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Employer wants to pay investment management fees of SEP participants


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Employer (an S corp) has two owner-employees who participate in a tax-qualified profit-sharing plan. The corporation directly pays an investment management fee to an RIA (a percentage of the plan's total assets, usually about $12,000 per year), rather than having the trustees pay the fee from plan assets.

Employer pays about $1,200 in administration fees for the preparation of Form 5500 and other administration services.

Employer pays for an ERISA fidelity bond for the plan's trustees (who are the two owner-employees).

COVID-19 occurs, with general chaos and substantial drop in revenue.

Employer looks for ways to save costs.

Idea: terminate the profit-sharing plan in order to stop the annual administration fee (no more Form 5500s). Also avoids the need to pay ongoing cost of the ERISA fidelity bond. Employer says it isn't wanting to make further contributions. So each employee-participant takes his or her account balance and rolls the distributed assets into an IRA at Schwab (for example).

The sun comes goes down and the sun comes up.

Employer sets up a new SEP arrangement, which covers all employees (being only the two owner-employees), using a document provided by Schwab (for example). The employer probably will need to set up two new IRAs at Schwab, but maybe Schwab will be happy to use the two existing IRAs.

Drum roll, please ...

Can the employer pay the investment management fees of the two IRAs (or "SEP-IRAs," if you prefer), and have the payments be deductible to the corporation and not counted as income to the SEP participants?

On the one hand, it is an employer-sponsored retirement plan of a sort. So, like investment management fees on a profit-sharing plan's trust that are paid to an investment adviser directly by a plan sponsor, the payment of the investment management fees on the SEP participants' accounts arguably is similarly deductible.

On the other hand, there is no trust once the employer has made the contributions to the employees' IRAs.

If the employer doesn't pay the investment management fees, the employees certainly could pay the investment management fees for their IRAs out of their own pockets, but such payments for managing an individual's investments are no longer deductible due to recent legislation. (Or they could have the fees deducted from the assets of the IRAs, which happily avoids income taxes, but which takes away funds that otherwise would generate compounded investment returns inside the IRAs.) So they'd probably opt to keep the plan running because the ability to avoid about $3,000 in income taxes on the $12,000 paid by the corporation would offset the administration costs and the cost of the ERISA fidelity bond.

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Dave, although I have not undertaken extensive research on this, I suspect there is not a clear answer, but there is probably a pretty good argument you can do it. The ability of an employer to pay and deduct investment management fees under Section 162 rather than have them be subject to 404 or 415 limits is not in the Code, as far as I know, but under Treas. reg. 1.404(a)(3)(d) and rulings, such as PLR 9252029. You could argue, strongly I think, that IRC sec. 404(h) makes 1.404(a)(3)(d) applicable to the SEP "plan" just as much as it would be applicable to a qualified trust. The IRS could for its part, I guess, argue that the personal control exerted by the employee over his or her individual IRA makes the payment of these expenses so personal to the employee that payment of them by the employer should be considered a fringe benefit, still deductible under 162, but includable on the employee's W-2 under Section 61(a)(1). If the employer were a C corp, it could probably defend strongly against that assertion by arguing that the fees were for "qualified retirement planning services" under 132(m), for which there are not yet any regulations, but it does not appear that 2% S corp shareholders would qualify as "employees" for purposes of 132(m). However, the 61(a)(1) argument might be a stretch for the Service to begin with.

Luke Bailey

Senior Counsel

Clark Hill PLC

214-651-4572 (O) | LBailey@clarkhill.com

2600 Dallas Parkway Suite 600

Frisco, TX 75034

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IMHO, I think Revenue Ruling 86-142 covers this, and no, you can't do it. It would be considered a plan contribution for 404 purposes. Stretching far into the dim and distant past, I have a hazy memory that this might have been allowed for a while under some old PLR's (we never had anyone attempt to do this for plans where we were the TPA) but then the IRS reversed course anyway. 

Whether or not such an arrangement might raise Prohibited Transaction issues, I'll leave to one of the PT experts here - I  certainly don't know off the top of my head - but I think the PT issue is moot since they can't successfully utilize the arrangement you mention.

P.S. Here's an interesting piece by Groom Law Group on paying "wrap fees" - https://www.groom.com/wp-content/uploads/2017/09/1000_Dold-Levine_MAG_05-11.pdf

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So the deduction probably would be available to the employer; question then is whether the fees are taxable income for the employees. 

IRS Pub. 525 distinguishes between "qualified retirement planning services" and "financial counseling fees":

Financial counseling fees paid for you by your employer are included in your income and must be reported as part of wages. Fees for tax or investment  counseling  are  miscellaneous  itemized deductions and are no longer deductible.....
 
If your employer has a qualified retirement plan, qualified retirement planning services provided to  you  (and  your  spouse)  by  your  employer aren't included in your income. Qualified services  include  retirement  planning  advice,  information  about  your  employer's  retirement  plan, and information about how the plan may fit into your  overall  individual  retirement  income  plan. You can't exclude the value of any tax preparation,  accounting,  legal,  or  brokerage  services provided by your employer. Also, see Financial Counseling Fees, earlier.

Another approach might be to terminate the plan, roll to individual IRAs, pay the fees directly from the IRAs, and have the owner-employees make individual deductible contributions that (at least in this case) could cover the total aggregate investment fees. 

The employer could increase W-2 salaries to cover those amounts, but that triggers FICA/FUTA costs.  Since it's an S-corp, the owner-employees could instead pay the fees from an S-corp distribution (or make the contributions from other assets).  Depending on the amounts involved, the 199A deduction could in fact make the S-corp distribution approach significantly less costly than W-2/FICA.

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8 hours ago, Belgarath said:

IMHO, I think Revenue Ruling 86-142 covers this, and no, you can't do it. It would be considered a plan contribution for 404 purposes.

Belgarath, 86-142 only addresses brokerage commissions, and says they are intrinsic investment expenses that must be paid by the plan or trust, and if paid by employer or IRA owner are deemed to be contributions. I am not aware (although there may be some) of guidance directly dealing with investment management expenses. Under 1.404(a)(3)(d) and 86-142 we know that the employer or IRA owner can separately pay  plan or IRA trustee's fees, actuarial fees, and administrative fees. Opposite for brokerage commissions.  Investment management fees would seem to fall more on the trustee/administrative fee side of the ledger, and that conclusion is clearly implied by the wrap fee rulings discussed in the Groom article that you provide the link for. And note that this issue (whether investment management fees can be paid and deducted separate from plan contributions in the first place) is even more basic than David's original question, which assumed that they could if the investments were in a 401(a) plan trust as opposed to being spread across to IRAs ion a SEP arrangement.

Luke Bailey

Senior Counsel

Clark Hill PLC

214-651-4572 (O) | LBailey@clarkhill.com

2600 Dallas Parkway Suite 600

Frisco, TX 75034

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On ‎7‎/‎17‎/‎2020 at 7:28 AM, Lois Baker said:

IRS Pub. 525 distinguishes between "qualified retirement planning services" and "financial counseling fees":

Financial counseling fees paid for you by your employer are included in your income and must be reported as part of wages. Fees for tax or investment  counseling  are  miscellaneous  itemized deductions and are no longer deductible.....
 
If your employer has a qualified retirement plan, qualified retirement planning services provided to  you  (and  your  spouse)  by  your  employer aren't included in your income. Qualified services  include  retirement  planning  advice,  information  about  your  employer's  retirement  plan, and information about how the plan may fit into your  overall  individual  retirement  income  plan. You can't exclude the value of any tax preparation,  accounting,  legal,  or  brokerage  services provided by your employer. Also, see Financial Counseling Fees, earlier.

Lois, thanks for pointing out that there is a little glimmer from IRS regarding what they think the term means. However, it is obviously not authoritative in any way, and, as with 86-142, does not address investment advice, which does not seem to fit well within any of what the IRS enumerates in the section you quoted as either included or excluded.

Luke Bailey

Senior Counsel

Clark Hill PLC

214-651-4572 (O) | LBailey@clarkhill.com

2600 Dallas Parkway Suite 600

Frisco, TX 75034

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I am thinking that the employer probably would need to make SEP contributions regularly in order to support the bona fides of the "plan" for purposes of having it be a retirement plan that supports employer-deductible payment of investment adviser expenses, which might kill the idea in this particular arrangement (where the business owners are looking for cost-savings and don't plan further employer contributions at least for a time). Might be too aggressive to simply terminate a 401(k) and then have the employer merely sign a SEP agreement that turns nondeductible (if paid by the IRA owner-shareholder-employees) investment advice fees into deductible expenses when paid by the employer. But hey, it's a tax-deductible "concept" so maybe we can name it, then put "(tm)" next to the name, and sell it! :-)

In lieu of the SEP mechanics, I am thinking another solution is to throw in the towel (maybe just a hand towel) and have the investment fees paid directly from the IRAs. It turns otherwise taxable (at distribution time) funds into tax-free "go poof" dollars, which is nice, despite the loss of the future potential tax-deferred earnings on those dollars. Plus, depending on the age of the owners, maybe the lost future compounding (losing a couple of decades rather than losing many decades' opportunity) isn't all that big of a dent.

Really appreciate your ideas and information, Luke! You're a gem.

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5 hours ago, Dave Baker said:

I am thinking that the employer probably would need to make SEP contributions regularly in order to support the bona fides of the "plan" for purposes of having it be a retirement plan that supports employer-deductible payment of investment adviser expenses, which might kill the idea in this particular arrangement (

Dave, agreed. I had paid insufficient notice to that point in your OP. Good luck.

Luke Bailey

Senior Counsel

Clark Hill PLC

214-651-4572 (O) | LBailey@clarkhill.com

2600 Dallas Parkway Suite 600

Frisco, TX 75034

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