation Covered compensation is considered to be the compensation of all eligible employees. Therefore, if an employer's total covered compensation paid to its employees is $1,000,000, then the largest income tax deduction that can be taken by the employer for contributions to the plan is $250,000 ($1,000,000 x 25%).

Profit-sharing plans have an employer contribution limit of what percentage?

The correct answer is d. Statement 1 is false. $150,000 is subject to the 1.45% and the wage base ($147,000 for 2022) is subject to 6.2%. $140,000 of wages are subject to federal income tax.

Reese earns $150,000. She defers $10,000 into her 401(k) traditional account and $5,000 into her 401(k) Roth account. Which of the following statements is/are true? 1. Only $140,000 of earnings is subject to FICA. 2. Her W-2 wages subject to federal income tax equals $135,000. a. 1 only. b. 2 only. c. Both 1 and 2. d. Neither 1 nor 2.

It must do so by September 15 of next year (partnership returns are due by the 15th day of the third month following the end of the tax year, and can be extended by six months). Contributions must be made no later than September 15 of next year assuming that it has properly filed all extensions for its tax return.

Sasso partnership, a calendar year taxpayer, wants to establish a profit-sharing plan for the current year. When is the latest it can make the first contribution?

The correct answer is d. The first three options require annual funding, which is generally not the best choice for a small business. Option d permits Seth to save over $50,000 per year or almost half of his income, between the salary deferral, catch-up and profit-sharing contribution. In addition, he has no requirement to fund it all, as the plan is discretionary.

Seth, who is about 55 years old, runs a local Po'Boy shop in New Orleans. He has several high school kids who work for him part-time. Seth's mom, Robin, helps make the best meatballs in the universe and works there full-time. Which of the following plans makes the most sense for Seth if he earns about $120,000 and does not want to spend too much on a retirement plan? a. Money purchase plan. b. Tandem plan. c. Cash balance plan. d. 401(k) / profit-sharing plan.

The correct answer is c. The excess percentage is 10% - it is limited to twice the base percentage.

Sheehan works for Andy Company and is a superior sales guy. His total compensation this year is $400,000. Andy sponsors an integrated profit-sharing plan with a base percentage of 5% and a maximum excess percentage. It uses the current wage base as the integration level. What is the excess percentage that will be applied Sheehan's compensation above the integration level? a. 5.0%. b. 5.7%. c. 10.0%. d. 10.7%.

profit-sharing stock bonus

Specifically, a CODA is permitted with _________ _______ plans and _________ ________ plans. The CODA permits employees to defer a portion of their salary on a pre-tax basis to the qualified plan, thereby reducing their current income tax liability. These employee elective deferral contributions are tax-deferred - meaning that the earnings are not subject to income taxation until such time as the employee receives a distribution.

The correct answer is b. The ACP test does not include employer profit-sharing contributions.

The ACP test includes which of the following contributions? 1. Employer matching contributions. 2. Employer profit-sharing contributions. 3. Employee after-tax contributions. a. 1 and 2. b. 1 and 3. c. 2 and 3. d. 1, 2 and 3

The correct answer is d. The ADP test generally only applies to non-safe harbor 401(k) plans. It does not apply to profit-sharing plans without a CODA.

The actual deferral percentage (ADP) test is one of the tests that some qualified plans must comply with. Which of the following plans must generally comply with the ADP test? 1. Profit-sharing plans. 2. Safe harbor 401(k) plans. a. 1 only. b. 2 only. c. Both 1 and 2. d. Neither 1 nor 2.

the lesser of twice the base rate or a maximum difference of 5.7 percent. The excess rate is generally 5.7 percentage points higher than the base rate. In other words, the maximum disparity equals the lesser of the base rate or 5.7 percent.

The excess rate is limited to...

False - A profit-sharing plan (like qualified plans) cannot require the participants to wait more than 2 years before becoming eligible for the plan

True or False A profit-sharing plan can require the participants to wait three years before entering the plan, but all contributions must then be 100% vested.

False - A profit-sharing plan allows all eligible employees to participate in the profits of the company. An eligible employee does not have to be an officer or shareholder to participate in a profit-sharing plan.

True or False A profit-sharing plan is a plan established and maintained by an employer to provide participation in the profits of the company solely for officers and shareholders.

False - For tax years after 1996, tax-exempt entities are permitted to establish 401(k) plans.

True or False A tax-exempt organization cannot establish a 401(k) plan.

True

True or False Age-based profit-sharing plans use both age and compensation as the basis for allocating contributions to employee accounts.

True

True or False All eligible employees (age 21 and one year of service) are included in the calculations for the ADP [Actual Deferral Percentage] test including those employees who elect not to defer.

False - The annual deferral limit of $20,500 for 2022 is the maximum that can be contributed to either account or in combination.

True or False An employee can contribute the maximum deferral limit of $20,500 to the 401(k) pre-tax account and another $20,500 to the Roth account, if both accounts are available in the plan.

False - Employee elective deferrals must be deposited and segregated from the employer's assets by the earliest date that is reasonably possible. However, the segregation of the funds must be completed by the 15th day of the month following the deferral from the employee's compensation.

True or False An employer is not required to deposit the employee's 401(k) plan deferral contributions until the 15th day of the month following the deferral.

True

True or False As a maximum, an individual age 50 or older can defer $27,000 in 2022 to a 401(k) plan.

True

True or False Employee deferral contributions to 401(k) plans are subject to payroll taxes at the time of contribution.

True

True or False Employers can establish 401(k) plans with minimal expense.

True

True or False Governmental entities cannot establish 401(k) plans today.

False - Hardship withdrawals are ONLY available if there is an immediate and heavy financial burden AND the participant has NO other assets available to satisfy the need.

True or False Hardship withdrawals are available if there is an immediate and heavy financial burden even if the participant has other assets available to satisfy the need.

False - If a CODA fails the ADP test, there are four alternative remedies to bring the plan into compliance: corrective distributions, recharacterization, qualified nonelective contributions, or qualified matching contributions.

True or False If a CODA [Cash or Deferred Arrangement] plan fails the ADP [Actual Deferral Percentage] test, the plan will be terminated.

False - Matching contributions vest on a 3-year cliff or 2 to 6 year graded vesting schedule.

True or False Matching contributions vest at either a 2 to 6 year graduated vesting schedule or a 5 year cliff vesting schedule.

False - The regulations associated with new comparability plans restrict their flexibility and require minimum allocations to NHCEs.

True or False New comparability plans are flexible plans that allow the employer to allocate all benefits to the owner[s].

False - The ADP for the NHCEs is 4% (20%/5). The HCEs are limited to 6%, which is 2% above the 4% average.

True or False Orange Co. has a non-safe harbor 401(k) plan with 5 NHCEs who defer 4%, 0%, 10%, 0% and 6%. As a result, the HCEs are limited to a deferral of 8%.

False - Permitted disparity is a technique of allocating plan contributions to employees whose compensation is in excess of the Social Security wage base [or integration level] for the plan year.

True or False Permitted disparity is a method of allocating plan contributions that allows the employer to make contributions only to highly compensated individuals because they do not receive Social Security.

True

True or False Profit-sharing plans may permit in-service withdrawals after a participant has attained two years of service in the plan.

True

True or False Profit-sharing plans must be established by, and contributions made by, the due date of the tax return including extensions for the tax year for which the employer wants to make contributions.

True

True or False The 401(k) eligibility rules are not the same as profit-sharing plans.

False - The 401(k) must have at least 2 entrance dates per year to meet the requirements of a qualified plan.

True or False The 401(k) must have at least 4 entrance dates per year.

True

True or False The elective deferrals of the highly compensated employees may be limited based on the elective deferrals of the non-highly compensated employees.

True

True or False The employee 401(k) plan deferral limit is indexed for inflation after 2006.

False - The pre-PPA 2006 safe harbor provisions require that matching contributions or nonelective contributions must be 100% vested to avoid calculating the ADP test.

True or False The pre-PPA 2006 safe harbor provisions require that a 401(k) plan use top-heavy vesting schedules to avoid calculating the ADP [Actual Deferral Percentage] test.

False - Under PPA 2006, profit-sharing plans must use a 3-year cliff vesting schedule or a 2 to 6 year graduated vesting schedule.

True or False Under PPA 2006, profit-sharing plans must use a 5-year cliff vesting schedule or a 3 to 7 year graduated vesting schedule.

Profit-Sharing Plans, Stock Bonus Plans, Employee Stock Ownership Plans, 401[k] Plans, Thrift Plans, Age-Based Profit-Sharing Plans, New Comparability Plans

What are the 7 types of profit sharing plans?

the amount not vested.

When employment is terminated and the employee has funds in a profit-sharing plan that are less than 100 percent vested, the employee forfeits what amount?

The correct answer is a. QACA is a another option to the safe harbor plan. However, the matching contribution requirements for the employer are slightly different.

Which of the following statements is correct regarding the qualified automatic contribution arrangement (QACA)? 1. The QACA can be used to avoid ADP testing. 2. The required employer contribution (or match) is the same as required for a safe harbor plan. a. 1 only. b. 2 only. c. Both 1 and 2. d. Neither 1 nor 2.

the base contribution percentage rate and the excess contribution percentage rate The base rate is applied on income earned up to the integration level [usually the SS wage limit $147,000 for 2022], while the excess rate is applied to income earned above the integration level but only up to the maximum covered compensation limit for the year, $305,000 for 2022.

With an integrated formula, there are two profit-sharing plan contribution rates established, what are the 2 rates?

"offset method" or an "excess method" "excess method"

With the Revenue Act of 1942, private pension plans are permitted to provide larger benefits to higher-paid workers than to lower-paid workers in an attempt to reduce the gap in total wage replacement. Plans may consider the benefits provided by Social Security in the design of their benefit formula. Plans can integrate their retirement benefit formulas with Social Security under (2 methods) However, a defined contribution plan may only use the _________ method.

Permitted disparity (often referred to as Social Security Integration)

____________ ___________ (often referred to as _________ _________ __________) is a technique or method of allocating plan contributions to employees' accounts that provides higher contributions to employees whose compensation is in excess of the Social Security wage base for the plan year.

New Comparability Plan

_____________plans are more complicated but provide an effective option for small businesses to benefit higher-paid owners.