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Craig Schiller

Is amendment to SEP discriminatory?

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Hi Benefits Link users:

Employer "A" started a SEP in 2009 at Wells Fargo bank and neither he nor the bank has a copy of the SEP document that was adopted. We don't know if it had a 0, 1, 2, or 3 year eligibility. Call this OLD SEP.

He hired employees for the first time in 2011.

Assume he adopts a new SEP in 2013 at another custodian, Schwab, and adopts it as a new SEP, not an amended and restated SEP, effective 1/1/2012. Assume he elects a 3 year eligibility. Call this NEW SEP.

Would the fact that the employees hired in 2011 met the eligibility in 2012 under OLD SEP, prevent the employer from being permitted to exclude these same employees by contributing to NEW SEP with the longer eligilibility? I don't think the SEP rules address this.

Assume one step further that Owner A had been hired in 2008 and he had started with a SEP with a 1 year eligibility. (I am working with and advisor so don't know at this point when the business started). Since Owner A met the eligibility in OLD SEP in 1 year, is it discriminatory to now amend to NEW SEP to a 3 year eligibility? Qualified plans are governed by 401(a)(4) which addresses a series of amendments being looked at together. I don't think that concept applies to a SEP but don't know.

Thanks,

Craig Schiller, CPC

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There is very little to no guidance on point that absolutely applies to a SEP, but see the "shall not discriminate in favor of the HCE" provisions under 408(k)(3).

Assuming the individal commenced employment in 2009, selecting service in more than two prior years could be considered discriminatory. Now, had the plan contined a two-year service rerquirement to begin with (possible to likely), amending it to three years (to exclude the newly hired employees) could also be considered discriminatory if there are any HCEs that could not meet the new eligibility requirementsa at the time the plan was established (a borrowed and related QP rule). Missing documents aside, a private letter ruling should be sought if extending the eligibility time period beyond the time a HCE was first eligible to participate. I am not aware of this question every being addressed in a PLR (or anywhere else, other than in my Answere Books),

Any new SEP has to be treated as a continuation of the old SEP (whether it be called an amendment or restatement, or nothing at all). So, selecting three years, again may be problematical, especially for the employees hired in 2011 since there is no document. Client might consider using "0" requirement for current employees and using two or, if employment commenced in 2008, three years starting in 2013.

Hope this helps answer all of your inquiries.

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I think you could take the viewpoint that the subparagraphs under 408(k)(3) spell out how you can not discriminate in favor of HCEs, and since changing eligibility is not there, you can do it. FWIW.

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Hi Gary and Bird -

Thanks for your responses. I checked out 408(k)(3) and subpart (A) is general enough - since it is very general "contributions that do not discriminate". While it says that to not discriminate contributions must be pro-rata (or with 414l disparity), that doesn't meant that if contributions are pro-rata that the contributions are not discriminatory.

I'm not sure why you (Gary) think a new SEP has to be considered a continuation of an old SEP. The IRS Model SEP is allowed to be used even if someone has another SEP, which contemplates there can be more than one SEP at the same time. By the same token then, each could have its own eligilibility. OTOH, starting NEW SEP in 2013 after employees have met the eligibility for the OLD SEP could be discriminatory under 408(k)(3). I would argue this is less likely covered by 408(k)(3) assuming the owner had met 3 years, and the other issue didn't apply. I think that because the IRS allows 2 SEP's at once. I think an Employer could even run 2 SEP's at the same time - one pro-rata amount those who met its eligibility, e.g. 2 years, and a second with an eligibility of 1 year. I think the idea of protected eligibility is less likely to relate to 408k3 but that is only my opinion. What do you think?

Craig Schiller

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While it says that to not discriminate contributions must be pro-rata (or with 414l disparity), that doesn't meant that if contributions are pro-rata that the contributions are not discriminatory.

I'm not sure how you reach that conclusion.

I don't know about the idea of running two SEPs with two sets of contributions at the same time, but I do feel that eligibility is not a protected benefit in the SEP environment.

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As I said, it is not an area that has much guidance. Borrowing ideas from the QP rules may be wrong (read: "may not apply to SEPs"), but should give a reasonable person an idea of where the IRS's head is. Having two nonelective SEPs could cause numerous problems (less so, but still problematical, if they are identical documents). If they are not identical (provisions, terms, definitions, option), then which one applies to an employee covered by both documents. Here's where the pro-rata rule could really go awry (and then there would be discrimination).

Why would an employer have different documents when all employees are treated as if employed by a single employer?

I do not believe that the dicrimination issue (if it even exists) can be avoided by adopting a new document each year. The IRS could argue that, in operation, the plan or plans are discriminatory. OTOH, your (Craig) research will add to what we still know very little about.

It is surprising that no PLRs have ever been requested on the rolling eligibility issue.

The phrase "protected benefit in the SEP environment" is just awesome, perhaps it will catch on!!

Different eligibility is discussed in ancient Rev. Ruls.70-75, 70-77, and 73-382

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I"m reading through this thread which has a lot of grey area. We have a SEP that we would like to amend from the 1 year service requirement to 3 years. An employee that received a distribution in 2014 would become ineligible in 2015. Thought it would be ok based on these Q&A's on IRS.gov website:

"I’d like to establish a SEP plan that allows me to participate immediately. Can I establish different SEP plan eligibility requirements for future employees?

Yes. You can initially establish your SEP plan so that you are immediately eligible to participate in the plan. Later, you can amend the plan to have more restrictive eligibility requirements, but you must also meet the new eligibility requirements to continue your participation in the plan.

What is the 3-of-5 rule?

The 3-of-5 eligibility rule means you must include any employee in your plan who has worked for you in any 3 of the last 5 years (as long as the employee has satisfied the other plan eligibility requirements). This is the most restrictive eligibility requirement allowable. You can choose to use less restrictive participation rules in your plan, such as allowing employees to participate immediately after they start work or after a shorter period of employment (for example, after working for only 1 year).

If you use the 3-of-5 rule, you must count any work, no matter how little, in each of the prior 5 years. Use plan years (often the calendar year), not years based on the date the employee started working for you.

Example: Your SEP plan uses the 3-of-5 eligibility rule, uses a calendar year and has no age or compensation requirements. To be eligible for a contribution for 2015, an employee must have worked for you for any length of time in any 3 years in the 5-year period from 2010 to 2014. An employee who worked for you for two months in 2010, 2013 and 2014 must share in the SEP contribution made for 2015.

If you didn’t include an employee who worked for you in 3 out of the last 5 years, or if you didn’t follow your SEP plan’s participation requirements, find out how you can correct this mistake."

Does the red print suggest that it is ok to do this and that an employee could become ineligible?

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I believe that you can amend a SEP from 1 to 3 years without regard for whether someone participated previously.

(FWIW when you say "distribution" did you mean "contribution"? To me "distribution" is money going out of a plan. It doesn't matter.)

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Thank you Bird. Yes I meant contribution. This isn't my area of "expertise" and I need to pay more attention to the terminology I use...

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Bumping.  Do we think we can make the change from immediate to 3 years "today" for 2018 (i.e., befoire 12/31/18? How about during 2019? Can I amend the 2018 eligibility in 2019, based on the rationale that I could have established the SEP in 2019?

That FAQ link someone posted is clutch.  The IRS had their opportunity to place restrictions on those changes, and they chose not to.

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FWIW - I would never counsel amending now for 2018. IF a contribution is made, the eligibility requirements to receive that contribution have already been satisfied. Amend it today for 2019, yes. Amend today for 2018, NO!

Just my humble opinion.

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I'm pretty sure that for a SEP you can "amend" eligibility any time you want to, right up to making the contribution.  You could definitely establish a new SEP and do that.  I don't think the concept of earning a contribution applies to a SEP.  Not saying it smells good but I'm pretty confident of that.

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Belgarath, dont you think the FAQ above would have been the method for the IRS to make that clear? They made no mention of any restrictions on timing.  All they had to say was "provided the amendment is exceuted prior to the first day of the calendar year."  But they didn't.  And the fact that they just left that wide open in the FAQ on their website for all of us to read, knowing too that nothing else on point exists, we would ll turn to that for any restrctions that should be considered.  But alas, nothing is there!  I believe SOME thought must have gone into that response.  

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I'm very conservative on this issue.

Bird, since there is no "last day" requirement for a SEP contribution if one is made, I'd still argue that a contribution is due and you can't amend that person or persons out of getting it.

Just your basic agree to disagree issue here.

By the way, being back at work sucks...

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Isn’t it the anti-cutback rules that your position is based on? Those rules don’t apply to SEPs.  And the rule was added ton401k/ps plans because without them you could cutback in benenfits.  So if that rule does not apply then what rule is stopping you?

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I don't equate the ability to amend eligibility in general to the ability to amend eligibility on the last day of the year that would allow a previously eligible employee to be excluded for THAT YEAR.

SEP's are supposed to be SIMPLIFIED plans, and as such, don't always have the voluminous guidance that is available for plans under 401(a). I'm using, as I said, a conservative approach, that can't get a sponsor in trouble. Your way, the IRS might disagree - I don't know.

I reject the argument that just because the IRS didn't post this specific question on their FAQ list that it means that they approve of an amendment such as you propose. I might ask if you think an auditor who disagrees with your interpretation would accept your argument that, "Well, since you didn't post it on your FAQ's, it must be ok."

Anyway, I'm not saying you are wrong, just saying that I wouldn't do it myself, and would never advise a client to do it. Again, just an "agree to disagree."

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