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IRS approval on this plan termination? Doubtful.


Guest dhall

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A company wants to terminate their 401(k) safe harbor match plan during the SECOND YEAR (first plan year was 2007), because the sole owner (well under age 55) wants to take his money out (we informed them that the owner cannot just willy nilly take his $$, and he didn't want a loan, and is not eiligible under the hardship rules).

There is no legitimate reason to terminate, i.e. no company financial hardship, not going out of business, etc.

They want to get a DL from the IRS on this termination, but I'm sure the IRS will ask what the reason for the termination is, not to mention I think after only 2 years in existence, it's a red flag for an audit.

Any advice?

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I would think that the plan would fail the permanency requirement if under the circumstances you describe the plan is terminated in its 2nd years of existence.

The consequences of terminating would be that the plan was never qualified.

A Form 5310 termination application could be made. If you do, make the termination amendment contingent on IRS approval. In that way, if the IRS withholds its approval, the owner can reconsider his next steps. That might not be such a red flag.

If the IRS withholds its approval but the owner goes through with terminating the plan, I would suggest that the plan be treated as never having been qualified. This means that the owner (and probably other employees) will have taxable income for 2007 for his benefits accrued during 2007. The 2008 accruals and earnings would be taxable income to them in 2008.

The company would need to amend its withholding and payroll reports to the IRS for 2007 and 2008 to date. The company ought to issue amended 2007 Forms W-2.

Those affected would need to amend their 2007 tax returns to reflect and pay tax on the greater taxable income.

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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A company wants to terminate their 401(k) safe harbor match plan during the SECOND YEAR (first plan year was 2007), because the sole owner (well under age 55) wants to take his money out (we informed them that the owner cannot just willy nilly take his $$, and he didn't want a loan, and is not eiligible under the hardship rules).

There is no legitimate reason to terminate, i.e. no company financial hardship, not going out of business, etc.

They want to get a DL from the IRS on this termination, but I'm sure the IRS will ask what the reason for the termination is, not to mention I think after only 2 years in existence, it's a red flag for an audit.

Any advice?

There are many valid reasons that the IRS will accept for terminting a plan including it no longer suits the needs of the employees, plan has become too expensive, etc. The acceptable reasons used to be listed in the IRM. Given the economic environment facing most employers they surely can find one or more valid reasons to terminate the plan such as lack of interest by employees, economic hardship, e.g., increasing energy/transportation costs, cost of borrowing, decline in customers, etc. or as too expensive to maintain in the uncertain economic times that are predicted in 2009. I dont see how the IRS can force an employer to maintain a safe harbor plan requiring employer contributions for 2009 when everone is expecting a recession.

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It is not that the IRS would require them to maintain a safe harbor 401(k), but merely maintain the plan. If the employer cannot fund the safe harbor, then they should consider a redesign to a traditional 401(k). As long as the contributions are recurring and substantial for a safe period (presumably 5 years), then he should be safe.

I wouldn't begin to argue a plan for two years is okay under certain circumstances. SIMPLE IRAs and SEPs do not have the permancy issues. It appears as if someone may have sold this individual the wrong plan. I think the IRS will take a strong stance on the permancy issue. They can always amend to eliminate the safe harbor, but maintain the plan.

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There is at least a chance of getting approval - you could probably cite the cost of running the plan and say "the perceived benefits are not worth the cost of maintaining the plan." We've used that (but not after a year). The IRS really doesn't want to issue unfavorable letters. I think the permanency requirement is that the plan is intended to be permanent, and if someone changes their mind after learning what maintaining a plan really means, you can't force them to continue it. It's probably a bigger concern if there were huge deductions in year one and that was the main purpose, to get those deductions and bail out. The more I think about it, the less I think they would care, at least in a non-DB instance.

Having said that, I wouldn't make it my problem. Lay it all out and say you just don't know what they'll say, and that the only thing you can recommend is that they keep the plan. If they want to do something else, it's their call.

Ed Snyder

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Having said that, I wouldn't make it my problem. Lay it all out and say you just don't know what they'll say, and that the only thing you can recommend is that they keep the plan. If they want to do something else, it's their call.

This is truly the bottom line. When we are dealing with client's, we cannot attempt to hold ourselves responsible for knowing what the IRS will say. Just lay it all out and let the client make an educated decision. Never make it your problem.

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There's no choice--you have to give the IRS some reason for plan termination in Item 10 of the Form 5310 (if you go in for an FDL). No getting around that. And the Form 5310 is signed until penalty of perjury.

The penalty will not be a refusal to permit the plan termination, but treating the plan as never having been in force due to violation of the permanency rules. The IRS might seek to apply the includability in income, however, only to HCEs. I don't think it means there's any greater chance for audit, since the issue can be dealt with as part of the FDL process.

Of course, aside from asking the client to decide what to do, we also should be suggesting alternative approaches, such as the owner taking a plan loan to get at his $$.

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It is not that the IRS would require them to maintain a safe harbor 401(k), but merely maintain the plan. If the employer cannot fund the safe harbor, then they should consider a redesign to a traditional 401(k). As long as the contributions are recurring and substantial for a safe period (presumably 5 years), then he should be safe.

I wouldn't begin to argue a plan for two years is okay under certain circumstances. SIMPLE IRAs and SEPs do not have the permancy issues. It appears as if someone may have sold this individual the wrong plan. I think the IRS will take a strong stance on the permancy issue. They can always amend to eliminate the safe harbor, but maintain the plan.

There is nothing that prohibits an employer from terminating a qualified plan in its entirety within a few years after adoption because it is no longer suitable for the employees or because of the risk of financial hardship to the employer in todays' adverse economic climate. Just read the papers or google the issue of business hardships. I have received favorable determinations for plans terminated after a few years because of economic hardship, costs or lack of interest by employees.

The question is whether counsel has the advocay skills to persuade the IRS of the validity of the reasons for a termination. Adoption of the wrong type of plan can be grounds for termination if it causes economic hardship. The easiest thing to do is tell the client that the plan cannot be terminated.

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The shortest plan duration I've been asked by an ER to prepare and file a F5310 for was 4 years--2 years as a traditional 401k and then 2 as a SIMPLE 401k. The IRS did not question the termination at the time, after 4 years in existence, but I was concerned enough to discuss at length with the employer the permanency issue before the employer decided to go ahead with the F5310 application. Does anyone have positive experience of the IRS approving termination of a plan with shorter than 4 year duration? Anyone had the IRS reject an F5310 due to the permanency requirement regarding an application for a plan that had existed longer than 4 years?

Treas Reg § 1.401-1(b)(2)

(2) The term "plan" implies a permanent as distinguished from a temporary program. Thus, although the employer may reserve the right to change or terminate the plan, and to discontinue contributions thereunder, the abandonment of the plan for any reason other than business necessity within a few years after it has taken effect will be evidence that the plan from its inception was not a bona fide program for the exclusive benefit of employees in general. Especially will this be true if, for example, a pension plan is abandoned soon after pensions have been fully funded for persons in favor of whom discrimination is prohibited under section 401(a). The permanency of the plan will be indicated by all of the surrounding facts and circumstances, including the likelihood of the employer's ability to continue contributions as provided under the plan. In the case of a profit-sharing plan, other than a profit-sharing plan which covers employees and owner-employees (see section 401(d)(2)(B)), it is not necessary that the employer contribute every year or that he contribute the same amount or contribute in accordance with the same ratio every year. However, merely making a single or occasional contribution out of profits for employees does not establish a plan of profit-sharing. To be a profit-sharing plan, there must be recurring and substantial contributions out of profits for the employees. In the event a plan is abandoned, the employer should promptly notify the district director, stating the circumstances which led to the discontinuance of the plan.

John Simmons

johnsimmonslaw@gmail.com

Note to Readers: For you, I'm a stranger posting on a bulletin board. Posts here should not be given the same weight as personalized advice from a professional who knows or can learn all the facts of your situation.

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Although I don't know the reason used on the application, my former employer got a D letter on the termination of his DB plan after only 2 years. And since he is a TPA, I would expect the IRS to hold him to as high a standard as anyone on that issue.

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Does anyone have positive experience of the IRS approving termination of a plan with shorter than 4 year duration? Anyone had the IRS reject an F5310 due to the permanency requirement regarding an application for a plan that had existed longer than 4 years?

How about - has anyone had the IRS reject a 5310, ever?

Ed Snyder

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  • 2 months later...
Guest lerieleech

I got an approval letter for a client who had the plan for just 15 months. But in that case, the owner had to pull the plug unexpectedly on the business, and with very little warning.

I got another one on a plan that existed for 2 years. In that one, a law was passed that made it illegal to do something (perfectly legitimate) that provided all the income to the company, and it had to shut down.

If the business shuts down because of unforeseen circumstances, I really doubt that IRS would have a problem with plan termination. I am not so sure, though, in cases involving business downturn, whether or not because of recession. If the IRS views this as a temporary factor, I don't know what they would say.

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Does anyone have positive experience of the IRS approving termination of a plan with shorter than 4 year duration? Anyone had the IRS reject an F5310 due to the permanency requirement regarding an application for a plan that had existed longer than 4 years?

How about - has anyone had the IRS reject a 5310, ever?

No we have never had one rejected. We've had several plans under 5 years. I think 3 was shortest but that was a dot com bust with valid reason.

I think the rescession may be a valid business reason, many employers are cutting expenses.

I'd make the client aware that the IRS might challenge on permancy issues to cover yourself but I'd be mildly surprised if the IRS didn't issue a favorable ruling.

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