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SIMPLE IRA: sole proprietor: return of contributions


Felicia
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A sole proprietor established a SIMPLE IRA, completed the salary reduction form and made elective deferrals and matching contributions throughout the year 2002.

His accountant has now adivsed the sole proprietor that he had no compensation for the year 2002 and therefore he was not eligible to make contributions to the SIMPLE.

What are the options & tax implications?

Does it make a difference if the plan was not in existence for 2 years?

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Guest Fishchick

From my understanding, the SIMPLE IRA rules do not specifically prescribe a remedy for any type of inelgible contributions. At my firm, we advise clients to seek help from their own tax advisors and then we proceed basically doing whatever they want us to do with the ineligible contribution. Most of the time, they elect to remove the contribution plus earnings prior to tax-filing deadline as if it was an IRA contribution (using the SEP/SARSEP assumption that any excess deferral/non-deductible employer contribution is automatically treated as the employee's Traditional IRA contribution).

What I have heard from a source who spoke to the person over SIMPLE plans at the IRS is that the IRS doesn't believe that these excesses exist and therefore is in no hurry to prescribe a fix.

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Actually, the IRS Restructuring and Reform Act of 1998 (IRRA) provide that excess contributions to SIMPLE IRA be handled in the same manner excess contributions to SEP IRAs are handled- of course with the obvious exception of recharacterizing the excess contribution as an IRA participant contribution, since such contributions are not permitted to be made to SIMPLE IRAs

Life and Death Planning for Retirement Benefits by Natalie B. Choate
https://www.ataxplan.com/life-and-death-planning-for-retirement-benefits/

www.DeniseAppleby.com

 

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  • 2 weeks later...

Appleby,

Can you provide the exact cite to the Act or the Preamble (and fax me the page) that says this? [Thanks.] I am not aware of any IRS guidance having ever been issued. I agree that 408(d)(4) and probably (d)(5) apply. It sd be noted, however, that Form 5329 does not seem to apply in paying the excess contribution penalty. Nor does Form 5330 seem to apply regarding the 10% tax on nondeductible contributions. The IRS has been very hesitant to address this issue. Although, representatives of the IRS very "informally" stated that the 25% penalty would not apply (under the 2-year rule) to an excess (when the employer later adopted a QP for the year). No mention was made of the 10% penalty. [ASPA Q&A, 2000, Q 36]. Seems like a PLR is the only solution for a definitive answer. IMO, it should be removed before the due date with gain. If received after the due date the amount will be taxable (again) upon withdrawal (and maybe that's why the 6% penalty doesn't apply). IRC 4972 does not specifically include simple IRAs as qualified plans subject to the 10% tax on nondeductible contributions. [Appleby, see Simple, SEP, and SARSEP Answer Book, Qs 14:61-14:64]

The code is not very helpful other than stating a SIMPLE IRA is a traditional IRA that must meet some additional requirements. The IRS seems to believe (and for good cause) that there is no such thing as a SIMPLE excess because Congress didn't pass any law making it so. No penalty, no law.!!

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Gary,

I just faxed you the page from H.R. 2676 (P.L. 105-206).

The exact cite is 6018(B), which provides that 408(d)(7)(B) should be amended to include SIMPLEs

Life and Death Planning for Retirement Benefits by Natalie B. Choate
https://www.ataxplan.com/life-and-death-planning-for-retirement-benefits/

www.DeniseAppleby.com

 

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URL for the IRS Restructuring and Reform Act of 1998 (IRRA) /(P.L. 105-206). http://frwebgate.access.gpo.gov/cgi-bin/ge...publ206.105.pdf

Life and Death Planning for Retirement Benefits by Natalie B. Choate
https://www.ataxplan.com/life-and-death-planning-for-retirement-benefits/

www.DeniseAppleby.com

 

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Guest Fishchick

Mr Appleby, you are making me work too hard!

I looked up your cites and I believe that this amendment still doesn't constitute a remedy, it merely requires that key employees keep their money in the plan until after the ADP test is met. This would not apply to a SIMPLE IRA, but could apply to a SIMPLE 401k.

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Somehow, Fishchick I think you are one of us where hard work can translate into fun, if the work is something you enjoy…:)

A couple of points for consideration…

1) Don’t forget that SIMPLE 401(k) plans are not subjected to discrimination testing…

2) The section of 408(d)(7) to which you refer is subsection (A)… the amendment was to subsection (B), which makes reference to paragraphs (4) and (5), which addresses Return of excess contributions from IRAs…

PS. You referred to me as "Mr. Appleby” just 'Appleby' is fine, but if you really want to use a prefix, Ms. would be one to use ;)

Life and Death Planning for Retirement Benefits by Natalie B. Choate
https://www.ataxplan.com/life-and-death-planning-for-retirement-benefits/

www.DeniseAppleby.com

 

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Appleby,

The amendment made to IRC 408(d)(7) by PL 105-206 (Sec 6018(B)), seems to suggest (strongly) that both 408(d)(4) and 408(d)(5) correction procedures apply to SIMPLE-IRAs. Arguably, SIMPLE excesses returned after the due date would not be taxable again (under 408(d)(1) -- assuming it applies). And that may be a big assumption. Since there is no way of paying the 6% tax and 10% tax, one has to question how excesses ARE to be treated. I think the W-2 takes care of the 10% penalty (if excess shown in box 1 as indicated, or reported as EI if SE). As a technical correction, Section 6018 did not have any legistlative history to guide us. With the IRS hesitant to give any advice, I don't think we have an answer that we can safely hang our hat on yet.

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