We have a couple of retirement plans that are sponsored by partnerships with complicated income allocation formulas. I was thinking that plan administration would be much easier if we could define compensation for purposes of the owners as an amount equal to the lesser of guaranteed payments or earned income. These are profitable partnerships so it would be rare that the guaranteed payments ever exceeded a partners earned income. This would greatly simplify plan administration as any profit sharing contribution would not change each time there was a slight adjustment to partnership income.

Do you see a definition of compensation like this as problematic? I worry about whether or not the IRS might argue that the profit sharing contribuiton is a deemed deferral becasue of the control a partner would have with regards to guaranteed payments. If the guaranteed payment amount was stipulated before the start of the plan year would it make a difference?

Thanks in advance for any advice you can offer.

Dean Huber

I think the definition is doable. The IRS wouldn't have that problem, since with a corporation the owner is doing the same thing, defining their salary.

However, this definition of compensation is not a safe harbor. If you have any NHCE's, you will have to run the compensation ratio test and to do that you need to know earned income. You would also need to know earned income to determine the deductible limit, the 415 limit, etc.

Personally, it sounds as if your proposed solution is harder then the original problem. BTW, what is the complication in this case? I don't understand what you mean by "income allocation formulas". Are you referring to the allocation of the contribution?

The plan I am most concened with doesn't push the limits of 415 or 404, so they don't worry me much. In the end we woudl have earned income calculated so we could make sure they complied. Since we would use the lower of earned income or the stipulated amount I don't see that there would ever be a chance of failing the compensation ratio test since the HCE's would be the only ones where less than 100% of their compensation was included.

With respect to complications. Both are complicated, partnership income allocation and contribuiton allocation, but the contribution is the biggest pain. The contribution is cross-tested so we are allocating the contribution using a spreadsheet (our software will do a partnership SE income allocation if one contribuiton is allocated, but when we are allocating different amounts to different groups our software won't correctly calculate SE income). After calculating the contribution using a spreadsheet we then enter the earned income amounts in our software, enter the contributions, and perform the testing. If the testing fails we have to go back to the spreadsheet and redo the contribution. This changes earned income which means we have to reverse all our transactions in our admin software, change the partners earned income, and repost the contribution transacitons and rerun the testing.

If we could use a stipulated income amount (an amount less than earned income), but used it for all our testing, we could eliminate the use of a spreadsheet altogether. If the plan passed all testing using the stipulated income amount it should pass if actual earned income (which would be greater) were used.

The weekness I see in this method is it wouldn't work well if we were trying to max out the principals at their 415 limit. In this case we are not, so I'm thinking it would be much easier. The time spent with the spreadsheet usually exceeds the time spent getting the data in our software.