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Correction of Partnership SEP


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A partnership with only highly compensated employees partners (and no employees) allowed the partners to set up their own SEPs and contribute whatever they wanted within IRS limits. Some made contributions, some didn't.

This violates the SEP rule that requires that all employees (includes partners for this purpose) of an employer (the partnership) must receive the same level of contributions (as a percentage of pay).

Question: The normal way to correct this would be for the parnership to contribute amounts (and make up earnings) for each partner so that all received the same contribution as a percentage of pay. But this bothers me because the partners are all highly compensated and self-employed - it doesn't make sense because the make up contributions will be made in a later year, reducing the partners' income in the later year, and the deduction will go to the partners who got the additional contribution. It seems useless to correct this way, not to mention the fact that it will make the partners who didn't have SEPs before unhappy.

Is there an argument that it would be ok not to do any sort of correction, other than to lay out procedures to ensure that it will never happen again?

Or, what about the partners who got contributions simply taking distributions? Is there an argument that this will correct so they don't have to change their tax returns? Could you argue that the distribution is not subject to the early withdrawal penalty or the penalty on excess contributions to an IRA because the distribution was a correction?

Any suggestions?

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  • 4 weeks later...

Locust, I am moving this post to the SEP board, to increase the chances of a response being posted.

By the way, are we talking 2004 or another tax year? The additional contribution to employees who did not receive contributions method must generally be completed by the employer's tax filing deadline, including extensions. If the issue relates to a year before 2004, that may not even be an option.

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 SEP was set up in 2004 and contributions were made for 2004. The partnership has filed its tax return for 2004. I am thinking that the correction will have to occur under the voluntary correction program.

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I'm assuming that the contributions went through the partnership and were reported on the K-1s, but I don't do the partnership tax returns and can't be sure, and I haven't asked. What is the significance? - to determine whether the contributions have been reported at a partnership level?

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If the partner's made the contributions with their own funds, then all contributions are excess contributions and should be corrected under the Code.

The problem can also be corrected under the Code if fixing isn't an option. Employees may have to pay a 6% penalty, until corrected. The amounts are treated as drawings and partners take no deduction. The employer may have to pay a 10% penalty. Depending upon the amount involved, correctiona after the due date may have to be spread out over more than one year.

See IRC Secs 408(d)(4) and (5).

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