USA W2 Wages Dependent of 401k Variance

[NeedingAdvice]

My company is being told by our legal counsel that we have to make our employer 401k match amount an "above the line" corporate expense in order to avoid the chance that the IRS might find our retirement plan "non-compliant" in an audit. Our current plan, has a 3% safe harbor, and a 200% employer match. So, for simplicity sake, let's say my company has 2 employees. For employee A making 280K: safe harbor of $8,100 + salary deferral $14,966.67 + employer match $29,933.33 = total 401k of 53K. For employee B making 280K: safe harbor of $8,100 + salary deferral $0 + employer match $0 = total 401k of 8.1K. Employee A's W2 gross wages is 280K - 53K = 227K. Employee B's W2 gross wages is 280K - 8.1K = 271.9K. Our legal counsel is saying that if audited, our plan would be thrown out because the W2 wages varies too much and each employee is able to manipulate his/her W2 too much.

What he proposes is for us to change our retirement plan so the following occurs: For employee A making 280K: safe harbor of $8,100 + salary deferral $14,966.67 + employer match $29,933.33 = total 401k of 53K. For employee B making 280K: safe harbor of $8,100 + salary deferral $0 + employer match $0 = total 401k of 8.1K. However, now we establish a "pool" for the employer match as an "above the line" corporate expense, so we require both employee A and B to contribute $14,966.66 to the employer match pool. Employee A gets 100% of that pool whereas employee B gets 0% of that pool. Employee A's W2 gross wages are now 280,000 + 14,966.66 - 53,000 = 241,966.66. Employee B's W2 gross wages are now 280,000 - 14,966.66 - 8,100 = 256,933.34.

Is this sound legal advice? Seems very unfair to employee B. Will force employee B to max out their salary deferral so that they don't lose out and end up giving money to employee A. Seems like we need to get a second opinion from another lawyer.

 

[Tyson]

There are several mistakes here:

• An above the line corporate expense would be a cost of goods sold. 401k matches are not a cost of goods sold.
• 3% of $280,000 is $8,400, not $8,100.
• Gross wages are not the same as taxable wages. Gross wages are not reduced by traditional 401k contributions, but taxable wages are.
• Employer matches do not increase or decrease an employee's taxable wages for the year.
• If this $8,400 is a non-elective contribution as it appears to be, then this amount is not deducted from the employee's gross wages. It is a contribution from the employer.
  
• Your pool explanation does not make much sense to me. The employer's match does not come from the employee's wages, it comes from the employer as an additional benefit to the employees. If employee B is making contributions to employee A's 401k, it is not an employer match; it is a contribution to employee A's 401k from employee B. This can't be done as employee B's tax liabilities are his own. He can't transfer them like this by making a donation to someone else's 401k. The best he could do is pay the taxes on the money himself and then give the remaining amount to his buddy A as a gift.

All of this being said, if the company indeed has only these two employees as you said, then the 401k plan seems to me to be fair. Your highly compensated employees and/or company owners do not have higher 401k contributions than your non-highly compensated employees because you don't have any non-highly compensated employees. If the terms of the 401k are equal among every member of the company and regular notices about the safe harbor plan are distributed to employees, then I think you are safe. It won't hurt to get a second opinion though; I am not an expert on this matter.

 

[Tyson]

Also I just noticed that your employee's annual compensation exceeds the IRS's compensation limits for 2016 ($260,000). The employer can only match deductions for wages at the company's match rate up until that limit. The numbers you have posted also exceed the annual 401k contribution limits by $300. Annual contribution limit is $53,000 and your numbers add up to $53,300 after correcting the non-elective contribution amounts.