Small Business Job Protection Act adds simplicity (and complexity.)

• Author: Schneider, Mark N.

EXECUTIVE SUMMARY

* A plan can provide that participants can waive the 30-day QJSA notice period requirement, as long as the first distribution begins more than seven days after notice is provide.

* The SBJPA limited application of the minimum participation rule to defined benefit plans.

* Plan administrators may be able to avoid nondiscrimination ADP/ACP testing under new safe harbor contribution formulas established by SBJPA Section 1433(a).

The Small Business Job Protection Act of 1996 (SBJPA) made many changes in the employee benefits area, some of which aid employers in administering plans. While this is good news, the so-called simplification provisions also add complexity in terms of creating new tests and standards to apply. This article highlights some of the many changes made by the SBJPA and their implications for both employers and employees.

The Small Business Job Protection Act of 1996 (SBJPA), enacted Aug. 20, 1996, contained many pension "simplification" provisions. This article highlights and analyzes some of the amendments made to Sec. 401(k) plan and other qualified plan provisions.(1)

Definition of HCE

The correct determination of which employees are highly compensated employees (HCEs) is pivotal to plan qualification. Prior to the SBJPA, Sec. 414(q)(1) contained four different definitions of HCE. SBJPA Section 1431(a) simplified the definition of HCE to include only any employee who:

1. Was a 5% owner at any time during the year or the preceding year (Sec. 414(q)(1)(A)), or

2. For the preceding year, had compensation from the employer greater than $80,000, and, if the employer elects for that year, was in the top-paid group of employees (Sec. 414(q)(1)(B))

   Sec. 414(q)(1), flush language, states that the $80,000 threshold is subject to cost-of-living adjustments. The top-paid group, according to Sec. 414(q)(3), is the top 20% of employees based on compensation. Other than for new shareholders acquiring a 5% interest during the year, plan administrators will now be able to determine the HCE group at the beginning of the year. Guidance on how and when to make the top-paid group election is needed. Narrowing or expanding the HCE group by making or forgoing the top-paid group election triggers interesting planning opportunities; for example, professional service firms with several HCEs may be able to forgo the election in order to target benefits to certain employee groups, and exclude lower-paid HCEs.

   According to SBJPA Section 1431(d), the effective date of the new definition is years beginning after 1996, except that, in determining whether an employee is an HCE for years beginning in 1997, the amendments are treated as having been in effect for years beginning in 1996.

   Family Aggregation Rules

   SBJPA Section 1431(b)(1) repealed the family aggregation rules under Sec. 414(q)(6), effective for years beginning after 1996. Under pre-SBJPA Sec. 414(q)(6), if an employee was a family member of either (1) a 5% owner or (2) one of the top 10 HCEs (by compensation), any compensation paid to, and any contribution or benefit under the plan for, such employee was aggregated with that of his HCE relative. The family member and the employee were treated as a single HCE.

   Recognizing the complexity of these rules and the importance of having adequate retirement benefits for all family members, Congress repealed Sec. 414(q)(6). Secs. 401(a)(17) (the $150,000 limit on compensation that a plan may take into account) and 404(1) (the qualified plan deduction) were correspondingly amended,by SBJPA Section 1431(b)(2) and (3).

   The repeal applies to the treatment of an HCE, but does not affect the ownership attribution rules used in determining HCE status.

   Example 1: H is a 100% shareholder in, and W, his spouse, is an HCE in, Z Corporation in 1997. H and W are considered separate HCEs; they are not combined into one HCE.

   ADP/ACP Tests: Prior-Year Deferrals

   Qualified cash or deferred arrangements (CODAs) are subject to a special nondiscrimination test under Sec. 401(k)(3)(A) for employee deferral contributions. A plan that would otherwise fail to meet the test is not treated as failing if the test is corrected by (1) additional employer contributions, (2) refunds of excess deferrals or (3) recharacterization of deferrals as employee after-tax contributions. Similar rules exist for employer matching and employee after-tax contributions under Sec. 401(m)(2). SBJPA Section 1433(c)(1) modified the Section 401(k)(3)(A) test by providing that the computation of the maximum permitted actual deferral percentage (ADP) for HCEs for the year is determined by reference to the ADP for non-HCEs for the preceding, rather than the current, year. Sec. 401(m)(2)(A) was similarly amended, by SBJPA Section 1433(c) (2), to provide for the use of prior-year data in determining the actual contribution percentage (ACP) of the non-HCEs.

   These amendments are effective for years beginning after 1996. According to Notice 97.2,(2) employers using the look-back test for their 1997 year do not recalculate their non-HCEs for 1996 using the new definition of HCE in Sec. 414(q)(1).

   Notice 97-2 states that employers may elect to use the current-year ADP/ACP results; this election, once made, will be difficult to revoke. Some transition relief is available; a plan that uses current-year data in determining the non-HCEs' ADP/ACP for the 1997 plan year can use prior-year data for the 1998 plan year without IRS approval. In the case of a new plan, the ADP/ACP for the non-HCEs is deemed to be 3% for the preceding plan year, under Sec. 401(k)(3)(E). Sec. 401(k)(3)(E)(ii) allows a new plan to use current-year non-HCE percentages for its initial ADP/ACP tests without losing the right to change to prior-year percentages thereafter.

   Minimum Participation Rule

   pre-SBJPA Sec. 401(a)(26)(A) required a qualified plan to benefit no fewer than the lesser of:

1. 50 employees, or

2. 40% of all employees of the employer (determined on a controlled-group basis).

   Comparable plans could not be aggregated in meeting this test, but Sec...