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SIMPLE established by ineligible employer


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Did a search and couldn't find any situation/question exactly the same, so here goes.

Employer established a SIMPLE-IRA in 2004. Employees deferred, employer matched, etc.. However, the employer had more than 100 employees who had earned more than 5,000 in both 2003 and 2004. The question was, what can they do?

It seems to me that this is corrected through Rev. Proc. 2003-44, and is an "employer eligibility" failure. It further appears that since the SIMPLE corrections are similar to the normal qualified plan corrections, that this cannot be corrected through SCP, and will have to be submitted through VCP.

However, since I've never encountered a situation like this, I thought I'd see if anyone has other thoughts/ideas? Thanks!

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Since the er was ineligible to sponsor a SIMPLE plan why not treat the plan as a defacto IRA plan established by an employer for 2004 in which employees can defer the max permissible, e.g $3000 for under 50 employees. EE contributions would be included in ee's comp. The excess should be removed by the employees by 4/15 and taxed as income for 04 and then redeposited as a contribution for 05 eg. 4k for ee under 50. Dont know if the SIMPLE plan custodian will go along with the recharacterizaton and changes in w-2, etc. which are a lot of work.

mjb

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I like your suggestion mbozek, except for the defacto IRA part-- which would work in a SEP-but not in a SIMPLE since IRA contributions cannot be made to a SIMPLE. The employee’s could choose not to redeposit the amount , or redeposit the amount to a regular Traditional or Roth IRA for 2004 or 2005, up to the allowable IRA limit

let's see what Gary says [Denise, how did you know I had my ears on! -- gsl]

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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Since it was a Simple it must be dealt with as a Simple. IRA contributions may not be made into a Simple-IRA.

Might it be better (and less expensive) not to fix it, but rather treat it as a bad plan for the year (by including the amounts on the employee's W-2 for 2004). The alternative of discontinuing contributions and retaining the amounts may be costly under EPCRS (in addition to the fees, charges, and penalties under the EPCRS). This would appear to avoid the 10 percent penalty on nondeductible conributions.

Although the 6 percent penalty does not appear to apply, to avoid double taxation, the excess (with earnings + or --) should be removed timely.

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Whether IRA funds can be put into a simple IRA or not is irrevalent- Worst case is that the SIMPLE contributions must be withdrawn from from the simple and redeposited to an IRA by 4/15 to take the max IRA deducton. Rest can be allocated as IRA contribution for 05.

mjb

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mbozek

It was a SIMPLE, it operated as a SIMPLE. I cannot be a defacto anything but a SIMPLE. How can it be a defacto IRA when IRA contributions are made into a SIMPLE (that can not hold traditional IRA contributions).

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IRA contributions would not and were not made to the SIMPLE. It is being suggested that the money be taken from the SIMPLE and put to a newly established IRA (as if there had been an IRA all along, hence defacto), a recharacterization of sorts, rather than returning the money to the participants which seem to be more work and probably cause more penalties.

George D. Burns

Cost Reduction Strategies

Burns and Associates, Inc

www.costreductionstrategies.com(under construction)

www.employeebenefitsstrategies.com(under construction)

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The contributions cant be made to a SIMPLE if the employer is ineligible to maintain a SIMPLE. Therefore the contributions are considered wages included in the employee's gross income which makes them eligible for a deductible IRA contribution if contributed to an IRA by 4/15. It is a principle of tax law that a taxpayer who is denied a deduction under one section of the IRC ( 408p) can take the deduction under another section for which he is eligible e.g., (408a).

mjb

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Thanks for the opinions. This isn't a plan we have anything whatsoever to do with, so I'll pass this information along to the CPA. Obviously going to be messy no matter what they do - with a lot of employees who are going to have to refile tax returns based upon their new W-2. Apparently at least 30 employees younger than age 50 contributed in excess of 3,000, not including the employer match, and several of the over 50 employees making more money contributed over 7,000.

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It is a principle of tax law that a taxpayer who is denied a deduction under one section of the IRC ( 408p) can take the deduction under another section for which he is eligible e.g., (408a).

I could use the cite for that one.

It is a principle of tax law that a taxpayer who is denied a deduction under one section of the IRC ( 408p) can NOT take the deduction under another section for which he is INELIGIBLE, e.g., (408a). This rule seems to make more sense in this situation because there are no IRAs under IRC 408(a) to speak of.

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mbozek, Gburns- I think I understand the end results of your suggestion …the apparent disagreement appears to caused by the literal meaning of the suggestion of treating the contribution as a defacto IRA.

For instance, if the contributions were made to a SEP IRA, the amount – being an ineligible employer contribution would be automatically recharacterized as an IRA contribution –within the same SEP IRA. When an IRA custodian is notified that a SEP employer contribution is an excess contribution- the response is to recharacterize the amount as an IRA contribution-making it a defacto IRA contribution. If the participant is not eligible for or does not want the amount to be an IRA contribution, then he/she would remove the amount as a return of excess. OTOH, for a SIMPLE, that ( recharacterizing the amount as an IRA contribution) is not possible, therefore, the amount must be removed from the SIMPLE as a return of excess, and could be deposited to a separate IRA as an IRA contribution.

It is a principle of tax law that a taxpayer who is denied a deduction under one section of the IRC ( 408p) can take the deduction under another section for which he is eligible e.g., (408a).

What may make this inapplicable in this example is that we are talking about two different individuals. In this case, it is the employer who is subject to 408(p), and not eligible under 408(p). The recharacterizing of the amount as wages, and subsequent application of the amount under 408(a) or 408A applies to the participant.

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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Gary - the tax law has multiple examples how taxpayers can take deductions for amounts that are not deductible under another provision of the tax law- e.g, self employed person can take deduction for health ins premium payments to extent permited under 162(l). Excess health ins premiums that are not deductible under 162(l) are deductible to extent permitted under 213. If the employer is not eligible to establish a SIMPLE at inception then the amounts that are contributed under the SIMPLE are not deferred and will be taxed as wages for the year contributed and reported on the w-2. The only question is whether the employee can leave the assets in the IRA that was supposed to hold the SIMPLE plan contributions, deduct the max amt permitted for IRAs in 04 and withdraw the excess before 4/15 or whether the ee must withdraw the entire amount in the SIMPLE IRA account and open an IRA to claim a deduction for 04.

A- I dont understand your reference to er being subject to 408p and not the ee because under 408(p) SIMPLE contributions are made to an IRA which are not inclcuded in the employees's income. If the contributions are not excluded from the employee's income under 408(p) then they are included as wages on the w-2 and the ee can claim a deduction for an IRA contribution under 408(a).

mjb

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Obviously, we agree on the end result, which is the employer may not take a deduction, treat the amount as wages and the participant may contribute the amount to a TIRA or RIRA. I was merely stating that the quote above suggested the employer and the employee are one and the same, which may not necessarily be the case. Yes, the deduction is being transferred (for lack of a better term) from 408(p) (if not allowed under 408(p) to 408(a), however, it is also being transferred from one party to another/different…not from one area of deduction to another for the same party. In your example with the health insurance premium, you are referring to the deduction being shifted from area to the next for the same person. Similarly, your example with the SIMPLE ( in your most recent post) correctly addresses shifting the deduction from plan contributions ( on the employer’s tax return) to wages ( again on the employer’s tax return)- one and the same party. However, you original post discussed shifting the deduction from the employer (on the employer’s tax return)—408(p) to the employee- on the employee’s tax return –408(a).

Apparently, you are thinking at a general- high-level perspective. Which is OK if you are explaining the issue to someone who is fairly familiar with the rules. I prefer to simplify things as much I we can, as most of my customers are usually unknowledgeable when it comes to these topics.

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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A- I dont understand your reference to er being subject to 408p and not the ee because under 408(p) SIMPLE contributions are made to an IRA which are not inclcuded in the employees's income.

You are right…I meant for purposes of claiming a deduction for the SIMPLE contributions

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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mbozek

The only question is whether the employee can leave the assets in the IRA that was supposed to hold the SIMPLE plan contributions, deduct the max amt permitted for IRAs in 04 and withdraw the excess before 4/15 or whether the ee must withdraw the entire amount in the SIMPLE IRA account and open an IRA to claim a deduction for 04.

NO. YES.

It has been suggested several times that the amount must be withdrawn from the SIMPLE IRA and then deposited into a different IRA that is a traditional IRA. A SIMPLE IRA is not a traditional IRA and can not hold IRA contributions. Therefore, taking into account all principles of tax law, you can not claim a deduction under another section of the Code unless that section grants a deduction. Neither Code Section 408 or 408(p) grant a deduction for contributions made to a SIMPLE IRA by an individual.

Contributions by employees to a SIMPLE IRA are not permitted (other than a rollover from another SIMPLE IRA). SIMPLE IRA contributions can not be recharacterized.

:blink: Do we agree? If not, I am a loss to understand the point you are trying to convey.

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