adding a Cash Balance before a Stock Sale

[Chipwood 24]

Dr Doogie Howser (age 47) and Dr John Trapper (age 51)  are eye doctors who both own 50% each of Lazy Eye, Inc (an S-Corp).  They have 7 employees and don't own any other businesses.

They currently in 2020 sponsor a 401(k) Safe Harbor with a Basic Match.  In 2021, they will be selling their business (it's a stock sale) to another entity and the expected proceeds from the sale will be $5 Million.  The doctors are expected to stay on as employees for the forseeable future.

They want to add a Cash Balance (CB) for 2020 (before the stock sale), so that will be Year 1 of the CB.  For 2021, they will amend the Safe Harbor 401(k) to the 3% Non-Elective and it will be year 2 of the CB.  In 2021, they expect the Stock Sale to go through.  

They would like to take advantage of the transition rule under 410(b)(6)(C) for the 401(k) and to let the CB run through 2021 and 2022.  At the end of 2022, they would like to terminate the CB.  

Of course, in the negotiations, the Buyer would most likely have to agree to all of this and it would most likely effect the $5 Million purchase price of the business.  For example, lets say it's sold for $4.2 Million instead.  By doing this, the doctors would be able to shelter some money away and not have to pay taxes right away on the sale of the business.

What challenges or issues do you see with this strategy of adding the CB (assuming the Buyers are ok with this format)?  In regards to the CB, do you think the IRS would disapprove of it being used in this fashion?  This seems like a great strategy and way to take advantage of the transition rule.  Am I missing something?

[CuseFan]

I think the IRS could challenge this on the basis of the "permanency rule" as this is not a change in the business that was unforeseen at the time the plan was adopted.  Employer would be attempting to get short term (1-2 years) tax deferred contributions to take advantage of a one-time windfall, which is exactly what the IRS frowns upon. Might they slip it through, sure, but as a practitioner I would not recommend. Unless you adopt the plan and then freeze it after year two and then maintain it for a number of years after before terminating.

[outdooractuary]

I wholeheartedly agree with CuseFan. 

I worked to help set up a plan that did something similar, but the plan was installed with the buy in of the new owners. The new owners were on board with the plan and are going to keep it for the foreseeable future (or at least that's what they told us, and they were either sincere or really good actors) even though it was installed primarily as a way to defer taxes on the sale to the prior owners. If we had gotten even a sniff of an intent to terminate in 3 years we would have run screaming in the other direction. 

[Chipwood 24]

CuseFan & outdooractuary, just wanted to thank you both for reviewing and chiming in to give your opinions/thoughts.  I sincerely appreciate it.