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A Real Mess - Part 2


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I have been contacted by a business owner who put in a SARSEP at the last possible minute in 1996. She was assisted in this process by a large, national brokerage firm. Since that time, it is quite likely that the plan has not operated in compliance. She was unaware of the 50% participation rule, the non-discrimination testing and the top-heavy rules.

She wants to know if there is a statute of limitations as to how far back she is subject to penalties, in the event her non-compliance was discovered.

She also wants us to give her an idea of how much fixing it all would cost. Based on the number of years involved and the multitude of issues, I'm not even sure where to begin. Is there any correction program open to her that would make sense for her to use?

There are only 3 people participating in her plan, herself included.

Thank you.

Kate Smith

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Under the EPCRS there is no Statute of Limitations. Outside of the IRS the same result likely occurs unless Form 5330 was filed and the penaties reported (and presumably paid).

Start with Revenue Procedure 2006-27--> LINK to 2006-27

See, in particular, section 6.10. The correction methods are somewhat flawed in regard to SEPs and SIMPLE IRAs.

Then you need a good census (compensation, age, DOH, DOT, contributions, and so on).

Generally, you need to determine what all the problems are and their associated penalties (e.g., 6% IRA excesses, 10% nondeductible, ADP tests, top-heavy status, 10% failure to give ADP failure notice(s), and so on)--year by year. Some penalties are cummulative. Then formulate an acceptable fix under the EPCRS. Spreadsheets, as attachments, are probably the best way to present the problem and the fix. The application would then summarize the spreadsheets. Several spreadsheets may be needed depending upon the failures.

The IRS user fee is generally $250 (but could be higher, see sections 12.02 and 12.06). I have been sucessful in having the 10% fee for retention of assets waived (sponsor is not retaining assets and has no control over them).

In some cases, there is more than one possible fix, so the "best" one needs to be determined.

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  • 2 weeks later...

I posted a question previously about a SARSEP that we believe has been administered incorrectly since its inception in 1996. At that time, I asked about corrections and Gary Lesser was kind enough to provide the link for the Rev. Proc. 2006-27, which I have read. I have also read through the IRS Form 5305A-SEP and the message boards.

Our client is hoping to determine her maximum financial exposure if she were to correct all the problems. If I have read things correctly:

1. To correct failure to deposit the top-heavy minimum, she would have to contribute the top-heavy minimum for each year in which the plan was top-heavy, with earnings.

2. To correct failure of the deferral percentage limitation, she would have to make fully vested contributions to all eligible participants in the year of the failure in an amount great enough to bring the NHC deferral rate up to passing.

Alternatively, she could withdraw the excess, adjusted for earnings, AND contribute the same amount of the withdrawal to the NHCs.

3. Failure to follow 50% participation rule. For every year of this failure, an amount up to the IRA contribution limit would be okay (except for payroll taxes?), but the excess amounts would be subject to a 6% excise tax, paid by the employee, and possibly a 10% tax on early distributions when withdrawn.

Assuming we can obtain all the data necessary to make these calculations, it will clearly take a great deal of time to calculate.

Is there an option to simply declare that since this plan was never operated in compliance with the document that there was never actually a plan, distribute all the assets and have the participants (there are only 3, including the owner) deal with distributions through their personal tax returns?

Thank you.

Kate Smith

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Regarding item #2, there is also a 10 percent tax for failure to notify affected participants f the ADP failure. The plan was no longer treated as a SARSEP at the end of the following year the notification failure occurrd (thus all elective deferrals become IRA contributions made by participants, the year this actually occurs is uncertain.)

3. Failure to follow 50% participation rule. For every year of this failure, an amount up to the IRA contribution limit would be okay (except for payroll taxes?), but the excess amounts would be subject to a 6% excise tax, paid by the employee, and possibly a 10% tax on early distributions when withdrawn.

There would also be a 10 percent tax on the nondeductible contributions made by the employer on the full amount contributed. The 6- and 10-percent taxes are cumulative. Since some are after the due date, earnings do not have to be withdrawn on those excesses. To some extent, the 6 percent penalty may be mitigated to the extent of the allowable traditional IRA contribution (remaining).

There may be an option to distribute the amounts to affected employees for this failure. IRA sponsors may require participant consent.

Assuming we can obtain all the data necessary to make these calculations, it will clearly take a great deal of time to calculate.

Yes, spreadsheets work nicely if well designed. Several may be needed when different employees are affected by different failures. They are then summarized and explained in the application. A Summary section works nicely.

Is there an option to simply declare that since this plan was never operated in compliance with the document that there was never actually a plan, distribute all the assets and have the participants (there are only 3, including the owner) deal with distributions through their personal tax returns?

Yes (read: "not really"), BUT everyone pays a lot of penalties and file amended tax returns (attaching Form 5330) for many years reporting their IRA contributions/excesses (Note: different excesses become IRA contributions at different times). There will be a lot of Form filing for each year (e.g., adding amounts to W-2) (possible FICA and FUTA issues). Unfortunately, everything has to be figured out (e.g., spreadsheets) anyhow. Needless to say, many of the Code fix rules are unclear as to timing, but doable. There is a risk that after you're all done, it wasn't done right. EPCRS offers some degree of "reliance." It will be somewhat necessary for employees/owners to be provided detailed notices as to what they must do for each year, they may want to be reimbursed. Getting amounts distributed from the IRAs may be another nightmare. The failure wd appear "egregious."

It is easier to fix it under the EPCRS (and everyone will be able to sleep with both eyes closed). You might want to see the SIMPLE, SEP, and SARSEP Answer Book (11th ed), Qs 12:18 through 12:39, and especially the SEP and SIMPLE Charts for Correcting Excesses in Appendix D under the Code (when fixable) and EPCRS (Aspen Publishers, NYC).

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I hear ya on the headache Kate. :blink:

By the way, I merged your two theads, to make it easier for others to follow- just in case you wondered...

If you get these and other SEP/SIMPLE issues ofen, you may find the SEP/SIMPLE answer book invaluable...Personally, I never leave home without it

http://www.aspenpublishers.com/Product.asp...cookie%5Ftest=1. I like the online version, because of the search feature. However, it expires and is unaccessable after a year- unless renewed. So, I do both...

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:

I did wonder how both my threads got combined. I figured I had just done something wrong! Thanks for letting me know.

We rarely deal with SEPs/SARSEPs but if we have to go forward on this project I think we will have to get the book that both you and Gary recommend.

Kate

Kate Smith

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