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 wages 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.

closed as off-topic by Dheer, Brythan, keshlam, Nathan L, MD-Tech Feb 2 '17 at 10:42

This question appears to be off-topic. The users who voted to close gave this specific reason:

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  • 2
    Are the two "employees" of the company also co-owners of the company, and one of them is yourself? If not, what the company does has nothing to do with you, and this question would be off-topic for this site. In general, employees cannot "manipulate" their W-2 wages; they are set by the company. – Dilip Sarwate Nov 24 '16 at 14:31
  • 2
    I'm voting to close this question as off-topic because about some legal aspects of running a company – Dheer Jan 28 '17 at 8:20

IANAL, but no, this is not sound legal advice. There are a few things that stick out to me as fishy.

First off: you are calculating the 3% safe-harbor on the 2017 compensation limit of $270k, but limiting yourself to $53k in total contributions which is the 2016 limit. It's hard to tell what tax year you're working in here. If you're planning for 2017, fine, but if you're wrapping up 2016 then you need to use 2016 limits.

Secondly (and this is something I think your counsel should know already): you don't take Employer contributions out of gross wages (box 1) on the W-2. They aren't even reported there in the first place! With your base scenario the 2 employees' W-2s would look like this:

Employee A's W-2 Gross Wages (box 1) = 280,000 - 14,966.67 = 265,033.33
Employee B's W-2 Gross Wages (box 1) = 280,000 - 0 = 280,000

Elective deferrals are the only thing that should come out of wages. Not the SH 3% or Match.

Thirdly: Retirement Plan expenses really aren't an "above the line" expense. They are not included in cost of goods sold. Even if you establish a "pool" for that expense, it's still not a direct cost attributable to the production of whatever your company sells.

Also: Employee B should not have to contribute to the retirement account of Employee A! The only situation I can see where Employee A and B would be required to fund the match equally, were if Employee A & B are both 50% owners and the company has no funds of its own with which to fund the match. The company has obligated itself to fund the match, and if the company doesn't have any money then the money still has to come from somewhere (ie. the owners pony up more funds for the match they promised their employees, it just happens that the employees are also the owners). Even in this situation though, I still stand behind my first 3 points.

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